Due to the weather, our physical offices will be closed Wednesday, 2/15; however, our we will be serving clients remotely. Please contact us via phone or email. Our physical offices will reopen for regular business hours on Thursday, 2/16. Please stay safe and warm.
Due to the weather, our physical offices will be closed Wednesday, 2/15; however, our we will be serving clients remotely. Please contact us via phone or email. Our physical offices will reopen for regular business hours on Thursday, 2/16. Please stay safe and warm.
Nonprofits typically work hard to make the world a better place and their success depends greatly on financial health and integrity. That is why many nonprofits need to employ a chief financial officer (CFO). Depending on your size and other factors, you may be one of them.
What are the CFO’s responsibilities?
Generally, the nonprofit CFO is a senior-level position charged with oversight of the organization’s accounting and finances. He or she works closely with the CEO/executive director, finance committee and treasurer and often serves as a business partner to your program heads. CFOs typically report to the CEO/executive and director or board of directors on the organization’s finances, analyze investments and capital, develop budgets and devise financial strategies.
The CFO’s role and responsibilities will vary significantly based on the organization’s size, as well as the complexity of its revenue sources. In smaller nonprofits with budgets of $1.5 million to $10 million, CFOs often have wide responsibilities — possibly for accounting, human resources, facilities, legal affairs, administration and IT. Midsize organizations, with budgets running up to $40 million and simple funding and programming, also may require their CFOs to cover such diverse areas.
In larger nonprofits, though, CFOs usually have a narrower focus. They train their attention on accounting and finance issues, including risk management, investments and financial reporting. CFOs of midsize organizations with diverse programs (for instance, several programs that generate revenue) or governmental funding may have a similar focus.
What are your requirements?
Nonprofits with small budgets and straightforward operations probably assign these responsibilities to the executive director or choose a more affordable option, such as hiring an outsourced CFO. As organizations grow and their financial matters become more complex, though, CFOs can help steer the ship.
Experts suggest weighing the following factors when determining whether to bring a CFO on board:
Static organizations are less likely to need a CFO than nonprofits with evolving programs and long-term plans that rely on investment growth, financing and major capital expenditures.
Who is right for you?
With CFOs playing such an essential role, your nonprofit should devote considerable time and effort to hire someone with the right qualifications. At a minimum, you want a person with in-depth knowledge of the finance and accounting rules particular to nonprofits. A CFO who has only worked in the for-profit sector may find the differences difficult to navigate. Nonprofit CFOs also need a familiarity with funding sources, grant management and, if your nonprofit expends $750,000 or more of federal assistance, single audit requirements.
What about educational and professional credentials? The ideal candidate should have a certified public accountant (CPA) designation and optimally an MBA.
In addition, the position requires strong communication skills, strategic thinking, financial reporting expertise and the creativity to deal with resource restraints. It also is useful if the CFO has had experience in an organization with a wide range of functions — for example, human resources and IT — so that he or she can identify when outside professional expertise vital to the success of your organization is needed.
Finally, it is beneficial to find a CFO who has a genuine passion for your mission is highly beneficial as it makes it easier for the CFO to understand that success for a nonprofit is not only about the bottom line.
Asset to your organization
CFOs bring many advantages to the table. Not only can they help maintain fiscal health and assist the organization in achieving its goals, but they also can boost your credibility with potential donors and watchdogs. If your budget is growing and financial matters are becoming more complicated, you may want to add a CFO, or outsourced CFO, to the mix.
Sidebar: The outsourcing alternative
Does your organization lack the size or complexity to warrant having a full-time chief financial officer (CFO) on staff, but desire the financial peace of mind the position may provide? Nonprofits often look to existing staff when filling the CFO position, but in-house accounting staff may not possess the requisite financial expertise. A popular option is to outsource CFO responsibilities to your CPA firm. With outsourcing, you gain cost-efficient access to top-notch expertise as well as other benefits at a far less cost. An outsourced CFO may also provide a strategic sounding board for the CEO/executive director and board of directors. To learn more, please contact SKR+CO’s Business Advisory team.
More than three-quarters of nonprofits are at least “somewhat likely” to pursue growth through expanded fundraising efforts during the next 12 to 18 months, according to a recent study. Nonprofit Finance Study: Managing Growth, conducted by nonprofit software firm Abila, also found that 84% of the financial professional respondents expect to seek new grant funding opportunities. Nonprofits are at least “somewhat likely” to pursue partnerships with other organizations (72%), provide new services that will bring in new revenue (69%) and seek corporate sponsorships (67%).
The results don’t only highlight a desire to grow among nonprofits. They also reflect the respondents’ recognition that growth makes risk management more challenging. More than 60% indicated that, as their organization grows, their ability to manage risk becomes somewhat or much harder.
If your organization is poised for growth, the report suggests a number of risk management activities. Among them: creating contingency plans for future funding uncertainty, maintaining compliance with funding requirements, assessing internal controls and training employees.
One out of three nonprofits that file paper Forms 990-EZ make a mistake. That’s according to the IRS, which is attempting to reduce errors with an updated form. The form has 29 “help” icons to help small and midsize nonprofits avoid common missteps.
The icons describe key information you need to complete many of the form’s fields, and provide links to useful information on the IRS website. Once organizations complete their forms, they can print them for mailing to the IRS. SKR+CO can work with you to ensure your 990 EZ is filed properly.
When natural disasters hit, many people look for ways to help the survivors get back on their feet. And some nonprofits have found particularly innovative approaches to compound the efforts they make and donations they receive. The Los Angeles Times reports, for example, that one charity, Direct Relief, received over $500,000 from thousands of online gamers in the wake of the 2017 hurricanes.
Gamers also raised more than $5 million for Save the Children over the last five years by holding marathon gaming sessions on live-stream platforms such as Twitch and Gaming for Good. The platforms let viewers watch and talk to their favorite players. The resulting donations — largely from young, male first-time donors — have prompted more nonprofits to reach out to the gaming community to build alliances.
Most nonprofits are understandably laser-focused on their mission, and other, seemingly less-critical matters may fall between the cracks. But if the finance function does not receive the attention it deserves, you run the risk of IRS penalties, reputational damage and lost revenue.
Here are four common mistakes related to managing the finance function:
According to the IRS, unreported business income ranks as one of the most common tax filing errors made by nonprofits. Revenue generated from a trade or business that your organization regularly engages in, but that is not substantially related to furthering its tax-exempt purpose (other than the need for funding), may well be subject to the unrelated business income tax (UBIT).
Generally, an exempt organization with $1,000 or more of gross income from an unrelated business activity must file Form 990-T. The nonprofit must also pay estimated tax if it expects its tax for the year to be $500 or more.
Nonprofits have long turned to independent contractors in the face of tight budgets and small staffs. Contractors can provide valuable flexibility, reduce administrative work and cut your costs and potential liability.
The IRS, however, has strict tests for determining whether an individual is indeed an independent contractor or is actually an employee for whom you must withhold, and pay, payroll taxes. If the IRS reclassifies any of your contractors as employees, you will likely find yourself on the hook for back payroll taxes, interest and penalties. You also may be subject to minimum wage and overtime laws, Social Security and Medicare contributions, and unemployment and workers’ compensation premiums.
Nonprofits sport plenty of choices when it comes to off-the-shelf accounting software packages. Although these products can improve efficiency, you can rely on them too much. The fact is that accounting software is not fail-safe; it may not flag a mistake or spot possible fraud.
Even with the most expensive and sophisticated software, garbage in means garbage out — the output, in other words, is only as reliable as the input. For example, if an employee enters cash receipts for the wrong amounts or dates, or simply fails to enter them at all, that may have a domino effect. Everything from financial statements to tax filings potentially may be impacted. You need a knowledgeable individual (someone other than the person who makes the entries) to review journal entries, reconcile account balances and perform other checks and balances.
An overreliance on software also may lead to inadequate investment in accounting resources. Some organizations may count on volunteers to serve as their accountants. Think about the critical role your financial reporting plays in obtaining funding, though. Can you really afford to leave it to underinformed volunteers or one-size-fits-all software?
An option some nonprofits are turning to is to hire part-time or interim CFO and controller contractors. By design, this service is performed by an independent, c-suite level executive at a fraction of the budget.
Mistakes in the oversight of the finance function can get in the way of accomplishing your organization’s mission. By allocating sufficient resources to this area, you can fortify your financial footing, protect your reputation and arm your leadership with vital information for decision-making.
Popular payment app, Venmo, explores nonprofit application
Venmo, a mobile payments app particularly popular with Millennials, is working on a channel that nonprofits can use to accept donations. Venmo is commonly used to transfer funds between friends who, for example, are splitting a restaurant check. With its emoji-filled news feed, the app could offer the opportunity for young people to donate, share their cause and perhaps subtly pressure their friends into donating, according to MarketWatch. The nonprofit program is currently undergoing testing with a limited number of organizations.
Nonprofits need to appeal to donors’ self-images
Charitable appeals should take into account prospective donors’ self-concepts, new research published in the Journal of Experimental Social Psychology suggests. Study participants viewed appeals that emphasized the pursuit of shared goals — for example, “Let’s save a life together,” or individual achievement: for instance, “You = Life Saver.”
Psychologists found that people who earn less money were more likely to give in response to an appeal that emphasizes community. But those with incomes of more than $90,000 responded better to appeals focused on personal achievement. The researchers concluded that, rather than trying to persuade prospective donors to see the world as they do, nonprofits may find it more effective to “meet them where they are” when tailoring appeals.
FASB proposes changes to grant, contribution accounting
The Financial Accounting Standards Board (FASB) has released a proposed Accounting Standards Update (ASU) that could result in more grants and contracts being accounted for as contributions. The ASU, Not-for-Profit Entities (Topic 958): Clarifying the Scope and Accounting Guidance for Contributions Received and Contributions Made, explains how to determine whether transactions should be considered contributions (which generally are recognized when pledged) or exchange transactions (which are subject to the revenue recognition standard, ASU No. 2014-09, Revenue from Contracts with Customers). The ASU also clarifies when a contribution is conditional rather than restricted by the donor, which affects the timing of revenue recognition.
The ASU would follow the same effective dates as the revenue recognition standard — with application for most nonprofits in periods beginning after December 15, 2018.
Overheard in a nonprofit’s office: “It’s so hard to find good board members. It’s going to be really difficult to fill these board openings.”
If your organization struggles each time it needs to fill a board vacancy or does not always come up with the candidates it desires; it may be time to consider creating a board compensation program.
Add up the pluses and minuses
Board member compensation comes with several pluses and minuses your nonprofit should consider. Different organizations might assign different weight to each of the factors.
On the plus side, offering compensation could help attract board members with specialized expertise, such as fundraising or a well-regarded community presence. It also could give you an edge when courting potential board members who would receive generous compensation from for-profit organizations for serving on their boards.
Compensation could be in order, as well, if your board members are expected to invest significant time and effort, or if your nonprofit has a business model that competes with for-profit organizations, such as a nonprofit hospital. In addition, providing compensation can help create an obligation to perform on the board member’s part and promote professionalism. This also might:
Board compensation also comes with several minuses. In general — and this is a big one — it can look bad. Donors expect their funds to go to program services, and board compensation represents resources diverted from the organization’s mission.
Further, there are IRS and legal implications. The IRS looks carefully at whether any arrangement could create a conflict of interest. And, board members receiving compensation of more than $10,000 aren’t independent members of the board by the IRS definition. Reimbursing for expenses under an accountable plan is not considered compensation for measuring independence. Also, in some states, volunteer board members are protected from legal liability, while compensated members may not be. So you will need to check on your state’s laws.
Launch a compensation program carefully
If you decide to compensate board members, do it correctly. First and foremost, the compensation arrangements must comply with the Internal Revenue Code’s private inurement and excess benefit regulations, as well as the IRS rules about “reasonable compensation.” Failure to do so can result in steep excise taxes, penalties and even the loss of your organization’s tax-exempt status.
Independence is indispensable when setting the amount of, or formula for, board compensation. It should be set by independent directors (who aren’t among those to be compensated), or an independent governance or compensation committee, with insight from an independent consultant. The amount should be comparable to that paid by similar nonprofits, as determined by compensation surveys or other data. Whoever sets the amount should be guided by a formal compensation policy.
The policy should include clear objectives outlining how compensating board members pays off for the organization (for example, by allowing it to attract a member with financial expertise). It should specify which board members are eligible for compensation (the chair, the officers or all members) and how compensation is structured (for instance, flat fee, retainer or per-meeting fee).
The policy also should address expectations for the board members in exchange for their compensation. Expectations can be described, for instance, in terms of number of meetings attended, hours worked or qualifications and experience.
Finally, document, document, document. You’ll want written evidence of a formal board vote approving the policy and the compensation amounts, related discussion and copies of the data the board relied on to make the decisions.
Leave no loose ends
Making a shift to a board compensation program is a major change. Your preparation also should include checking to see how other nonprofits with compensation programs handled communicating the change to the public, which can help you develop your own communication plan.
Be sure to seek advice from an attorney who’s familiar with laws governing nonprofits in your state. And you may also want to get feedback from supporters and donors before making a final decision.
Donors and other stakeholders continue to look for more accountability and transparency from nonprofits, especially regarding fundraising. Not only is the sum of money raised in campaigns meaningful, but how efficiently you’re able to raise it, too.
Interested parties look beyond total dollars raised to also consider associated costs in fundraising efforts. Cost ratios that present fundraising costs as a percentage of funds raised (also known as cost-per-dollar) focus on the expense of fundraising, while return on investment (ROI), importantly, focuses on the returns. It makes sense to track both.
Determining ROI vs. cost ratios
The formula for ROI uses the same inputs as the cost ratio but flips them:
ROI = Fundraising revenue / Investment in fundraising (Fundraising expense)
Focusing not only on the big picture but on specific fundraising activities will allow your organization to identify its weaker methods and strategies and improve its overall fundraising performance. Which of your fundraising activities generates the highest return? Once you establish a baseline, you can see where your results are improving and which programs are most effective.
Some organizations feel it’s more meaningful to measure gross revenues raised compared to the fundraising expenses for that effort. However, many follow a more traditional method of measuring ROI using net revenues (revenues minus the related expenses) when comparing to costs. Either way is OK, but you must be consistent by measuring your revenues in the same way for each year and campaign. And remember, these metrics are only meaningful when you compare fundraising activities or trends from one year to prior years.
Calculating the inputs
There are other considerations. How, for instance, do you compute your “fundraising expense”? Although the revenue information is easily available to your development staff, your accounting staff should be recruited to gather data on expenses at the same level of detail by campaign or fundraising effort.
Your fundraising expense should include the direct costs of the initial effort, as well as later efforts. Initial costs might include the investment to create a new donor relationship (for example, online advertising costs or the costs of a phone campaign), while subsequent costs include those associated with maintaining that relationship (for instance, the costs of a renewal mailing).
What about indirect or overhead costs? Be consistent! If you exclude those that you would incur with or without the monitored activity, such as the costs for your website or donor database, make sure they are excluded from every campaign metric. For both costs and revenues, you should use rolling averages that cover three to five years. This will reduce the effect of “one-offs,” whether in the form of a significant donation or an economic downturn. You’ll also avoid penalizing fundraising activities, such as a major gift campaign, that require some time to show results.
Calculating these metrics will help you make better decisions when it comes to allocating your fundraising resources. But keep in mind that ROIs can vary greatly by activity, and a lower ROI doesn’t necessarily mean you should cut the activity. One fundraising expert suggests striking a balance between high-cost, high-potential long-term activities and low-cost, short-term activities.
A win-win scenario
Going to the effort of computing the cost ratios and ROIs is a win-win. With this information in hand, you can make more informed decisions and satisfy your stakeholders. Your CPA can help you in these efforts.
Whether an executive on staff or a member of the board, new to the organization or a long-time veteran, a nonprofit leader sometimes faces tough challenges that a formal development class will not address. But according to the nonprofit Community Resource Exchange (CRE), learning on the job itself can be a rich source of leadership and management development. The CRE advocates two self-coaching opportunities that lean on resources you can find in yourself, within the workplace and among your networks.
The CRE’s first technique is a method known as “reframing.” It refers to the ability to shift your perspective and unlock a fresh approach to problems.
The organization also urges leaders to follow what it calls the 1-2-3 steps, which target low-hanging fruit first. This approach calls for beginning with the first few, relatively easy actions you can take to address a specific challenge. The idea is that these initial steps will help move you from understanding the problem to taking action and accomplishing real change.
These strategies can work, for example, to reframe a problem familiar to many nonprofits — the lack of the strong accounting systems and staff needed to ensure the accurate and timely reporting required for continued funding of your organization.
You could reframe this situation by shifting staff from other areas of the organization to shared responsibilities in finance, thus encouraging managers to think beyond narrow roles. Would involvement of a board member or volunteer supply the manhours and controls you’re missing? You also can get past hiring the additional person you can’t afford by trying to improve the processes in place, and by inviting and seriously considering creative suggestions from your staff.
From here, you can identify the 1-2-3 steps to get the ball rolling. For instance, you might establish a team from various areas of the organization to outline what needs to be completed on a project and when. Are there tasks that should be prioritized to satisfy government and grantor requirements? Are there other nonessential recordkeeping tasks that could be minimized or eliminated? You also could obtain information and pricing from professional outside accounting firms that specialize in this type of work. Then compare those costs with providing accounting in-house.
The CRE also has applied its suggested strategies to the challenges of managing differences. Imagine you’re dealing with several diverse groups that use your library’s services. Reframing would shift from viewing the different groups as a hodgepodge to seeking common ground among the personalities, demographics and needs. Are these groups all from the local community? Do they all need access to the programs in person? Are they all readers? You also could move from trying to achieve uniformity of interest to mining their diversity.
Easy steps might include convening all of the relevant parties to develop an initial plan for priority activities in the coming year. How best can these groups interact? Possibly, you could bring the children from Story Hour to share an activity with the Writers’ Group.
You also could take time to learn more about strategies for managing differences by reading relevant books and articles, meeting to share what you’ve learned, and planning how to handle future interactions with the various groups that benefit from your services.
The most effective leaders always encourage their employees to seek more knowledge and then lead by example. Employing the methods above can help you continually hone your leadership and management skills, even when you don’t have the time or money for formal development.
Three “top jobs” that nonprofits will need to fulfill their missions in the future have been identified by business magazine, Fast Company: 1) chief culture officer (CCO), 2) data scientist and 3) user experience (UX) designer.
A CCO manages an organization’s relationship with the community, implements internal wellness and health initiatives and devises policies to combat employee burnout, according to the magazine. Data scientists help nonprofits identify trends and critical information that can guide their program and service decisions. And UX designers improve the on- and offline processes that clients use (or don’t use) to access a nonprofit’s programs and services.
Online nonprofit revenue in 2016 grew by 14%, and email marketing revenue grew by 15%, according to a new study by nonprofit consultants M+R. Based on input from 133 nonprofits, “Benchmarks 2017” found that web traffic, email list size, Facebook fans, and Twitter and Instagram followers were all on the rise in 2016, while most individual email metrics were down. For example, the emails opened per number delivered fell 7% overall, for an average just under 15%.
For fundraising messages, the response rate was only 0.05%, an 8% drop from 2015. In other words, a nonprofit had to deliver 2,000 fundraising emails to generate a single donation. For every 1,000 fundraising emails delivered, nonprofits raised $36.
The M+R study also found that respondents increased their spending — including paid search, display and social media advertising spending.
The bottom line is that email marketing can be an effective fundraising tool. Two components for success are targeting your audience and building your email list of prospective supporters.
Recognition, trust and support — both monetary and otherwise — are among the critical factors that make nonprofit employees happy and, thus, create a superior nonprofit employer, according to The NonProfit Times “2017 Best Nonprofits To Work For” report.
Among the eight categories considered, the largest disparity overall between organizations that made the “Best Nonprofits” list and those that didn’t was found within “pay and benefits” (an 18-point differential) and “leadership and planning” (a 16-point differential). Across the 50 nonprofits recognized, the key drivers for employees included confidence and trust in the organization’s leadership and overall satisfaction with the organization’s benefits package.
Another statement where the “Best Nonprofits” diverged from others was “This organization gives enough recognition for work that is well done.” About 84% of respondents at the recognized organizations responded positively to that statement, compared to only 66% for nonprofits that didn’t make the list.
Every organization, whether for-profit or nonprofit, is at risk of falling victim to costly acts of fraud. Nonprofits, though, have some common characteristics that make them particularly susceptible to such schemes. Fortunately, you can help combat the risks at your nonprofit by implementing some simple controls.
Nonprofits tend to operate in a culture of trust and rapport, and that is one reason that they are attractive targets for fraud perpetrators. Organizations are often founded by a handful of passionate and idealistic volunteers and develop over time into a team with tighter relationships than typically seen in many for-profit businesses. As a result, management may not feel the need for antifraud controls, or they find it hard to ask tough questions when confronted with possible signs of fraud.
Similarly, many nonprofits place significant control in the hands of a limited number of people. This is a risk even in an organization with some internal controls, because more powerful individuals within an organization can simply override the controls, with lower-level staff too intimidated to intervene.
Nonprofits that have a lot of cash on hand, either in the office or at remote events, also can run into fraud problems. Cash has a way of disappearing into people’s pockets, especially at events held without proper accounting procedures. Creating a paper trail, with numbered tickets or receipts and multiple people involved every time cash is handled, helps mitigate the risk.
These are not the only factors that make nonprofits so vulnerable to fraud. High turnover among staff, volunteers and board members, as well as limited resources, also may contribute.
Internal controls in the form of strong policies, procedures and governance are a must for every nonprofit, regardless of size. Controls can help deter and detect fraud.
Perhaps the most critical control is segregation of duties. A single employee should never be responsible for all the steps in any accounting process — for example, collecting, recording, reconciling and depositing cash receipts. Segregating duties can be a challenge for smaller nonprofits. But, at the very least, the duties of handling and reconciling funds should involve more than one individual. And a separate individual should receive and review bank statements. If your nonprofit lacks the manpower, consider including board members or outside advisors to segregate duties.
Nonprofits also should conduct background checks on board members, employees, volunteers and anyone else who might handle cash. The checks should encompass credit history, references and criminal history and be updated periodically.
Governance plays a role in deterring and detecting fraud, too. Your board of directors must perform proper oversight by, for example, naming qualified individuals to independent finance and audit committees. It also should set an antifraud tone by developing — and enforcing — policies on matters such as conflicts of interest and the treatment of whistleblowers.
The Association of Certified Fraud Examiners has consistently found that tips are the most common (and low-cost) detection method for occupational fraud. It is best if tips are reported to the board or one of its committees, rather than management. The organization should make an anonymous fraud hotline available to employees, volunteers, vendors and clients.
Finally, you will need to formally educate your employees about fraud. You should provide training on the organization’s antifraud policies, red flags that could signal fraud and how the hotline works. Board members and volunteers with financial responsibilities should receive training, as well.
You can not prevent all fraud — no organization can. But you can reduce the risk of substantial fraud losses by recognizing your vulnerabilities and taking appropriate steps to mitigate them and to investigate thoroughly when fraud is suspected. Choosing to ignore fraud and hope for the best may result in suffering both financial and reputational damage.
When the Financial Accounting Standards Board’s (FASB’s) new revenue recognition standard was released in 2014, it caused quite a stir across industries. But the standard applies only to revenue from “exchange transactions,” also known as reciprocal transactions. Contributions to nonprofits are nonreciprocal, and your grants may be, too — meaning different rules apply.
In Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, the FASB defines a contribution as an unconditional transfer of cash or other assets to an entity in a voluntary nonreciprocal transfer. It specifically distinguishes contributions from exchange transactions, which it describes as reciprocal transactions where each party receives and sacrifices approximately equal value.
That means that contributions don’t fall within the rules in ASU 2014-09, including its voluminous disclosure requirements. Instead, you generally should report contributions in the period you receive the pledge or commitment to donate. Restrictions imposed — directions given by the donor — as to how or when the funds may be used do not change the timing of recognition.
However, when the donor’s gift is available only after certain requirements are met by your organization, the timing may be different. Specifically, you should not recognize a conditional promise to give as revenue until the conditions are substantially satisfied. For example, a promise to give, requiring a minimum matching contribution, can not be recognized until the match is received.Transfers of assets with donor-imposed conditions should be reported as refundable advances until the conditions are substantially met or explicitly waived by the donor.
But you can recognize a conditional promise to give upon receipt of the promise, if the possibility is “remote” that the condition will not be met. An example is a grant requiring you to submit an annual report to receive subsequent annual payments on a multiyear promise.
Determining whether a grant is an exchange transaction, where the grantor expects goods and services for its money, or a type of restricted or conditional contribution, where the grantor intends to make a gift to support the organization, can be more complicated. For example, a grant based on the number of meals or beds a nonprofit provides its client population could be considered an exchange transaction because it is essentially a contract to provide goods or services. Similarly, a research and development grant could be characterized as an exchange transaction, if the grantor retains intellectual property rights in the outcomes.
A grant that is an exchange transaction is subject to ASU 2014-09’s five-step framework:
1. Identify the contract (or contracts) 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 in the contract.
5. Recognize revenue when (or as) you satisfy a performance obligation.
Say you received a fixed-fee grant to perform specific research for a governmental agency, and the agency will own the outcome. The grant is a contract because each party receives something of equal value (grant funds and research) (step 1). The provision and delivery of the research is the performance obligation under the contract (step 2). The fixed fee is the transaction price (step 3). With only one performance obligation, the entire transaction price is allocated to it (step 4), and you will recognize the grant revenue when you deliver the research to the agency (step 5).
This is a simplified example. Nonprofits can find it challenging merely to determine whether a grant is an exchange transaction or a contribution — or a combination of the two, requiring bifurcation for proper accounting treatment. And, when a grant is an exchange transaction, it can be tough to identify the performance obligations, when they’re satisfied and the proper allocation of the transaction price to those obligations.
ASU 2014-09 will take effect for some nonprofits as soon as 2018. Now is the time to start analyzing all of your revenues to determine when and how you should report them.
Determining how and when to recognize grant and contribution revenue can be tricky for many nonprofits, particularly those receiving government funds. The good news is that the Financial Accounting Standards Board (FASB) is at work on an Accounting Standards Update that will provide more guidance. As part of its “Revenue Recognition of Grants and Contracts by Not-for-Profit Entities” project, the board is considering two main issues:
• How to distinguish between grants and similar contracts that are exchange transactions (subject to the FASB’s five-step revenue recognition framework) and those that are contributions (not subject to the framework), and
• How to distinguish between conditions and restrictions for contributions.
Although still in the early stages of the project, the FASB has tentatively decided that a donor-imposed condition will require: 1) a right of return (either a return of the assets transferred or a release of the donor from its obligation to transfer the assets), and 2) a barrier that must be overcome before the recipient is entitled to the assets transferred or promised. (For example, the recipient must raise a threshold amount of contributions from other donors.) A final ASU is expected in first quarter 2018.