July 11, 2018

“Threading the Needle”—Accounting Standards Update Closes Hole in Nonprofit Grant Guidance

In the nonprofit world, organizations are fueled and sustained by generous contributions and grants, which are used to support the organization’s mission.  Although such funding can often be the deciding factor for a nonprofit’s success or failure, accounting for these contributions can be a headache.  For several years, nonprofits have been trying to “thread the needle” on grant classification to find a solution for simplifying the process.  Stakeholders have repeatedly vented frustration in this area; and, as a result, a new standard has been introduced to address these nonprofit sector concerns.

The Financial Accounting Standards Board (FASB) has released an updated standard, Accounting Standards Update (ASU) 2018-08 Clarifying the Scope and the Accounting Guidance For Contributions Received and Contributions Made, to enhance the new revenue recognition rule that has been applied to all nonprofit organizations.  This ASU will help clarify a key issue: whether grants should be classified as an exchange transaction or non-exchange transaction (contribution).  Historically, grants and similar contracts have been accounted for as contributions, or nonreciprocal transactions by some entities, but as reciprocal, or exchanges, by others.

This new ASU is a more robust framework that will help determine whether a transaction has met the requirements for a contribution, and if it should be classified as a contribution, or as an exchange transaction.  In order to infer classification, nonprofits should first determine the motive or expectations of the resource provider.  If the resource provider is expected to receive value in return, the transaction should be treated as an exchange, rather than a contribution.

Based on the released standards, transactions that should be treated as contributions are nonreciprocal transactions, while those treated as exchanges are reciprocal.  By distinguishing between exchange transactions and contributions, not-for-profit entities will be able to determine which revenue recognition principle to apply.  Reciprocal (or exchange) transactions will be governed by ASC 606, Revenue from Contracts with Customers.   Accounting for contributions (or nonreciprocal transactions) will be pursuant to Subtopic 958-605, Not-for-Profit Entities—Revenue Recognition.  According to the FASB, the new update will seek to remove the “gray area” that nonprofits often fight when determining whether a grant is an exchange transaction or a contribution.  In other words, the question of whether a grantor or contributor (in this case, the resource provider), has received any value equal to the exchange of resources transferred will be a critical area for clarification.

The new ASU also emphasizes FASB’s intent to ensure that treatment of contributions be consistent from the perspective of both the contributor and recipient; conditionality of the grant should apply to both parties.  ASU standards mandate that organizations should determine whether a contribution is conditional based on whether a contract or agreement includes: (1) a barrier that must be overcome, and (2) either a right of return of assets transferred, or a release of the promisor’s obligation to transfer assets. These indicators are expected to serve as a guide when assessing barrier components of any agreement.  The timing of recognizing a contribution can be impacted if the contribution is determined to be conditional.

It is important to note that although the accounting for contributions stands as one of the primary concerns for nonprofit entities, the released update will apply to any entity that receives or makes contributions in the form of cash and/or other assets, including business enterprises. However, the new release does not apply to transfers of assets from government entities to business entities.  This ASU will follow the same effective date as the Revenue Recognition standard for nonprofit entities and is effective for annual reporting periods beginning after December 15, 2017.  For other organizations, the standards should be applied to annual reporting periods beginning after December 15, 2018.

Although many universities, colleges, and research institutions that rely heavily on grants and contracts may take a moment to breathe a sigh of relief, adoption of new accounting standards has never been a sprint–it is a marathon.  In other words, because these changes occur very rarely, while nonprofits revel in this moment of change, in order to comply with the new regulations, they must prepare for the possible hurdles associated with understanding and implementing new accounting rules.  To help with this preparation, the FASB is hosting a webinar about the new release September 14, 2018, at 1:00 pm.

If you would like more information about this ASU, or would like to request a speaker for your organization or event, contact one of our PYA executives below at (800) 270-9629.

About the Authors

Mike Shamblin

Managing Principal of Audit & Assurance Services

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