This is the second in a series of articles in which we will explore the revenue recognition standard requirements and the impact on higher education institutions, including the types of contracts with customers that your institution may have, while highlighting some of the decisions that you will need to make as you evaluate your contracts under the revenue recognition standard.
An overview of the standard
In June 2018, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2018-08, Not-for-Profit Entities (Topic 958), Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made. This update is intended to clarify and improve accounting guidance for contributions received and contributions made and applies to the recipient of the contributions (resource recipient) as well as the resource provider.
The amendments in this ASU should assist entities in: (1) evaluating whether transactions should be accounted for as contributions (nonreciprocal transactions) or as exchanges (reciprocal transactions), and are subject to other guidance, such as ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606); and (2) determining whether a contribution is conditional.
When will the amendments be effective?
The amendments in ASU No. 2018-08, Topic 958 should be applied on a modified prospective basis – although retrospective application is also permitted. Under a modified prospective basis, the entity should apply this ASU to agreements that are either: (1) not completed as of the effective date; or (2) entered into after the effective date.
For entities that are either a public business entity or a not-for-profit entity that have issued conduit debt and serve as the “resource recipient,” the effective date is annual periods beginning after June 15, 2018. All other entities should apply the amendments to annual periods beginning after Dec. 15, 2018. For entities that are either a public business entity or a not-for-profit entity that have issued conduit debt and serve as the “resource provider,” these amendments should be applied to annual periods beginning after Dec. 15, 2018, with a one-year deferral for all other entities for annual periods beginning after Dec. 15, 2019. Early adoption of the amendments is permitted.
Analyzing grants and contracts
When analyzing grants and contracts, many institutions have difficulty determining if revenue should be recognized as either an exchange transaction or a contribution. Further, institutions may struggle in determining whether a contribution is conditional when applying the previous guidance. The issuance of ASU No. 2014-09, Topic 606 generated a second look at the contribution guidance.
ASU No. 2018-08, Topic 958 helps to clarify and improve current guidance about whether a transfer of assets is a contribution or an exchange transaction, and therefore, which guidance to follow. This ASU focuses on the underlying transaction and not on the resource provider.
Let’s take a look at some examples and questions to consider when analyzing grants and contracts.
Example 1 - A research grant is made to a university from the federal government. The rights of the research results are not provided back to the federal government.
To understand which guidance to follow, you need to determine where the exchange of value is going. Is it going back to the resource provider? In this example, the federal government is not receiving value in exchange for the grant. The results are maintained and can be used by the university. This would be considered a contribution.
If the exchange of value is going to the general public or a third party, then this transaction would be considered a contribution and the guidance under ASU No. 2018-08, Topic 958 should be followed. Also, if the exchange is going to a third party, the university should determine whether the transaction is reciprocal and follow the applicable guidance under the ASU.
Example 2 - A student is enrolled at a university and is charged tuition. The student receives a grant to use towards the tuition and fees, which is paid directly by the grantor to the university.
In this example, let’s focus on the two underlying transactions when determining which guidance is applicable. First, the student and the university entered into an exchange transaction – as an exchange of value was incurred – and the university should account for the tuition in accordance with the guidance in ASU No. 2014-09, Topic 606. Second, the grant was awarded to the student – not to the university. Since the third-party payment is paying for an existing contract, the payment received from the third party would not be considered as additional revenue.
After you have analyzed the transaction and determined that each party is not receiving commensurate value, and the transfer of assets is not part of an existing exchange transaction between a recipient and the identified customer or another transaction outside the scope of the contributions received, then the transaction can be considered a nonreciprocal contribution or non-exchange transaction. This transaction should therefore follow the guidance within ASU No. 2018-08, Topic 958.
Another scenario to consider: Is the grant or contract conditional or unconditional? Also, is there a donor-imposed condition or conditions that present a barrier and a right of return/release?
If the grant or contract has certain barriers and revenue cannot be recognized until those barriers are met, then the grant or contract is considered conditional. Once the barriers are met, or if there are no barriers identified, then the grant or contract is considered unconditional and the revenue should be recognized in the appropriate net asset class. If restrictions are present with limited purpose or timing, then the grant or contract can be considered unconditional with donor restrictions; otherwise, it is considered unconditional without donor restrictions. Sometimes donor stipulations will be ambiguous, and in these cases the grant or contract should be assumed as conditional.
As you begin analyzing the underlying transactions of your grants and contracts, evaluate the time and resources available to dedicate to this effort. Many institutions require help in assessing and documenting these decisions. The documentation will be valuable when you implement the new financial reporting standard for not-for-profit entities.