For the general public, the designation “nonprofit” is often correlated with donations. The thought of a nonprofit entity earning revenue and having customers can appear contradictory. However, these entities can earn revenue and have customers, so long as these transactions serve their mission and purpose.
Why, suddenly, is earning revenue and having customers an important topic for nonprofits?
As part of its convergence project to remove inconsistencies and weaknesses in existing revenue requirements, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). This new revenue recognition standard is intended to improve the comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets, including nonprofits.
How can a nonprofit earn revenue and have customers?
Many nonprofit entities have contracts with government agencies that request the performance of specific services and are paid by the government for those services. Often time these transactions occur when government agencies elect to outsource certain services. These arrangements may be in the form of fee-for-service contracts. Nonprofit entities will now be required to review the terms of all their contracts to determine whether they need to apply the new revenue recognition standard.
Under fee-for-service contracts, the nonprofit entity earns revenue from their customer (i.e., the government agency) and most likely will record the revenue under Topic 606. An example of this transaction is funding provided by the Department of Health and Human Services for Medicare-related services to the elderly or individuals with a disability.
However, it is important to note that you cannot assume a fee-for-service contract will automatically fall under Topic 606. You must perform an analysis by reviewing the contract terms to make this determination.
Is this all that a nonprofit must do to determine how to record revenue?
The answer is, not exactly. Due to the unique aspects of the nonprofit industry, there was a need for additional revenue recognition clarification as a result of Topic 606. FASB’s answer came in the ASU 2018-08, Not-for-Profit Entities (Topic 958) that provides clarifying scope and accounting guidance for contributions received and contributions made.
You ask yourself, “Why are contributions affected? Those are simply a donation, are they not?” The answer, again, is not exactly. Let’s stick with the government agency example.
Contracts with government agencies, most commonly referred to as federal or state grants, can take various forms such as fee-for-service, advance payment, and cost reimbursement, among others. We already covered the fee-for-service, so let’s discuss a contract that provides for advance payment. Previously, a nonprofit would typically record the advance payment as deferred revenue and revenue would be recorded over time as the work was performed. However, under the new standards, a nonprofit entity must perform an analysis to determine if this advance payment should be treated as revenue from a customer or a contribution. This distinction can dramatically change how the transaction is recorded.
Recording a contribution from government agencies may appear unusual. However, Topic 958 clarifies what meets the definition of a nonexchange transaction (i.e., a contribution). In which case, the advance payment from the government agency may be recorded immediately as a contribution in the year the funds are received, if there are no conditions or barriers. It is partly due to the need to clarify these conditions and barriers that ASU 2018-08 was issued.
How to analyze if a revenue stream falls under Topic 606 or Topic 958 and where to begin?
A revenue transaction that falls under revenue from contracts with customers (Topic 606) is one in which there is a reciprocal (exchange) transaction where each party directly receives commensurate value. For exchange transactions, the following five-step analysis must be performed by all entities, including nonprofits:
- 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.
A revenue transaction under the contribution method of accounting (Topic 958) is one in which there is a nonreciprocal (nonexchange) transaction where the result benefits the general public. In this case, the entity will consider the following contribution accounting factors:
- Are conditions present (i.e., right of return/release and barriers), and what are those conditions?
- Are there restrictions present, and what are those restrictions?
When are Topic 606 and Topic 958 effective?
The effective date of Topic 606 is for annual reporting periods beginning after December 15, 2019 (see related article related to recent extension). This means the standard would be applicable to calendar year nonprofits for their December 31, 2020 year-end and fiscal year nonprofits for their fiscal year 2021 year-end. Early adoption is permitted.
The effective date of Topic 958 is effective for annual reporting periods beginning after December 15, 2018 (i.e., beginning with the December 31, 2019 calendar year-ends and 2020 fiscal year-ends). Early adoption is permitted.
It should be noted that due to the complexity of the topics discussed above, it may be beneficial that a nonprofit adopts Topic 606 since Topic 958 has not been extended.
FASB Accounting Standards Update No. 2018-08. June 2018. “Not-for-Profit Entities (Topic 958)”. https://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176170810258&acceptedDisclaimer=true
FASB Accounting Standards Update No. 2014-09. May 2014. “Revenue from Contracts with Customers (Topic 606)”. https://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176164076069&acceptedDisclaimer=true
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