FASB Draft May Require Nonprofits to Change Mindset on Grants and Contracts
An exposure draft issued by the Financial Accounting Standards Board (FASB) on August 3, 2017, has nonprofit organizations wondering whether grants and contracts were included in the new revenue standard (Accounting Standard Update [ASU] 2014-09 Revenue from Contracts with Customers), or if they remained within the scope of contribution accounting.
Contribution or exchange? Check the ASU flowchart for help in deciding.
This question highlights the long-standing diversity in classifying grants and contracts, particularly from governmental entities. The new exposure draft, titled Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made, stemmed from a FASB project intended to improve and clarify existing guidance. By exploring these changes, you can better voice concerns during the open comment period and prepare for the impact on your organization should the proposal be finalized.
Reciprocal versus nonreciprocal
In practice, many nonprofits treat grants and contracts with governmental entities as exchange transactions, regardless of the underlying substance of the contract. This is done for two key reasons:
- First, some equate the government with the general public. Even though the government isn’t getting a direct commensurate value in return for the services provided, the general public is.
- Second, many believe the government does not give “contributions.” This is where the FASB exposure draft is clarifying the existing guidance. and our mindset shift begins.
The definition of contribution from the FASB Master Glossary is:
An unconditional transfer of cash or other assets to an entity or a settlement or cancellation of its liabilities in a voluntary nonreciprocal transfer by another entity acting other than as an owner. Those characteristics distinguish contributions from exchange transactions, which are reciprocal transfers in which each party receives and sacrifices approximately equal value; from investments by owners and distributions to owners, which are nonreciprocal transfers between an entity and its owners; and from other nonreciprocal transfers, such as impositions of taxes or legal judgments, fines, and thefts, which are not voluntary transfers. In a contribution transaction, the value, if any, returned to the resource provider is incidental to potential public benefits. In an exchange transaction, the potential public benefits are secondary to the potential proprietary benefits to the resource provider.
With the issuance of the proposed update, FASB established that distinguishing grants and contracts between nonreciprocal (contributions) and reciprocal (exchange) transactions would require clarification to the existing guidance, plus more illustrative examples. Entities would be required to assess whether the “resource provider is receiving commensurate value in return for the resources transferred.”
The two main considerations in this assessment are:
- A resource provider is not synonymous with the general public.
- Execution of the resource provider’s mission does not equate to commensurate value. If a resource provider receives value indirectly by providing a societal benefit, this would be considered a nonreciprocal transaction.
Upon factoring in the clarified definition, many grants and some contracts could now be considered nonreciprocal. Does that mean grants and contracts that entities may have previously accounted for as “exchange” transactions are now contributions? Not exactly. There is one more clarification to the standard: conditional contributions.
A contribution could be considered conditional if the agreement between the donor/granter/agency and the nonprofit includes either a right of return of assets transferred or a release of the donor/granter/agency from its obligation to transfer assets. Several other indicators of barriers are listed in the proposed ASU, including:
- Measureable performance-related requirements that may include the organization raising matching funds, achieving a specific outcome, or helping a specific number of individuals
- Primary purpose agreements, which may include a specific purpose on which funds must be spent
- Limited discretion over how funds are spent
- Additional actions which must be undertaken that are deemed significant, for example, starting a new program that didn’t exist previously
Other considerations, conditions, and restrictions
The proposed ASU includes a flowchart to help nonprofits navigate through the determination of a contribution versus an exchange, in which the decision point is based on its reciprocal nature. If the transaction is deemed a contribution, the next decision point is whether there are conditions that indicate a right of return/release, and therefore, a barrier. Once the organization is past the conditions, either because they do not exist or they have been meet, it must assess if there are restrictions, such as use being limited to a specific purpose or time.
Get ready for a shift in mindset
What will be the impact on your nonprofit organization? Possibly nothing. But you could see differences:
- If you received funding up front. In the past you may have accounted for the entire grant as a temporarily restricted contribution; the portion that is still subject to the right of return if a barrier is not met would now be shown as deferred revenue.
- If you previously accounted for agreements as exchanges, and your policy is to not show restrictions met during the same year as received as unrestricted support; the revenue would be shown initially as restricted and then as a release from restrictions.
- If you were accounting for your grants and contracts using a cost-based reimbursement model; the revenue recognition is likely the same. In the past, you recognized revenue as you met the barrier (i.e., performed the required service). You would in the future, too; the condition and the restriction are likely met simultaneously.
How we can help
The proposed ASU is available in its entirety on the FASB website. We encourage you to submit written feedback directly to FASB or via the website portal. The comment period for feedback ends November 1, 2017. In addition, we encourage you to reach out to your CLA professional to discuss the potential changes to your accounting processes and procedures.