Revenue Recognition and the Non-Profit

Revenue recognition has been a hot topic in the accounting world for what seems like a decade now.  In various contract arrangements and sales, it is possible to manipulate earnings pretty dramatically through the timing of recording revenues.

Fortunately, when you work with non-profit organizations, a lot of that hubbub can go largely ignored.  Non-profits deal with (and manipulate) revenue in their own manner, primarily through the application of FASB 116 and 117 or under the codification 958-605.

As with anything, there are complicated issues in non-profit revenue recognition, especially when dealing with split interest agreements, but there is a concept that underlies all of the standards that is easy to grasp.  And once a person knows what to expect, they can move forward from there.

Exchange vs. Non-Exchange Transactions

Arguably, the most important step in recognizing revenue in a non-profit organization is determining whether or not the transaction is an exchange or a non-exchange transaction.

Exchange transactions are very similar to a sale in the for profit world.  You provide a product or service in exchange for a fee or revenue.  The revenues are recognized when they are earned and realizable.  Many program service revenues, like a concert or clinical services, fall in this category.

Earned is generally defined as the exchange has occurred and realizable means that you are likely to be paid for it.

An example would be in the case of a mental health organization where a clinician meets with a client for 30 minutes.  The exchange has occurred, so the revenue can be recorded.  The amount realizable, however, has to be limited to the extent of the insurance contract rate.  So, if your rate is $45 for a half hour, but insurance or the state only allows $36, then you would record net revenue of $36.  The receivable for that service can come from a combination of sources and would be analyzed for collectibility in a separate accounting task.

Pretty easy, right?  Okay, not so easy, but at least familiar to those who work in for profit industries.

Non-exchange transactions are where things get goofy.  Most contributions and support are considered to be non-exchange transactions.  Basically, the person contributing the money gets no service or product in return for giving you these funds.

I can hear Executive Director's and accountants and program manager's everywhere saying, "Wait a minute!  We provide a service!  We are making the community a better place!  Plus, in the case of that one grant from United Way, we have to spend it on a specific program, so that is an exchange."

I hear you, but that is not exactly the right way to look at it.  The fact is that United Way could give you money and tell you exactly how they want you to spend it, but United Way is not the one receiving a benefit.  They have restricted the use of the funds, but they will get no exchange in return for giving you this money.

And because there is no exchange, GAAP (in the U.S.) says you need to record receipt of the funds immediately upon notification that you received it.  And that is where people get grouchy around non-profit accounting.

Most grants are applied for and awarded for future fiscal years or projects. And when you record the revenue upon receipt (notification of the award), the expenses are not there to match it.  This is going to cause a revenue/expense mismatch in your financial reporting that is non-intuitive to those who work primarily in for profit accounting models.

The required handling of this mismatch is to show that award or contribution as a temporarily restricted revenue.  This means that you record the grant, but you do it in a different bucket.  You say, we got this money this year, but it can not be used until either time or purpose restrictions have been satisfied.

If the grant is used in the following period in the manner the donor required, then those funds would be released from restriction to match with the expenses of the program.

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This particular post is not meant to be a comprehensive explanation of how we show all these transactions (I hope to cover that in more detail and smaller chunks at a later time) - it is merely an introduction to the concepts needed to record revenue in a non-profit.  As, such here is a quick review:

Non-exchange revenues:  When you receive revenue for which the grantor or contributor receives no direct services or products.   Recorded upon notification.

Temporarily restricted:  A way of recording non-exchange revenue to show that it relates to a future period and/or a specific purpose.  Note:  ONLY  a donor can impose a restriction.  If a board or management wishes to set aside funds for a future purpose, that is generally a designation and remains in the unrestricted bucket.

Release of restrictions:  The moving of a temporarily restricted item to unrestricted revenue to match the expenses and satisfaction of the restriction.  Note:  Expenses are always unrestricted.

As I mentioned above, this gets even more complicated when dealing with split-interest agreements and reimbursement grants, but that is beyond the scope of this post.  If you can approach the influx of funds with the question of whether or not they are exchange or non-exchange and if non-exchange, whether or not the funds are unrestricted or restricted, you will be on the right path to correct revenue recognition procedures.