For the first time in many years, not-for-profit (NFP) entities are inundated with a series of new Accounting Standards Updates (ASU). These likely will require organizations to invest significant time and resources to understand and implement the required changes and to communicate the effects to various stakeholders. Further, NFPs that have issued debt securities listed on an exchange or over-the-counter market (including conduit debt securities) are considered Public Entities by the Financial Accounting Standards Board (FASB) and are therefore subject to expanded disclosures and accelerated effective dates when adopting certain ASUs.
This article series explores expected challenges organizations may encounter when adopting each of these new standards and provides tips for successful implementation. The following table outlines the upcoming accounting pronouncements and effective dates for December 31 and June 30 year-ends.
*And interim periods within those fiscal years such that adoption in the first quarter of the fiscal year is necessary.
In the previous article, we took an in-depth look at the expected implementation challenges of the new lease accounting standard. As the final installment in this article series, we’ll examine ASU 2018-08, Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made.
The ASU was issued to make it easier for NFP organizations to evaluate whether gifts, grants or contracts should be accounted for as contributions—subject to Accounting Standards Codification (ASC) 958, Not-for-Profit Entities—or as reciprocal (exchange) transactions accounted for under other topics such as ASC 606, Revenue from Contracts with Customers.
Under the new guidance, all organizations are required to evaluate whether the resource provider, e.g., federal agency, foundation, corporation, NFP, etc., is receiving commensurate value in a transfer of resources, e.g., assets or reduction/settlement of liabilities, and whether contributions are conditional or unconditional. If commensurate value is received by the resource provider, the transaction is to be accounted for as an exchange transaction by applying Topic 606 or other topics.
If commensurate value isn’t received by the resource provider, i.e., the transaction is nonexchange, the recipient organization would determine the transaction to be a contribution under Subtopic 958-605, Not-for-Profit Entities—Revenue Recognition, and determine whether the contribution is unconditional (and record immediately upon notification) or conditional (and disclose until conditions are met and then record the arrangement).
Under the new ASU, there’s no assessment of the likelihood of failing to meet a condition in ultimately determining if it’s conditional or unconditional. Instead, for a contribution to be conditional, it must have both of the following:
- A barrier that must be overcome
- A right of return to the resource provider for assets transferred or a right of release of the promisor from its obligation to transfer its assets
Indicators of a barrier to overcome include (but aren’t limited to) the following:
- Inclusion of a measurable performance-related barrier or other measurable barrier – For example, a requirement to achieve a specified level of service, e.g., serving a specific number of individuals, or a matching requirement is placed on the gift, e.g., an organization is required to raise $500,000 in addition to the funds from a resource provider, are considered measurable performance-related or other measurable barriers.
- Extent to which a stipulation limits discretion by the recipient on the conduct of an activity – For example, an agreement includes a requirement that assets transferred must be used for specific qualifying expenses that follow cost principles issued by the Office of Management and Budget (OMB), therefore limiting the recipient’s discretion in how the funds are spent.
- Extent to which a stipulation is unrelated to the purpose of a grant – For example, many grants require filing of progress reports; however, these typically aren’t related to the underlying purpose of the grant, e.g., don’t act toward achieving the purpose of the grant, and are simply a means of providing the resource provider with information on how the assets transferred were used (an administrative task). In these cases, the stipulation doesn’t constitute a barrier for purposes of applying the standard.
Based on the clarified guidance, FASB expects more grants and contracts (particularly with the federal government) to be accounted for as contributions (often conditional contributions) than under current practice.
Challenge 1 – Identification of Commensurate Value & Exchange Transactions
Exchange transactions are considered “reciprocal transfers in which each party receives and sacrifices approximately commensurate value.” Commensurate value isn’t defined within the standard, so judgment may be required in certain situations to determine if commensurate value is transferred. The ASU does clarify that execution of a resource provider’s mission and/or the positive sentiment from acting as a donor doesn’t constitute commensurate value. Further, the resource provider isn’t synonymous with the general public; therefore, benefits received by the general public (representing an indirect benefit to the resource provider) aren’t considered commensurate value.
Under current practice, many NFPs were considering federal grants as exchange transactions with the view the NFP was providing a service and being paid for that service. With the clarified guidance, however, this will no longer be considered commensurate value, as the resource provider isn’t synonymous with the general public. Therefore, the resource provider, i.e., the federal government, isn’t receiving direct benefit of equal value.
This may require organizations to change their current evaluation process to truly understand who’s receiving the direct benefit to determine if the resource provider is receiving something of commensurate value in exchange for assets transferred. Each arrangement will need to be carefully examined to determine if there’s direct commensurate value back to the resource provider.
Challenge 2 – Determining Conditions vs. Restrictions
If a transaction is deemed to be a contribution, the next step is to determine if it’s conditional or unconditional. Conditions may sometimes be confused with donor-imposed restrictions; therefore, it’s important to ensure organizations have a thorough understanding of the differences. A donor-imposed condition requires a barrier to be overcome and a right of return/release and dictates when an arrangement is to be disclosed versus recorded, i.e., disclosed while conditional and recorded when unconditional.
The standard didn’t change the treatment of donor restrictions but emphasizes that the donor restriction is narrow in scope. That is, a donor-imposed restriction specifies resources are available for use only after a specified date and/or for a purpose that’s more specific than the broad limits resulting from the nature of the NFP entity, the environment in which it operates in or the purposes specified in its articles of incorporation, bylaws or comparable documents for an unincorporated association.
Donor-imposed conditions dictate when an arrangement is recognized in the financial statements, while donor-imposed restrictions limit the use of resources and dictate how the revenue is presented and classified, e.g., with or without donor restrictions.
For example, a grantor promises an NFP $100,000 to support the construction of a building if it raises $500,000 on its own (a barrier to be overcome). If the NFP doesn’t raise the $500,000, the grantor won’t be obligated to provide the $100,000 (right of release). In this instance, the promise of $100,000 wouldn’t be recorded as revenue by the NFP until the condition of raising the $500,000 is met. The conditional contribution would be disclosed.
Once the NFP raises the $500,000, it would record $100,000 in revenue with donor restrictions. It’s important to note the restriction for the $100,000 to be used for the building construction also isn’t considered a condition as the donor didn’t place any further specifications on how the building should be constructed, which would be indicative of a barrier, e.g., limit use to a specific portion of the construction, such as plumbing or electrical, which could be construed as limiting the organization’s discretion in how the funds may be spent within the construction project or indicate the $100,000 only is provided if the constructed building met certain energy-efficient criteria indicating there is a measurable barrier, etc.
There may be situations where conditions and restrictions are simultaneously met. For instance, a federal agency may award an organization $100,000 to provide quality care to individuals with HIV, and the expenses under the grant must follow applicable OMB cost principles. A right of return is included in relation to unspent funds or funds spent on unallowed costs. This grant would be considered conditional due to the limited discretion by the organization (must incur qualifying expenses) and right of return. In addition, serving individuals with HIV is narrower than the overall purpose of the organization; therefore, the grant also is considered restricted by the donor. The organization would simultaneously meet the condition and restriction as the qualifying expenses are incurred (condition met) to serve individuals with HIV (restriction met).
Challenge 3 – Financial Statement Presentation & Disclosure
Under the new ASU, the expectation is that more grants will be considered contributions as opposed to exchange transactions. Transactions historically considered exchange transactions and presented as revenue without donor-imposed restrictions may now be classified as contributions with donor-imposed conditions and restrictions. This will affect not only financial statement presentation but also disclosures.
Entities that haven’t elected the policy to report donor-restricted contributions—and whose restrictions are met in the same reporting period as support within net assets without donor restrictions (“simultaneous release option”)—may see a significant change in their financial statement presentation. More revenues may be presented as with donor-imposed restrictions and then have subsequent releases from restrictions. Not only would this significantly change the face of the financials, but disclosures also would be required over the releases, e.g., information about the nature and extent of the expenditures that satisfied restrictions.
Because the clarified guidance may have effects on the financial statements, the ASU does allow an organization to adopt the simultaneous release option for only those contributions with donor-imposed conditions without having to also adopt this policy for other contributions. If this policy election is made, organizations will need to evaluate their internal controls and processes in place to ensure they’re properly capturing and presenting transactions within the financial statements to support that only the unconditional donor-restricted contributions would flow through the classification of “with donor restrictions,” while the conditional donor-restricted contributions (in which revenue recognized and restrictions are met in the same time period) would flow through the classification of “without donor restrictions.”
In addition, under current and new guidance, recipients of conditional contributions are required to disclose a description and amount for each group of outstanding conditional contributions having similar characteristics within the notes to the financial statements, e.g., amounts of promises conditioned on establishing new programs, raising match gifts by set date, etc. This disclosure could take a significant amount of time and resources to develop and maintain.
Challenge 4 – Organizations Awarding Contributions
The clarified guidance also affects those organizations making contributions and presents changes for organizations making contributions that were previously considered conditional simply based on the right of return or a probability assessment. If a contribution made doesn’t contain both a right of return and a barrier to overcome as described above, the contribution made wouldn’t be conditional. In that situation, the maker of the contribution would record a contribution expense and related payable for the full contribution when the award is made. This may accelerate the recognition of such arrangements, resulting in increases to contribution expense and related payables in the period of adoption.
Challenge 5 – Effective Date
The ASU allows for different effective dates for contributions received versus contributions made. In an attempt to align the adoption date of ASU 2018-08 for contributions received closely with the adoption of ASU 2014-09 (revenue recognition), the effective dates are accelerated for organizations receiving contributions. An NFP entity with conduit debt obligations, for example, is required to adopt the new guidance for contributions received on July 1, 2018, or January 1, 2019, depending on whether it has a June 30 or December 31 year-end, respectively. With the standard having been issued on June 22, 2018, this doesn’t leave much time for adoption and can cause resource constraints with organizations also working to adopt ASU 2014-09.
In relation to contributions made, the adoption of the clarified guidance isn’t required until one year later, although early adoption is permitted. Organizations with both contributions received and contributions made will need to consider whether staggering the adoption makes sense.
As with the previous articles in this series, the overarching theme is “don’t wait.” Similar to the recommendation for adopting ASC Topic 606, consider appointing a project leader or assembling a task force responsible for developing and executing an implementation strategy. This could be the same leader and task force, or a subset thereof, created for the implementation of Topic 606. Implementation strategies should include the following:
- Gain a thorough understanding of the modified definitions, e.g., reciprocal versus nonreciprocal, conditional versus unconditional, etc.
- Inventory and review contracts and grants currently and re-evaluate based on the clarified guidance if commensurate value is truly exchanged. As opposed to Topic 606, neither practical expedients nor a portfolio approach was included in the transition guidance.
- For those contracts and grants determined to be contributions, organizations will need to re-evaluate the agreements based on the clarified guidance to determine if a condition exists under the new requirements, i.e., whether the arrangement includes a barrier to overcome and a right of return/release. Remember that the probability assessment has been removed; therefore, this shouldn’t be considered in the conditional assessment. Under the guidance, there either is or isn’t a barrier that must be overcome and a right of return. It’s also important to note the guidance specifically called out reporting requirements, e.g., annual or progress reports, as administrative tasks and not a condition, which would prevent recognition of the contribution.
- Analyze the effect on the financial statements and related disclosures. Contribution revenue may be presented using different terms, so organizations may treat grants that are considered contributions as grant revenue as opposed to contribution revenue, though the underlying accounting is the same. In addition, with this ASU, management should discuss with their finance committees (or equivalent) and consider the users of their financial statements to determine if the simultaneous release option policy election should be made and if it should be made for only those contributions with donor-imposed conditions or all contributions. The chosen policy will be disclosed and should be followed consistently from year to year and, once made, generally shouldn’t be changed.
- If there’s a significant increase in conditional contributions or amounts reported as releases from restrictions and net assets with donor-imposed restrictions, review the relevant disclosure requirements for your organization and determine how the amounts will be tracked and accumulated.
- Review internal processes and controls and make changes as necessary. These changes may include:
- Updating policies or procedures (or initially documenting policies and procedures) over the evaluation methodology for grants, contracts and contributions
- Implementing additional review controls over key determinations of recognition and disclosure
- Changes in general ledger structure (including use of fund accounting) for tracking of exchange transactions versus conditional contributions versus unconditional restricted contributions
- Implementing controls over determining when a condition and/or restriction has been met
How BKD Can Help
For organizations with significant grants contributions and other arrangements, this ASU likely will require significant time and effort to correctly implement. With the final implementation date just around the corner, we encourage organizations to start planning for this transition now. BKD is here to help. We can help by educating your team and governing board on the upcoming changes and assist with analysis and documentation as well as related process and control recommendations and documentation.
Additional resources for your reference include:
For assistance complying with the contribution clarification ASU, contact Alissa or your trusted BKD advisor.