New Accounting Standard on Accounting for Contributions and Grants – Focus on Exchange Transactions and Conditional Contributions

As part of a broader effort to address revenue recognition, in 2018 the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2018-08, Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made, to address practical difficulties in characterizing grants and similar contracts as either exchange transactions or contributions and in determining whether a contribution is conditional or unconditional. The guidance applies to organizations that issue financial statements in conformity with U.S. generally accepted accounting principles (GAAP).

For most nonprofit organizations, the amendments in ASU 2018-08 should be applied for contributions received during fiscal years beginning after December 15, 2018 (i.e., calendar years ending December 31, 2019 and non-calendar years ending in 2020) and one year later on contributions made (i.e., calendar years ending December 31, 2020 and non-calendar years ending in 2021). This article focuses on the provisions addressing contributions received.

Determining Whether a Transaction is a Contribution or an Exchange Transaction

There has been diversity in practice among nonprofit organizations in classifying grants and contracts as either contributions or exchange transactions, particularly with respect to revenues received from governmental entities. Making a proper determination is important, because distinguishing between contributions and exchange transactions determines which accounting guidance applies. If a transaction is determined to be a contribution, Accounting Standards Codification Subtopic 958-605, Not-for-Profit Entities – Revenue Recognition is followed. For exchange transactions, Topic 606 generally applies.

The key question is “Does the resource provider (i.e., a governmental entity) receive commensurate value in return for the resources provided to the recipient organization?” If the answer is “yes, commensurate value is received,” the arrangement is accounted for as an exchange transaction or otherwise outside the scope of Subtopic 958-605. If the answer is “no, commensurate value is not received,” the arrangement is accounted for as a contribution subject to the guidance in Subtopic 958-605. In some cases, a transaction may be both an exchange transaction and a contribution, and the nonprofit organization will be required to bifurcate the transaction and analyze each component separately.

There are two important considerations when determining whether the resource provider receives commensurate value (“commensurate value” refers to reciprocal benefits of equal value flowing between two parties to an agreement).

First, a resource provider (whether it be a governmental entity, a foundation, or someone else) is not synonymous with the general public. Therefore, a benefit received by the general public in connection with the resources provided is not the same as commensurate value to the resource provider itself.

Second, the carrying out of a resource provider’s mission (or the positive sentiment from acting as a donor) is not considered commensurate value when making this determination.

Let’s take a look at an example.

Governmental Entity (GE) awards a $1 million contract to Soup Kitchen (SK). Pursuant to the terms of the contract, SK is to use substantially all of the contract funds to provide meals in one of its kitchens to the needy people of City A.

In order to determine whether this arrangement constitutes an exchange transaction or a contribution, SK asks the question “Who receives the benefit of the funding?” SK properly determines that the beneficiaries of the funding are the needy people of City A – that is, the public. Therefore, GE does not receive commensurate value. SK properly determines that its arrangement with GE should be accounted for as a contribution.

Conditional Versus Unconditional Contributions

Once you determine that a transaction is a contribution, it may be difficult to determine whether a contribution is conditional or unconditional. This is an important distinction, because conditional contributions should not be recognized as revenue until the conditions are satisfied.

The ASU clarifies that a contribution is conditional if both:

(a) an agreement includes a barrier that must be overcome and

(b) either a right of return of assets transferred or a right of release of a promise to transfer assets exists.

This is not an “either/or” scenario…both (a) and (b) must be present. If both (a) and (b) are present, the recipient organization is not entitled to the transferred assets (or future transfer of promised assets) until the barrier has been overcome. (Upon deeming a contribution unconditional, consideration must also be given to whether a donor-imposed time or purpose exists on the contribution. A detailed discussion of donor-imposed restrictions is beyond the scope of this article.)

Let’s break these concepts down a little further.

What is a barrier? Simply put, a barrier is precisely what it sounds like. It is a stipulation built into an agreement that allows one party to avoid carrying out the full terms of the agreement. It is protective language. A common barrier encountered by many nonprofit organizations is the existence of a matching requirement (e.g., a $10,000 matching grant will be paid only if and when the nonprofit organization raises $10,000 from other sources within a stated period of time).

Expanding on our Soup Kitchen example, a barrier may exist if GE requires SK to serve at least 1,000 meals per month.

The ASU describes certain indicators to assist an organization in determining whether a barrier exists, and no single indicator is determinative in making the evaluation. Indicators include:

  • The inclusion of a measurable performance-related barrier. In our example, the requirement for SK to serve 1,000 meals per month would be a measurable performance-related barrier.
  • The extent to which a stipulation limits discretion by the recipient organization when conducting an activity. In our example, a requirement that SK only purchase certified organic foods with the funding provided by GE would be an example of such a stipulation.
  • Whether a stipulation is related to the purpose of the agreement. One consideration with respect to this indicator is whether a stipulation is merely an administrative matter. In our example, assume SK must report the number of meals it has served in City A in a quarterly report to GE. The requirement to report quarterly to GE is not, in and of itself, indicative of a barrier. But, the fact that GE requires SK to issue regular reports is an indicator that a barrier may exist…in this case, the requirement to serve a certain number of meals per month.

Note that a probability assessment about whether the recipient is likely to meet a stipulation is not a relevant factor when determining whether an agreement contains a barrier. It is a binary decision…there either is or is not a barrier.

Determining whether a right of return of assets or a right of release of a promise exists should be straightforward – such a provision will ordinarily be written into the agreement in a clear manner. If there is not an apparent indication that a barrier must be overcome, the agreement should be considered unconditional. If an organization determines that both a barrier and a right of return exist, the contribution should be considered conditional, and revenue should only be recognized at such time that the contribution becomes unconditional.

Disclosure Requirements

Recipients of conditional contributions are required to comply with current disclosure requirements, including disclosure of the total amount of conditional contributions promised, their purpose and other relevant information.

Transition Guidance

The guidance should be applied on a modified prospective or retrospective basis. Under the modified prospective basis, in the first set of financial statements issued following the effective date, the ASU should be applied to agreements that are either:

  • Not completed as of the effective date or
  • Entered into after the effective date.

The ASU should be applied only to the portion of revenue that has not been recognized before the effective date in accordance with current guidance.

Implementation – Next Steps

If you believe the new guidance will significantly impact the treatment of contributions for your organization:

  • Evaluate any government or foundation contracts or agreements.
  • Evaluate the terms of any “challenge” gifts, where contributions are conditioned on the raising of matching funds.
  • Make a determination about whether the transaction contemplated in each agreement is an exchange transaction or a contribution and recognize revenue according to the applicable section of the accounting guidance.
  • For contributions, evaluate any agreements for the presence of barriers and right of return provisions and recognize revenue according to the requirements set forth in Subtopic 958-605 and as described in the ASU.
  • Collaborate with others in the organization about the potential impact of the new guidance.
  • Talk with your auditor to ensure your organization and your auditor have the same expectations regarding the impact of the ASU on your organization’s financial reporting.
  • Educate appropriate groups within the organization about the impact of the new guidance (if significant), including the board of directors and/or audit and finance committees.

A Final Word

Organizations with significant government grants are likely to be among those most affected by the new standard. However, the clarifications brought forth in the new ASU described in this article should not have a significant impact on most nonprofit organizations. In reality, many organizations already account for government and private foundation grants as contributions, and many organizations apply the principles clarified in the ASU when making a determination about whether a contribution is conditional. However, each organization should analyze its treatment of these items to ensure that it is complying with the new guidance. And as is the case with all GAAP requirements, it is important to remember that the provisions of the new ASU need not be applied to immaterial items.  For those organizations whose financial reporting will be affected by the new rules, the time to assess and implement has come.

Mike Lee is a partner in Batts Morrison Wales & Lee (BMWL) and is the firm’s National Director of Audit & Assurance Services. BMWL is a national CPA firm exclusively serving nonprofit organizations and their affiliates across the United States.

The author would like to thank Lee Klumpp, National Assurance Partner – Nonprofit & Government, of BDO USA, LLP, for his technical review and input with respect to this article. 

This publication is for general informational and educational purposes only, and does not constitute legal, accounting, tax, financial, or other professional advice. It is not a substitute for professional advice. For permission to reprint, please contact us.  © 2024 Batts Morrison Wales & Lee, P.A.  All rights reserved.
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