With the release of the Financial Accounting Board’s (FASB) Accounting Standards Update (ASU) 2014-09, Topic 606, Revenue from Contracts with Customers, there was some confusion on how it would affect the not-for-profit industry, specifically how entities recognize grants. Even before the issuance of ASU 2014-09, there has been diversity in practice in recognizing grants, but the implementation placed a renewed focus because the type of revenue dictated what guidance to use. Contributions should follow the Subtopic 958, whereas exchange transactions should follow other guidance, including Topic 606.
Difficulty in implementation stems from the inability to categorize all grants as either contributions or exchange transactions. A grant, which has historically been recorded as an exchange transaction, may now be classified as entirely a contribution, entirely an exchange, or a combination of the two. To assist in finding the answer, FASB issued ASU 2018-08, Topic 958, Clarifying the Scope and Accounting Guidance for Contributions Received and Contributions made.
Defining the Terms
The ASU clearly defines a contribution as an unconditional transfer of cash or other assets, as well as unconditional promises to give, to any entity or a reduction, settlement, or cancellation of its liabilities in a voluntary nonreciprocal transfer by another entity acting other than as its owner. Exchange transactions are defined as reciprocal transfers in which each party receives and sacrifices approximate commensurate value. In a contribution transaction, the resource provider often receives value indirectly by providing a societal benefit, although that benefit is not considered to be of commensurate value. In an exchange transaction, the potential public benefits are secondary to the potential direct benefits to the resource provider. Because it is typically not easy to identify the components that contribute to commensurate value being received, you must look at the underlying substance of the transaction.
In the ASU, FASB has provided some guidance in what key factors to consider when determining whether a transaction is a contribution or an exchange transaction.
It is important to note that the type of resource provider (for example, a government agency, a foundation, a corporation, or other entity) does not factor into the determination of whether the transaction is a contribution or an exchange transaction. A common misconception is that a resource provider (specifically the government) is synonymous with the general public. Though the government, foundations and other entities are often working to help the general public, they are not deemed to be the general public; and, therefore, benefits received by the public as a result of the assets transferred is not equivalent to commensurate value received by the resource provider. Another common misconception of receiving commensurate value is if the not-for-profit is executing the mission of the resource provider. The alignment of the each organization’s goals does not constitute commensurate value received.
However, expressed intent by both the recipient and the resource provider can be indicative of determination of a transaction as a contribution or an exchange transaction. If it is both parties’ intent to exchange resources for goods and services that are of commensurate value, the transaction is seemingly an exchange transaction. On the contrary, if the recipient solicits assets from the resource provider without the intent of exchanging goods of commensurate value, then it is sounding more like a contribution.
If the resource provider has full discretion in determining the amount of the assets, then it is an indicator that the transaction is a contribution. If both the resource provider and the recipient agree on the amount of assets transferred in exchange for goods and services that are of commensurate value, then it is indicative of an exchange transaction.
Finally, if penalties assessed on the recipient for failure to comply with the terms of the agreement are limited to the delivery of assets or services already provided and the return of unspent amount, the transaction is generally indicative of a contribution. The existence of contractual provisions for economic forfeiture beyond the amount of assets transferred by the resource provider to penalize the recipient or nonperformance generally indicates that the transaction is an exchange of commensurate value.
Overall, the guidance in the ASU is expected to significantly change the classification of many government grants and contacts. By default, these have been typically classified as exchange transactions under the logic that the government does not make contributions, and that the entity is being paid for the services it performs on the government’s behalf. However, many activities funded by the federal government are carried out for the benefit of the general public, rather than to obtain goods or services for the government, which does not constitute commensurate value exchanged.
Example 1 (taken from ASU 2018-08). A student is enrolled at a university. The student received a grant of $2,000 to assist in payment of the tuition fee of $30,000, which was paid directly by the grantor to the university. The grant was awarded to the student, not to the university. The university entered into an exchange transaction with the student and accounts for the $30,000 (commensurate value exchanged by the payment of tuition for the student’s education) following the guidance outside of Topic 958. Commensurate value was exchanged by the payment of tuition for the student’s education. The $2,000 grant does not create additional revenue, but serves as partial payment against the $30,000 due to the university.
Example 2 (taken from ASU 2018-08). A university applied for and was awarded a grant from the federal government. The university must follow the rules and regulations established by the federal government and the awarding agency. The university is required to incur qualifying expenses to be entitled to the assets. Any unspent funds during the grant period is forfeited, and the university is required to return any advanced funding that does not have related qualifying expenses. The university is required to submit a summary of research findings, but retains the rights to the findings. This grant is not a transaction in which there is commensurate value being exchanged. The federal government, as the resource provider, does not receive direct commensurate value in exchange for the assets provided because the university retains all rights to the research. Also, the university and the public received the primary benefit of any findings, and the federal government received and indirect benefit because the research and findings serve the general public. Thus, this grant should be accounted for as a contribution.
What Is Next?
Once it is determined that a transaction represents a contribution, the next step is to determine if it is conditional, which is a topic for another blog.
For resource recipients who are not-for-profit conduit bond obligors and public business entities, the ASU is effective for annual periods beginning after June 15, 2018 (including interim periods). For all other entities, the ASU is effective for annual periods beginning after December 15, 2018, and interim periods beginning after December 21, 2019.
For resource providers who are not-for-profit conduit bond obligors and public business entities, the ASU is effective for annual periods beginning after December 15, 2018 (including interim periods). For all other entities, the ASU is effective for annual periods beginning after December 15, 2019, and interim periods beginning after December 15, 2020.
For more information, contact Sarah Widlock at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Not-For-Profit Group.