Being Involved in Revenue Recognition Analysis Pays Off in Preparing for New Rules
Over the past year, when accounting consultants and analysts introduced the revenue recognition model outlined in the Financial Accounting Standards Board’s Accounting Standards Codification 606, most nonprofit leaders’ responses were, “What’s that going to do for our bottom line?”
Answering the question requires both consultants and nonprofit leaders be involved in an analysis of revenue streams and accounting procedures.
The consultants bring expertise in the nuances of the new standards, gleaned from workshops, guidance from organizations within their industry and from helping other clients to achieve compliance.
The leaders bring an understanding of their particular nonprofit and its revenue streams. They provide the data and the knowledge to ensure that the analysis, its judgements and its estimates are made in a way that results in a presentation that is compliant and meaningful.
Before the analysis begins, both members of the team should understand how this new standard uses a principles-based model, designed to improve consistency, comparability and usefulness of revenue disclosure. The guiding principle is this:
An entity should recognize revenue to report 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 and services.
This principle is implemented using the five-step process:
- Identify the contract between the organization and the customer.
- Identify the contract’s obligations, separating them and creating benchmarks for full or partial performance.
- Determine the price.
- Split the price among the separate performance obligations.
- Recognize revenue as the obligations and/or their parts are satisfied.
Upon beginning Accounting Standards Codification (ASC) 606 analyses, consultants quickly found themselves and their nonprofit clients struggling with some of the rules — and grants are an example.
The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2018-08 to help clarify when grants are in the scope of ASC 606. For example, it explained that a grant to a nonprofit to produce a white paper on cancer treatment for general consumption did not provide commensurate value to a customer. As such, the grant should be treated as a contribution.
But if the white paper is for a specific audience — for example, research into a drug to treat cancer for a pharmaceutical company — it is a performance obligation and subject to ASC 606 revenue recognition rules.
These subtle nuances require nonprofit leaders’ participation in the analysis. With participation, not only will proper rules be followed, but also the nonprofit can determine changes to operations or record-keeping for the future that can better reflect revenue.
An example of a change that proved to be beneficial involved a Mid-Atlantic organization that produces educational and leadership materials for classes that lead to an end-of-term expedition that tests knowledge and teamwork development. The organization had been recognizing revenue at the end of the expedition, in effect not acknowledging that the instruction materials had value that could have been recognized earlier in the process.
The importance for nonprofits of distinguishing between contributions and exchange transactions also extends beyond grants.
For example, zoos, museums and other cultural establishments often operate on revenue from memberships. A customer buys a one-year membership for $100, for which the new member and family can attend exhibitions as often as they want. In effect, a portion of the $100 is paid for admissions, creating what is called an exchange transaction, or value for value.
If the tickets are valued at $50, then half the $100 membership is subject to the five rules of the ASC 606 revenue recognition model, as an exchange transaction. The other half is a contribution, not subject to the rules.
The problem can become even more complex when other elements — caps, t-shirts, contributors dinners and the like — are included in the formula. Perhaps, then, the organization might decide to create another membership tier with a greater philanthropic impact.
These are complexities that impact nonprofit leaders as a result of the revenue-recognition analysis. By teaming with consultants, leaders understand the process and questions the analysis engenders. Remedies for noncompliance can be derived more quickly and easily when their need is understood, even before a final report is written.
One of the elements that many consultants have found during the early stages of ASC 606 compliance was a lack of leaders’ questions beyond the first “bottom line” inquiry. As teaming with nonprofit leaders has evolved, more questions showing greater understanding of the process have evolved with it. This is generating more streamlined reactions to the needed changes for compliance, along with changes that use ASC 606 as a tool for enhanced operations and a better-looking revenue report.
Ultimately, this can lead to an enhanced bottom-line for nonprofits.
Alan Stein is a principal, audit and accounting services, at Gorfine, Schiller & Gardyn. He has more than 10 years of public accounting experience. He manages audits, review and agreed upon procedures and engages with clients in a wide variety of industries, including the nonprofit arena.
Alan is on the Maryland Association of Certified Public Accountants’ (MACPA) Accounting & Auditing Committee and is a member of the MACPA and the AICPA. He is also a member of the board of directors of Congregation Shomrei Emunah and Karina Association, Inc.