What is revenue recognition?

What Is Revenue Recognition, and Why Is it Critical for Nonprofit Accounting?

While a traditional commercial organization has little to no trouble determining what is revenue on its statement of activities, nonprofits often find this to be a challenge. Generally speaking, a nonprofit isn’t receiving payment for services rendered. Instead, contributions, promised contributions, and exchanges of goods or services make up the bulk of revenue.

The problem with nonprofit accounting is that it relies on a firm understanding of what counts as revenue and for how much. It may be clear with unrestricted contributions, where the money has already been received. However, promised contributions that have strings attached and transactions conditioned upon the occurrence of future events can be more difficult to decipher.

Contributions—The Most Straightforward Case

A contribution can either take the form of a direct transfer of assets or a settlement of liabilities. The important thing to note here is that the simplest form of contributions are unconditional and unrestricted.

Conditions— Roadblocks to revenue recognition

Many donors, including the Federal Government, put conditions in place which complicate the revenue recognition process. A contribution can be considered conditional if there is a right of return and there are barriers imposed by the donor that must be overcome. The right of return is pretty self explanatory but what about barriers. Well barriers can represent things like matching requirements imposed by donors, or the requirement to incur allowable expenses for government grants.

If a barrier has not been met, then nonprofits cannot recognize the contribution as revenue at the time it is received. Once a condition is met, for instance sufficient matching contributions were received from other donors, or allowable expenses were incurred on a federal award, then the related revenue can be recognized.

Restrictions – Waiting for release

A restriction means that a contribution has to be used for its intended purpose or that it is for a future period. An example of a purpose restricted contribution is a gift received from a donor to be used for children’s programs. Assuming an organization has a variety of programs, the use of these funds would only be authorized specifically for programs benefiting children. A time restricted gift generally arises when a donor provides a multi-year pledge. For example a donor gives $100,000 for children’s programs in the current year and pledges to do the same in the next fiscal year. The initial gift of $100,000 is restricted as to purpose (children’s programs) and the second installment is restricted as to time in the current year. Next year when the additional payment is received it will be purpose restricted as well.

When a restricted contribution is received you should actually recognize the revenue in the period it is received. In the example above, both the initial gift of $100,000 and the second installment would be recognized as revenue in year 1. However, until the restrictions are met, the revenue will most likely be included in the “with restrictions” column on your statement of activities. (Certain policy decisions can be made which allow you to recognize unrestricted revenue equal to the $ amount of restrictions met in the same year.)

Pledges and Promises

A promise is a written or oral agreement to contribute cash or a non-cash resource, such as property, at a later date. Pledges and promises may be conditional or unconditional. Most include restrictions, since most pledges or promises to give will be collected in a future period.

If there are no conditions attached to a pledge or a promise, it can be recognized as a contribution. However, if it covers multiple fiscal years it may need to be discounted to account for the time value of money. Also, you should consider establishing an allowance for uncollectible promises to give.

Overwhelmed yet?

Exchange Transactions

Whereas contributions and promises are made without an expectation of the donor receiving anything in return, exchanges are reciprocal. This could simply take the form of providing some service or other obligation.

Membership dues are an example of an exchange. Are members of an organization simply providing funding, or are they paying dues in exchange for the use of services, facilities, or some other benefit? What about a government grant to provide services to children. Let’s consider a Head Start Grant. A Head Start Grant requires an organization to provide high quality preschool education to qualified 3 and 4 year olds. In exchange for providing services to Head Start children, the non profit receives monetary compensation. Isn’t this an exchange transaction? Actually the accounting standards say no. The benefit received by the Federal granting agency is considered to be for the greater good or for the general benefit of society. This is not considered to be commensurate value, so Head Start grants are contributions (that are conditional and restricted as to purpose).

Recognizing the Differences and Accounting for All of It

Most nonprofits are not operating with simple-to-calculate or easily recognizable contributions. More often, contributions, promises, and exchanges create multiple revenue streams that must be teased apart for accounting purposes. This is where Rubino can help.

The process of revenue recognition can have substantial impacts on a nonprofit’s ability to receive a clean audit report. Sorting out the books is often a job that can use professional assistance. Give us a call today, and we’ll be happy to help.