Nonprofits prepare for impacts of revenue standard

Many nonprofit organizations are making changes in their accounting and financial reporting as they address the impact of the 2014 revenue standard. Some have additional time to make changes because of a later effective date. All nonprofits can expect to benefit from information being developed by advisory task forces and proactive accounting firms.    

For many, the new standard is a clean sweep
The new framework for revenue recognition replaces almost all existing revenue recognition guidance and impacts any entity that enters into a contract to sell goods or services that are a consequence of that entity’s ordinary activities. It also impacts any entity that enters into a contract to sell nonfinancial assets.

The May 2014 standard, Revenue from Contracts with Customers, represents a convergence of Accounting Standards Update (ASU) 2014-09 and IFRS 15 from the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board.  

This guidance replaces numerous industry-specific U.S. GAAP revenue recognition requirements, and it is codified in a new Topic 606 in the FASB Accounting Standards Codification (ASC).

Effective dates vary
Because of the comprehensive nature of this guidance and its potentially substantial implications, the ASU has a delayed effective date for public entities of annual periods beginning after Dec. 15, 2016. A not-for-profit organization that has issued, or is a conduit bond obligor for, securities that are traded, listed or quoted on an exchange or an over-the-counter market would also have an effective date of period beginning after Dec. 15, 2016. All other not-for-profit organizations would have an effective date of period beginning after Dec. 15, 2017.

A not-for-profit organization may elect early application but no earlier than the effective date for public entities.  

Guidance follows a 5-step model
This ASU establishes a new model and changes the basis for deciding when revenue is recognized, based on five steps:
  1. Identify a contract with a customer
  2. Identify performance obligations
  3. Determine the transaction price
  4. Allocate the transaction price to the performance obligations
  5. Recognize revenue when/as performance obligations are satisfied

Step 1. Identifying contracts with customers
The first step in the model is to identify whether an entity has a contract with a customer. The new standard provides the definition of a contract for accounting purposes, and contracts may be written, oral or in accordance with customary business practices. If you do not have a contract with a customer, you do not proceed through the remaining steps. Collectability of the expected amount of revenue must be considered probable before revenue is recognized.

Therefore, not-for-profit organizations should primarily focus on revenue from exchange transactions, since contributions, certain grants and contracts, cooperative agreements and other similar revenue streams may not be within the scope of this standard. Contributions would continue to be accounted for under existing guidance in ASC 958-605. Other types of revenue that would not be affected by this guidance include investment income and rental income.

Step 2. Identifying performance obligations

A customer contract may cover a bundle of goods or services. ASC 606 requires performance obligations to be accounted for separately if they are distinct — for example:
  • If the customer benefits from the item on its own or along with other readily available resources
  • If the supplier does not provide a significant service of integrating the various performance obligations

Step 3. Determining transaction price
If performance obligations are distinct, the contract price is allocated between them based on the estimated standalone selling price of each performance obligation. An entity should take into account such elements as variable consideration (such as discounts, incentives, credits and price concessions), the existence of a significant financing component, noncash considerations, and consideration payable to the customer.

Step 4. Allocating transaction price to performance obligations
If there is more than one performance obligation, the transaction price will be allocated to each separate performance obligation based on relative standalone selling price at contract inception. However, under the new guidance, the transaction price may be adjusted for variable consideration and discounts, which may be allocated to all or some performance obligations.

Step 5. Recognizing revenue in required timing
ASC 606 requires revenue to be recognized as the work is performed if, and only if, control over the promised goods or services is transferred to the customer over time. Broadly, this occurs:
  • If the customer simultaneously receives and consumes the benefits
  • If the customer controls the asset as it is created or enhanced
  • If the asset has no alternative use, and the supplier is entitled to payment for performance-to-date and expects to fulfill the contract

Disclosure requirements are more extensive

ASC 606 will require considerably more disclosure about revenue, including information regarding:
  • Customer contracts, such as the remaining performance obligations (backlog)
  • Key judgments made
  • Contract costs recognized as assets
A significant change for nonprofit organizations could be the additional disclosures required under the new standard, especially for not-for-profits with public debt. Required quantitative and qualitative disclosures disaggregate revenue streams and identify contract assets/liabilities, and significant judgments utilized in revenue recognition. Disclosures will be more extensive and may require information not previously reported. However, some of the qualitative disclosures will not be required for not-for-profit organizations that follow the related nonpublic company effective date. IT systems and software applications may also need to be redesigned to capture the appropriate level of information related to data used to make revenue recognition estimates and new disclosures.  

AICPA task force will provide education
The American Institute of Certified Public Accountants (AICPA) has established revenue recognition task forces to review the effect of this new standard on the many different industries impacted. The AICPA Not-for-Profit Entities Revenue Recognition Task Force is reviewing the effect on unique revenue streams, including:
  • Tuition and tuition discounts
  • Sponsorships
  • Government grants
  • Membership dues
  • Royalties/licensing
  • Subscriptions
  • Service concession arrangements

Specifically, the task force will be addressing issues such as whether government grants and cooperative agreements constitute exchange transactions or collaborative agreements. This list will be updated as the task force continues its discussions, and the result of the task force’s work will be helpful hints and illustrative examples for how to apply this standard.

Use additional time wisely
Revenue recognition methodologies for all not-for-profit organizations’ exchange transaction revenue will be affected by the new guidance and the AICPA’s task force activities. However, the potential changes to timing and amounts of revenue recognition will be based on each revenue stream’s unique facts and circumstances. Not-for-profit organizations should use the extra time allowed by the delay of the effective dates to consider any changes needed to accounting and financial reporting systems or processes.

We can help your organization prepare for the changes. Contact our professionals to discuss your challenges and questions.