Topic 3.5 Considerations for Gov Funding - Revenue Recognition PDF

A PRACTICAL GUIDE FOR REVENUE RECOGNITION AT HIGHER EDUCATION INSTITUTIONS Applying Topic 606 Using Various Contract Examples WEALTH ADVISORY | OUTSOURCING | AUDIT, TAX, AND CONSULTING CLAconnect.com ...

A PRACTICAL GUIDE FOR REVENUE RECOGNITION AT HIGHER EDUCATION INSTITUTIONS Applying Topic 606 Using Various Contract Examples WEALTH ADVISORY | OUTSOURCING | AUDIT, TAX, AND CONSULTING CLAconnect.com  ©2017 CliftonLarsonAllen LLP ©2016 In May 2014, the Financial Accounting Standards Board and cumbersome. But implementing the following practical (FASB) issued new accounting standards (Topic 606) that steps can make what appears to be a monumental task much overhauled accounting for revenue recognition. more manageable: The objective of these new rules is to develop a single, Review commentary from accounting firms and other principle-based revenue standard. Topic 606 aims to improve resource groups and, when possible, attend live training accounting for contracts with customers by providing a courses. Once you get a baseline understanding, read the robust framework for addressing revenue issues as they standard while thinking about your institution’s revenue arise, increasing comparability across industries, and streams and questions you may have in interpreting Topic requiring better disclosure. 606. The AICPA’s Revenue Recognition Task Force has published helpful information on specific revenue steam The scope of the new standards includes all contracts with implementation issues. customers (except lease contracts, insurance contracts, Take inventory of all your institution’s significant revenue financial instruments, guarantees, and non-monetary streams. Have a team member create an Excel spreadsheet exchanges in the same line of business to facilitate sales to that lists all of the current revenue sources. This is an customers). It should also be noted that contributions are important starting point for implementing Topic 606 and not within the scope of Topic 606, so you will continue to can guide later implementation steps. account for contributions under the current standards (ASC Using your inventory, assign team members to be 958-605). responsible for adopting Topic 606 for assigned revenue Achieving the core principle in five steps streams or categories. Consider utilizing legal or operational personnel. New model includes a five-step process Task each champion with determining an initial position The core principle of the new standards is to recognize on Topic 606’s effect on their assigned categories. Start revenue to depict the transfer of promised goods or services by documenting the current revenue recognition process, in amounts that reflect the consideration to which your and then identify the relevant sections in Topic 606. When entity expects to be entitled in exchange for those goods or options or judgements are required, be specific as to services why a certain decision was made. Support this decision FASB included five steps to achieve this core principle. These with facts, and review your conclusions with other team steps will help your institution determine how to recognize members, external auditors, and peers within the higher revenue from contracts with customers: education industry. Finalize and approve the new revenue recognition policy. Step 1: Identify the contract(s) with the customer. Consider the need to train staff on new policies and Step 2: Identify the performance obligations. procedures. Ensure significant changes are communicated to the Step 3: Determine the transaction price. president and governing board. Other team members Step 4: Allocate the transaction price to notify may include internal auditors, any individual responsible for executing external contracts, and vice Step 5: Recognize revenue when (or as) a performance presidents with budget responsibilities who may be obligation is satisfied. affected. There is significant guidance contained in Topic 606 further Keep in mind while reviewing specific revenue contracts or defining and showing examples of the five-step process. For accounts that any potential change to revenue recognition those institutions with conduit debt, the new standards are may be immaterial your current practices. If a change is effective for fiscal years beginning after December 15, 2017; deemed insignificant, there may not be a need to alter your all other institutions are required to implement the new current revenue recognition policy. Any decisions to that standards for fiscal years beginning after December 15, 2018. effect should be discussed with your external auditor; there could be a need for annual passed audit adjustments. Practical steps for implementing ASC 606 For many accountants, principle-based standards can be the hardest to implement. We tend to feel more comfortable with the rules-based standards and their black-and-white decision points. To add to the discomfort, Topic 606 is long 2 CLAconnect.com  ©2017 CliftonLarsonAllen LLP Application examples would be materially different between a portfolio approach Once you have an implementation plan in place, it’s helpful (e.g., all students enrolled for the fall semester) and to take a look at some common higher education revenue recording each individual student separately. In this case, the stream scenarios and how they might analyzed within university determined that there is not a material difference the five-step process. Common revenue stream examples and used the portfolio approach to recognize revenue from include: tuition, room, and board services. Tuition and housing Step 2: Identify the performance obligations Naming rights The university has the obligation to provide classroom License and royalty instruction and a room in a residence hall. Are these services Intellectual property distinct? If so, they need to be accounted for separately. The Exclusive food service university concluded that tuition and housing are distinct Research grant services, as a student can benefit from educational services Sponsorship without the need for housing. As a result, tuition and housing are considered separate performance obligations. Membership revenue These scenarios are hypothetical, and analysis and Step 3: Determine the transaction price application could significantly change depending on your The university has published fees for different educational unique circumstances. levels and programs offered, so the transaction price is different based on different class of students. The university Tuition and housing receives payments from its students, or from others on Scenario — A university’s charges for tuition and housing are behalf of its students. The transaction price includes published on its website. Upon acceptance to the university, payments from all sources. a student must pay a non-refundable deposit to hold a spot. The university offers aid packages to students in various The university sends a bill for the remaining balance due a forms, including scholarships and discounts. If a student month prior to the start of the semester. There is an add/ is doing nothing in return for a particular scholarship, the drop period (first two weeks of the semester) when the amount of that scholarship is recorded as a reduction to student may receive a partial refund of the gross amount of revenue when revenue is recognized. If a student performs tuition and housing charged. a service in exchange for a reduction of tuition, that amount Using the AICPA Financial Reporting Executive Committee would be recorded as an expense. (FinREC)’s working draft for recognizing revenue from tuition The university has an add/drop period in which the student and housing, the university could apply the five-step process can receive a refund. Based on historical experience, the in the following way: university estimates the percentage of students who will be due a refund. This percentage will then be used to reduce Step 1: Identify the contract(s) with the customer revenue recognition. If a student paid the bill prior to the A contract exists as a student is exchanging consideration start of the semester, this amount will be reclassified from for education and housing services to be provided by the contract liability (deferred revenue) to refund liability. After university. However, the contract’s timing will vary among the two-week add/drop period ends, the university makes institutions based on individual policies and procedures. adjustments to this estimate based on actual results. This would include a review of registration and admission practices. Step 4: Allocate the transaction price The university requires a student to pay a non-refundable The university had concluded (in step 2) that tuition and deposit to hold a spot for the upcoming semester. This in housing are separate performance obligations. As a result, essence is a prepayment for the educational and housing the price is allocated to these separate contracts based services to be provided at a later date. As a result, when on their respective published rates. The university also the university receives the deposit, it will record a contract concluded that financial aid applies both to tuition and liability (deferred revenue). When the student begins taking housing and so reduced the transaction prices accordingly. class and moves into the dorm, this contract liability will be Step 5: Recognize revenue included in the transaction price (see step 3 below). Revenue for tuition and housing would be recognized ratably In this step in the revenue recognition process, the university over the course of the semester as the related services are should determine if applying the revenue recognition criteria performed. 3 CLAconnect.com  ©2017 CliftonLarsonAllen LLP Practical considerations Naming rights (first example) According to a typical academic calendar and related billing Scenario — A university receives $13,000,000 from a cycle, the journal entries would be made as follows: corporation. In exchange, the university agrees to name its new basketball stadium in the corporation’s name. Nonrefundable deposit received prior to the start of the That name must be prominently displayed on the front of semester — debit cash, credit contract liability (entire the stadium to certain specifications contained within an amount of deposit) agreement between the university and the corporation. The A bill is sent for the remaining balance due prior to the stadium is located next to a heavily traveled road in the heart start of the semester — no entry, an unconditional right to of the city where the university is located. The term of the consideration does not exist agreement is 15 years. Student pays entire bill prior to the start of the semester — debit cash, credit contract liability (the entire amount Step 1: Identify the contract received) This is considered to be a reciprocal contract. The university Debit contract liability, credit refund liability (estimated and the corporation have approved the agreement and refunds due based on historical analysis during the add/ are committed to satisfy the terms. The university has the drop period) obligation to name the stadium in the corporation’s name First day of class — Debit contract liability, credit revenue. and display that name per specification in the contract. The Amount is calculated by taking the total fee divided by the payment terms are identified. The contract is deemed to have number of days in the semester; less the refund estimate commercial substance as the corporation is receiving value calculated by taking net fees (total fees less un-refundable (advertising). The university determines that collectability of deposit) divided by the number of days in the semester the consideration is probable. times the percentage estimate of refunds. Assume total charges are $10,000, the refund estimate is 10 percent, Step 2: Identify the performance obligations the semester is 100 days, and the non-refundable deposit The university must exclusively name the stadium after the is $1,000. Amount recorded would be $91 ($10,000)/100) corporation and maintain signage in accordance with the – ($9,000/100 * 10 percent) terms of the contract. End of add/drop period assuming student dropped 10% of classes — Debit refund liability, credit cash (This entry Step 3: Determine the transaction price assumes the refund liability was estimated 100 percent The transaction price is $13,000,000. correct. If the refund liability needed adjustment, an entry would be made to update the refund estimate to actual.) Step 4: Allocate the transaction price There is one performance obligation; therefore the entire Throughout the remainder of the semester — Debit transaction price is allocated as such. contract liability, credit revenue (ratably over the semester term) Step 5: Recognize revenue Analysis under the new revenue recognition model may not Revenue is recognized when a performance obligation is be necessary for semesters that begin and end within the satisfied. In this case, the naming right for the stadium fiscal year, assuming interim GAAP reporting is not utilized. lasts 15 years. It is deemed reasonable to conclude that the corporation simultaneously receives and consumes the The above example may seem complicated. But for benefits over the term of the contract. Therefore, revenue traditional academic calendars and semesters, Topic 606 may would be recognized pro ratably over the term of the not have a significant impact. If you have a summer semester contract. that spans fiscal years, you would need to implement procedures to track and calculate refund estimates. Journal entries will need to be prepared to record contract liabilities and or refund liabilities. If your institution historically recorded a receivable and deferred revenue as bills were rendered and mailed, that practice is not acceptable under Topic 606, as an unconditional right to consideration does not exist. 4 CLAconnect.com  ©2017 CliftonLarsonAllen LLP Naming rights (second example) Step 3: Determine the transaction price Scenario — A university receives $200,000 from an alumnus. The transaction price includes both fixed and variable In exchange, the university agrees to name a residence hall consideration. The fixed component is the upfront payment in the alumnus’ name. That name is to last into perpetuity so of $500,000 upon the execution of the contract. The variable long as the residence hall stands. consideration is the royalty of 1 percent of future sales on items containing the university’s name or logo. Step 1: Identify the contract The revenue recognition standards note that if there are Step 4: Allocate the transaction price other sections of the FASB Accounting Standards Codification As noted in step 3, there is only one performance obligation. that specify how to separate and/or initially measure one Therefore, the entire transaction price is allocated to that or more parts of a contract, then those provisions should performance obligation. be applied first. We need to consider guidance contained in FASB ASC 958 to determine if this particular example meets Step 5: Recognize revenue the definition of a contribution, an exchange transaction, or The university analyzed if the nature of the license being both. To be considered an exchange transaction, each party provided was a functional license or symbolic license as to a contract receives and sacrifices commensurate value. defined by Topic 606. Generally, a functional license equates The university analyzed the above contract and determined to point-in-time recognition, where a symbolic license that the alumnus did not receive commensurate value for equates to over-time revenue recognition. Functional the consideration paid. Therefore, the above transaction intellectual property has the characteristics of standalone would be accounted for as a contribution and further functionality. Symbolic intellectual property does not have analysis under the new revenue recognition standards would standalone functionality. The value of symbolic intellectual not be required. property is derived from the university’s past and ongoing activities. The university concludes that the commercial company has obtained the rights to symbolic intellectual property, as the value of the university’s name and logos License and royalty (similar to that contained comes from a rich history of quality education services and in ASC 606-55-395) competitive sports teams. Absent these activities, the logos Scenario — A university participates in significant NCAA would have little value or standalone functionality. As a Division I sporting events. A commercial company obtains result, the single performance obligation identified is satisfied the license to use the university’s name and logos. The over time. commercial company manufactures various items such as clothing, hats, and memorabilia on which it plans to affix the The consideration for this contract has a fixed piece (upfront university’s name and logos. For these rights, the university payment of $500,000) and a sales-based component receives $500,000 at the execution of a contract. The (royalty). As it relates to the fixed consideration, the university will also receive a royalty of 1 percent of the sales university analyzed FASB 606-10-25-31 through 25-37, which price of any products using its name and logos. The term of covers measuring progress toward complete satisfaction of a the contract is four years. performance obligation. This section further defines output and input methods for measuring progress. After careful Step 1: Identify the contract consideration, the university decided it would utilize an There is a contract between the university and the input method as resources are consumed as time elapses. commercial company wherein the university receives The university expects that inputs are expended evenly commensurate compensation for allowing the commercial throughout the performance period and, therefore, will company to access its name and logos. recognize revenue on a straight-line basis over the term on the contract, starting on the commencement date. Step 2: Identify the performance obligations As it relates to the sales-based royalty, FASB ASC 606-10-55- The university has analyzed the provisions of Topic 606 65 applies. Revenue should be recognized only when or as related to if there is one or more distinct goods or services the latter of 1) sale occurs or 2) the performance obligation contained within the contract. The university will continue to which some of the sales-based usage has been partially to participate in athletics and maintain excellence in satisfied. As a result, the university will recognize revenue as educational services. These activities do not directly transfer the subsequent sales occur. a good or service to the commercial company, so only one performance obligation is identified: the granting of a license to the commercial company. 5 CLAconnect.com  ©2017 CliftonLarsonAllen LLP Intellectual property completed. The university will also receive an agreed-upon Scenario — A university has a world-renowned marching percentage of food sales to students, to be remitted by the band that recently completed a recording of marches by food service company to the university on a monthly basis. famous composers. The university enters into a contract The agreement term is 10 years. with a vendor who wishes to use the recordings in advertisements. Significant terms of the contract include: Step 1: Identify the contract the term is two years, the vendor receives a license to use A contract exists; the university grants the food service the recordings in advertisements for that period, and the company exclusive access to provide services to its students university receives a payment of $40,000 at the start of the in exchange for consideration in the form of capital two-year term. improvements and a specified percentage of monthly sales. Step 1: Identify the contract Step 2: Identify the performance obligations A contract exists; in exchange for a license to use university- The university’s has one performance obligation: to grant the owned intellectual property, the vendor pays $40,000. exclusive right to provide all food services on campus to the food service company. Step 2: Identify the performance obligations The university’s performance obligation is to provide the Step 3: Determine the transaction price vendor a license for a two-year period. The transaction price includes both noncash and variable consideration. Step 3: Determine the transaction price The capital improvements represent noncash consideration, The transaction price is $40,000. as the university obtains control of the capital items. As a Step 4: Allocate the transaction price result, the university measures the estimated fair value of the As there is only one performance obligation, the entire capital improvements at contract inception. transaction price is allocated to the license of intellectual Variable consideration is the percentage of monthly sales to property. be remitted to the university. This amount will depend on monthly sales to students. Step 5: Recognize revenue Topic 606 notes that a license to functional intellectual Step 4: Allocate the transaction price property grants the use of that property as it exists at As there is only one performance obligation, the entire a point in time, unless the functionality is expected to transaction price is allocated to the exclusive right to provide change because of activities performed by the owner of the food services. property and the customer is required to use the updated intellectual property. The university concludes that the Step 5: Recognize revenue recordings have standalone functionality which will not be The university is transferring control of the exclusive right changed. Revenue is recognized at the start of the two-year over time and therefore will satisfy the performance contract term. obligation over the term of the contract. The food service provider simultaneously receives and consumes the benefits Practical considerations provided by the university’s performance. As a result, If the payment for the license to the intellectual property revenue is recognized over the term of the contract. In was made over the term of the contract, the university assessing the methods for measuring progress, the university would have to consider if there is a significant financing concluded that the passage of time is the most appropriate component to the contract. measure; therefore, revenue will be recognized over the term of the contract based on the passage of time. Practical considerations Exclusive food service At inception of the contract, the university will record Scenario — A university enters into a contract with a food a capital asset in the amount of the estimated fair value service provider. The university grants the food service of the capital assets provided by the food service company. provider the exclusive right to operate all dining facilities The other side to this initial entry will be contract liability, and charge students for these services. In exchange for this which will be recognized into revenue over the term of right, the food service provider agrees to update the food the contract. service facilities by installing new equipment. Ownership of The variable consideration can be measured on a monthly these capital improvements reverts to the university when basis as the related sales occur. 6 CLAconnect.com  ©2017 CliftonLarsonAllen LLP Research grant Sponsorship Scenario — A university enters into an agreement with Scenario — A university gives local employers the the National Science Foundation (NSF). The university opportunity to sponsor a career fair. The sponsors receive will receive milestone payments upon specific research placement of their logo in the event brochure and signage at performed. The output of this research becomes the the event. property of NSF. Based on similar research grants from various organizations, the University determines that it is Step 1: Identify the contract 95 percent probable it will receive the milestone payments In analyzing the advertising the employers are receiving for defined in the agreement. their sponsorship, the university concludes the value is de minimis. As a result, there is not a contract with a customer, Step 1: Identify the contract and the university applies contribution accounting standards. It is determined that both the university and NSF receive something of value, so a contract is determined to exist. Step 2: Identify the performance obligations Membership revenue There is one performance obligation: the research activity as Scenario — A university has a related alumni association defined in the agreement. that is a separate nonprofit. The purpose of the alumni association is to keep connected with graduates and raise Step 3: Determine the transaction price funds on behalf of the university. Annual membership dues The agreement contains terms that state the university are $100. Members receive quarterly newsletters but no will be paid a specified amount when defined milestones further benefits. are achieved. It cannot be determined at the inception of the agreement that 100 percent of the milestones will be Step 1: Identify the contract reached. Therefore, each milestone payment is deemed a The amount paid for the newsletter is deemed to be variable consideration. The variable consideration should be a contract with a customer, as each party is receiving estimated using the likely amount to be received. reciprocal benefits. Fair market value for the newsletter was determined to be $25. The remaining $75 is considered to Step 4: Allocate the transaction price be a contribution, as no further benefits are provided to the There is only one performance obligation, so no allocation is members. required. Step 2: Identify the performance obligations Step 5: Recognize revenue There is one performance obligation: providing quarterly Revenue would be recognized as the research output newsletters to members. defined in the agreement is delivered to NSF. Step 3: Determine the transaction price Practical considerations Fair market value for the newsletter was determined to be Identifying the contract (step 1) calls for close analysis. $25. In this example, it was determined that each party to the contract received equal value (cash consideration in Step 4: Allocate the transaction price exchange for defined research output). If the agreement was There is only one performance obligation, so no allocation is not reciprocal, Topic 606 would not apply. required. Step 5: Recognize revenue The transaction price is recognized over four quarters, as the quarterly newsletters are provided. Outside of the scope of Topic 606, the contribution revenue would be recognized when received. Practical considerations If the alumni association provided benefits to its members in addition to the quarterly newsletter, additional performance obligations would exist. In that case, the transaction price would be allocated to those additional performance obligations. 7 CLAconnect.com  ©2017 CliftonLarsonAllen LLP Applying the new revenue recognition About CliftonLarsonAllen standard at your institution CLA is a professional services firm delivering integrated As you can see from these examples and scenarios, every wealth advisory, outsourcing, and public accounting revenue situation is unique. Once you determine that a capabilities to help enhance our clients’ enterprise value contract exists (which can take a good deal of analysis in and and assist them in growing and managing their related of itself), accurately analyzing the conditions that lead to personal assets — all the way from startup to succession and compliant revenue recognition takes time and thought. With beyond. Our professionals are immersed in the industries practice and experience, however, the process will become they serve and have deep knowledge of their operating and less challenging over time. regulatory environments. With more than 5,000 people, more than 100 U.S. locations, and a global affiliation, we Tuition and housing are the primary revenue sources for bring a wide array of services to help clients in all markets, higher education institutions and will account for the bulk of foreign and domestic. For more information visit CLAconnect. your revenue recognition activities. As the industry adjusts com. Investment advisory services are offered through to the new standard, we’ll have more practical information CliftonLarsonAllen Wealth Advisors, LLC, an SEC-registered to share among our organizations. investment advisor. The new standard is complex. Start preparations now so you can implement the updated procedures as smoothly as possible. Author Michael Johns, Principal, Higher Education [email protected] 267-419-1620 WEALTH ADVISORY | OUTSOURCING | AUDIT, TAX, AND CONSULTING Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC, an SEC-registered investment advisor. The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, investment or tax advice or opinion provided by CliftonLarsonAllen LLP (CliftonLarsonAllen) to the reader. The reader also is cautioned that this material may not be applicable to, or suitable for, the reader’s specific circumstances or needs, and may require consideration of nontax and other tax factors if any action is to be contemplated. The reader should contact his or her CliftonLarsonAllen or other tax professional prior to taking any action based upon this information. CliftonLarsonAllen assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein. 8 CLAconnect.com