We are pleased to share this article written by David exploring revenue recognition for NFPs/NPOs.
Note: this article was first published by David on LinkedIn and the opinions expressed are his own.
Revenue recognition for NFPs / NPOs
How should grants and funding (also called non-exchange revenue) be recognised for not-for-profit / non-profit organisations (NFPs / NPOs)? Many want some form of ‘matching’ of the revenue to the associated expenses, because it is intuitive and ‘common sense’. However, the response by accountants is often “sorry, we cannot do matching”. The matching concept was not included in the original conceptual framework issued over 30 years ago, so income can no longer be deferred to match expenditure purely on that basis. Instead, the conceptual framework is focused on a tight definition of assets and liabilities, with revenue and expenditure linked to movements in those. Nonetheless, most of the preparers and users I interact with want matching.
The IFR4NPO (International Financial Reporting for Non-Profit Organisations) project is currently seeking feedback on their Consultation Paper, including proposals for revenue recognition, by 24 September 2021.
I have been involved in the consultation process for the IFR4NPO project, including their revenue outreach webinar. I have also recently been following or contributing to revenue issues for NFPs through:
- the revised Australian standards that apply IFRS 15 Revenue from Contracts with Customers to NFPs, and an Australian specific Income of Not-for-Profit Entities standard
- the Australian Accounting Standards Board’s (AASB’s) work on addressing stakeholder problems with the revised standards
- the AASB’s work on a ‘Tier 3’ for (smallish) NFPs
- the International Public Sector Accounting Standards Board’s (IPSASB’s) project on revenue (ED 70 Revenue with Performance Obligations and ED 71 Revenue without Performance Obligations).
Maybe, or at least something that gets the same or similar results. To achieve matching, at least for funding in advance, income needs to be deferred, which means recognition of a liability. That is, recognition of an obligation.
In Australia, we are applying IFRS 15 to NFPs (with AASB 15). We have done that by giving some NFP specific guidance, that clarifies contracts as being enforceable (binding) arrangements, and expands the role of ‘customer’ to include someone providing the funds and directing where the goods and services are transferred – even if they do not receive the benefits directly.
In order to apply the revenue deferral treatment in AASB 15, there must be ‘sufficiently specific’ ‘performance obligations’ under an ‘enforceable agreement’. So, what is sufficiently specific? A very good question, as the feedback to the AASB is that more guidance is needed. Broadly, to be sufficiently specific you need to know what goods and services will be transferred, and how much of the arrangement has been performed, so that the unperformed portion can be deferred. That often means at least some sort of quantitative measure to determine what goods and services are yet to be transferred.
In practice, many grants and funding agreements do not have quantitative output obligations (for example, 100 counselling hours). Often, the arrangements are more like: “here is some money for the activities you proposed to do”. Consequently, the criterion of ‘sufficiently specific’ is frequently not met due the absence of identification of goods and services to be transferred (other than amounts to be spent). Therefore, as the sufficiently specific measure of completion cannot be determined, the funding has to be recognised up-front (as there is no liability to defer).
Currently under IPSAS 23, treatment of non-exchange revenue depends on the funding arrangements; if there are restrictions then recognise revenue upfront, but if there are conditions then defer revenue. Are you confused about the difference between restrictions and conditions? If you are, I am not surprised! Looking up ‘restrictions’ on the Microsoft Word Thesaurus brings up limits (constraints, restraints). The word ‘conditions’ brings up stipulations (restrictions, preconditions). So, restrictions appears in both lists. While IPSAS 23 does define the terms, the IPSASB has noted that the concepts of restrictions or conditions under its current approach are difficult to apply in practice.
The IPSASB is currently proposing to apply IFRS 15 to the public sector with ED 70, like what Australia has done with our NFP modifications to AASB 15. Importantly, the IPSASB proposals include an additional standard (ED 71) that will allow deferral (i.e., ‘matching’) for some additional arrangements.
The mechanism for deferral under ED 71 is the recognition of a present obligation (liability) under a binding arrangement for ‘specified activities’ or ‘eligible expenditure’. Revenue is recognised as the recipient satisfies the present obligation – which is usually when the money is spent. At least an argument could be made that expenditure acts as a ready proxy for satisfying the present obligation in a majority of cases.
The reasoning that a present obligation (liability) exists is that there is a binding obligation (legally or by equivalent means), which a recipient has little or no realistic alternative to avoid and which results in an outflow of resources. The binding arrangement leads to an outflow of resources because the recipient cannot avoid using the resources received either to fulfil the requirements in the binding arrangement or by repaying the resources to the resource provider (grantor) or incurring some other form of penalty.
Under ED 71:
- a ‘specified activity’ is an action in a binding arrangement that must be completed by a transfer (grant) recipient
- ‘eligible expenditure’ is an outflow of resources incurred in accordance with the requirements set out in a binding arrangement.
In my experience, many grants are:
- written using terminology like specified activity or project, or eligible or allowable expenditure, and
- have refund clauses if money is not spent appropriately, or for unspent funds.
So, it does seem as though ED 71 may present a mechanism to achieve ‘matching’ while staying neatly within the conceptual framework definition of a liability. However, grants that have generalised provisions, without refund clauses or penalties, then upfront revenue recognition is likely.
Capital grant revenue also causes problems. What is the obligation? In Australia, capital grant revenue can be deferred over the construction period (the obligation to construct the asset), but not over the useful life of the asset to match depreciation.
The IPSASB ED 71 proposals in relation to capital grants (called capital transfers) are not entirely clear. It appears that the recognition of revenue is linked to the acquisition or construction of the asset – similar accounting to Australia.
However, situations where capital grants are combined with specified activities (for example, using a building to provide childcare services) can get complicated. Using the reasoning of the proposals, it would appear that once the building is constructed, there is still a present obligation to use the building for the ‘specified activities’. So, this could mean deferring the grant over the building’s useful life (therefore matching revenue with the depreciation expense).
The above discusses some of the issues surrounding ‘matching’ and recognition of grant and funding revenue, including capital grants.
I think the IPSASB proposals under ED 70 and ED 71, currently being redeliberated with the aim to issue standards in the near future, give the best approach to achieve ‘matching’ for NFPs / NPOs. However, these would need to be simplified for IFR4NPO project to be consistent with the approach of an IFRS for SMEs type document.
The first consultation period closed on 7 October 2021, but look out for future consultations on this topic in 2023.
To comment on this blog, please join the non-exchange revenue thread on the IFR4NPO LinkedIn page here.