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.

Recognizing contributions

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. 

Recognizing grants

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.

Be prepared

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. 

On the Horizon: FASB works on more guidance

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. 

With baby boomers — the largest and wealthiest generation in U.S. history — expected to transfer trillions of dollars worth of assets in the next few decades, this could be the right time to launch an endowment. Nonprofits have long turned to endowments for help providing the necessary financial resources to carry out their mission, now and into the future.

All endowments are not created equal. With a permanent endowment, the original gift is usually intended to be held into perpetuity, with only certain income available for use in operations. With a term endowment, you are generally allowed to also use the principal after the designated term has ended. Either way, though, you need to consider several key issues before making the move.

Balancing the pros and cons

Endowments appeal to nonprofits for several reasons. For example, the funds provide financial stability and can help ensure that programs stay focused on areas your board and donors rank as most important. An endowment also can reduce the headaches and uncertainty often experienced when you are forced to rely solely on work-intensive annual campaigns, special events and fundraising. Moreover, less event planning often equals more time to devote to your actual mission!

Endowments can help you attract additional donors, too. They demonstrate that your not-for-profit has earned the trust of other donors and will be around for the long haul. Endowments may also provide the added benefit of approaching donors from a position of strength and confidence, rather than neediness.

Be forewarned, however: An endowment can turn off potential donors, who might think your organization does not really need their contributions. Administrative tasks also could consume staff time, diverting it from the organization’s current needs.

Managing assets and spending

Not surprisingly, endowments come with some restrictions. The Uniform Prudent Management of Institutional Funds Act (UPMIFA) lays out the standards for managing and investing endowments. You wil need to establish a written investment policy for your endowment that satisfies those standards by addressing, among other things, asset allocation and spending.

Your board’s investment committee, with input from an investment advisor, should determine the best allocation across asset classes (for example, stocks, bonds and real estate) to earn your desired return on investment. If board members do not have expertise in this area, consider hiring an investment manager to advise you. Each investment decision must be made in the context of the endowment’s total portfolio, taking into account the risk and return objectives of the endowment and the organization.

When it comes to spending, UPMIFA lets you spend or accumulate at a rate the board determines is prudent for the endowment’s uses, benefits, purposes and duration — subject to seven specific criteria. These include the purposes of the organization and the endowment, general economic conditions and the organization’s other resources. And UPMIFA lets you base spending on the expected total returns of the endowment, including earnings on original principal and appreciation.

Taking a different route

If a traditional endowment does not seem like a good fit, do not worry — you are not necessarily out of luck. You can establish a “quasi endowment,” also known as a board-designated endowment or funds functioning as endowments. A quasi endowment could work well if your organization isn’t quite ready for a full-blown endowment campaign but wants the financial stability and other benefits associated with endowments, and has the funds to set aside for this purpose.

Unlike traditional endowments, quasi endowments are established by the board — not a donor. They are usually funded by unrestricted donor gifts or excess operating funds, and are not subject to UPMIFA. A quasi endowment may be more flexible than permanent or term endowments because the board can change its designation(s) at any time and for any reason.

Planning for the complexities

If you decide to pursue an endowment of any kind, keep in mind that the arrangements are more complicated than for funds raised through ordinary fundraising or capital campaigns. You will need to make sure you have, or can acquire, the requisite expertise in areas such as drafting investment policies, managing the investments and related financial reporting.