Not-for-profit organizations: How to account for conditional and restricted contributions (guide with journal entries)
Posted by: V.Weber
In June 2018 Financial Accounting Standards Board issued accounting standards update (ASU 2018-08, Not-for-Profit Entities (Topic 958): Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made. The purpose of this update was twofold: 1) to evaluate whether a transaction is reciprocal (exchange transaction – when something is given and something is gotten in return) or nonreciprocal (contribution – something is given and nothing is expected to be received in return, i.e. a gift); 2) distinguish between conditional and nonconditional contributions. I wanted to note that this ASU update is applicable not only to not-for-profit organizations, but also to all entities that make or receive contributions of cash and other assets (it doesn’t apply to transfer of assets from government to business entities).
Reciprocal versus nonreciprocal transactions (exchange versus nonexchange transactions)
To unpack the first question and evaluate whether a transaction is a reciprocal or nonreciprocal one, we should be asking ourselves a question on whether the donor receives something of value (commensurate or similar value, monetary or otherwise). In a case, for example, when a donor receives something for giving a gift to a not-for-profit organization, this would constitute an exchange transaction and would not be considered a contribution. On the other hand, when a donor contributes let’s say $500,000 to a charity organization without anything in return (except for a thank you letter or a small appreciation sign) – in that case, this would constitute a contribution.
Conditional versus unconditional contribution
Now let’s assume that we have determined that we do have a true contribution on our hands, now we have to determine how to record it according to the new ASU 2018-08 rules and determine whether the contribution is conditional or unconditional, restricted on unrestricted. The chart below helps to visualize the important differences between all the factors. According to the chart, there could be 4 scenarios:
- Unrestricted unconditional revenue
- Unrestricted conditional revenue
- Restricted unconditional revenue
- Restricted conditional revenue
Let’s take a look at each one of these scenarios in more detail.
Unrestricted unconditional revenue
This is the easiest one for everyone to understand. This situation would occur when a donor would make a contribution with “no strings attached”. Donee (the contribution recipient or a not-for-profit organization) would have a full discretion as to how and when the resources will be used. Not-for-profit organizations would recognize unrestricted support when contribution is received. At the same time, donor would recognize expense when contribution is made. Not-for-profit organization would record the following journal entry to record the transaction:
| Debit | Cash | $XXX,XXX |
| Credit | Unconditional Revenue | $XXX,XXX |
Now let’s take a look at another scenario.
Unrestricted conditional revenue
This is where donor conditions or “barriers” come into play. When it comes to barriers there are several factors that we need to consider. To begin, barriers are typically performance-related or measurable somehow. This typically means that the donor requires a certain level of performance before the contribution is transferred to the not-for-profit organization. For example, a certain specific outcome or a certain number of clients served, or a certain event or a matching requirement where the donor requires the not-for-profit organization to come up with a certain amount of cash to match the donation related to the purpose of the donation (and typically is written in the agreement). Another example of a barrier could be when a donor requires the nonprofit to perform a certain action or additional activity, like hiring an individual with specialized knowledge. A contribution can have multiple barriers (or conditions).
In terms of revenue recognition, if a donor establishes a barrier, it must be overcome before the revenue can be recognized. The donor recognizes revenue only when the condition has been substantially met at which point the donor can also recognize the expense. The following journal entry would be recorded by a not-for-profit organization when donor condition is substantially met:
| Debit | Cash | $XXX,XXX |
| Credit | Unconditional Revenue | $XXX,XXX |
I would like to point out an important key factor here and indicate that barriers (or conditions) are not the same as donor restrictions. We will dive into the restricted revenue below
Restricted unconditional revenue
As mentioned above, donors can impose restrictions on how and when their donation is to be used by a not-for-profit organization. As such, the main restriction types that a donor can impose is a purpose or time restriction of the use of funds. One example of restricted unconditional revenue could be a multi-year grant. For example, a not-for-profit received a three-year grant in the amount of $900,000 that stipulates that every year $300,000 is used to support a new program. In this case the full $900,000 is recorded when it’s received and recorded as revenue with donor restriction. A portion of the revenue will be released from restriction each year according to the agreement. On the statement of activities, the release from restriction would be shown each year. Journal entry at the receipt of the donation would be the following:
| Debit | Cash | $900,000 |
| Credit | Restricted Grant Revenue | $900,000 |
The at the end of the first grant year to recognize the release from restriction the following entry would be made:
| Debit | Net Assets released from restriction | $300,000 |
| Credit | Grant Revenue – Unrestricted | $300,000 |
On the statement of activities there would be two columns showing a column “without donor restriction” and a column with “donor restriction”.
Restricted conditional revenue
And last, but not least, I’d like to talk about restricted conditional revenue. This situation occurs when a donor establishes a barrier (discussed earlier in this article, please refer above) that must be met before the donee is entitled to the contribution. In addition to that, donors have also specified how the contribution must be used once the condition is satisfied. In this case a not-for-profit organization would recognize restricted revenue when conditions are substantially met, and donor would recognize the expense when the condition is substantially met. Journal entry to record this type of revenue will be a combination of the original transaction when the condition is met (barrier has been overcome) and after that similar journal entry pattern as described above can be used.
Right of Return
As the last point of this discussion, I wanted to add the importance of the right of return when dealing with conditional revenue. A right of return allows a donor to retrieve their contribution if the barriers are not appropriately met. The condition and the language of the right of return must be clearly identified in the agreement. Also, the wording does not need to be very specific and strict, it should contain a statement that would indicate a possible return of funds. For example, “any unused funds will be forfeited” or “any funds spent on unallowable costs must be returned to donor”. If the donor did not mention the possibility of return – the revenue would be considered an unconditional revenue and could be recorded immediately. A standard right of return clause with no actual barriers to overcome would also typically mean that the revenue is unconditional. If the barriers or right of return are not clearly documented within the agreement or elsewhere, it may a good idea to communicate with the donor to determine if there are any barriers. In addition to that, the guidance states that if a case when it is not clear whether the contribution has a barrier or right of return or not, the revenue should be treated as conditional rather than unconditional. Additional information on the guidance can be found at the official FASB website ACCOUNTING STANDARDS UPDATE 2018-08—NOT-FOR-PROFIT ENTITIES (TOPIC 958): CLARIFYING THE SCOPE AND ACCOUNTING GUIDANCE FOR CONTRIBUTIONS RECEIVED AND CONTRIBUTIONS MADE (fasb.org).
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