In May 2014, after years of research and deliberation, the Financial Accounting Standards Board (FASB), approved a sweeping change to revenue recognition accounting guidance, culminating in the issuance of Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers. ASU 2014-09, along with many other ASUs tweaking ASU 2014-09, became Accounting Standards Codification (ASC) 606, Revenue from Contracts with Customers (ASC 606). In addition to that, In June 2018 the FASB issued ASU 2018-08, Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made (ASU 2018-08). While larger nonprofit organizations may already be evaluating the impact of this guidance, many nonprofits may not even realize they apply to them. But guess what? They probably do. In fact, these two changes together can have a significant impact on how nonprofit organizations account for their revenues. Below are some answers to some common (and more basic) questions about ASC 606 and ASU 2018-08.
Q: What are the key provisions of the changes?
A: Even though it came later, ASC 2018-08 was born out of and sort of feeds into ASC 606, so let’s start there. ASU 2018-08 does a couple of things:
- Provides clarification about how to make the distinction between a contribution (a nonreciprocal transaction) and an exchange transaction (a reciprocal transaction).
- Clarified how to determine if a contribution is conditional.
That first point is particularly important, because if you determine a transaction (or portion of a transaction) is a contribution, ASC 606 won’t apply to it. If the transaction (or portion of a transaction) is an exchange transaction, chances are it will fall under ASC 606, which can be very complicated.
ASC 606 is a move towards a more principles-based approach to revenue recognition for contracts with customers. It requires you to perform five (seemingly basic) steps in the accounting lifecycle of a contract:
- Identify the contract(s) with a customer
- Identify the performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price to the performance obligations in the contract
- Recognize revenue when (or as) the entity satisfies a performance obligation
Of course, the devil is in the details. While in most cases it will be fairly easy to perform step 1 (identifying the contract), identifying the performance obligations and the subsequent steps can be more complicated. For example, a membership organization may offer a “membership” that includes a subscription to its journal, member advocacy, and discounts for continuing education and trade meetings. Depending on the facts and circumstances, each of those things may represent separate performance obligations that will have to be assigned values and accounted for separately, which can get hairy pretty quickly.
Q: What are the likely financial statement implications of these changes?
A: While impacts will vary by organization, ASU 2018-08 will likely lead to a higher percentage of revenues attributed to contributions as opposed to exchange transactions. Because its main provisions narrow the definition of what can be considered “commensurate value”, there will be more transactions where the value received by the nonprofit organization will exceed the value it provides in return. For example, ASU 2018-08 specifically states that “…A resource provider (including a foundation, a government agency, or other) is not synonymous with the general public. A benefit received by the public as a result of the assets transferred is not equivalent to commensurate value received by the resource provider…”. This provision had not been included in the accounting guidance before, so nonprofit management could have made a judgment that the value to the general public from a government contract equated to value to the governmental entity that made the grant, which would have pushed more revenue into the category of an exchange transaction. Generally, revenue from a contribution would be recognized earlier than revenue from an exchange transaction, so the clarification of this nuance could lead to some significant differences in the timing of recognizing revenue.
For revenue that is considered an exchange transaction, nonprofits will be more likely to have to “unbundle” its service offerings. Using our membership example, under previous guidance you may have been more likely to conclude that your membership offering was a “bundle”, and spread the entire membership payment over the membership period ratably. It’s more likely now that you’ll have to break out the different components of the bundle and recognize revenue separately on each component, which can lead to differences in the timing of revenue recognition.
Q: What types of revenue streams are most likely to be affected?
A: For a nonprofit organization, it can affect just about everything: grants, government contracts, membership dues, sponsorships, etc.
Q: That’s a lot. Maybe we should ask if there anything this new guidance won’t affect instead?
A: Good point. Not a lot will remain unaffected, but in practice you probably won’t see much of a change on these types of revenue streams:
- Unrestricted donations or contributions with no requirement to provide anything in exchange
- Stand-alone service offerings where there is an exchange of commensurate value, such as magazine or journal subscriptions.
There are also some specific types of contracts excluded from ASC 606, including lease contracts, insurance contracts, financial instruments, and guarantees. It also won’t affect the accounting for investment income.
Q: What difference does it make if a contribution is “conditional”?
A: If a contribution is conditional (not to be confused with “donor restricted”), then revenue recognition is deferred until the condition(s) are satisfied and the rules allow you to recognize it. An unconditional contribution (not to be confused with an “unrestricted” contribution) is recognized as revenue immediately.
Q: OK, great, but how do I determine when a contribution is considered “conditional”?
A: To determine if a contribution is conditional, you’ll need to evaluate whether an agreement contains a barrier that must be overcome and whether there is a right of return of assets transferred or, in the case of a promised contribution, a right of release of a promisor’s obligation to transfer assets. ASC 2018-08 lists some indicators to help determine whether a contribution has a barrier, but more than likely there will need to be some judgment applied.
Q: When do I have to be ready for all of this?
A: The effective date of ASU 2018-08 and ASC 606 for most nonprofits is for annual periods beginning after December 15, 2018, so January 1, 2019 for calendar year organizations, July 1, 2019 for June 30 fiscal year organizations, etc. If your organization has interim period reporting requirements (most frequently quarterly), the effective date for those periods is for interim periods within annual periods beginning after December 15, 2019.
Q: Do I have to look backwards once these are effective, or do I just need to worry about transactions after the effective date?
A: ASU 2018-08 allows either a “modified prospective” or “retrospective” application of the change. “Modified prospective” essentially means that if all the revenue from a contract hasn’t been recognized by the effective date, that it and any new agreements should apply the new guidance. Retrospective means it would be applied to all periods presented in a set of financial statements, so you’d have to look at any transaction that would have any effect on the financial statements in any of the periods presented and retroactively change what had been previously recorded if the guidance leads you to a different conclusion than you had reached before.
ASC 606 allows either a “full retrospective” or “modified retrospective” application. Each method allows you to use a number specific practical expedients. There is no “prospective” – modified or otherwise – application option for ASC 606.
There are a number of nuances that should be considered when deciding what election to make. Just figuring this piece out can get very complicated.
Q: Ugh. Where do I start?
A: The first thing you’ll need to do is take an inventory of your revenue sources. From there, you’ll need to start going through them one by one and figuring out whether they fit into the contribution or exchange transaction buckets (or a combination of the two) and working through the various steps required under the guidance to figure out how they’ll be accounted for. As you work through that you’ll begin to understand the complexity of the task at hand, which should help you determine how to apply the guidance when it’s effective (i.e. retrospective, etc.).
Keep in mind that this article is just the tip of the proverbial iceberg. While we’ve tried to hit on some key points and translate some things into plain english, the amount of information you’d need to read to truly digest the depth and complexity of the new guidance is massive. Suffice it to say you’d need to go deeper than this article.
If you need help with your implementation of the new revenue recognition guidance, or have questions about the article, just contact us, we’d be happy to help.