An overview of the standard
The Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606), was issued by the Financial Accounting Standards Board (FASB). The standard’s effective date is for public entities’ annual reporting periods beginning after December 15, 2017. A public entity is, according to FASB, an entity that, “is any one of the following: (1) a public business entity, (2) a not-for-profit entity that has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market, (3) an employee benefit plan that files or furnishes financial statements to the SEC.” If your organization is a not-for-profit institution with conduit debt, then your institution is considered a public entity and the standard is effective for your fiscal year beginning July 1, 2018. For non-public entities the standard is effective beginning July 1, 2019.
The core principle of the new standard under the Account Standards Codification (ASC) topic 606, paragraph 10-05-3, 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.”
In addition, another proposed ASU, Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made, is being issued to improve and clarify existing guidance on revenue recognition of grants and contracts by not-for-profit organizations. This proposed ASU is expected to be effective at the same time as ASU No. 2014-09.
As institutions navigate implementation of these standards, many institutions struggle to answer the following questions as they progress:
- What are the potential issues when implementing?
- How do the new requirements affect the timing of balance sheet transactions? Could this change the amount of tuition and housing revenue recognized in each fiscal year for those academic periods that cross over the fiscal year-end?
- How will the presentation of net tuition change if an institution has price concessions?
- What type of new financial statement disclosure will be required?
- What new policies, procedures and documentation will my institution need to put in place to comply with these standards?
- Will my institution’s revenue be recognized at a point in time or for a period of time?
The American Institute of Certified Public Accountants (AICPA) revenue recognition taskforce for not-for-profit entities addressed implementation issues relating to tuition and housing revenue for not-for-profit higher education institutions. The AICPA Financial Reporting Executive Committee (FinREC) reviewed the taskforce’s implementation issues and the guidance was finalized and included in the AICPA revenue recognition guide. The following summarizes the issues that were identified by the taskforce.
Steps to address tuition and housing revenue using the new standard
Now is the time for action and to take steps to ensure that you can answer the above questions and effectively implement the standards. First, we will explore tuition and housing revenue using the five step process.
Step 1 – Identify the contract
An inventory of all of your contracts is a great place to start. There are five criteria that need to be met in order for a contract to exist.
- The parties to the contract have approved the contract (in writing, orally or in accordance with customary business practices) and are committed to perform their respective obligations.
- Higher education institutions will need to consider whether and when an agreement with a student creates enforceable rights and obligations. ASC topic 606, paragraph 10-25-4 states that a contract does not exist if each party to the contract has the unilateral enforceable right to terminate a wholly unperformed contract without compensating the other party. In evaluating whether a contract is considered wholly unperformed, institutions should consider whether a nonrefundable deposit represents an exchange for promised services or services have already been started. In either case, a contract would exist.
- When should you recognize revenue for a prepayment of a nonrefundable deposit recorded initially as a contract liability? FinREC believes an institution would not record the prepayment as revenue until expiration of the student’s right to enroll or be provided housing. Consider your policy regarding nonrefundable deposits.
- The institution can identify each party’s rights regarding the goods or services to be transferred.
- The institution can identify the payment terms for the goods or services transferred.
- The contract has commercial substance (that is, the risk, timing or amount of the institution’s future cash flows is expected to change as a result of the contract).
- It is probable that the institution will collect the tuition and housing charges to which it is entitled in exchange for goods or services transferred to the student (e.g., instruction and housing).
- In evaluating collectability, the institution will need to consider the student’s ability and intention to pay the amount due. Per FinREC, assessing a student’s ability to pay should take into consideration all expected payments from all potential parties, including student financial aid. If collectability from a student is not probable, then the institution would conclude there is not yet a contract and would not recognize revenue until the facts and circumstances change. Consider your policies and procedures for continually reassessing the collectability threshold.
- ASC topic 606 is generally applied to an individual contract with a customer. However, as a practical expedient, an institution may apply the guidance to a portfolio of contracts with similar characteristics if the institution reasonably expects that the effects on the financial statements would not differ materially from applying the guidance to the individual contracts. Institutions will need to consider the cost/benefit of the portfolio approach, especially when evaluating collectability, as discussed here in Step 1, and refunds, described in Step 3.
Step 2 – Identify the performance obligations in the contract
Institutions will need to determine if tuition and housing are distinct services promised by the institution or whether they should be combined.
FASB ASC topic 606, paragraph 10-25-21 provides factors to consider when assessing whether two promises exist. However, per FinREC, in most cases, tuition and housing are distinct services and, therefore, separate performance obligations. Consider whether your institution has evaluated and documented how you identify each performance obligation.
Step 3 – Determine the transaction price
Institutions will need to consider FASB’s guidance in ASC topic 606, paragraphs 10-32-2 through 10-32-27 when determining the amount to be measured for both tuition and housing revenue.
- In determining the transaction price, institutions should factor in all of the consideration (e.g., student financial aid, payments by parents, external scholarships) it expects to be entitled to for the student’s tuition and housing. The contract price could differ by student depending on the different tuition and housing rates charged based on the fee schedule. Have you determined the transaction price for each contract identified? If you evaluated the tuition and housing as separate contracts, then separate transaction prices will need to be determined for each contract.
- Institutions must also take into account the student’s right to withdraw, which may result in a full or partial refund in those cases where consideration has been received in advance. The institution would need to recognize a refund liability for the amount of consideration received (or receivable) for which the institution does not expect to be entitled. The new standard requires this to be estimated using one of two methods: the “expected value” or the “most likely amount” method. As noted above, institutions may choose to use the portfolio approach in estimating this liability.
Step 4 – Allocate the transaction price to the performance obligations in the contract
If tuition and housing are included in a single or combined contract, institutions will need to consider the FASB’s guidance under ASC topic 606, paragraphs 10-32-28 through 10-32-36 with respect to allocating the transaction price to the performance obligations in the contract. When determining the transaction price, institutions should also consider whether any discounts or financial aid awarded to a student should be applied to tuition, housing or both. Consider documenting your policy (if you have not already done so) on how your transaction price was allocated.
Step 5 – Recognize revenue when (or as) the entity satisfies a performance obligation
Under ASC topic 606, paragraph 10-25-23, an entity shall recognize revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service to a customer. For each performance obligation, the institution must determine if it has been satisfied either over time or at a point in time. FinREC believes that, generally, students simultaneously receive and consume all of the benefits provided by the institution’s performance because the institution provides instruction or housing to students throughout the academic period, and it would be appropriate for institutions to recognize tuition and housing revenues over time in these circumstances.
Because ASC topic 606 prescribes that revenue is based on the transaction price (net of any reductions or consideration payable to the customer), presenting the gross amount as revenue on the Statement of Activities is not allowed. However, per FinREC, it is acceptable to disclose the financial aid or scholarships parenthetically on the face of the Statement of Activities or in the notes to the financial statements.
As you begin answering these questions and considering your options, evaluate the time and resources available to dedicate to this effort. Many institutions have required help in assessing and documenting these decisions. The documentation will be valuable when you are ready to craft the required disclosures that are detailed in ASC topic 606, paragraph 10-50. With the standard effective date less than a year away, it’s time to dig in and begin your analysis today.