Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers, ASC Topic 606, was released in May 2014. As its effective date approaches for privately-held companies, many nonprofit organizations remain unclear whether and how it will affect them. Indeed ASC 606 impacts all entities, including nonprofits. Most private companies including nonprofits with calendar -year-ends must implement the new revenue recognition rules as of the December 2019 reporting period, except in one case: Nonprofits that have issued or are conduit bond obligors for securities traded, listed, or quoted on an exchange or over-the counter market that meet the definition of a public company and thus must have implemented the new rules as of the December 2018 reporting period. However, it is common to see nonprofits with fiscal year-ends than calendar-year-ends. For e.g. a nonprofit with June 30 year-end will have to implement new revenue recognition rules as of the June 30, 2020 reporting period.
Unlike public companies, the private companies are not required to adopt the new revenue standard until they report their annual results. For e.g. if a nonprofit with calendar-year-end has quarterly reporting requirements due to debt covenants, they are not required to adopt the new revenue standard for quarterly financial statements if such period occurred in the year ended December 31, 2019. However, given that the annual results will be reported on a new basis (i.e. under ASC 606), the nonprofit may find it beneficial to early adopt the standard for quarterly reporting since it would otherwise be required to revise the accounting of its revenue transactions as presented in its quarterly financial statements when including full-year results in its year-end reporting.
Revenue streams included and excluded
The new revenue recognition guidance in ASC 606 supersedes the requirements in ASC 605, Revenue Recognition, as well as most industry-specific guidance provided by the Accounting Standards Codification. For nonprofits, this industry guidance is currently found in subtopic 958-605, Not-for-Profit Entities—Revenue Recognition. While some of this guidance will remain in effect, mainly the portions relevant to contributions, all revenue generated through exchange transactions (“contracts with customers”) will be subject to ASC 606.
Included: Revenue streams. Many ways that nonprofits generate income are considered revenue from contracts with customers and are subject to the new revenue standard. Nonprofits should start by evaluating all their revenue streams to determine if they are contributions or exchange transactions. Nonprofits that have contracts including both components need to separate the exchange portion, which will require some judgement. Nonprofits must evaluate the following types of contracts to determine applicability to ASC 606:
- Products and services
- Royalty agreements
- Conferences and seminars
- Federal and state grants and contracts
Excluded: Certain types of contracts. Some contracts with customers that are specifically excluded from this standard include lease contracts, insurance contracts, financial contracts, and guarantees. In addition, investment income revenue streams are not affected by ASC 606.
Excluded: Contributions and collaborative agreements. Although contributions are not specifically detailed in ASC 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 ASC 606. The existing accounting guidance under ASC 958-605-55-8 is useful to determine which transactions are contributions and which are exchange transactions.
Evaluation of grants and contracts
ASU 2014-09 highlights the importance of determining whether grants and contracts are in scope of ASC 606 and if these contracts are reciprocal or nonreciprocal. If a transaction is nonreciprocal, it should follow the current contribution guidance, whereas if a transaction is reciprocal, it falls under the scope of ASC 606.
Similar grants and contracts are accounted for as nonreciprocal transactions (often conditional) by some nonprofits and as reciprocal transactions (exchange transactions) by other nonprofits. FASB acknowledges the difficulty and diversity in practice among nonprofits in distinguishing between grants as exchange transactions or contributions. As a result, on June 21, 2018, FASB issued Accounting Standards Update (ASU) No. 2018-08, Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made.
ASU 2018-08 helps nonprofits determine if transactions should be accounted for as a contribution or an exchange transaction. It provides clarifying guidance to evaluate whether a resource provider receives value in return for the resources transferred. The ASU also includes improved guidance to determine whether a contribution is conditional or not and to better distinguish between donor-imposed conditions and donor-imposed restrictions. All nonprofits should take ASU 2018-08 into consideration now when evaluating grants and contracts for applicability of ASC 606.
The core principle of the new standard is that revenue recognition should “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” (ASC 606-10-05-3). For nonprofits, this guidance applies to contracts that are exchange transactions and therefore are evaluated under the new standard.
To accomplish this objective, reporting entities are to apply a five-step approach:
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 contains certain concepts and judgments that will have an impact on the revenue recognition process as described in ASC 606.
Impact to your organization
Some of the areas that may affect your nonprofit include the following:
- Management may be required to make more estimates and use more judgment under the new standard, such as estimates related to variable considerations.
- You and your lenders may need to revise debt covenants tied to accounts affected by the new guidance, such as revenues or liabilities.
- Management may consider changes to its standard contract terms, 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, internal controls, and accounting policies to capture the necessary information and ensure it meets the new requirements.
- 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.
Nonprofits should start the implementation process sooner rather than later to determine how the new standard will affect the organization. It is important to develop an implementation plan that includes a kick-off meeting, determining resource needs, training to all stakeholders, consultation with your auditors, and legal advisors to get all parties involved and help navigate the process and ensure compliance with ASC 606.
The nonprofits must carefully evaluate whether to implement internally or hire a consulting firm to help implement. The organizations interested in internal implementation should make sure they have the bandwidth and time to implement on their own. While the day-to-day accounting functions must still be maintained throughout this process, there need to be personnel specifically assigned to implementing ASC 606 for a successful transition. The factors influencing the decision include, but are not limited to, the size of the company, internal resources available, experience of key personnel, complexity, and the length of time before the targeted implementation date.
If a consulting firm is hired, they will generally approach implementation through two basic phases: assessment and implementation. While the final deliverables are the restated financial statements according to ASC 606 standards, the consulting firm generally helps produce additional work papers, resources, and systems to ensure the client is prepared to continue revenue recognition according to the new policy. In addition, the consulting firm can also help produce slide decks for trainings and prepare various position papers to support revised accounting policy, processes and internal controls under the new revenue standard on behalf of the client.
The clock is ticking on the effective date for implementing the new revenue standard and nonprofits should make it a priority to ensure smooth transition for accounting under ASC 606.