Applying New Revenue Recognition Standard to Tuition and Housing
New accounting standards issued by the Financial Accounting Standards Board (FASB) in May of 2014 have significantly changed revenue recognition for higher education institutions. You’ll have to apply a new framework in determining when and how you recognize revenue in your customer contracts. For schools, this primarily means revenue from tuition and housing.
The AICPA’s Financial Reporting Executive Committee (FinREC) has issued a working draft for recognizing revenue from tuition and housing. The draft reviews the proposed Accounting Standards Update and provides helpful hints and illustrative examples. The 13 pages of information are quite helpful, and we recommend you give them a thorough review.
FASB has defined a core principle: revenue should only be recorded when you transfer goods to your customer at an agreed-upon price. It has outlined five steps to achieve this before you can determine how to recognize revenue from your customers:
- Identify the contract(s) with a customer.
- Identify the performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price to the performance obligations in the contract.
- Recognize revenue when (or as) the entity satisfies a performance obligation.
The new rules will be effective for years beginning after December 15, 2017 (for conduit debt users), or December 15, 2018 (for all others). They are complex, so your preparation for the changes should begin soon. A good place to start is with FinREC draft guidance paper.
FinREC implementation for tuition and housing revenues in five steps
FinREC has classified the impact of the tuition and housing revenue standards as moderate. The draft is out for exposure until September 1, 2016, and you can send any comments or feedback to email@example.com.
The working draft outlines implementation issues to achieve the core revenue recognition principle. It also includes case studies, their solutions, and related journal entries.
Here is a brief overview of FinREC’s guidance for each of the five steps.
Step 1: identify contract(s) with a customer
Determining whether a contract exists on the surface would appear to be a simple exercise, but it can actually get a little complicated. The new guidance states that a contract does not exist if each party to the contract has the unilateral, enforceable right to terminate a wholly underperformed contract without compensating the other party. FASB ASC 606-10-25-4 states that a contract is wholly underperformed if both of the following criteria are met: 1) your institution has not transferred any promised goods or services to your customer, and 2) you have not received — and are not entitled to receive — any consideration.
When applying this guidance to nonrefundable enrollment or housing deposits, you will need to decide if your institution merits consideration in exchange for the services you will eventually deliver, or if you have already begun to perform the services. In either case, the contract would not be considered wholly underperformed.
FinREC believes that when a student pays a nonrefundable deposit for enrollment or housing, the student is thereby extended the right to receive instruction or housing, and your institution is obligated to provide it. So when a nonrefundable deposit is received, a contract liability should be recorded. When the student eventually enrolls, the deposit will be included in the transaction price and revenue recognized as your institution performs.
Step 2: identify the performance obligations
Your institution will need to decide if tuition and housing are contracted together in a single contract or are in fact two separate contracts. For the purpose of applying the new standard, FASB ASC 606-10-25-9 notes two or more contracts can be combined if one or more of the defined criteria are met. If the contracts are negotiated as a package with a single commercial objective, and consideration paid in one contract depends on the price or performance of the other contract, then services promised in the contracts are a single performance obligation, and you would combine the contracts.
One final consideration would be if financial aid has been provided in a bundled agreement. If none of the stated criteria is met, you would treat tuition and housing as separate contracts for applying the revenue recognition standards. FinREC believes that more often than not, tuition and housing are separate services with separate performance obligations. As a result, tuition and housing contracts would need to be accounted for separately.
Step 3: determine the transaction price
Guidance in this section of the working draft is divided into four subsections.
Your institution would consider all you expect to be entitled to when determining transaction price(s). Some schools vary tuition rates for different situations or categories of students (e.g., international or out of state). So contract prices may vary, too, and would depend on the individual contract each student has with your school.
Consideration includes amounts that will be paid by a third party, such as the federal government, on behalf of the student. You will need to determine the transaction price of each contract. If tuition and housing are contracted separately, you would need to identify a distinct transaction price for each.
Consideration payable to the customer
Some schools provide reductions to tuition and housing, perhaps for financial aid awarded and then directly applied to tuition or housing charges. If your institution provides these types of reductions to a student other than in an exchange for a distinct good or service, in accordance with FASB ASC 606-10-32-25 you must account for it as a transaction price and revenue reduction. If these reductions are known and agreed up prior to the revenue recognition, they would be recognized normally.
Right to withdrawal
Many institutions have “add/drop” periods where students may receive a full or partial refund. In many of these cases, consideration will have been received from a student in advance. When this has occurred, the consideration is deemed variable (FASB ASC 606-10-32-10), and you must recognize a refund liability. This liability would be measured at the amount of consideration received or receivable that you don’t expect to be entitled to.
According to FASB ASC 606-10-32-8, there are two defined methods for estimating variable consideration, one of which is the expected value method, which is the sum of probability-weighted amounts in a range of possible consideration amounts. A portfolio approach is allowable, as you may find it impractical to estimate a refund liability at an individual contract level. But this approach is only allowable if the application on a portfolio basis would not differ materially from application on a contract-by-contract basis. Variable consideration is included in the transaction price only to the extent that it is probable that a significant reversal in revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved (FASB ASC 606-10-32-11).
If you have significant predictive experience in estimating withdrawals, and the uncertainty regarding a student’s withdrawal will be resolved in a short timeframe, FinREC believes that you probably won’t expect a significant reversal of recognized revenue, so you should include the anticipated amount of withdrawals in the transaction price.
Impact of collectability to the measurement of revenue
Revenue recognized would not reflect any adjustments for amounts that you might not be able to collect from a customer (BC261 of ASU 2014-09); therefore, the transaction price is not adjusted. Your institution would need to separately calculate the contract assets and receivables for impairment (bad debt) and present and disclose them as directed by FASB Topic 310.
Step 4: allocate the transaction price to the performance obligation in the contract
Assuming that tuition and housing are separate performance obligations, the transaction price is allocated to each performance obligation on a relative standalone selling price basis. The best evidence for a standalone selling price is the observable price of a good or service when your institution sells that good or service separately in similar circumstances to similar customers (FASB ASC 606-10-32-32).
Your school may sell tuition separately, for example, to commuter students, so the standalone selling price for tuition would more likely than not be observable. This may not be the case for housing; you may consider other similar housing processes to estimate the selling price. FASB ASC 606-10-32-33 to 32-35 provides guidance on estimating the standalone selling price when it is not observable.
Step 5: recognize revenue when (or as) the entity satisfies a performance obligation
FinREC believes that, in most cases, because students receive instruction and housing concurrently during the academic term, they simultaneously receive and use all the benefits you provide in the performance of your contracts. It would be appropriate, then, for your institution to recognize tuition and housing revenues over time.
FinREC also takes the view that that it would be appropriate for your institution to recognize revenue ratably over academic terms based on time elapsed.
How we can help
The implementation date for the new revenue recognition standards will be here before you know it. Given the complexity, we recommend you get ahead of implementation issues while there is still plenty of time. CLA’s higher education industry professionals are studying the new revenue recognition rules and can help you evaluate how these changes will impact your tuition and housing revenue cycles.