Essay 14

REVENUE RECOGNITION – CONTRIBUTIONS AND GRANTS

Part 2 – Financial Statements and Year One Journal Entries

In Part I of this series we established definitions for unconditional and conditional contributions and grants within the framework of FASBs 116 and 117 and FASB ASU 2018-08. Our task now is to explore how we account for and report grant and contribution revenue. As you read, keep in mind that the FASB does not share a CFO’s understanding of the terms “contribution” and “grant.” To us, contributions are donations from individuals or businesses, and grants are awarded by institutions. In our minds there is an enormous difference between the two, but to the FASB both are contribution revenue. As far as GAAP is concerned, there is only one set of rules whether we are talking about a $25 individual donation or a $1 million grant.

We learned in Part 1 that the revenue recognition rules are all about timing. FASB 116 dictates that unconditional contributions are recorded upon receipt of cash or a promise to give. Now we will dip our toes into 117. Most CFOs of small- to mid-sized organizations have not committed FASB 117 to memory and don’t include the language of 117 in their monthly financial statements. However, as the architect of your general ledger system, you need to understand the essential concepts. The CFO is charged with keeping track throughout the year of the comings and goings of restricted revenue. General ledger accounts, cost centers, and proper coding of receipts and expenses all must conform to GAAP rules in order to avoid nasty surprises that may arise in the following months when the auditors set up shop in your conference room and start asking for reports and account detail.

FASB 117—FINANCIAL STATEMENT PRESENTATION

A bit of housekeeping: Back in 1993 when 117 came out as a companion to 116, new terms for financial statements were introduced. Audited financial statements now label the income statement the “Statement of Activities” and the balance sheet the “Statement of Financial Position.” Many of us continue to use the old terms, such as “Profit and Loss Statement” for our internal financials, but we’ll use the official terms here.

Most of your donations will probably come with no restrictions and will therefore be classified as unrestricted contribution income on the statement of activities. A restriction is present when the donor has specified a purpose and/or timeframe for the contribution. The restriction is “released” when the money is spent according to the donor’s intentions. Donations received in the first two or three quarters will usually be spend in the year of receipt. In this case the restriction is released in the year of receipt and is classified as unrestricted on the statement of activities, along with the donations that came with no restrictions. If you are not able to spend the money in the year of receipt, the revenue will be classified as restricted.

Let’s say a restricted donation of $1,000 received in 20×1 is not spent as of 12/31/x1. It is classified as “donor restricted” on the statement of activities in 20×1. The $1,000 is closed out to net assets on the statement of financial position in 20×1, but it is segregated within net assets in the section called “with donor restrictions.” On this point: be sure that you are clear that even though that $1,000 gets special treatment in the audited financial statements, it has been recognized and closed out to net assets. This is not an esoteric point that need only concern the auditors. The 20×1 entry has been made in your general ledger, and you therefore cannot use the revenue to offset the expenses in 20×2 in your internal financial statements. I learned from painful experience that you cannot simply make a journal entry the next year to bring that $1,000 back. You would have to debit net assets, which is almost always taboo.

Assuming that the money is spent in 20×2, the amount of the restricted revenue makes a encore appearance on the audited financials, but don’t be fooled into thinking that the revenue is miraculously reborn. In 20×1 we reported that we had income with donor restrictions. In 20×2 (or later) we must tell the readers that the restrictions have been released. You will see Net Assets Released from Restrictions” twice on the statement of activities, coming in and going back out, with a net effect of zero. On the 20×2 statement of financial position, the $1,000 has been released, so it is moved from the section in net assets titled “with donor restrictions to the section called “without donor restrictions.”

RECORDING CASH RECEIPTS AND PROMISES TO GIVE

Revenue Recognition Examples

The Cape Rose Early Education Center will serve as our hypothetical nonprofit preschool.

Selected accounts and cost centers:

General Ledger (GL) Accounts

• GL account #1000 Cash (assets)
• GL account #2000 Accounts Receivable (assets)
• GL account #3010 Deferred Revenue (liability)
• GL account #5010 Unrestricted Contributions (Income)
• GL account #5020 Restricted Contributions (Income)
• GL account #5030 Grant Revenue (Income)

Cost Centers

• Cost center #999 Unrestricted Revenue
• Cost center #025 Preschool
• Cost center #030 Teacher Training

Unconditional contribution revenue—individual donations

Unconditional contributions—unrestricted or restricted—are recorded upon receipt.

Example – no donor restriction:

• Check for $500 made out to the organization with no indication of a donor restriction
  • Debit GL #1000—cash—$500
  • Credit GL #5010—Unrestricted Contributions—$500; Cost Center #999—Unrestricted Revenue

I believe that it is best to use a dedicated cost center (#999) for unrestricted contributions. You can always “give” some of that revenue to programs that need it at year-end, but you can avoid confusion by keeping restricted revenue in the programs and segregating unrestricted revenue in #999 throughout the year. Management and board will have a truer picture of the financial health of your programs when program revenue reflects only the restricted amounts.

Example – donor restriction

• Credit card payment of $100 in response to a fundraising appeal for the preschool program
  • Debit GL #1000—cash—$100
  • Credit GL #5020—Restricted contributions—$100; Cost Center #025—Preschool

Unconditional contribution revenue—grants

Unconditional grant revenue is recognized when the promise to give is officially communicated. When no barriers are present, the revenue event has occurred for the entire amount of the grant—even a multi-year grant—when the award letter or executed contract arrives. In GAAP speak, an award letter is a promise to give and triggers revenue recognition even before the contract is executed.

Example—unconditional grant

Executed contract for an unconditional five-year grant of $500,000 for teacher training is received in December of 20×1 along with a cash advance of $50,000.

• Entry #1
  • Debit GL #1000—Cash—$50,000
  • Credit GL #5010—Grant Revenue—$50,000; Cost Center #020—Teacher Training
• Entry #2
  • Debit GL #2000—Accounts Receivable—$450,000
  • Credit GL #5100—Grant Revenue—$450,000; Cost Center #030—Teacher Training

Note that there is no entry to deferred revenue!!

CFOs looking at these entries will say, “all this revenue is going to blow up the Teacher Training cost center!” Quite true, but if you are making the entries at the end of the year, your internal financials won’t be affected. If cash is not involved, many CFOs will wait until they are preparing for the audit and include this in their year-end closing entries. Alternatively, you could create a cost center, say #998, called “Restricted Grant Revenue.”

Conditional contribution revenue – grants

In the small to mid-sized nonprofit arena the concept of conditional contribution revenue applies pretty much exclusively to grants. Speaking from my experience I will limit my comments to grants because I have never seen an individual contribution that specified a right of return and a barrier.

Conditional grant revenue is earned by overcoming the barrier specified in the agreement.

Example – conditional grant

An award letter is received for a conditional grant of $50,000 requiring that five teachers each complete an identified series of LEAN Six Sigma trainings before payment can be requested.

• The award letter or contract is received: no entry
• Cash advance of $5,000 is received with the executed contract.
  • Debit GL #1000—Cash—$5,000
  • Credit GL #3010—Deferred Revenue—$5,000
• When the trainings are completed
  • Debit GL #3010—Deferred Revenue—$5,000
  • Debit GL #2000—Accounts Receivable—$45,000
  • Credit GL #5010—Grant Revenue—$50,000; Cost Center #030—Teacher Training

Consulting with the auditors on grant revenue

Before deciding on the accounting for new grant funding, be certain whether it is unconditional or conditional. Study your grant contract with great care and consult with the auditor. There could be differing interpretations of the provisions in the contract. Since the auditors will be certifying your financial statements, their interpretation is the one to base your accounting on. For example, a five-year grant contract may specify that the funding from years two through five is dependent upon the grantor’s funding sources. This limits the availability of funding, in which case you will record revenue each year when you are notified that it is available. Is this a barrier? Is your grant conditional? Show the auditors the contract when you receive it. You will both be grateful to avoid angst-producing surprises during fieldwork.

RECAP

• Restricted contribution revenue is “released from restrictions” when the money is spent for the intended time and/or purpose.
• Restricted contribution revenue becomes unrestricted when it is released from restrictions. This often happens in the year of receipt.
• Restricted contributions that are not released from restrictions by year-end are classified as “donor restricted” in the net asset section of the statement of financial position.
• In the year that restricted contributions are released from restrictions the released amount is reclassified as “without donor restrictions” in the net asset section of the balance sheet.
• Grant funding that has no barriers is defined as unconditional, restricted, contribution revenue.
• Unconditional grant revenue is recognized when the promise to give is officially communicated with an award letter.
• Conditional grant revenue is recognized when the barrier is overcome. Cash advances for conditional grant projects are credited to a deferred revenue account.

We have made our way through the accounting for receipt of cash and promises to give. In Part 3—our final article in the series—we will look at the impact of contribution revenue on daily operations and internal reporting.