The revenue recognition landscape dramatically changed with the May 2014 release of Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606). This ASU partially supersedes not-for-profit (NFP) industry-specific guidance and substantially all existing revenue recognition guidance. It also adds significant interim and annual disclosures. Implementation and documentation will be significant undertakings for entities in all industries. NFPs may face more challenges than other industries due to the variety of funding sources and existing diversity in practice. The ASU’s effect on each NFP will vary depending on existing revenue streams and current accounting practices. Even if the amount or timing of revenue recognition doesn’t change, presentation and disclosure will. In addition, NFPs will have to redraft accounting policies under the new principles and update internal controls for the increases in management’s judgments.
The revenue recognition model’s core principle is that an entity would recognize as revenue the amount that reflects the consideration to which it expects to be entitled in exchange for goods or services when (or as) it transfers control to the customer. To achieve that core principle, an entity will apply a five-step model:
- Identify the contract(s) with a customer
- Identify the separate performance obligations
- Determine the transaction price
- Allocate the transaction price to the separate performance obligations
- Recognize revenue when or as a performance obligation is satisfied
The new revenue standard applies to all contracts with customers, e.g., members, sponsors or grantors, except for those within the scope of other standards, e.g., lease and insurance contracts, financing arrangements, financial instruments, guarantees and certain nonmonetary exchanges between vendors.
Bifurcating Contribution & Exchange Components
A contract may be partially in the new standard’s scope and partially in the scope of other accounting guidance. If the other accounting guidance specifies how to separate and/or initially measure one or more parts of a contract, an entity should first apply those requirements before applying Accounting Standards Codification (ASC) 606.
Many NFP transactions are in part a contribution and in part an exchange transaction (also referred to as bargain purchases). These transactions include an inherent contribution, which the Financial Accounting Standards Board (FASB) defines as “a contribution that results if an entity voluntarily transfers assets (or net assets) or performs services for another entity in exchange for either no assets, or for assets of substantially lower value and unstated rights or privileges of a commensurate value are not involved.” Examples of transactions that may be in part a contribution and in part an exchange transaction include:
- Membership dues
- Grants, awards and sponsorships
- Naming opportunities
- Donor status
- Gifts in kind
A contribution differs from an exchange transaction because an exchange transaction is a reciprocal transfer in which each party receives and sacrifices something of approximately equal value. Existing guidance in ASC 958 illustrates separating and initially measuring such transactions, which by analogy could be applied to the transactions noted above.
When the transaction is in part a contribution and in part an exchange, the NFP should bifurcate the exchange from the contribution by determining the fair value of the transaction’s exchange portion, with the residual (excess of the resources received over the fair value of the transaction’s exchange portion) reported as contributions. The NFP should apply the guidance in ASC 606 to the transaction’s exchange portion and apply ASC 958 to the contribution.
Example: Membership Dues
The term “members” is broadly used by some NFPs to refer to their donors and by other NFPs to refer to individuals or other entities that pay dues in exchange for a defined set of benefits. These transfers often have elements of both a contribution and an exchange transaction because members receive tangible or intangible benefits from their NFP membership, i.e., the exchange portion of member benefits may include a journal subscription, discounted or free continuing professional education classes, conferences and seminars, discounted or free tickets to seats at performing arts events, discounted services, access to locked website contents or a library, networking opportunities and/or career qualifications. When membership dues carry traits of both contributions and exchange components, they should be bifurcated.
The determination of whether membership dues are contributions rests on whether the value received by the member is commensurate with the dues paid. For example, if an NFP has annual dues of $100 and the only benefit members receive is a monthly newsletter with a fair value of $25, $25 of the dues are received in an exchange transaction and $75 of the dues are a contribution. Member benefits generally have value regardless of how often (or whether) the benefits are used. For example, most would agree that a health club membership is an exchange transaction, even if the member stops using the facilities before the completion of the membership period. However, it may be difficult to measure the benefits members receive and determine whether the value of those benefits is approximately equal to the dues paid by members.
FASB guidance in ASC 958 provides indicators that may be helpful in determining whether memberships are contributions, exchange transactions or a combination of both.
Depending on the facts and circumstances, some indicators may be more significant than others; however, no single indicator determines a particular transaction’s classification. Indicators of a contribution tend to describe transactions in which the value, if any, returned to the resource provider is incidental to potential public benefits. Indicators of an exchange tend to describe transactions in which the potential public benefits are secondary to the potential proprietary benefits to the resource provider.
Any income streams not in ASC 606’s scope must be separately identified on the income statement. Entities will need to make this disclosure in the notes to the financial statements, if not presented separately on the face of the financial.
The model creates a new concept: a contract asset or liability. When an NFP satisfies a performance obligation by delivering promised goods or services, the NFP has earned a right to consideration and has a contract asset. When the customer performs first, e.g., prepayment, the NFP has a contract liability. Under existing guidance, when revenue is recognized but not yet billed, an entity records an asset for unbilled accounts receivable. After an invoice is sent to the customer, the related balance is reclassified as billed accounts receivable. Under Topic 606, reclassification from a contract asset to a receivable is contingent on fulfilling performance obligations—not on invoicing a client. As a result, the point at which a contract asset is reclassified as a receivable may be different than the time of invoicing.
NFPs must report contract assets separately from accounts receivable on the balance sheet. A contract liability shouldn’t include amounts that are expected to be refunded. All NFPs must present opening and closing balances of receivables, contract assets and liabilities on the balance sheet or in the notes to the financial statements. FASB again provides significant relief for nonpublic entities. Only public entities are required to explain significant changes in the contract asset and liability balances during the reporting period. All entities will need to disclose reductions in a contract liability balance for services provided during the reporting period. The explanation will be required to include both qualitative and quantitative information. Public entities must disclose how the timing of satisfaction of its performance obligations relates to the typical timing of payment and the effect those factors have on the contract asset and liability balances.
All entities must disclose how performance obligations are satisfied, i.e., at a point in time or over time, significant payment terms, if the consideration is variable and if the estimate of variable consideration is constrained. All entities must describe the nature of goods or services provided, highlighting if an entity is acting as an agent.
For public entities, the standard is effective for interim and annual reporting periods beginning after December 15, 2017. All other entities have an additional year for annual reports and two years for interim reporting. NFPs with access to public capital markets, including conduits, should apply the public entity effective dates, disclosures and implementation guidance.
Don’t wait. The common theme from those who adopted the standard early is that it took significantly more time than expected to navigate through the new standard’s complexities. A multipronged approach to learning will most likely be necessary. Consider appointing a project leader or assembling a task force responsible for developing and executing an implementation strategy that includes the following phases:
- Gain a thorough understanding of the five-step model, including all essential terms and definitions.
- Inventory all material revenue streams within the ASU’s scope. Determine which transactions can be grouped and analyzed as a portfolio versus those that will need to be reviewed on a contract-by-contract basis.
- For each significant contract (or portfolio of contracts), analyze and document the results of each of the model’s five steps, including the final determination on how revenue should be recognized.
- Determine what, if any, modifications need to be made to internal processes, controls and IT systems to comply with the new revenue recognition method.
- Establish the adoption method (full or modified retrospective method) that will be the least burdensome for the organization.
- Review the relevant disclosure requirements for your organization and determine how amounts will be accumulated.
For organizations with significant resource and time constraints, outsourcing the analysis and documentation might be a viable solution.
Contact David or your trusted BKD advisor if you have questions.