The Financial Accounting Standards Board (FASB) has issued an exposure draft that aims to clarify the guidance on determining whether a transfer of assets is a contribution or an exchange transaction and how to distinguish between a conditional and an unconditional contribution. The distinction is substantial because contributions are reported in accordance with FASB Topic 958-605, and exchange transactions are reported in accordance with FASB ASC Topic 606 (a/k/a the “new” revenue recognition standard that applies to contracts with customers). Although the accounting for contributions most commonly affects not-for-profit organizations, this draft proposal would apply to all entities (including business entities) that might receive or make contributions.
Distinguishing Between Contributions and Exchange Transactions
Under current guidance, the starting point for whether a transfer of assets is an exchange transaction or a contribution is whether there is a reciprocal benefit. In short, reciprocal benefit means that the resource provider (foundation, government agency, corporation, etc.) is getting something of equal or “commensurate” value in return for that transfer. Some have argued that the benefit to the resource provider is not having to secure staff and resources necessary to carry out the same services provided by the not-for-profit or that it creates an indirect influx of interest or positive publicity for the resource provider. Others have argued that primary benefit is really to the public, who would receive job training, early childhood education, nutrition, transportation, education, etc., depending on the services provided using those resources. The draft proposal would clarify that when the benefit of the transfer is to the general public, rather than the resource provider, the benefit to the public should not be considered commensurate value to the resource provider. Furthermore, any positive public perception or sentiment that the resource provider may receive because it is transferring assets as part of its mission or as a donor should not be considered commensurate value.
What does this really mean? Ultimately, it could result in more not-for-profits reporting grants and contracts as contributions rather than exchange transactions and will have an impact on the timing of the recognition of revenue.
Distinguishing Between Conditional and Unconditional Contributions
Under current guidance, the definition of a donor-imposed condition is “a stipulation that specifies a future and uncertain event whose occurrence or failure to occur gives the promisor a right of return of the assets it has transferred or releases the promisor from its obligation to transfer the assets.” Today’s definition under the draft proposal clarifies that for a contribution to be conditional, an agreement must include both that a barrier must be overcome for the recipient to be entitled to the transfer of assets and a right of return of the assets transferred (or release of obligation to transfer assets) if the barrier is not overcome. The draft proposal would require an agreement or a document referenced in an agreement to indicate the condition above but does not explicitly require use of the terms “right of return” or “release from obligation” as long as it is clear enough that this is a reasonable conclusion to draw.
What is a barrier? The draft proposal provides a few examples of indicators:
- The agreement contains a measurable performance-related barrier. This is often coupled with a time limit and can include achieving certain levels of service, a specific outcome, or completion of a specific event (e.g., a matching requirement).
- The agreement contains a stipulation related to the purpose of the agreement that is more significant than a trivial task (such as producing a financial report).
- The agreement limits the discretion the not-for-profit has over the direction of the use of assets transferred.
- The agreement requires the recipient to take action the not-for-profit would not otherwise have undertaken. This is often paired with a measurable barrier.
As with current guidance, a certain amount of judgment is necessary. No one indicator is considered most significant, and a not-for-profit should always consider facts and circumstances when making the determination as to whether a contribution is conditional or not.
Common examples of barriers seen in practice today include a:
- Cost reimbursement grant that specifies that allowable/qualifying expenses must be incurred for early childhood development.
- Grant from a community foundation requires a not-for-profit to provide job training to 1,000 individuals over the course of one calendar year.
- Donor provides a pledge for a new building with specific square footage and design requirements.
It is important to note that the addition of an element of barriers removes the previous guidance that states a contribution is considered unconditional if a condition has only a remote possibility of not being met.
The draft proposal doesn’t change the definition of donor restrictions, which are not to be confused with conditions. A donor-imposed restriction is a stipulation that is more specific than the broad parameters of a not-for-profit, including the nature of the entity, the environment in which it operates, and the purposes specified in its organizing documents. A donor-imposed restriction is different from a condition in that it does not require a barrier to be overcome, nor does it require the return of assets or release of obligation of payment/transfer of assets if that barrier is not overcome.
WHAT THE DRAFT PROPOSAL MEANS FOR YOUR ORGANIZATION
It’s important to understand your current revenue recognition policy. This policy dictates how and when you recognize revenue on your statement of activities and should be disclosed in your financial statements. If your policy currently considers grants and contracts to be exchange transactions because of an indirect benefit to the public, you’ll likely need to approve a change in accounting policy when and if the standard is implemented and effective, and you’ll need to change the timing of your revenue recognition, subject to the consideration of whether the contribution is conditional or unconditional. Government and other grants commonly require a not-for-profit to fulfill certain criteria (such as incurring specific allowable or qualifying expenses) before a resource provider is obligated to transfer assets or could require a return of those resources to the provider. This change also would require a disclosure of the nature and reason for the accounting change, with additional explanation for each financial statement line item change resulting from the application.
TRANSITION AND EFFECTIVE DATE
The effective date would align with the current standard outlined in ASC Topic 606. For public business entities and certain not-for-profits that have certain conduit bonds, the effective date is for annual periods beginning after December 15, 2017. For all other entities, the effective date is for annual periods beginning after December 15, 2018. Early adoption is permitted.
If you or your organization are interested in commenting, the FASB is accepting comments through November 1, 2017. Interested parties may submit comments in one of three ways:
- Using the electronic feedback form available on the FASB website at Exposure Documents Open for Comment.
- Emailing comments to firstname.lastname@example.org, File Reference No. 2017-270.
- Sending a letter to “Technical Director, File Reference No. 2017-270, FASB, 401 Merritt 7, PO Box 5116, Norwalk, CT 06856-5116.”