As we continue to dig into some of the most prevalent changes that ASC 606 will have on each industry, we would like to today put special focus on nonprofits, who, much like other organizations, will have to make changes to become compliant with the new standards. However, nonprofits have higher stakes and fewer resources (with just as little time).
Background: Nonprofits and the Impacts of ASC 606
Nonprofits are not immune to the effects of ASC 606, which is designed to change the way that organizations handle contracts, recognize revenue, and account for their revenues. Since nonprofits’ revenues go directly toward their mission, complying with ASC 606 is not just necessary to avoid GAAP noncompliance, it’s necessary to help the people who require your services.
Over the past couple years, we’ve spent a lot of time discussing the steps, as noted in our whitepaper on the topic and the following resources:
- AICPA Industry Task Forces Weighing in on ASC 606 Implementation
- ASC 606 Webinar for Private Entities: August 28, 2018
- ASC 606 Realities for Private Companies
- How to Know if You’re Ready for the New ASC 606 Standards
- What Departments Face the Biggest Changes from ASC 606?
A Brief Overview of the New Standards
ASC 606 is designed to simplify standards across industries, combining over 200 different processes into one large standard. Since contracts are constructed differently for different industries, the changes need to be handled differently. It’s why we’ve started our industry spotlight series—to show just how big the change will be for each company.
Impact of the New Standard on Nonprofits and Educational Nonprofits
For nonprofits, especially those in the education community, you will have unique challenges in recognizing revenue from contracts.
What ASC 606 Does Not Cover
Before getting into revenue streams that are covered by the new standard, first we’d like to share what’s not covered, namely the following:
- Lease contracts
- Insurance contracts
- Financial contracts
- Investment Income Revenue
- Contributions and Collaborative Agreements
ASC 606 for Nonprofits
Looking at what the standard does cover, there are a few general considerations.
- Reciprocal vs. Nonreciprocal Grants and Contracts: For grants and contracts, nonprofits will need to decide on each transaction whether it represents a reciprocal or nonreciprocal agreement. Knowing this, reciprocal grants and contracts will need to follow the standard, nonreciprocal will not, but from here additional complexities could arise, in which nonprofits may have to analyze which portion of a contribution is an exchange transaction and which is a contribution.
- More Estimates and Judgements: With the rise of performance obligations, management may need to make more estimates than previous standards.
- Revising Debt Covenants and Contract Terms: If a debt covenant is tied to accounts impacted by the standard, you may have to discuss this issue with lenders. Additionally, contract terms regarding payment arrangements may need to change if they do not result in the desired accounting treatment.
- Potential Changes to the Timing of Taxable Income: If revenue timing changes, you may need to make a change to the timing of your taxable income.
ASC 606 for Educational Nonprofits
While nonprofits have their own general standards, RevenueHub noted that educational nonprofits had unique challenges:
What Makes a Contract?
A contract creates enforceable right between a customer and a customer and entity. However, for educational institutions with admissions and enrollment, it may require analysis of whether this process creates enforceable rights and obligations.
Regarding the existence of a contract, ASC 606-10-25-4 notes that a contract does not exist if both parties have a “unilateral enforceable right to terminate a wholly unperformed contract without compensating the other party.” When considering whether a contract is wholly unperformed, the following two criteria must exist:
- the entity has not transferred any promised goods or services to the customer and
- the entity has not received (nor is entitled to receive) any consideration for the promised goods or services.
For instance, in the event of a nonrefundable enrollment fee or housing deposit, consideration has been received/the institution is entitled to consideration, then the contract is not ‘wholly unperformed,’ and a contract likely exists.
In the event of nonrefundable deposits, institutions must recognize a contract liability in the event of a prepayment. In this prepayment, the contract liability is considered deferred revenue, as the payment has been received before services rendered.
Sometimes, the student pays the deposit but does not take use the services, resulting in breakage. ASC 606-10-55-48 allows entities to recognize the expected breakage amount as revenue. For nonrefundable deposits, in which only two outcomes are possible—services are rendered or the deposit is forfeited entirely—the institution can only recognize breakage revenue when the student’s right to receive services has been forfeited.
Another part of a contract’s existence is the collectability threshold. In order for a contract to exist, it must meet a collectability threshold, i.e. the probability that the institution will collect tuition, housing fees, or the like meet certain criteria, additionally looking at things such as payments from third parties. Knowing this, if the institution concludes that it’s unlikely that they will collect, a contract does not exist and the institution cannot recognize revenue.
ASC 606-10-25-7 provides three circumstances in which revenue may be recognized even though the contract requirements listed in ASC 606-10-25-1 are not met:
- The entity has no unfulfilled obligations to the customer and all (or substantially all) of the promised consideration has been received.
- The contract has been terminated.
- The entity has transferred to the customer control of all goods or services relating to the received consideration and has no obligation to transfer additional goods or services.
Combination of Contracts
ASC 606-10-25-9 lists three criteria which indicate that the contracts should be included in a single contract:
- The contracts are negotiated together with a single commercial objective.
- Consideration amount depends on the price or performance of another contract.
- The promised goods or services are a single performance obligation.
Practical Expedient for Portfolio Approach
If you have a portfolio with similar characteristics ASC 606 allows entities to apply the revenue recognition guidance for the entire portfolio as opposed to single contracts, if doing so would not cause the financial statements to differ materially.
Identifying Separate Performance Obligations
When offering housing and education, institutions need to determine if the two processes are distinct. If the services are distinct, then each service is treated as a separate performance obligation.
Consideration Paid to Customer
In some events, discounts to tuition are offered by the institution in the form of price reductions. For educational institutions, this constitutes consideration paid to the customer. However, to determine whether this is actually consideration paid to the customer, the institution has to determine that the price reductions are made in exchange for a good or service. If in exchange for a work-study, this is consideration, but if it is a scholarship, this would be considered a reduction in transaction price.
Right to Withdraw from a Contract
Certain situations arise in which the student is allowed to withdraw from a course without incurring costs, resulting in a refund for the student. In this case, the tuition is refunded. When this happens, the payment is considered variable consideration. After receiving potentially-refundable consideration, institutions must recognize a refund liability for the amount which they have received but expect to refund. For institutions, they should only include variable consideration when they believe that a significant reversal will not take place. At the end of each reporting period, institutions must re-measure the size of the refund liability, adjust for updated estimates of variable consideration, and recognize the resulting impacts as additions or reductions to revenue.
Allocating Transaction Price to Performance Obligations
The transaction price should be allocated to different performance obligations within the same contract based on relative standalone selling prices. ASC 606-10-32-32 explains that the “best evidence of a standalone selling price is the observable price of a good or service” sold separately to similar customers in similar circumstances.
Timing Revenue Recognition—Over Time
Under ASC 606, revenue can be recognized at a point in time or over time. If the performance obligations are satisfied at a point in time, then revenue is recognized at a point in time. If the performance obligations are satisfied over time, then revenue is recognized over time. With much of a student’s education taking place over the course of a quarter, trimester, semester or year, revenue needs to be recognized over time
Per ASC 606-10-25-27, entities satisfy performance obligations over time if a customer simultaneously receives and consumes the benefits related to a performance obligation, and institutions need to measure progress towards the satisfaction of such performance obligation using either the input or output method.
In addition to providing a revenue recognition framework, ASC 606 requires specific financial statement presentations relating to revenue. Paragraphs 285 and 286 of ASC 606-10-55 show that entities must recognize a receivable (and a corresponding contract liability) if contracts become non-cancellable (often after the refund period ends). In a manner similar to customer prepayments, not-for-profit entities should recognize a contract asset if they provide services to customers before receiving payment.
Nonprofit entities have many challenges, and the transition to ASC 606 is another one of which that will cause them to scramble to make changes. From nonprofits in general to educational nonprofits ranging from private and independent schools up to universities. At Wipfli, we work with nonprofit entities every day to improve their accounting processes and technologies to not only stay incompliance but to thrive despite their limited budgets and resources. We invite you to learn more about Sage Intacct, ASC 606, and our proprietary solution for independent schools—SchoolConnect.