What is the impact of the New Revenue Recognition Standard on Not-for-Profits?
Shanika Pathati Mudiyanselage
College of Staten Island, School of Business?347-832-5362
Faculty Advisor: Professor Patricia Galletta
Not-for-profit entities (NFPs) are required to comply with the new revenue recognition standard (ASC 606) issued by the Financial Accounting Standards Board (FASB), effective 2019. This transition will significantly change the way not-for-profits account for revenue from contracts with customers; mainly exchange transactions. As a result, development of the new revenue recognition structure demands not-for profit entities to distinguish between customer transactions that have obligations tied to them or decide if the transaction is merely a contribution to the organization. As a large percentage of not-for-profit revenue consists of membership subscriptions, income generated through sale of products and services, sponsors and fundraising events, detaching the exchange portion of a transaction is extremely challenging. This paper will review different types of not-for-profit entities to further evaluate the crucial steps to consider when recognizing revenue from exchange transactions and determine its impact on financial reporting. Accordingly, the conclusion of this research will prove that the new revenue recognition standard provides a clear guidance for NFPs to accurately report revenue generated from exchange transactions.
NFPs will be affected by the new revenue recognition standard developed by FASB and International Accounting Standards Board. Depending on the type of entity, the effective date varies; for NFPs that trade securities on an exchange or over the counter market, the standard will be effective for annual periods that begin after December 15,2017. Furthermore, for all other NFPs the standard will be effective beginning December 15,2018.
Accounting for contributions will remain the same. However, the term “exchange transactions” have been replaced by “contract with customer”. Although the concept of exchange transactions will be the same, revenue will be recognized either at a point in time or over time as the contract obligations are fulfilled. The new standard is completely a principle based approach rather than rule based. Another major change to revenue recognition will initiate with this new standard as industry-specific revenue recognition methods will no longer be relevant as a single standard applies to all industries and transactions. As for changes to financial statements, entities will be obligatory to show two-years of comparative data on the face or as notes in 2017 financial statements.
Contributions or Exchange Transactions?
It is extremely challenging for NFPs to differentiate between contributions and exchange transactions. In order to comply with the recent changes, not for profit entities can use the following criteria to determine the difference:
If the award is a contribution, the resource provider will state specifically for which programs funds can be used, method of delivery of the funds will be the choice of the receiving organization although the contributor will determine the amount of the award. If the stated work scope conditions are not met, the not-profit entity could be penalized for non performance. The benefit of the contribution is expected to be delivered to the recipients of the users of the programs administered by the non profit entity.
Unlike for contributions, exchange transactions have an obligation tied to them. The resource provider expects the receiving entity to perform agreed transactions in exchange of the funds. The amounts of the funds will depend on the value of benefits and the method of delivery of funds will be specified by the resource provider. Similar to a contribution, the not-for-profit entity can be penalized for non performance. The benefits of the funds are required to be transferred to recipients stated by the resource provider.
Conditional and Unconditional or Promises and Intentions
FASB Accounting Standards Codification section 958-605-25 states that NFPs should not recognize revenue until all conditions in the agreement are satisfied. If meeting the conditions set forth in the agreement is certain to be met, it is safe for NFPs to recognize that portion of revenue. A resource provider has the right to suspend or discontinue funds if reports that were requested were not submitted on time, funds were used for purposes other than what was agreed or if the progress of the activities the funds are used for is unsatisfactory.
FASB Accounting Standards Codification section 958-605-25-9 states that NFPs should not record revenue based on “intentions to give”. Unconditional promises to give can be recognized as revenue although it is difficult to distinguish between the two.
The Five Step Revenue Recognition Model
One of the most significant stage of implementing the new revenue recognition standard is breaking down each transaction in to a five step model as the entity transfers promised goods or services to their clients. The five steps are as follows;
1. Identify the contract
The first step is to check if a contract exists. An enforceable contract must have specific terms and conditions, state the goods and services, value of contract and the payment terms.
2. Identify separate performance obligations
The second step is to separate the performance obligations tied to each transaction. This step is more applicable when entities transfer goods and services in bundles and the receiver enjoys added services for the value of one item. For example: If a car was sold with a 5 year warranty included and a separate extended 3 year warranty, the 3 year extended warranty will be identified as a separate obligation.
3. Determine the transaction price
This step can be considered as one crucial step. The transaction price is determined by evaluating the variables such as discounts, rebates, refunds and royalties. The management need to make a judgment based on either the best value method or the expected value method.
4. Allocate the transaction price to separate performance obligations
In order to implement this step successfully, the entity will first need to evaluate price of bundled goods and services separately. Thereby, the amount can be applied to separate performance obligations.
5. Recognize revenue when the entity satisfies a performance obligation
The final step is to recognize revenue as each performance obligation is being satisfied. Clear judgment and accurate estimates will enhance this process.
A detailed example;
Museum members with an annual subscription of $60 will receive benefits such as free museum parking, a monthly newsletter, access to museum archives. Before the new standard, the museum was able to recognize the $60 fair value as subscription revenue.
However, after the new standard goes in to effect, the museum will have to analyze the stand alone price of each of the benefits the member receives. If the stand alone price for admission was $15, $15 for parking and $30 for the other benefits, the museum can recognize revenue as the member uses each benefit from the bundle. The allocation of the obligation will be creating a “contract liability”. Another method being adopted by museums is the addition of gift shops and restaurants so that they qualify to treat revenue under the new standard. Below is a comparison of journal entries before and after;
Effects on financial statements
Additions to contract liability will result in higher total liabilities in statement of financial position. Although, total revenue reported under the old and new standard will be the same, when the revenue will be recognized will be different which satisfies the objective of the new standard. Yet, the revenue recognized will vary up on the judgments and estimates of financial statement preparers.
Auditors will need to be extra cautious when auditing NFP financial statements. It is vital that auditors research in depth the sources of NFP resources. Auditors also need to thoroughly understand the judgment and methodology used by the NFP to assess obligations and transaction prices and check if proper internal controls including risks of material misstatements are in place. As the new standard requires more accounting estimates, auditors need to address and document any fraud risks observed to management.
Reasons for the new revenue recognition standard (ASC 606) update
FASB issued this new revenue recognition standard to improve the revenue recognition process by providing NFPs with a more standardized guide on how to recognize revenue resulting from exchange transactions. Therefore, NFPs with revenue such as tuition, room and board, fee for services, cost reimbursements, membership subscriptions and revenue from fundraisers will require to comply with the new standard. According to FASB, ASC 606 was mainly introduced to remove irregularities and flaws in the revenue requirement, provide a strong framework for resolving issues related to revenue, accurately compare revenue recognition methods between entities, industries, jurisdictions and capital markets, generate more useful information to users of financial statements and to streamline the preparation of financial statements.
ASC 606 VS IFRS 15
There are key differences when reporting revenue recognition under US GAAP and IFRS.
Non cash considerations measured at contract inception
No measurement date for non cash consideration to be received
Reversal of previously impaired contract acquisition and contract fulfillment costs -prohibited
Reversal of previously impaired contract acquisition and contract fulfillment costs -required
Effective date for non public entities – After December 2017
Effective date for non public entities – On or after January 2018
Similar to annual disclosures – disaggregated revenue, contract balances and remaining performance obligations.
Interim disclosures – Disclosure of disaggregated revenue.
ASC 606 Vs US GAAP
How NFPs get ready for the new challenge
Many NFPs face the task of adhering to the new ASC 606 standard soon. Although it may seem like the new standard simplifies the revenue recognition process, it also complicates the process. To add to the experiment, FASB has also issued guidelines to categorize grant revenue as exchange transactions. Several of the complications that ASC 606 could create are complex technical accounting assessments, management judgment, operational process and system changes, difficulties in data gathering & analysis and changing business models. As some exchange transactions may take longer to recognize revenue than others, these transactions will have deferred revenue components in their financial statements longer than others. Thus, to resolve these issues FASB created ASC 606-10-25-27 to specify transfer of control of goods and services if one of the following criteria is met;
• The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs.
• The entity performance creates or enhances an asset that the customer controls as the asset is created or enhanced.
• The entity’s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date. The right to payment must include a profit margin or reasonable return on capital.
Because the new standard involves a significant amount of judgments in the process of recognizing revenue, it may have different views. The best way to overcome any challenges arising from the new standard is to use best practices.
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