By Melisa Galasso, CPA
In June, the Financial Accounting Standards Board (FASB) issued ASU 2018-08, Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made, which will have a major impact on the financial statements of nonprofit entities. The timing of this ASU was critical considering the impending effective date of Topic 606, Revenue from Contracts with Customers, which creates significant new disclosures requirements regarding exchange transactions.
Topic 606 only applies to revenue from customers. By definition, a customer is engaged in an exchange transaction. Therefore, contributions, a key revenue source for nonprofits, were scoped out of Topic 606. However, certain transactions, including grants and other contracts, have been a source of confusion in the industry. It is not acceptable that three nonprofits could theoretically receive the same grant and could literally have three different accounting treatments for that grant. One may treat it as an exchange transaction and another as a contribution, while the third may bifurcate the transaction.
As a result of this confusion, FASB needed to address the classification of exchange and non-exchange transactions before nonprofits had to adopt Topic 606. Ultimately, FASB not only tackled that issue, but also addressed a longstanding problem with a lack of guidance around conditions. As a result, ASU 2018-08 will have a major impact on nonprofits.
Exchange versus non-exchange transactions
Distinguishing between an exchange transaction (where each party receives commensurate value) and a contribution (a non-exchange transaction) may seem like a simple task. In practice, however, this distinction was not always obvious, and accounting for grants is a prime example of how diversity in practice has muddied the waters. Some believe that governmental entities do not make contributions and therefore treat all government grants as exchange transactions. Others believe that the public good is equivalent with the governmental entity, therefore a grant that benefits the public should be treated as an exchange transaction.
Prior guidance indicated, “In a contribution transaction, the value, if any, returned to the resource provider is incidental to potential public benefits. In an exchange transaction, the potential public benefits are secondary to the potential proprietary benefits to the resource provider.” However, this was perceived by many to be insufficient guidance. ASU 2018-08 makes fundamental changes by clarifying that “In a contribution transaction, the resource provider often receives value indirectly by providing a societal benefit although that benefit is not considered to be of commensurate value.”
This clearly shows that public benefit would not lead to an exchange transaction. In addition, the standard also indicates that “the type of resource provider shall not factor into the determination,” which now clearly puts governmental grants on the same footing as grants from foundations and corporations.
ASU 2018-08 supersedes the prior guidance, Indicators Useful in Distinguishing Contributions from Exchange Transactions (958-605-55-8). In its place, FASB continues to address topics like expressed intent, discretion in determining amount and potential penalties. However, FASB also explicitly states that the resource provider (grantor) is NOT synonymous with the general public, as well as that the execution of the grantor’s (resource provider’s) mission or positive sentiment is NOT commensurate value. The effect of this language is intended to end existing diversity in practice. Ultimately, it is expected to also take many transactions that are today treated as exchange transactions and move them to the contribution guidance, which will reduce the number of items that are subject to the new Topic 606 disclosures.
FASB addresses the scope of the contribution standard by specifically excluding third-party payer scenarios, agency transactions and tax abatements. Transfers of assets from government entities to business entities are also not subject to contribution accounting. FASB does have a separate disclosure project that will address governmental assistance to for-profits.
Finally, ASU 2018-08 includes several examples of discerning commensurate value in the implementation guidance. These examples expand greatly on prior guidance to assist entities in making the determination.
Conditions versus restrictions
Now that more grants and contracts will be treated as contributions, FASB took the opportunity to address a gap in contribution guidance related to conditions. Many people misunderstood the difference between a condition and a restriction and the use of probability analysis often led people to not recognize conditions.
The old definition of a donor-imposed condition was “A donor stipulation that specifies a future and uncertain event whose occurrence or failure to occur gives the promisor a right of return of the assets it has transferred or releases the promisor from its obligation to transfer its assets.” ASU 2018-08 updates the definition to require two items: a right of return and a barrier. It removes the concept of a future uncertain event.
The ASU provides significant new guidance on determining a condition. It includes three indicators that would suggest that a contribution contains a barrier. The original exposure draft contained four, but FASB ultimately settled on three, while also clarifying certain terminology based on comment letter suggestions. In the final ASU, no single indicator is determinative and some indicators may be more important than others in certain circumstances. As a result, an entity would have to review the facts and circumstances carefully in each agreement. FASB also removes probability analysis, indicating that even if it was probable that a condition would be met, that would not impact the classification.
The first indicator is the existence of a “Measurable Performance-Related Barrier or Other Measurable Barrier.” If a contribution requires the nonprofit to achieve a certain level of service or a particular unit of output, that would indicate a condition. For example, if a grant says a specific number of people need to be assisted on a monthly or weekly basis, or a certain level of achievement is required (on a standardized test, for example), that would indicate a barrier. Let’s take a look at an example that would result in a change in treatment under ASU 2018-08. If a grant indicates the nonprofit must assist 100 people per week when historically the entity supported 1,000 people per week, the contribution would still be deemed conditional, as probability assessments are no longer permitted. Under prior guidance, if the possibility of not achieving the condition was remote, then it would not have been treated as conditional. Matching grants are another example of a measurable barrier. Conditions impact the timing of contribution accounting as the contribution revenue cannot be recognized until the condition has been met — thus creating timing differences when nonprofits are recognizing contribution revenue under the new standard.
The second indicator is “Limited Discretion by the Recipient on the Conduct of an Activity.” If a contribution indicated that a specific protocol must be followed or included specific guidelines regarding qualifying expenses, this would be an indicator of a barrier. The term “limited discretion” refers to the methods used to conduct the activity, which is different than a restriction, which limits the timing or purpose for which the funds can be used. Grants that are subject to U.S. Office of Management and Budget guidance on allowable costs are great examples of limited discretion.
The final indicator of a barrier is that the stipulation must be “Related to the Purpose of the Agreement.” Therefore, stipulations that are trivial or administrative would not require conditional treatment. In the past, for example, the requirement to provide an annual report would be looked at from a probability analysis. Under the new standard, probability assessments are no longer applicable. However, since the annual report is not related to the purpose of the agreement and instead informative, such a stipulation would not be indicative of a barrier and therefore not result in conditional treatment.
One of the more eye-catching lines in the standard related to these barriers is a statement that “In cases of ambiguous donor stipulations, a contribution containing stipulations that are not clearly unconditional shall be presumed to be a conditional contribution.” Obviously, this can lead to more contributions being deemed conditional. However, the standard does indicate that if there are no barriers and only a right of return then the contribution is unconditional. The implementation guidance again was augmented to include many more examples distinguishing a conditional stipulation from one that would not create a condition.
For entities that are resource recipients (grantees), the effective date is critical. Topic 606 differentiates between those nonprofits that are conduit bond obligors and those that are not. Therefore, Topic 606 was technically effective Jan. 1, 2018, for nonprofits with a calendar year-end that had conduit debt. As this standard was not issued until June, FASB was forced to be creative in its effective date. Therefore, public business entities or nonprofits that have issued, or are a conduit bond obligor for, securities that are traded, listed or quoted on an exchange or an over-the-counter (OTC) market will implement ASU 2018-08 for annual periods beginning after June 15, 2018, including interim periods within those annual periods. HOWEVER, this means that if a grant is currently treated as an exchange transaction, the entity would adopt Topic 606 and its related disclosures. Then when the nonprofit adopts this standard, if the grant is now treated as a contribution, the entity would have to undo all their prior disclosure efforts. Nonprofits with conduit debt should be thoughtful as to their date of adoption.
For all other entities, ASU 2018-08 is effective for annual periods beginning after Dec. 15, 2018, and interim periods within annual periods beginning after Dec. 15, 2019. This will align with Topic 606’s adoption date.
FASB also gave unique effective dates for resource providers (grantors). For public business entities or nonprofits that have issued, or are a conduit bond obligor for, securities that are traded, listed or quoted on an exchange or an OTC market that provide grants, ASU 2018-08 is effective for annual periods beginning after Dec. 15, 2018, including interim periods within those annual periods. All other entities will implement for annual periods beginning after Dec. 15, 2019, and interim periods within annual periods beginning after Dec. 15, 2020. The standard applies a modified retrospective approach, with a full retrospective approach permitted if desired.
Melisa Galasso, CPA, is the founder of Galasso Learning Solutions LLC in Charlotte, N.C., where she designs and facilitates courses in advanced technical accounting and auditing topics, including nonprofit and governmental accounting. She is a member of the VSCPA Board of Directors and sits on the Disclosures Editorial Task Force.