The Financial Accounting Standards Board issued ASU 2014-09, Revenue From Contracts with Customers (Topic 606) to provide guidance for revenue recognition related to contracts with transfer of promised goods or services to customers and related disclosures. This standard is effective for non-profits that are not defined as public entities (i.e. have direct or conduit public debt) beginning after December 15, 2018 (so for the December 31st, 2019 and June 30, 2020 reporting periods).
How should revenue be defined? Revenue is defined as the transfer of promised goods and services to a customer in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. This article will provide specific examples and guidance as you apply the Revenue Recognition standard in your non-profit’s financial reporting:
What Are Non-Profit Areas of Focus for Topic 606 in Determining Revenues?
●Membership dues
●Subscriptions
●Tuition
●Fees for service
●Retail sales
●Licensing
●Potentially some government grants and contracts
What Areas Does Topic 606 Exclude?
●Insurance contracts
●Financial instruments
●Guarantees
●Non-monetary exchanges in the same line of business to facilitate sales to customers
●Contributions
●Collaborative arrangements
How Does A Non-Profit Apply Revenue Recognition?
Under the new revenue recognition standard, revenue will be recognized after:
●Identification of the contract with a customer
●Identification of the performance obligations in the contract
●Determination of the transaction price
●Allocation of the transaction price to the performance obligations in the contract
●Recognition of revenue when (or as) each performance obligation is satisfied
Step 1 – Identify the Contract with a Customer
●When the new revenue recognition standard refers to a contract with a customer, it does not have to be a written contract.
●A contract may be oral or even implied by the entity’s customary business practices, but it needs to create rights and obligations that are legally enforceable against the parties.
Characteristics of a Contract with a Customer – An entity shall account for a contract with a customer that is within the Scope of Topic 606 only when all of the following criteria are met:
●The parties to the contract have approved the contract and are committed to perform their obligations.
●The entity can identify each party’s rights.
●The entity can identify the payment terms.
●The contract has commercial substance.
●It is probable that the entity will collect substantially all of the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer.
Characteristics of When A Contract Does Not Exist
●A contract does not exist if each party to the contract has the unilateral enforceable right to terminate a wholly unperformed contract without compensating the other party (or parties) or the collectability threshold is not met.
●A contract is wholly unperformed if the entity has not yet transferred any promised goods or services to the customer and the entity has not yet received, and is not yet entitled to receive, any consideration in exchange for the promised goods or services.
●To meet the collectability threshold, an entity must conclude that it is probable that it will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer.
●Note that determining whether a contract is wholly unperformed and whether a collectability threshold has been met will be a bigger challenge for some non-profits (e.g. colleges with tuition and housing revenues) than others.
Example: Trade Association X believes that all of its annual membership dues are exchange transaction revenue. Trade Association X has a 9/30 year end and bills its members for the upcoming year (i.e., 10/1 to 9/30) around 7/31 each year. Under the new revenue recognition standard, Trade Association X would most likely say that it has a contract when it actually receives the renewal payment as until it occurs, rights and obligations do not exist between the parties as the member has not accepted the “contract”. (Note that some non-profits today try to record deferred revenues and accounts receivable for billed amounts instead of billed and received amounts if they believe that they will actually receive these amounts shortly after year end. Under the new revenue recognition standard, this position will be much more difficult to take as a contract is not in place just based on the billing.)
Step 2 – Identifying the Performance Obligations in the Contract
●A performance obligation is a promise in a contract with a customer to transfer a good or service to the customer.
●At the inception of a contract, the entity will assess the goods or services promised to be transferred to the customer and identify as a performance obligation (possibly multiple performance obligations) each promise to transfer the customer either:
-A good or service, or a bundle of goods or services that is distinct; or
-A series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.
●A good or service that is not distinct will be combined with other promised goods or services until the entity identifies a bundle of goods or services that is distinct. In some situations, that would result in the entity accounting for all the goods or services promised in a contract as a single performance obligation.
Example: The annual memberships at Zoo X go for $250 each. Zoo X has determined that $100 of this amount is a contribution and that the remaining $150 is a contract for the benefits that members receive (i.e. the performance obligations). In step 2, Zoo X will identify the specific performance obligations and their characteristics. For example, Zoo X determines that the benefits provided consist of an annual pass to Zoo X, a monthly newsletter, and attendance at the annual gala.
Step 3 – Determining the Transaction Price
●The transaction price is the amount of consideration (fixed or variable) that the entity expects to be entitled to in exchange for transferring the promised goods or services to the customer.
●An entity should consider the terms of the contract and its customary business practices in determining the transaction price.
Example: Zoo X determines that the benefits provided (i.e. the annual pass to Zoo X, the monthly newsletter, and the attendance at the annual gala) are valued at $150.
Step 4 – Allocating the Transaction Price to the Performance Obligations in the Contract
●The transaction price is allocated to separate performance obligations in proportion to the stand-alone selling price of the promised goods or services.
●When a contract has only one performance obligation, the entire transaction price is attributed to that performance obligation.
●If the contract has more than one performance obligation, the transaction price will be allocated among the individual performance obligations. That allocation is done based on the stand-alone selling prices of each of the distinct goods or services underlying the performance obligations. Note that an entity should estimate a stand-alone selling price if it is not directly observable.
Example: Zoo X determines that the $150 exchange transaction (i.e. contract) components of the membership consist of an annual pass to Zoo X valued at $50, a monthly newsletter valued at $25, and attendance at the annual gala valued at $75.
Step 5 – Recognizing Revenue When (or as) Each Performance Obligation is Satisfied
●The 5th step in the new recognition standard is to recognize revenue.
●The revenue recognized when the transfer of the promised good or service to a customer is equal to the amount allocated to the satisfied performance obligation, which may be satisfied at a point in time or over time.
●A good or service is transferred when (or as) the customer obtains control of that good or service.
Example: The annual pass to the zoo and monthly newsletter would likely be recognized as revenue over the 12 months and the amount allocated to the gala would likely be recognized after the event.
Example: The Today and Tomorrow Theatre offers lifetime subscriptions to all future theatrical productions for $2,000. The subscriptions are non-refundable and non-transferable. The Theatre would likely consider recognizing revenue over the average time span of the subscription, the life expectancy of the subscriber, or other suitable time periods.
What are the Significant Disclosure Requirements for Topic 606?
●Contracts with customers (including revenue recognized, disaggregation of revenue, and information about contract balances and performance obligations); and
●Significant judgments and changes in judgments affecting the amount of revenue and assets recognized (determining the timing of satisfaction of performance obligations and determining the transaction price and amounts allocated to performance obligations).
Note this summary is not meant to substitute for reading the new standard in its entirety.