Are Grants Subject to Revenue Recognition?

What does this new guidance change for nonprofit organizations, stakeholders, and donors?
The latest guidance from the FASB arrives at a time when nonprofit chief financial officers (CFOs), controllers, and other key financial players are facing a fast-approaching deadline to implement new revenue recognition requirements (Topic 606). The revenue standard aims to improve accounting for contracts with customers, but it also introduces a layer of complexity and challenge to nonprofits of every size. The newly released second edition of Nonprofit Standards, BDO’s benchmarking survey, offers a glimpse of the administrative burden regulatory changes place on nonprofits: 45 percent of organizations say the time and effort required to deal with regulatory and legislative changes pose a moderate- or high-level challenge.

Revenue recognition brought to light a diversity of practice in the way that nonprofit organizations and funders classified grants and contracts from federal, state and local governments and other funding sources such as foundations in the financial statements, with some categorizing them as contributions and some as exchange transactions.

What makes standardizing practices so important now? Contributions, defined as an unconditional transfer of cash or assets in a voluntary non-reciprocal transfer, are scoped out of revenue recognition. Exchange transactions—a reciprocal transaction in which two parties exchange something of commensurate value—are within the scope and need to be accounted for following the new revenue recognition requirements.

In a recent BDO webinar, my colleagues and I discuss that classifying grants as either a contribution or exchange transaction is the first step in implementing revenue recognition. The clarified guidance aims to help nonprofits complete that first step in a consistent way across the sector.   

Practical Example: How to evaluate a grant under the new guidance
Description of ‘Nonprofit A’:  A large research association that specializes in space exploration. Their mission is advancing scientific discoveries and supporting the advancement of new technology. The organization receives funding from various individuals, corporations, and governments to support its efforts.

Description of the grant: Nonprofit A received a $15 million grant from the federal government to finance the costs of a research initiative to test the effectiveness of newly developed technology.

How should Nonprofit A classify the $15 million grant?
This grant could be classified as either an exchange transaction or a contribution, depending on the exact parameters of the funding. Let’s examine both scenarios:
 

	Classify the grant as an exchange transaction if:	Classify the grant as a contribution if:
Specific provisions of the grant	The resources are paid by the federal government as the work is incurred (cost reimbursement) and request for payment is submitted. The federal government specifies the protocol of the testing, material the technology is made of, and the type and duration of testing that must take place.   The federal government requires a detailed report of the test outcome within two months of its conclusion and any intellectual property (IP) as a result of the grant belongs to the federal government.	Nonprofit A makes all decisions about research protocol, material the technology is made of, and the type and duration of testing that must take place.   In addition, the nonprofit retains all the commercial rights for any IP that is developed as a result of the research. Nonprofit A still has to produce the detailed report of the test outcome within two months.
Deciding factor: Reason for classifying the grant as an exchange transaction or contribution	This example would be an exchange transaction because of how prescriptive the grant is, and because the government owns the IP. Therefore, in this case the federal government is receiving something of commensurate value.	In this scenario, the transaction would be considered a contribution because there is no commensurate value being exchanged.   Even though Nonprofit A is expected to produce a report, the FASB does not consider this an equal exchange of value. The ASU deems filing this type of specified report to be administrative in nature and not a performance standard.
Is the grant subject to the new revenue recognition standard?	Yes. All exchange transactions are subject to revenue recognition.	No. The above scenario is a conditional contribution, which is not subject to revenue recognition. The condition is met as the work is incurred in accordance with the grant agreement.   Determining whether a grant is conditional or unconditional can be difficult. The ASU states that determining if a donor-imposed condition exists is the key to determining when the contribution can be recognized as revenue. The first consideration is whether the grant agreement has a right-of-return requirement in which grantee must return to the promisor (grantor) assets transferred as part of the agreement or a right to release of the promisor from its obligation to transfer assets. The scenario in the above does not meet any of these requirements.     Additionally, the ASU has provided the following indicators that  could create a barrier and make the grant conditional: The inclusion of a measurable performance-related barrier or other measurable barrier Whether a stipulation is related to the purpose of the agreement The extent to which a stipulation limits discretion by the recipient

Disclaimer: These examples are for illustrative purposes only. Changing even one fact in the example could significantly change the accounting treatment.

What types of organizations need to take action?

• Grantees: All nonprofits that receive grants from foundations, governments, or other funding entities will need to assess how they are accounting for contributions. College, universities, research institutions, and social services organizations that rely heavily grants and contracts could see the greatest impact.
• Grantors: Non-governmental organizations like public and private foundations, as well as for-profit entities that issue grants to nonprofits, will need to think about how they write their grants and contracts.

What organizations will not experience a significant impact?

• Public charities: As organizations that derive the bulk of their funding from individual contributions, they will be less impacted by this guidance.
• Local, state, and federal governments: Nonprofits will still need to assess how they classify federal and state funding, but governmental bodies are not within the FASB’s scope and do not need to comply with this guidance. Governments are subject to standards issued by the Governmental Accounting Standards Board (GASB).

What’s next for nonprofits?
Accounting changes are like a relay race. Today, the FASB handed off clarified guidance on accounting for contributions and answered a longstanding question for the sector. And now it’s up to nonprofits to apply it to their own books, run the rest of the race to implement revenue recognition, and finish strong.

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Lee Klumpp, CPA, CGMA is the National Assurance Partner – Nonprofit & Government for BDO and has been with the firm for over a decade. He serves as a resource to BDO’s Institute for Nonprofit Excellence^SM, providing information about the current issues that the FASB is dealing with, as well as timely updates on Accounting Standards as they are released.