Authored by Andrea Caladie
ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), has an effective date for annual reporting periods beginning after Dec.15, 2017, for public companies, and Dec.15, 2018 for non-public companies. This means if you are a not-for-profit institution with conduit debt, the standard is effective for fiscal year 2019.
The core principle of the new standard is that revenue recognition should “depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services” (ASC 606-10-05-3).
Some of the changes under the new standard will be easy to understand, such as the terminology currently used by not-for-profits, "exchange transactions," which will be superseded by "contracts with customers." All revenue generated through exchange transactions (“contracts with customers”) will be subject to the standard. However, revenue recognition of grants and contracts is still being worked out by the FASB.
A proposed ASU, Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made, is expected to be effective at the same time as ASU No. 2014-09 and will help clarify the timing of revenue recognition for grants and government contracts.
Our clients frequently turn to us to help them answer the following questions as they work towards implementing these new standards:
- What are the potential issues when implementing?
- How do the new requirements affect the timing of balance sheet transactions and could this change the amount of revenue recognized in each fiscal year for those contracts that cross over the fiscal year end?
- What type of new financial statement disclosure will be required?
- What new policies, procedures and documentation will my not-for-profit need to put in place to comply with these standards?
- Will my not-for-profit’s revenue be recognized at a point in time or a period of time?
Now is the time for action and to take steps to ensure that you can answer the above questions and implement the standards.
For many not-for-profits, the largest source of revenue is generated through fees for goods and services from private sources. One example is membership dues and subscriptions. These transactions, however, often include a contribution element that complicates implementation of the new standard. Therefore, not-for-profits will have to bifurcate the exchange component from the contribution amount, a task that will require considerable judgment. Let’s evaluate membership dues and subscriptions using the five step process.
Step 1 – Identify the contract
An inventory of all of your contracts is a great place to start. There are five criteria that need to be met in order for a contract to exist.
- The parties to the contract have approved the contract (in writing, orally or in accordance with customary business practices) and are committed to perform their respective obligations.
- The not-for-profit can identify each party’s rights regarding the goods or services to be transferred.
- The not-for-profit can identify the payment terms for the goods or services transferred.
- The contract has commercial substance (that is, the risk, timing or amount of the not-for-profit’s future cash flows is expected to change as a result of the contract).
- It is probable the not-for-profit will collect substantially all of the dues to which it will be entitled in exchange for both the membership and subscription transferred to the member.
- In most cases, not-for-profits require and receive payments in advance of their dues and subscription membership. Therefore, the Financial Reporting Executive Committee (FinRec) believes that the criteria for contract existence would generally be met between the not-for-profit and the member relating to both the membership and the subscription.
- When a not-for-profit bills a member or subscriber for a renewal in advance of the service period, ASC 606-10-45-4 states that the not-for-profit would only recognize a receivable if it has a present right to payment even though that amount may be subject to refund in the future. In evaluating collectability, the not-for-profit will need to consider the member’s ability and intention to pay the amount due. If the not-for-profit concludes that collectability from a member is not probable, then the not-for-profit would conclude there is not yet a contract and would not recognize revenue until the facts and circumstances change.
- What are your policies and procedures in continually reassessing the collectability threshold?
Step 2 – Identify the performance obligations in the contract
A performance obligation is defined in ASC 606-10-25-14 as a promise in a contract with a customer to transfer to the customer either:
- A good or service that is distinct
- A series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer
Under ASC 606-10-25-19, there are four promised goods or services that are evaluated whether they are performance obligations that meet the criteria:
- The promise to the member to provide discounted tickets during the one year term
- The promise to the member to provide early access to tickets during the one year term
- The promise to the member to provide a subscription to provide two semi-annual magazines
For the purpose of this example, the promises to deliver all of these goods and services are distinct. However, the promise to deliver discounted tickets and access to tickets are delivered concurrently and have the same measure of progress and may be accounted for as if they were a single performance obligation referred to as “membership benefits.”
- Have you evaluated and documented how you identified each performance obligation?
Step 3 – Determine the transaction price
ASC 606-10-32-2, defines the transaction price as the amount of consideration to which a not-for-profit expects to be entitled in exchange for transferring goods or services to a member (customer), excluding amounts collected on behalf of third parties.
To determine the transaction price, the not-for-profit should consider whether the not-for-profit needs to adjust the promised amount of consideration for the effect of the time value of money if the timing of the payments agreed to by the parties of the contract provides the member with a significant benefit of financing the transfer of goods or services. As a practical expedient, a not-for-profit need not adjust the transaction price for a significant financing component if the period between transfer of the goods or services to the member and payment by the member will be one year or less.
- Have you determined the transaction price for each contract identified?
Step 4 – Allocate the transaction price to the performance obligations in the contract
As noted above, there were three performance obligations identified and therefore the transaction price or cash consideration for a one year membership which includes the subscription should be allocated between the three performance obligations based on the relative standalone selling prices of each performance obligation. The standalone selling price for each magazine subscription could be determined if the not-for-profit sells the magazines separately outside of the membership. If the standalone selling price is not available then the not-for-profit will need to estimate the price.
- Have you documented your policy on how you transaction price was allocated and estimated?
Step 5 – Recognize revenue when (or as) the entity satisfies a performance obligation
Under ASC 606-10-25-23, an entity shall recognize revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service to a customer. For each performance obligation, the not-for-profit will need to determine if it has been satisfied either over time or at a point in time. For membership dues and/or subscriptions, the recognition point will depend on the specific facts and circumstances. For example, the performance obligation for each semi-annual magazine subscription may be satisfied at a point in time. Revenue should then be recognized when control of the magazine has been transferred to the customer. Assuming the not-for-profit concludes that control transfers to the customer upon shipment, the revenue is recognized when the magazine is shipped. For the membership dues, the member simultaneously receives and consumes the benefits of membership and the membership performance obligation is satisfied over time. Therefore the not-for-profit may conclude that measurement over time is best and will recognize revenue ratably over the one year membership.
- Have you documented your policy on when you will recognize revenue based on a time-based measure or a point in time?
As you start answering these questions and evaluating your options, we can help you assess and document these decisions. These decisions will then be ready for you to incorporate into the required disclosures that are detailed in ASC 606-10-50. It’s right around the corner so begin your analysis today.
For more information on this topic, or to learn how Baker Tilly not-for-profit specialists can help, contact our team.