The clock is ticking on the effective date for implementing the new revenue recognition standard that will impact many nonprofits.
The Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers
, Topic 606, is effective for all entities, including nonprofits. For nonprofits that have issued, or are conduit bond obligors for, securities traded, listed, or quoted on an exchange or an over-the-counter market, the standard takes effect in annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. For all other nonprofits, the standard takes effect in annual reporting periods beginning after December 15, 2018, and interim reporting periods within annual reporting periods beginning after December 15, 2019.
Many nonprofits are unsure as to which revenue streams Topic 606 will apply, how to implement it, and when they should start to prepare.
Overview of the new recognition standard
Topic 606 is the result of a joint project between the FASB and the International Accounting Standards Board (IASB) to issue a single converged principle-based revenue recognition standard. The result of this effort provides consistency between the FASB and IASB regarding revenue recognition across all industries globally. Topic 606 moves from a rules-based approach to a principle-based focus and supersedes virtually all revenue recognition guidance in US GAAP and IFRS, including prescriptive guidance and industry-specific practices. The core principle of Topic 606 focuses on the contract between the nonprofit and its customers for goods and services, and ultimately, the rights and obligations between the nonprofit and the customer. Topic 606 requires more estimates and greater judgment than prior guidance. And finally, Topic 606 will require the evaluation of the policies, processes, systems and controls by which revenue is recognized and disclosed. Once Topic 606 is implemented, the FASB and IASB believe there will be improved comparability of revenue recognition across all industries and between entities.
Revenue streams covered and excluded under Topic 606
There are a significant number of nonprofit revenue streams that would be covered under a five-step model. The nonprofit should evaluate all contracts to determine applicability of Topic 606. Some of the contracts with customers that are specifically excluded from this standard include:
In addition to the above, investment income revenue streams would not be affected by Topic 606.
Contracts not with customers that are excluded are contributions and collaborative agreements. Although contributions are not specifically scoped out of Topic 606, the guidance does define revenue as “inflows or other enhancement of assets of an entity or the settlement of its liabilities from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing and major activities.” Since contributions are both voluntary and nonreciprocal, they do not fall under Topic 606. The existing accounting guidance under ASC 958-605-55-8 is useful to determine which transactions are contributions and which are exchange transactions.
To add further complexities, there may be situations where transactions are a combination of both a contribution and an exchange transaction, requiring an organization to bifurcate the transaction. For example, consider a museum that has annual member dues of $150, and the only benefit members receive is a monthly magazine with a $38 annual value. The portion considered to be a contract with a customer and accounted for under Topic 606 would be $38, and the remaining amount of $112 would be considered to be a contribution.
Grants and contracts
ASU 2014-09 escalates the importance of whether grants and contracts are in scope of Topic 606 and if these contracts are considered to be reciprocal or nonreciprocal. The issue here is, if the transaction is nonreciprocal, that it should follow the current contribution guidance. If the transaction is reciprocal, it would fall under the scope of Topic 606. Currently, similar grants and contracts are accounted for as nonreciprocal transactions (often conditional) by some nonprofits and as reciprocal transactions (exchange transactions) by other nonprofits. Topic 606 has placed renewed focus on the issue due to the elimination of limited exchange transaction guidance in FASB ASC 958-605 and additional disclosure requirements that do not seem relevant to these types of transactions.
The FASB recognizes the difficulty and diversity in practice among nonprofits in distinguishing between grants as exchange transactions or contributions. On August 3, 2017, the FASB issued an exposure draft ASU intended to clarify and improve the scope and the accounting guidance for contributions received and made.
The proposed ASU would help organizations determine if transactions should be accounted for as a contribution or an exchange transaction. Organizations would accomplish this by using clarifying guidance to evaluate whether a resource provider is receiving value in return for the resources transferred. The ASU also includes an improved framework for determining whether a contribution is conditional or not, and to better distinguish between donor-imposed conditions and donor-imposed restrictions.
Topic 606 provides for a five-step model.
The core principle of Topic 606 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This guidance applies only to contracts with customers - those broadly classified as exchange transactions. Exchange transactions are defined as “a reciprocal transfer between two entities that results in one of the entities acquiring assets or services or incurring other obligations”. Therefore, common nonprofit revenue streams like membership dues, tuition, admission fees, licensing, training fees, trade show registrations, and program fees will likely be included under this guidance.
The five steps are completed at the contract level. The five steps are as follows:
Step 1: Identify the contract with a customer
Step 2: Identify the performance obligations
Step 3: Determine the transaction price
Step 4: Allocate the transaction price to the performance obligations
Step 5: Recognize revenue when or as the entity satisfies performance obligations
Each of the above steps contain certain concepts and judgments that will have an impact on the revenue recognition process. For example, Step 1 requires the nonprofit to determine whether an agreement with a customer is a contract that creates enforceable rights and obligations and if it is probable that the nonprofit will collect “substantially all” of the consideration to which it will be entitled. If the nonprofit cannot answer “yes” to this question, it should not proceed to step 2, and would likely not record revenue until a contract exists.
The second step of the model can also lend itself to certain challenges regarding the identification of performance obligations. A performance obligation is a promise to transfer a “distinct” good or service to a customer. Goods or services in a contract are defined as “distinct” if (1) the customer can benefit from the goods or services on their own or together with other resources that are readily available to the customer and (2) the promise to transfer the goods or services to the customer is separately identifiable from other promises in the contract.
For many contracts, the identification of the related performance obligations and the selling price may not be overly complex. When the transaction price is clearly stated for a single performance obligation that will be delivered on a specific date, Steps 2 through 5 should be easily determinable. Added layers of complexity come into play when the ultimate transaction price is not fixed and/or there are multiple performance obligations. For example, for membership dues that provide the member (customer) with a monthly newsletter, publications, seminars, or training programs, the timing and amount of revenue recognized may depend on how the dues payment (transaction price) is allocated to the various member benefits (performance obligations) and when those benefits are received by the member. Under the old guidance, the nonprofit may view all member benefits as a bundle of goods and services and recognize the dues ratably over the membership period. In addition, there could also be certain contractual elements, such as discounts on future purchases, sales incentives, award credits and tiered pricing, which would require further consideration and evaluation when implementing Topic 606.
When the nonprofit is transferring various goods and services (performance obligations) at various points in time, careful consideration should be given as to when to recognize revenue for each performance obligation and at an estimated amount per performance obligation. For instance, when a contract contains multiple performance obligations that are not regularly sold on a stand-alone basis, the nonprofit will need to estimate the stand-alone selling price and allocate the fees to each of the performance obligations.
How will Topic 606 impact your organization?
Nonprofits should start the implementation process sooner rather than later to determine how this will impact your organization. Some of the areas that may have an impact on your nonprofit include the following:
Key steps to start the implementation process
Management may be required to make more estimates and use more judgment under current guidance, for instance regarding existence of performance obligations and estimated stand-alone selling prices.
A discussion with your lenders may be needed to revise debt covenants that may be tied to accounts impacted by the new guidance, such as revenues or liabilities.
A change to standard contract terms may be warranted, including payment arrangements and distinct performance obligations, if current terms do not result in the desired accounting treatment.
Management may need to revise documented processes and internal controls, in order to capture the necessary contract information and appropriately recognize revenue as performance obligations, such as training, publications, and other promised deliverables, are satisfied.
Technology updates and enhancements to current accounting and financial reporting software may be required, to allow for the capture of the necessary inputs for proper revenue accounting, including the ability to track contract liabilities for performance obligations that have not yet been satisfied.
Changes in timing of revenue recognition may result in changes in the timing of taxable income.
Nonprofits may consider having an all-hands meeting to discuss how to tackle this new guidance. Making sure everyone is familiar with Topic 606 may include summarizing its key factors, reading relevant commentary from accounting firms, attending technical training, and talking through the new guidance with your auditors.
Nonprofits should also be considering not only the accounting and tax ramifications, but also what other resources may be needed, such as their people, infrastructure, processes and technology. You should determine which departments in your organization this will affect and understand that implications will go beyond your accounting department. Including personnel cross-functionally is important, and all departments that may be impacted by this change should be included in the planning meeting. It is also important to determine who within and outside the organization should be included in future implementation meetings –which may include your accounting and legal advisors.
Conduct an inventory of your revenue streams and those that include contracts with customers. Each revenue stream that includes a contract with a customer should be further evaluated in accordance with the five-step model. Pay particular attention to those contracts where the transaction price may be variable or where multiple deliverables are promised to the customer, including goods, services, options, future discounts, and other rights that the customer would not receive if not entering into the contract.
Evaluate differences between old and new guidance. Determine the financial implications and communicate the changes to the organization’s Board and management. Determine the requirements to retrospectively adopt the new guidance.
Identify what changes in controls are needed, and update your policies and procedures. Educate and communicate the changes to staff. Include training as an essential part of the process.
Determine the changes to the financial statements and related disclosures, and alert the Board, audit committee, senior staff, key programmatic stakeholders, contract signors, banks and bondholders. Consider preparing a mock-up of the financial statements and disclosures to show how the new guidance will impact the financials.
As you embark on implementing Topic 606, keep in mind the importance of developing an implementation plan and understanding how this will affect your organization. Upfront planning, coordination, and timely communication within the organization are key steps to starting the process. Don’t go this alone, consult with your auditors, accountants and legal advisors to help you navigate through this process to ensure compliance with Topic 606.
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