Although many in the industry do not believe governmental agencies provide contributions, new guidance issued by the Financial Accounting Standards Board (FASB) may result in accounting for just that. When an organization receives a grant or contract from a governmental agency, foundation or other nonprofit, the agreement normally states what those funds should be used for and when they should be used.
Historically, grants that required a nonprofit to provide services to the general public could have been considered an exchange transaction, therefore, recording revenue when services were provided. Under the new guidance, this would be considered a contribution and would no longer follow the same revenue recognition process.
Accounting Standard Update (ASU) 2018-08, “Clarifying the Scope and Accounting Guidance for Contributions Received and Contributions Made,” was issued in June 2018 to provide clarity in the accounting guidance for contributions received and contributions made. Although these challenges have been troubling practitioners for many years, the issuance of ASU 2014-09, “Revenue from Contracts with Customers,” highlighting these challenges and created new questions.
The first issue ASU 2018-08 addresses is determining whether a transaction is a reciprocal (exchange) transaction or a nonreciprocal (contribution) transaction. This important classification determines whether Revenue Topic 606 or Nonprofit Contribution Topic 958-605 is followed. If the entity providing funds receives direct commensurate value – meaning the entity directly receives services that equal the amount paid – the transaction is reciprocal.
If the general public receives the services and value from the agreement, the transaction is a contribution. The greyer area involves payments for specified third parties as these can be reciprocal or nonreciprocal based on the circumstances and details of the agreement.
The guidance clearly states that the type of entity providing the funds should not override the substance of the transaction and furthering the entity’s mission or “feel good” sentiment does not constitute commensurate value. The guidance also specifically spells out that providing services to the general public is a nonreciprocal transaction, which may be different from how organizations are currently treating these transactions.
For example, if a nonprofit provides medical treatment to a patient and then receives payment from Medicaid for the treatment, this is most likely a reciprocal transaction. The underlying transaction – providing medical services to the patient – would be accounted for as patient revenue under Topic 606, and the payment from Medicaid would be payments on behalf of the patient.
On the flip side, if a nonprofit entity received a grant to provide medical services to individuals in a specific area during the current calendar year, which sets out certain eligibility criteria, this may be considered a contribution and accounted for under Topic 958.
Although in both situations, the organization is providing medical services and are paid for by a governmental agency, a review of the facts and circumstances, as well as consideration of the substance of the transaction is required to determine whether a specific grant or contract is a reciprocal or nonreciprocal transaction.
The second issue ASU 2018-08 addresses is determining whether a nonreciprocal transaction is conditional or restricted. Many funders stipulate how and when funds can be utilized, and there is judgement involved to determine whether the stipulations make the contribution conditional or restricted.
Since only unconditional contributions are recorded as revenue, the distinction will determine whether revenue is recorded at the time the grant is received or not and the types of disclosures required. ASU 2018-08 states for a contribution to be conditional, a right of return or release exists, and there is a barrier that must be overcome. A right of return can be said in many ways in an agreement, but the intent should indicate that the entity’s obligation to provide funds can be extinguished or the funds returned under certain circumstances.
Examples of a barrier include a matching requirement, a specified level of services to be provided or the occurrence of an event. A barrier can be reached all at one time or achieved in steps. It is important to note that both must be present to be conditional. In other words, when is the organization entitled to the funds? Although conditional promises to give are not recorded as revenue in the financial statements, they are required to be disclosed in the financial statements.
ASU 2018-08 is effective for annual periods beginning after Dec.15, 2018 for most entities receiving funds. Organizations also have a choice whether to apply the guidance on a modified prospective basis or retrospectively.
If you have questions about whether this new guidance applies to your organization, be sure to consult with your professional advisors.