Revenue Recognition Considerations for the Not-for-Profit Sector
The core principle within the standard is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration it expects to be entitled in exchange. The five-step framework will be used to determine whether the core principle has been achieved:
1. Identify the contract(s) with a customer
2. Identify the performance obligations in the contract
3. Determine the transaction price
4. Allocate the transaction price to the performance obligations
5. Recognize revenue when/as performance obligations are satisfied
Step 1 – Identify a Contract with a Customer
A contract is an agreement between two or more parties that creates enforceable rights and obligations. The criteria for a contract includes the following:
1. Approval and commitment by both parties
2. Identification of the rights of both parties
3. Identification of payment terms
4. The contract has commercial substance
5. It is probable that the entity will collect the consideration to which it will be entitled for the goods and services provided to the customer
Step 2 – Identify the Performance Obligations
A performance obligation is a promise in a contract to transfer goods or services. If more than one good or service is promised to the customer, each should be recorded as a separate performance obligation only if (1) it is a distinct good or service or (2) a series of distinct goods or services that are substantially the same and have the same pattern of transfer. A distinct good or service means the customer can benefit from the good or service on its own and is separately identifiable in the contract.
Step 3 – Determine the Transaction Price
A transaction price is the amount of consideration that an entity expects to be entitled in exchange for transferring the promised goods or services to the customer. If the consideration in the contract is variable, the entity should determine the transaction price by estimating the expected value or the most likely amount to be received. Other considerations in determining the transaction price include, but is not limited to, the existence of a financing component and noncash consideration.
Step 4 – Allocate the Transaction Price to the Performance Obligations
For a contract that has more than one performance obligation, an entity should allocate the transaction price and related discounts to each performance obligation based on a standalone selling price of the distinct good or service underlying each performance obligation. If a standalone selling price is not readily determinable, it must be estimated. Subsequent changes in the transaction price should be allocated on the same basis as the entity used at contract inception.
Step 5 – Recognize Revenue When/As Performance Obligations are Satisfied
An entity should recognize revenue when each performance obligation is satisfied, determined by when the customer obtains control over the good or service. Entities must carefully assess whether each performance obligation is satisfied at a point in time or satisfied over time, and they must measure the progress of delivering performance obligations satisfied over time. The result is that an entity recognizes revenue over time in an amount equal to the portion of the transaction price that is commensurate with the progress measured.
Revenue recognition is based on the above core principle in all industries and sectors. In the not-for-profit sector, there are certain sources of revenue requiring other considerations.
In a healthcare organization, the identification of when a contract exists and what performance obligations are required is generally based on written, verbal, or other customary business practices such as a patient registering at the facility.
Determining the amount of consideration can be unusually complicated in the healthcare industry. An entity must evaluate the forms of variable consideration and related financing options for the services provided. In addition, patients may self-pay and/or there may be third party payments. The transaction price should be recorded at the amount the Hospital expects to be entitled, taking into consideration the amount to which the customer has the ability and intent to pay, which is often considerably different than the “list” price for the goods or services provided. If the customer does not have the ability or intent to pay the amount the hospital would be willing to accept in exchange for the provided good or service (after concessions), then the transaction would not meet the criteria of being a contract within the scope of the guidance, and no revenue would be recorded.
There was no change in charity care guidance.
Tuition and Housing Revenue
In an educational institution, a contract generally exists when a contract is signed by a student and/or the student’s family.
Determining the transaction price is impacted by several components. Educational institutions generally require a deposit (refundable or nonrefundable) to hold a student’s place, and contracts may include rights to withdraw with full or partial refunds. Students may receive financial aid from the institution or another entity. In addition, an institution may have day students and boarding students. The contracts for boarding students may be a combined contract including room and board.
To determine the transaction price, the institution should consider separate versus combined contracts (tuition/room & board), financial aid, the right to withdraw and collectability.
From a practical perspective, rather than tracking each student contract separately, different types of contracts can be grouped using a portfolio approach. Determination of the transaction price and when to recognize revenue can be done at the portfolio level.
Generally, tuition and housing revenue obligations are provided over time and, therefore, the related revenue is recognized over the school term.
Generally, membership dues are amortized monthly over the life of the membership. If a membership includes multiple performance obligations and/or a charitable gift component, the transaction price (membership dues) should be bifurcated. A transaction price should be determined for each performance obligation. The portion of the membership dues for which a performance obligation does not exist represents a contribution. Revenue related to each performance obligation is recognized when the performance obligation is satisfied. The charitable contribution is recognized under the revenue recognition standards for contributions, described below.
Contributions and Grants
ASU 2014-09 specifically excluded revenue from contributions and grants from the scope. However, in June 2018, the FASB issued ASU 2018-08 Clarifying the Scope and Accounting Guidance for Contributions Received and Contributions Made.
The first requirement of ASU 2014-09 requires an organization to evaluate if a contract is an exchange transaction or a contribution. If a contract is an exchange transaction, revenue recognition is based on the framework addressed above. If a contract is a contribution, it follows the guidance in ASU 2018-08.
ASU 2018-08 is effective at the same time as the revenue recognition standard ASU 2014-09.
These new standards will affect many organizations differently. Management should take proactive steps to evaluate how the new framework will affect how revenue is recognized, document its evaluation of each step noted above and document for the basis for changes in recognizing revenue. This process should also include a review and update of policies and procedures regarding revenue recognition.
For more information about revenue recognition considerations for the not-for-profit sector, please contact Patricia McGowan, CPA, Partner, Not-for-Profit & Education Practice, CohnReznick, at 959.200.7007 or Patricia.McGowan@CohnReznick.com. Or, contact Georgina Harris, CPA, Director, Not-for-Profit & Education Practice, CohnReznick, at 310.622.4362 or Georgina.Harris@CohnReznick.com.