Essay 15

REVENUE RECOGNITION—CONTRIBUTIONS AND GRANTS

Part 3 – Using Restricted Revenue in Year Two and Later

CFOs have been coping with the challenges presented by FASBs 116 and 117 regarding individual contributions since 1993. ASU 2018-08 brought grant revenue into the sphere of 116 and 117, and we are still scrambling to adjust. In Part I we defined contribution and grant revenue. In Part II we talked about recording contribution and grant revenue in the year of receipt. In this final part I will share strategies for:

• Reporting in years after restricted revenue has been recognized.
• Tracking and using restricted revenue.
• Avoiding the restricted revenue conundrum whenever possible.

WHAT HAPPENS TO RESTRICTED REVENUE AFTER THE YEAR OF RECEIPT

When a program’s revenue is exclusively restricted contributions, any surplus in that program at the end of the year of receipt is classified as donor restricted revenue in the audited financial statements. The surplus represents donation income that has not yet been used for the intended purpose and therefore has not been “released from restrictions,” to use the language of Generally Accepted Accounting Principles (GAAP).

But the revenue was recognized in 20×1 and closed out to net assets. How can we now use it for the intended purpose in later years? Good question! You will release the restrictions in a subsequent year by spending the money, which may lead to a deficit. While GAAP assumes that you will use the restricted revenue at your earliest opportunity, it does not name a specific timeframe. You will need to train yourself, management, and board to think in multi-year terms. If you had only one program which had a surplus of $250 in 20×1 attributed to restricted revenue, and a deficit of $250 in 20×2 or 20×3 because the money was spent and the restrictions released, the revenue and expense will find each other in unrestricted net assets over the two- or three-year period. Management and board will have to be reminded regularly that this year’s deficit is offset by prior years’ surpluses.

INTERNAL FINANCIAL STATEMENT PRESENTATION WHEN THE MATCHING PRINCIPLE IS ABSENT

Presenting internal financial statements is a challenge when you are spending money that was recognized as revenue in a prior year because you will not have current year revenue to match with this year’s expenses.

Example:

Let’s say your appeal for the preschool went gangbusters and you wound up 20×1 like this:

20×1:

Total revenue exclusively from the appeal: $100,000

Total expenses: $50,000

Surplus: $50,000

20×2—no appeal:

Revenue: $0

Expenses $50,000

Deficit: ($50,000)

You have $50,000 of prior year restricted revenue to offset these expenses but it was recorded in 20×1. How to present 20×2 activity to management and board? Assuming even spending, each month the deficit in the preschool program will increase by plus or minus $4,000 ($50,000/12, roughly). CFOs everywhere have devised their own strategies. Here are some suggestions:

• Don’t do anything if the $4k monthly expenses are an immaterial amount compared to the size of the total budget. No need to confuse the board with complicated explanations.
• Manually adjust the bottom line on the face of your income statement by adding back the amount of last year’s restricted revenue that has been spent to date.
• Include an explanation in a footnote on the face of the income statement or in your financial statement narrative.

When a program is running a large deficit due to the timing of restricted revenues, you might try this trick:

(reference Carol Wilson)

Mini chart of accounts:

Accounts:

GL account #5099 Restricted Revenue Adjustments (revenue)

Cost Centers:

• Cost Center #997 GAAP Adjustments
• Cost Center #025 Preschool

Prepare the following journal entry each month (assuming even spending each month):

• • Debit GL revenue account #5099 in cost center #997 for $4,000
  • Credit GL revenue account #5099 in cost center #025 for $4,000

This entry will create a negative balance in GL account #5099 in cost center #997. This allows you to add revenue to cost center #025 with an overall net effect of zero.

The bottom line in your consolidated income statement will not change, but revenue is now available in the preschool cost center to offset the expenses. This strategy will help management review the individual program income statements.

KEEPING TRACK OF RESTRICTED CONTRIBUTION REVENUE

GAAP does not prescribe the length of time that net assets can remain as donor restricted on the balance sheet. I don’t imagine it was the intention of FASB 116 to encourage nonprofits to forget about prior years’ restricted revenue, but it certainly can happen. Many CFOs spend as little time as possible studying their audited statements and may not recognize the significance of a balance that shows up year after year in donor restricted net assets.

To go back to our preschool example: $100,000 was raised in 20×1 and only $50,000 was spent. Now let’s say the preschool started charging tuition in 20×2, raising enough revenue to cover current year expenses.

Revenue : $50,000

Expenses: $50,000

Net Income: $0

The $50,000 of restricted revenue reported in 20×1 was not needed in 20×2 so it remains in net assets with donor restrictions, and may languish there until an astute board member asks, “What is this?” The CFO is responsible for keeping the principles of restricted revenue in the forefront of decision-making. When it became clear in 20×2 that tuition would cover the preschool’s operating expense, the CFO should have reminded management that $50,000 of donor restricted revenue was still unspent. At that point a plan should have been formulated to use the money on, say, playground equipment, enrichment materials, teacher training, a bus, etc., and to make it known during the 20×3 budgeting process that these expenses were going to happen in 20×3, causing deficits. Each month the financial statement narrative would remind the reader of this situation. By the end of 20×3 the revenue and expense would be united in net assets.

The unspent revenue phenomenon usually applies to individual contributions versus grants. In our preschool example, the unused $50,000 came from scores of donors who will never know if it is actually spent or not. It is, of course, a disservice to the donors and the organization to forget to spend the money. Once it has become “stale” there might be a temptation to leave it there indefinitely as a cushion to help with cash flow. This would be unethical and noncompliant with GAAP.

I managed prior years’ unspent restricted revenue with a manual spreadsheet, but your auditors, GL software vendor, or members of a CFO network may be able to offer an alternative.

CONDITIONAL CONTRIBUTION REVENUE

Quick refresher (from Part I):

• Conditional contribution revenue is most often grant revenue.
• Grants are conditional when the grant contract specifies a barrier and a right of return.
• Conditional grant revenue is recognized when the barrier is overcome.

Just as restricted contribution revenue becomes unrestricted when the money is spent for the intended purpose, conditional revenue becomes unconditional when the barrier is overcome. Theoretically, conditional grant revenue that has become unconditional could be either unrestricted or restricted. However, once the barrier is overcome and the revenue becomes unconditional, the funding is usually released from restrictions and treated as unrestricted in the audited financial statements.

STRATEGIES FOR SALVAGING THE MATCHING PRINCIPLE

Throughout the three parts of this series I have not entirely concealed my views on the inconvenience of accounting for unconditional contribution revenue with restrictions. When revenues and expenses cross years, the income statement loses clarity, and you always carry around a nagging feeling that unused revenue is buried on a spreadsheet somewhere in your documents folder. It follows that in our ideal revenue picture, 1. donation revenue restrictions would be released in the year of receipt, and 2. all grants would be conditional.

I have emphasized in other articles that the CFO should be included in decision-making; grant applications is a case in point. Only the CFO fully understands the headaches to be avoided by employing these strategies:

Individual contributions:

• Be careful that your fundraising appeals do not inadvertently restrict the donations. If your appeal intentionally targets a program, fine, but general appeals should be carefully worded so that the auditors don’t tell you after the fact that the revenue is restricted.
• Make every effort to use restricted donations for the designated purpose in the year of receipt. You don’t have many options if the donations come in late December, as they tend to do. But as restricted contributions come in throughout the year, be sure to let the program managers know the funding is available, especially when the restriction mentions a specific line item, such as “Christmas presents for children” in a residential facility or “personal hygiene products” for the pantry.
• Train the program managers to look out for the restricted contribution line item on their income statements and to understand what it means. That way they can play a proactive role in ensuring that their contributions are used to maximum effect.

Grants

• Unconditional grants: timing of the official notification of an unconditional grant award determines the timing of the recognition of the revenue. Ideally your funder would date the award letter on or after day one of the year in which the project will be carried out.
• Conditional grants:
  • Since conditional grants have barriers, try to build a barrier into your grant applications. Barriers are likely to be metrics to be achieved before payment can be requested. If your program manager can identify a meaningful and achievable metric that can be defined as a barrier, your application will be stronger and the grant will potentially be classified as conditional.
  • Approach your funder about your intention to include barriers. Many grantors are aware of ASU 2018-08 and may therefore lend a sympathetic ear in your pre-application discussions.
  • Check with the auditors to verify that the barrier(s) you have identified will pass muster under GAAP.

RECAP

• Use of restricted revenue (also known as “release”) may lead to a deficit in cases where the revenue was recognized in a prior year.
• When prior years’ restricted revenue is released, this year’s deficits are offset by prior years’ surpluses.
• Restricted revenue should be released at the earliest opportunity.
• Prior year restricted revenue must be tracked from year to year.
• Conditional grants include at least one barrier; keep this in mind when preparing your applications.
• Conditional grant revenue becomes unconditional when the barriers are overcome.

Wrestling with the revenue recognition beast is challenging, for sure. I’m going to go out on a limb and say that no CFO, executive director, or board treasurer is an expert on the GAAP rules for contribution and grant revenue. Your goal should be to develop the ability to spot a revenue recognition issue when it arises and to make use of the services of your auditors. They endure countless continuing education seminars on the subject. They certify your statements, and their interpretation of the rules is the law. You might be able to persuade them of the validity of your interpretation, but don’t count on it.

The auditors do not have all the answers, though, for customizing your general ledger, training staff to properly code receipts, and preparing meaningful internal financial statements. Trainings on revenue recognition abound and can be useful, but they often target CPAs rather than CFOs. Networking with other practitioners is the best way to get moral support and suggestions for practical solutions to issues that are specific to your software and your sector. Always keep in mind that you are in the company of just about every nonprofit CFO in finding the rules bewildering. You will find solutions and live to tell the tale!