Board Meeting Handout Clarifying the Scope of Subtopic and Accounting for Partial Sales of Nonfinancial Assets April 20, 2016

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1 Board Meeting Handout Clarifying the Scope of Subtopic and Accounting for Partial Sales of Nonfinancial Assets April 20, 2016 PURPOSE OF THIS MEETING 1. The April 20, 2016 Board meeting is a decision-making meeting. The purpose of this handout is to present the cost-benefit analysis to the Board and ask the Board for permission to draft guidance in a proposed Update for vote by written ballot. BACKGROUND INFORMATION 2. The Board added a project to its agenda in May 2013 on clarifying the definition of a business with the objective of adding guidance to assist entities in evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or acquisitions (or disposals) of businesses. When the Board added the project, it anticipated clarifying the reference to in substance nonfinancial assets and the accounting for partial sales of nonfinancial assets. The Board decided to address the issues associated with the project in three phases: (a) Phase 1: The Board proposed guidance to assist entities in applying the definition of a business. Proposed Accounting Standards Update, Business Combinations (Topic 805): Clarifying the Definition of a Business, was issued in November 2015, and the comment period ended on January 22, (b) Phase 2: The Board decided to address (i) the scope of the nonfinancial asset derecognition guidance and clarifying the reference to in substance nonfinancial assets and (ii) the guidance on partial sales of nonfinancial assets. (c) Phase 3: In a future phase of this project, the Board will discuss whether there are differences in the acquisition and derecognition guidance for assets and businesses that could be removed. The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations. Page 1 of 4

2 3. The second phase of this project was primarily focused on the guidance in Subtopic , Other Income Gains and Losses from the Derecognition of Nonfinancial Assets, which was created as part of Accounting Standards Update No , Revenue from Contracts with Customers (Topic 606). That guidance specifies that an entity should apply the guidance in Topic 606 for the existence of a contract, for control, and for measurement to contracts for the transfer of nonfinancial assets in nonrevenue transactions. That guidance also applies to in substance nonfinancial assets, which is not currently a defined term. 4. The primary motivation for creating that guidance is related to transfers of real estate. Subtopic , Property, Plant, and Equipment Real Estate Sales (originally issued as FASB Statement No. 66, Accounting for Sales of Real Estate), which is being replaced by the amendments in Update , addresses sales of real estate in revenue and nonrevenue transactions. The amendments in Update do not include any guidance on a partial sale of a nonfinancial asset to replace the real estate guidance in Subtopic ; therefore, stakeholders have indicated that they are uncertain about how an entity would account for partial sales transactions. Furthermore, there was uncertainty around the scope of that guidance and, in particular, what constitutes an in substance nonfinancial asset. ISSUE 1: PERMISSION TO BALLOT Benefits, Costs, and Complexity 5. The main benefits of the proposed amendments to Subtopic would be the removal of uncertainty on how to account for partial sales, clarification of how to determine what constitutes an in substance nonfinancial asset, and the elimination of the potential for diversity in practice to arise. That is because without the proposed amendments, Subtopic currently provides no guidance regarding partial sales or what constitutes an in substance nonfinancial asset. 6. In addition, the following proposed clarifications to the scope may reduce complexity throughout the FASB Accounting Standards Codification by eliminating certain exceptions: Page 2 of 4

3 (a) All businesses would be excluded from the scope of Subtopic and an entity would not have to consider if a business also is an in substance nonfinancial asset. (b) The guidance in Section on transfers of nonfinancial assets for a noncontrolling interest in another entity would be eliminated and those transactions would be accounted for within Subtopic (c) An equity method investment would no longer meet the definition of an in substance nonfinancial asset, and, therefore, the scope exception for transfers of equity method investments in real estate entities in Topic 860, Transfers and Servicing, would be eliminated. (d) Accounting for contributions of nonfinancial assets to joint ventures similar to other partial sales transactions would be in the scope of Subtopic The Board s decisions also aligned certain asset versus business accounting differences, which was one of the goals of the overall project. Those proposed amendments would include: (a) A change in ownership interest of a subsidiary while the parent retains control would be accounted for as an equity transaction and no gain or loss would be recognized. (b) An entity would derecognize a nonfinancial asset in a partial sale transaction when it does not have a controlling financial interest in the entity and has transferred control of the nonfinancial asset in accordance with the guidance in Topic 606. (c) If an entity meets the criteria to derecognize the nonfinancial asset, the entity would measure any retained noncontrolling ownership interest at fair value. (d) Transfers to equity method investees would result in full gain recognition. 8. The proposed amendments would result in a change from historical practice in certain industries that would need to be implemented. However, entities would be required to implement Subtopic according to the amendments in Update Page 3 of 4

4 with or without the proposed amendments that would clarify how the guidance should be applied. Questions for the Board 1. Would the expected benefits of the proposed changes justify the perceived costs? 2. Have all the relevant issues been deliberated? 3. Have Board members received sufficient information and analyses to make informed decisions on those issues? If not, what other information or analyses do they need? 4. Should the staff proceed to drafting guidance in a proposed Update for vote by written ballot? If yes, what should be the comment period? Page 4 of 4

5 Ratification of One EITF Consensus-for-Exposure April 20, 2016 At today s meeting, the staff will request that the Board ratifying a consensus-for-exposure reached by the Emerging Issues Task Force (EITF) at its March 3, 2016 meeting. TASK FORCE CONSENSUS-FOR-EXPOSURE Issue No. 16-A, Restricted Cash Stakeholders have indicated that diversity exists in the classification and presentation of changes in restricted cash on the statement of cash flows under Topic 230, Statement of Cash Flows. Entities classify transfers between cash and restricted cash as operating, investing, or financing activities, or as a combination of those activities, on the statement of cash flows. Also, some entities present direct cash receipts into, and direct cash payments made from, a bank account that holds restricted cash as cash inflows and cash outflows, while others disclose those cash flows as noncash investing or financing activities. The Task Force reached a consensus-for-exposure that a statement of cash flows should explain the change during the period in cash, cash equivalents, and amounts generally described as restricted cash and restricted cash equivalents. That is, amounts generally described as restricted cash and restricted cash equivalents would be included with cash and cash equivalents when reconciling the beginning and end of period total amounts shown on the statement of cash flows under the amendments in this proposed Update. The Task Force believes that a primary objective of a statement of cash flows is to provide relevant information about the sources and uses of cash of an entity during a period and, therefore, it is most meaningful to present the ultimate cash inflows and outflows of an entity, irrespective of whether those cash flows are from restricted cash accounts. Some entities disclose the ultimate cash flows of a segregated restricted cash account as noncash investing or financing activities. For example, some entities disclose repayments of amounts borrowed that are directly paid from a segregated restricted cash account as noncash financing activities rather than as cash outflows from financing activities in the body of the statement of cash flows. Including amounts generally described as restricted cash and restricted cash equivalents with cash and cash equivalents on the statement of cash flows would result in presenting the ultimate cash inflows and outflows of the entity in the body of the statement of cash flows. The Task Force reached a consensus-for-exposure that certain disclosures should be required to supplement the statement of cash flows. Specifically, those disclosures include (a) the nature of the restrictions on cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents and (b) if the total amounts of cash, cash equivalents, and amounts generally described as restricted cash and restricted cash equivalents at the beginning and end of the period shown on the statement of cash flows cannot be reconciled to the amounts of similarly titled line items on the statement of financial position, an entity should disclose on the face of the statement of cash The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations. Page 1 of 2

6 flows or in the notes to the financial statements, the amounts and line items where such amounts are reported within the statement of financial position. The Task Force discussed whether to require disclosures about the gross transfers between cash and restricted cash but did not reach a consensus-for-exposure. Rather, the Task Force decided to include a question in the proposed Update about whether disclosure of the amounts of gross transfers between cash and restricted cash would provide meaningful information to financial statement users. The Task Force reached a consensus-for-exposure that the amendments in the proposed Update should be applied retrospectively to all periods presented. The Task Force believes that there would be a significant benefit to retrospective transition because it would enhance the interperiod consistency and comparability of financial information. The Task Force reached a consensus-for-exposure to require the transition disclosures in paragraphs (a) and (b)(1) and , as applicable, in the interim and annual period in which the amendments in the proposed Update are adopted. Question 1 for the Board Does the Board wish to ratify the consensus-for-exposure for Issue 16-A? EXPOSURE PERIOD FOR THE CONSENSUS-FOR-EXPOSURE The staff recommends that the proposed Update for Issue 16-A be exposed for a 60-day comment period. Question 2 for the Board Does the Board agree with the staff s recommendation that the proposed Update for Issue 16-A be exposed for a 60-day comment period? Page 2 of 2

7 Board Meeting Handout Potential New Agenda Item Effects of Yieldco Dropdown Transactions on Historical Earnings per Share April 20, 2016 PURPOSE OF THIS MEETING 1. The April 20, 2016 Board meeting, the Board will be asked to decide whether to add a project to its agenda that would address the effects of Yieldco dropdown transactions on historical earnings per share (EPS) and, if so, whether that project should be addressed directly by the FASB staff or added to the agenda of the EITF. BACKGROUND INFORMATION 2. EITF Issue No. 14-A Effects on Historical Earnings per Unit of Master Limited Partnership Dropdown Transactions, resulted in guidance for master limited partnerships (MLPs) that specifies how historical earnings per unit should be affected when a dropdown transaction occurs subsequent to formation of the MLP that is accounted for as a transaction between entities under common control. In a comment letter on the proposed Update that resulted from Issue 14-A, the respondent suggested expanding the scope to include Yieldcos. Rather than including Yieldcos within the scope of Issue 14-A, however, the Task Force requested that the staff perform additional research about the effects on historical EPS of Yieldco dropdown transactions. Yieldcos 3. Yieldcos are publicly traded corporations or partnerships that invest in renewable energy assets (for example, wind and solar farms) and generate predictable cash flows as a result of long-term contracts. Yieldcos are sometimes referred to as synthetic MLPs because, like MLPs, they are expected to distribute a majority of their available The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations. Page 1 of 3

8 cash flows to their owners and they can simulate the single shareholder-level of taxation of MLPs. Dropdown transactions 4. Yieldcos are typically formed when a sponsor transfers assets or a business to the Yieldco s operating subsidiary in exchange for equity interests and/or cash. These transactions (referred to as dropdowns ) are often accounted for as reorganizations of entities under common control in accordance with the business combinations guidance in Topic 805. When the reorganization involves the transfer of a business, the Yieldco presents its financial statements as if the transfer had occurred at the beginning of the period. In addition, financial statements for prior periods are retrospectively adjusted for periods during which the entities were under common control. 5. Dropdown transactions accounted for under the common control guidance could also occur subsequent to formation of a Yieldco. Earnings per Share Guidance 6. Issue 14-A resulted in guidance for MLPs about using the two-class method to compute earnings per share when a dropdown transaction occurs subsequent to formation. The staff did not identify any Yieldcos registered in the U.S. that follow GAAP that use the two-class method, at least in situations where one entire class of stock is held by a controlling shareholder. However, the staff identified several that present a noncontrolling interest in an operating subsidiary that is held by a sponsor that controls the Yieldco. The alternatives below address that organizational structure. Paragraph A states that, if one or more less-than-wholly-owned subsidiaries are included in the consolidated group, income from continuing operations and net income shall exclude the income attributable to the noncontrolling interest in subsidiaries. 7. While the two-class method guidance and the guidance for computing EPS when a noncontrolling interest is present are different, one key concept is the same both sets of guidance require earnings (losses) to essentially be allocated between the reporting entity s common shareholders and certain other equity interests when computing EPS. Page 2 of 3

9 ISSUE 1: EFFECTS ON HISTORICAL EARNINGS PER SHARE OF YIELDCO DROPDOWN TRANSACTIONS 8. When a common control transaction is reflected in a Yieldco s financial statements, the statement of operations is retroactively adjusted as if the dropdown occurred on the earliest date that the entities were under common control. However, no guidance specifically addresses how to calculate EPS for periods prior to the date of a dropdown transaction that occurs subsequent to formation of the Yieldco. 9. The staff has developed two alternative views to address this proposed issue. a. Alternative A: Allocate earnings (losses) of the transferred business for periods before the date of the dropdown to the Yieldco common shareholders as if those shareholders had rights to those earnings (losses) during those historical periods. Consequently, historical EPS will be recomputed based on the retrospectively adjusted numerator. b. Alternative B: Allocate earnings (losses) of the transferred business for periods before the date of the dropdown entirely to the Yieldco s sponsor. Consequently, historical EPS will not change as a result of the dropdown transaction. Questions for the Board 1. Does the Board want to add a project to the FASB s agenda that would address how a Yieldco would allocate the earnings (losses) of a transferred business for periods before the date of a dropdown transaction that occurs subsequent to formation for purposes of computing historical earnings per share? 2. If yes, should it be addressed by the FASB staff or the EITF? Page 3 of 3

10 Board Meeting Handout Employee Benefit Plans Phase 2 April 20, 2016 PURPOSE OF THIS MEETING 1. The purpose of this decision-making meeting is for the Board to decide whether the Employee Benefit Plans Phase 2 project should be added to the FASB's technical agenda, and what the scope of the project should be. The staff will discuss the outreach that has been performed to date, the staff analysis, and the proposed alternatives. 2. Research efforts have focused on two key issues (specifically, those relating to master trusts and derivative disclosures) raised by the American Institute of Certified Public Accountants Employee Benefit Plan Expert Panel (AICPA EBP EP) that relate to Topic 960, Plan Accounting Defined Benefit Pension Plans; Topic 962, Plan Accounting Defined Contribution Pension Plans; and Topic 965, Plan Accounting Health and Welfare Benefit Plans. BACKGROUND INFORMATION 3. In October 2013, the FASB received a discussion memorandum from the AICPA EBP EP on the subject of Observations about Current Employee Benefit Plan Accounting (the AICPA memo). The purpose of the AICPA memo was to provide the FASB with observations regarding areas in current accounting that do not consider the specialized characteristics of employee benefit plans and to identify areas where there are challenges in practice. While many of the key issues identified within that memo were addressed in Accounting Standards Update No , Plan Accounting: Defined Benefit Pension Plans (Topic 960), Defined Contribution Pension Plans (Topic 962), Health and Welfare Benefit Plans (Topic 965): (Part I) Fully Benefit-Responsive Investment Contracts, (Part II) Plan Investment Disclosures, (Part III) Measurement Date Practical Expedient, the lack of guidance The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations. Page 1 of 4

11 on master trusts was not one of the issues addressed by the Update. In addition to being raised as a concern in the AICPA memo, master trusts were also a common theme in comment letter responses to Update when the Board asked respondents to identify other areas within employee benefit plan reporting that could be improved. Concerns about the lack of guidance on master trusts is covered under Issue While not noted in the AICPA memo, the other most common comment letter response was related to how extensive the derivative disclosures are within plan financial statements. Concerns about the volume of derivative disclosures is covered under Issue Since the Board added employee benefit plans to its agenda as a research project, the staff has reviewed the AICPA memo and held outreach meetings with the AICPA EBP EP and the Department of Labor (DOL) to assess whether the issues raised are pervasive and whether there are technically feasible alternatives. Issue 1 Master Trusts 6. According to the DOL Form 5500 instructions, a master trust is a trust for which a regulated financial institution (bank, trust company, or similar financial institution that is regulated, supervised, and subject to periodic examination by a state or federal agency) serves as a trustee or custodian and in which assets of more than one plan sponsored by a single employer or by a group of employers under common control are held. 7. Many preparers find the master trust disclosure requirements within GAAP to be limited and incomplete. Most preparers rely on the AICPA Audit and Accounting Guide, Employee Benefit Plans, to provide some clarity as to how extensive the disclosures that are provided should be. The AICPA EBP EP considers the effects of the lack of guidance relating to master trusts to be prevalent, affecting most employee benefit plans, and an area in which standard-setting action is requested. 8. During its outreach effort, the staff identified seven issues relating to master trusts, which are summarized in the chart below. Issue Number Issue Description Page 2 of 4

12 Issue 1A: Presentation of master trust activity within a plan s financial statements Issue 1B: Master trust financial statement reporting Issue 1C: Disclosures for plans with a specific interest in master trust investments There is currently divergence in practice for the presentation of master trust activity within plan financial statements. For example, should investmentrelated receivables/payables at year-end be recorded at the plan level? While not required for Form 5500 purposes, there are certain situations in which financial statements are issued for master trusts. However, when financial statements are prepared, it is unclear whether to follow guidance for investment companies or employee benefit plans. The existing disclosure requirements for master trusts present all investments in a master trust as if each represents an undivided interest in a pool of assets. However, that is not always the case. The question that arises is whether the current disclosure is appropriate and relevant for master trust arrangements in which a specific interest exists? Issue 1D: Additional disclosures regarding master trust financial information Since master trust financial information is presented in different ways (that is, sometimes at the plan level and sometimes at the master trust level), some recommend including the full master trust financial statements within the disclosures for the plan. Issue 1E: Additional disclosures regarding master trust investment risks Issue 1F: Presentation of Section 401(h) accounts within a master trust Issue 1G: Consistency between Topics There is diversity in practice regarding how extensive the detail provided for investments held within a master trust should be. For example, while there are no explicit requirements for derivative or fair value disclosures, should those disclosures be required for plan investments that are held within a master trust? The question arises as to whether the health and welfare plan that includes the 401(h) account assets must include all master trust disclosures in its financial statements. Is that information relevant to health and welfare plan users? Topics 960 and 962 provide guidance relating to master trusts, while Topic 965 does not. Should the guidance for master trusts be provided within all Topics? Issue 2 Derivative Disclosures Page 3 of 4

13 9. For derivative disclosures, employee benefit plans are required to follow Topic 815, consistent with all other entities that hold derivative investments. The concern that some have noted is that because the volume of derivative disclosures that plans make is so large, it is time consuming and costly from a preparer standpoint to disclose them all. Some suggest that the benefits of the disclosures do not justify the perceived costs. Questions for the Board Does the Board think that the Employee Benefit Plan Phase 2 project should be added to the technical agenda? If so, should that project include (a) only master trusts, (b) only derivative disclosures, or (c) both master trusts and derivative disclosures? Should that project be addressed by the FASB or the EITF? What additional research or outreach would the Board like to see? Page 4 of 4

14 Board Meeting Handout Revenue Recognition of Grants and Contracts by Not-for-Profit Entities April 20, 2016 PURPOSE OF THIS MEETING 1. The April 20, 2016 Board meeting is a decision-making meeting. The purpose of this meeting is to assist the Board in determining whether to add a project to its agenda on the revenue recognition of grants and similar contracts 1 by not-for-profit entities (NFPs). BACKGROUND INFORMATION 2. Issues were raised by stakeholders, including the American Institute of Certified Public Accountants (AICPA) NFP Expert Panel, the AICPA NFP and Healthcare Revenue Recognition Task Force members, the National Association of College and University Business Officers (NACUBO), and the NFP Advisory Committee (NAC), indicating that there is difficulty and diversity in practice among NFPs with the following two issues: (a) (b) Issue 1: Characterizing grants and contracts with governmental agencies and others as (i) reciprocal transactions (exchanges) or (ii) nonreciprocal transactions (contributions) Issue 2: Distinguishing between conditions and restrictions for nonreciprocal transactions. 1 The staff refers to grants and similar contracts throughout this handout. Those revenue contracts falling under the guidance of Topic 606, Revenue from Contracts with Customers, such as procurement contracts, are not intended to be included in this category. The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations. Page 1 of 29

15 Issue 1: Characterizing Grants and Contracts with Governmental Agencies and Others as (i) Reciprocal Transactions (Exchanges) or (ii) Nonreciprocal Transactions (Contributions) 3. It is sometimes difficult in practice to distinguish between a conditional promise of financial support (nonreciprocal transaction) and a transaction in which the resource provider receives commensurate value in return (reciprocal transaction). For example, if resources are transferred to an NFP by a governmental agency or foundation with restrictions or conditions indicating that a primary purpose is to achieve an outcome that is for the public s benefit (the government or foundation receives value indirectly by furthering its mission), it may not be clear whether the transaction is reciprocal (purchase of the NFP s services) or nonreciprocal (financial support for the NFP s activities). Distinguishing between reciprocal and nonreciprocal transactions determines which guidance an NFP should follow: Topic 606 for reciprocal transactions or Subtopic , Not-for-Profit Entities Revenue Recognition, for nonreciprocal transactions. The accounting may differ on the basis of the guidance applied. 4. Implementation guidance is provided by paragraphs through of the FASB Accounting Standards Codification (Accounting Standards Codification). Much of that guidance was codified from the AICPA Audit & Accounting Guides or the FASB staff Q&As that draw from the principles that were established by FASB Statement No. 116, Accounting for Contributions Received and Contributions Made (Statement 116). The table of indicators in paragraph (from the 2008 edition of the AICPA Audit & Accounting Guide, Not-for-Profit Entities) and other guidance in the excerpted paragraphs were intended to be helpful in practice when assessing the relevant facts and circumstances to distinguish between the receipt of resources in a reciprocal transaction and the receipt of resources in a contribution. Feedback indicates further clarification or guidance would be helpful, if not necessary. Page 2 of 29

16 Issue 2: Distinguishing between Conditions and Restrictions for Nonreciprocal Transactions 5. There is also difficulty in practice in distinguishing between a condition and a restriction for nonreciprocal transactions, including many grants and contracts. If a promise is conditional, there can be additional difficulty in determining (a) when a condition is met and (b) if a condition would fail to meet the premise of being remote. There is inconsistent application in practice of the remote notion. 6. An informal recommendation was made from the AICPA to explore these issues further, articulate the problem and diversity in practice, and seek suggested solutions from the AICPA NFP Revenue Recognition Task Force, the FASB s NAC, and other stakeholders. 7. The objective of this meeting is to determine whether a project is necessary to address the issues raised in this handout, whether other educational efforts might be more effective, or whether both may be needed, and which specific changes to the Accounting Standards Codification could be made through a potential project. PERVASIVENESS OF THE ISSUES 8. Feedback from stakeholders has indicated that despite the degree of existing guidance, there is significant diversity in practice on the conclusions being reached for Issue 1 and Issue 2 unconditional nonreciprocal transaction (contribution), conditional nonreciprocal transaction (conditional contribution), or reciprocal transaction (exchange) on many grants and contracts. In some instances, similar grants and contracts are accounted for as nonreciprocal transactions (generally conditional) by some NFPs and as reciprocal transactions by other NFPs. Diversity occurs for grants and contracts from various types of funders, but government grants and contracts appear to cause the most concern among stakeholders. The conclusions can affect the timing and net asset classification of the revenue recognized in such transactions. 2 2 If the grant or contract is deemed an unconditional contribution, the revenue would be recognized when the grant or contract is awarded. If the grant or contract is deemed either a conditional contribution or a reciprocal transaction, the revenue would typically be recognized as the money is spent because the Page 3 of 29

17 Issue 1: Characterizing Grants and Contracts with Governmental Agencies and Others as (i) Reciprocal Transactions (Exchanges) or (ii) Nonreciprocal Transactions (Contributions) 9. It appears that most NFPs currently account for grants (in particular, government grants) as reciprocal transactions and may be misinterpreting the guidance. In some instances, similar grants and contracts are accounted for as nonreciprocal (generally conditional) transactions by some NFPs and as reciprocal transactions by other NFPs. Generally, most NFPs and their auditors seem to believe that governments do not provide outright contributions, except in rare cases. FASB Accounting Standards Update No , Revenue from Contracts with Customers (Update ), introduces the additional wrinkle for reciprocal transactions of determining whether the funder is functioning as a customer, as a third-party payer on the behalf of a customer, or in some other capacity. 10. There is difficulty in practice in determining whether the government or other funder is receiving commensurate value by directing an NFP to fulfill its own obligations to benefit the public (obtaining a service). Some conclude that an NFP is stepping in to fulfill the funder s moral obligation and, thus, the funder is receiving commensurate value in return (reciprocal transaction). However, upon the issuance of Update , others seem to now place less emphasis on the funder s role, obligation, or intent and now focus instead on whether reciprocal benefits flow directly between two parties to the contract (a supplier and a customer). Issue 2: Distinguishing between Conditions and Restrictions for Nonreciprocal Transactions 11. Diversity exists in the application of distinguishing between a donor-imposed restriction that limits how transferred assets can be used and a condition on which a promised contribution depends. If funds are provided to an NFP with the stipulation spending for a qualifying expense generally is the point at which a condition or series of conditions is being met. While the pattern of recognition may not be dissimilar for these latter two categories, the revenue for the conditional contribution, like that for the unconditional contribution, would typically be reported in a different net asset class (temporarily restricted) than the reciprocal transaction (unrestricted) unless the NFP has elected to report as unrestricted those contributions with restrictions that are met in the same period as the award, as permitted by paragraph Page 4 of 29

18 of a certain outcome (for example, a basic research grant to obtain an understanding of the cause of and possible solutions for an environmental problem), there is difficulty in distinguishing whether this contribution is conditional, restricted, or both. The guidance indicates that the distinction lies in whether or not the funds will be returned if the outcome should not occur (or, if the funds are not provided in advance, whether they will be given at all). However, there are cases in which a return policy to the resource provider is not stipulated; this ambiguity and uncertainty has created the diversity in practice. 12. Additionally, if an NFP determines that a contribution is conditional, it must also determine whether the likelihood of failing to meet a condition is remote to determine when the contribution should be recognized. Typically, conditional contributions are not recognized until the condition has been met; however, if the likelihood of failing to meet a condition is remote, then the contribution can be recognized immediately. There is inconsistent application in practice of the remote notion. While some believe that only trivial conditions meet this threshold (such as a condition requiring an administrative form to be filed), others believe that any factor that is within the entity s control has a remote likelihood of not being met. This inconsistency results in different timing of revenue recognition for similar transactions. Further, the Accounting Standards Codification does not contain many examples of the types of performance conditions that have been causing most of these difficulties in practice. DURATION OF THE ISSUES 13. The issues have been long-standing implementation problems that predate Update However, the new revenue recognition guidance has placed renewed focus on the issues because (a) the revenue guidance eliminated some existing industryspecific guidance on reciprocal transactions in Subtopic and (b) the added disclosure requirements for contracts with customers are raising concern. At a previous NAC meeting, some NAC members indicated that (a) the disclosures do not seem highly relevant or useful for grants and (b) there is a need for additional clarification because of the existing diversity in practice. Page 5 of 29

19 14. In addition, conditional promises of financial support for specified types of purposes and reciprocal transactions often result in similar revenue recognition (over time as qualifying expenses are incurred). Thus, until now, the distinction has not been a major concern. Questions for the Board 1. Does the Board want to add a project to the FASB s agenda on clarifying the guidance for revenue recognition by NFPs of grants and contracts that would address Issue 1 and Issue 2? If so: a. Should it be addressed by the FASB or the Emerging Issues Task Force (EITF)? b. Which alternative (described below) does the Board prefer for the staff to pursue as a general direction for the project? ALTERNATIVE SOLUTIONS 15. The staff has developed the following alternatives to address Issues 1 and 2 in this handout: (a) (b) (c) (d) Alternative 1 Improve and clarify the existing guidance Alternative 2 Define grants and contracts and account for them separately from reciprocal transactions (contracts with customers) or contributions Alternative 3 Make a call one way or the other and account for all grants and similar contracts the same way, either as reciprocal transactions (contracts with customers) or nonreciprocal transactions (generally conditional contributions) Alternative 4 Do nothing at this time. Alternative 1: Improve and Clarify the Existing Guidance 16. Alternative 1 would provide additional guidance to clarify how to distinguish between types of (a) grants and contracts that should be accounted for as nonreciprocal transactions (contributions) or reciprocal transactions (exchanges) (and thus, would be within the scope of Topic 606), (b) donor stipulations that Page 6 of 29

20 impose a condition that must be met to receive a promised gift or grant and a restriction that limits the use of the assets given or granted, and (c) conditions that may (or may not) be judged as trivial and nonsubstantive and for which the failure to meet a conditional promise is remote. Refer to Appendix D for a sample flowchart that the staff could develop if the Board chooses Alternative Part of the additional guidance could include: (a) Additional clarification (addition, removal, or modification) of the indicators in paragraph , including: (i) (ii) (iii) Clarification that reciprocal transactions (or contracts with customers) are within the scope of Topic 606 Reinforcement that grants in which the resource provider (or customer) receives direct, tangible value such as proprietary rights, and in which benefit to the public is incidental, would be classified as reciprocal transactions, while those in which the general public receives the primary benefit with incidental benefit to the resource provider would be classified as contributions Clarification that the grantor, including a government, is not synonymous with the general public; that is, who the maker or funder of the grant or contract is (private foundation, corporate foundation, or government agency) ought not to override the classification of the transaction on the basis of the substantive terms of the grant. (b) (c) Examination of existing key definitions (for example, remote, conditional contribution, and so on) Provide more illustrative examples of (i) what constitutes a nonreciprocal transaction versus a reciprocal transaction, (ii) what constitutes a restriction versus a condition, and (iii) what constitutes a remote condition. Page 7 of 29

21 NAC Feedback on Alternative At its March 2016 meeting, the NAC members held break-out sessions to discuss potential solutions for Issue 1 and Issue 2. Overall, the NAC members agreed that a clarification of terminology would be a significant aspect in helping to distinguish between nonreciprocal and reciprocal transactions and conditions and restrictions. However, there was not a consensus reached about how the terms should be labelled. This will be an area for which the staff may need to conduct additional outreach should the Board decide to add this project to its agenda. 19. The NAC members also discussed the addition of a flowchart into the guidance, which they believe could help in the classification of grants and contracts for both Issue 1 and Issue 2. Several NAC members also believe that it will be important to clarify how a grant or contract should be distinguished on the basis of whether the grantor, including a government, is receiving direct, economic value or whether the value is being received by the general public because the grant will help an NFP carry out its mission. The NAC members also suggested that the staff examine how grants and contracts should be categorized and accounted for on the basis of whether or not the funds are subject to clawback provisions. 20. The staff believes that the outcome of Alternative 1 would be clarifying guidance that would often result in more grants and contracts being accounted for as conditional contributions (note: it is possible that some will be determined to be donor-restricted but unconditional) in comparison to practice today. If Alternative 1 is chosen, the staff will need to be mindful of concerns about terminology 3 and will need to consider transition provisions that emphasize that clarifying guidance to improve the interpretations being made in practice does not imply that a prior classification was erroneous. 3 Some stakeholders that might end up agreeing with classification as a conditional contribution, rather than as a reciprocal transaction, would nevertheless not want to call it such on their financial statements. Currently, many NFPs label such line items as grants and contracts on their statement of activities. Page 8 of 29

22 Alternative 2: Define Grants and Contracts and Account for Them Separately from Reciprocal Transactions (Contracts with Customers) or Contributions 21. Similar to Alternative 1, Alternative 2 would include contributions (both unconditional and conditional) and reciprocal transactions (contracts with customers). However, Alternative 2 would modify the existing guidance in Topic 958, Not-for-Profit Entities, by creating another classification for most or nearly all grants and other contracts. For example, this classification could include grants and contracts that may qualify as nonreciprocal transactions but may have different characteristics than contributions. Contributions would continue to be accounted for under Topic 958, reciprocal transactions would follow the guidance in Topic 606, and other grants and contracts would be accounted for separately. Other grants and contracts could be accounted for similarly to the current guidance on reciprocal transactions in paragraph (which will be amended by Update ), though that guidance is somewhat general, does not specifically reference grants and contracts, and may or may not be sufficient. Some changes to the guidance on conditional contributions would still be necessary; however, because grants and contracts generally would not be included there (unlike in Alternative 1), the staff believes a significant change would probably not be needed. 22. The staff believes it could be very difficult to distinguish between which types of transactions would fall under the grants and contracts category and which would be considered contributions. The term contribution is defined as follows: Contribution An unconditional transfer of cash or other assets to an entity or a settlement or cancellation of its liabilities in a voluntary nonreciprocal transfer by another entity acting other than as an owner. [The rest of the definition has been omitted.] Many grants and contracts would be considered voluntary nonreciprocal transfers, meaning the existing definition of a contribution would also need to be modified under Alternative 2 to facilitate a distinction between contributions and transactions that are considered to be grants and contracts. While the distinction between a reciprocal and a nonreciprocal transaction is relatively clear (some clarifications can be made to the guidance), the distinction between a contribution and a category of grants and contracts is not as logical or straightforward. Page 9 of 29

23 23. Part of the additional guidance for Alternative 2 could include many of the items identified under Alternative 1. However, Alternative 2 would result in the creation of an additional category (grants and contracts or other terminology) and the need to develop additional guidance or illustrations showing how to account for such grants and contracts. Appendix E includes a sample flowchart that the staff could develop if the Board chooses Alternative 2. The flowchart depicts the additional steps that an NFP would need to take in comparison to Alternative 1. NAC Feedback on Alternative Several members of the AICPA NFP Revenue Recognition Task Force, who are also members of the NAC, initially favored Alternative 2 because there could be little or no change in practice for reclassification, recognition, or measurement. However, through discussion at the NAC meeting, most agreed that Alternative 2 would be less practical due to the need for a further third split with the addition of a separate category for grants and contracts. 25. The staff highlights that the somewhat general existing guidance in paragraph , which does not specifically reference government grants and contracts but which many have used to essentially match revenue with expenses, may or may not be acceptable or sufficient for an Alternative 2 approach. The guidance is not on point, is vague, and provides an example that references membership dues (which clearly fall under Topic 606). In addition, the AICPA Audit & Accounting Guide, which many look to, does not provide a significant amount of on-point guidance to help with the issues that have been raised. Alternative 3: Make a Call One Way or the Other and Account for All Grants and Similar Contracts the Same Way, either as Reciprocal Transactions (Contracts with Customers) or Nonreciprocal Transactions (Generally Conditional Contributions) 26. Alternative 3 is similar to Alternative 2 or Alternative 1 because grants and contracts would need to be defined and clarified. However, all grants and contracts would be accounted for in the same way (either as nonreciprocal transactions or reciprocal transactions). In comparison to Alternative 2, there would not be separate guidance (a third category) on how to recognize and measure grants and contracts. Page 10 of 29

24 NAC Feedback on Alternative Although many agreed that Alternative 3 would be the easiest to apply in practice, the NAC members generally believed that Alternative 3 is not a feasible solution to the issues. Drawing a bright line may not always be the most appropriate for transactions in which the economics are not all the same. Alternative 4: Do Nothing at This Time 28. Under Alternative 4, the Board would not add a project to its standard-setting agenda at this time, and existing generally accepted accounting principles (GAAP) on this topic would remain in its current form. NAC Feedback on Alternative A few NAC members believed that this project should not be added to the Board s agenda. One NAC member, a preparer from the health care industry, said that the revenue recognition of grants and contracts should be an accounting policy choice for NFPs so long as the policy choice is adequately disclosed. Another NAC member thought that the current guidance, taken in context with the basis for conclusions from Statement 116, is sufficient in distinguishing for both Issues 1 and 2. A suggestion was made to codify some of the guidance from the basis for conclusions. 4 However, these two members made up a minority of the NAC, of which the majority generally agreed that a project should be added to the Board s agenda. CONVERGENCE POSSIBILITIES 30. The staff believes that there is minimal opportunity to converge with other standard setters; however, the staff has and will continue to leverage and gain ideas for possible solutions from a number of sources (including guidance from other standard setters such as the GASB, the UK, and the Australian Accounting Standards Board [AASB]). 4 The staff highlights that codifying information from the basis for conclusions of Statement 116 could also be done under any of the alternatives presented in this handout. Page 11 of 29

25 31. The UK Charities Statement of Recommended Practice (SORP) FRS 102, Accounting and Reporting by Charities: Statement of Recommended Practice applicable to charities preparing their accounts in accordance with the Financial Reporting Standard applicable in the UK and Republic of Ireland, makes a distinction between performance-related grants (in which the income is conditional on delivering certain levels or volumes of a service or goods) and grants of a general nature (in which the income is not conditional on the delivery of the items above). Performance-related grants are treated much like our conditional contributions, while grants of a general nature are treated much like our unconditional contributions, which may be restricted or unrestricted as to use. Relevant excerpts from the UK Charities SORP are included in Appendix C. 32. The AASB s Exposure Draft 260, Income of Not-for-Profit Entities, focuses on the idea of whether a contract exists and whether the contract includes performance obligations to determine the timing of revenue recognition. The AASB has essentially proposed to bypass any consideration of whether performance-related grants to NFPs are of a reciprocal or a nonreciprocal nature and instead use the revenue recognition model of AASB 15, Revenue from Contracts with Customers (IFRS 15, Revenue from Contracts with Customers), which is their version of our Topic 606 for all such transactions. Conversely, they would keep IAS 20, Accounting for Government Grants and Disclosure of Government Assistance, for government grants to business entities, which the staff believes sometimes could result in a different recognition pattern for NFPs versus business entities. For this reason, and in light of a possible U.S. GAAP recognition and measurement project for government grants to business entities that could follow the current disclosure project, the staff is not proposing the AASB s proposed approach as an additional alternative for NFPs at this time (to avoid the risk of a potential double switch). The staff will, however, continue to monitor the progression of the AASB s project. COOPERATIVE OPPORTUNITIES 33. During the pre-agenda research phase, the staff has been working closely with the AICPA Revenue Recognition Task Force members and will continue to do so to Page 12 of 29

26 ensure that any developed solution or clarification made by the Board will address the concerns of stakeholders, address the issues in practice, and provide appropriate transition guidance and illustration. Page 13 of 29

27 Appendix A: Excerpts from Accounting Standards Codification on Issue 1 Glossary Contract An agreement between two or more parties that creates enforceable rights and obligations. Contribution An unconditional transfer of cash or other assets to an entity or a settlement or cancellation of its liabilities in a voluntary nonreciprocal transfer by another entity acting other than as an owner. Those characteristics distinguish contributions from exchange transactions, which are reciprocal transfers in which each party receives and sacrifices approximately equal value; from investments by owners and distributions to owners, which are nonreciprocal transfers between an entity and its owners; and from other nonreciprocal transfers, such as impositions of taxes or legal judgments, fines, and thefts, which are not voluntary transfers. In a contribution transaction, the value, if any, returned to the resource provider is incidental to potential public benefits. In an exchange transaction, the potential public benefits are secondary to the potential proprietary benefits to the resource provider. The term contribution revenue is used to apply to transactions that are part of the entity's ongoing major or central activities (revenues), or are peripheral or incidental to the entity (gains). See also Inherent Contribution. Customer A party that has contracted with an entity to obtain goods or services that are an output of the entity s ordinary activities in exchange for consideration. Inherent Contribution A contribution that results if an entity voluntarily transfers assets (or net assets) or performs services for another entity in exchange for either no assets or for assets of substantially lower value and unstated rights or privileges of a commensurate value are not involved. Nonreciprocal Transfer (Second Definition) A transaction in which an entity incurs a liability or transfers an asset to another entity (or receives an asset or cancellation of a liability) without directly receiving (or giving) value in exchange. Not-for-Profit Entities Revenue Recognition Scope and Scope Exceptions Contributions Received > Transactions The guidance in the Contributions Received Subsections does not apply to the following transactions and activities: a. Transfers of assets that are in substance purchases of goods or services exchange transactions in which each party receives and sacrifices commensurate value. However, if an entity voluntarily transfers assets to another or performs services for another in exchange for assets of substantially lower value and no unstated rights or privileges are involved, the contribution received that is inherent in that transaction is within the scope of the Contributions Received Subsections. b. Transfers of assets in which the reporting entity acts as an agent, trustee, or intermediary, rather than as a donor or donee (see the Transfers of Assets to a Not-for-Profit Entity or Charitable Trust that Raises or Holds Contributions for Others Subsections of this Subtopic). c. Tax exemptions, tax incentives, or tax abatements. d. Transfers of assets from governmental units to business entities The Contributions Received Subsections also use terms such as gift and donation to refer to a contribution; however, they generally avoid terms such as awards, grants, sponsorships, and appropriations that often are more broadly used to refer not only to contributions but also to assets transferred in exchange transactions in which the grantor, sponsor, or appropriator expects to receive commensurate value. Page 14 of 29

28 Recognition General Revenue from exchange transactions follow generally accepted accounting principles (GAAP); for example, revenue derived from membership dues in exchange transactions shall be recognized over the period to which the dues relate. Nonrefundable initiation and life membership fees received in exchange transactions shall be recognized as revenues in the period in which the fees become receivable if future fees are expected to cover the costs of future services to be provided to members. If nonrefundable initiation and life membership fees, rather than future fees, are expected to cover those costs, nonrefundable initiation and life member fees received in exchange transactions shall be recognized as revenue over the average duration of membership, the life expectancy of members, or other appropriate time periods. **Update replaces the above paragraph with the following pending content with a transition date of December 16, 2017: Exchange transactions shall be accounted for in accordance with Topic 606 on revenue from contracts with customers. Implementation Guidance and Illustrations General > Implementation Guidance The accounting and reporting of grants, membership dues, and sponsorships is determined by the underlying substance of the transaction. Those terms are broadly used to refer not only to contributions but also to assets transferred in exchange transactions. A grant, sponsorship, or membership may be entirely a contribution, entirely an exchange, or a combination of the two; therefore, care must be taken in evaluating each grant, sponsorship, or membership agreement. In addition, those resource transfers may also have the characteristics of agency transactions A The implementation guidance is organized as follows: a. Distinguishing contributions from exchange transactions (see paragraphs through 55-8) b. Distinguishing the contribution portion of membership dues (see paragraphs through 55-12) c. Distinguishing contributions from agency transactions (see paragraph ). >> Distinguishing Contributions from Exchange Transactions Some transfers of assets that are exchange transactions may appear to be contributions if the services or other assets given in exchange are perceived to be a sacrifice of little value and the exchanges are compatible with the recipient's mission Foundations, business entities, and other types of entities may provide resources to not-forprofit entities (NFPs) under programs referred to as grants, awards, or sponsorships. Those asset transfers are contributions if the resource providers receive no value in exchange for the assets transferred or if the value received by the resource providers is incidental to the potential public benefit from using the assets transferred. A grant made by a resource provider to a not-for-profit entity (NFP) would likely be a contribution if the activity specified by the grant is to be planned and carried out by the NFP and the NFP has the right to the benefits of carrying out the activity. If, however, the grant is made by a resource provider that provides materials to be tested in the activity and that retains the right to any patents or other results of the activity, the grant would likely be an exchange transaction. A careful assessment of the characteristics of the transaction, from the perspectives of both the resource provider and the recipient, is necessary to determine whether a contribution has occurred For example, a resource provider may sponsor research and development activities at a research university and retain proprietary rights or other privileges, such as patents, copyrights, or advance Page 15 of 29

29 and exclusive knowledge of the research outcomes. The research outcomes may be intangible, uncertain, or difficult to measure, and may be perceived by the university as a sacrifice of little or no value; however, their value often is commensurate with the value that a resource provider expects in exchange. Similarly, a resource provider may sponsor research and development activities and specify the protocol of the testing so the research outcomes are particularly valuable to the resource provider. Those transactions are not contributions if their potential public benefits are secondary to the potential proprietary benefits to the resource providers Moreover, a single transaction may be in part an exchange and in part a contribution. For example, if a donor transfers a building to an entity at a price significantly lower than its fair value and no unstated rights or privileges are involved, the transaction is in part an exchange of assets and in part a contribution to be accounted for as required by the Contributions Received Subsections of this Subtopic. See paragraphs through for premiums provided to donors and Example 4 (paragraphs through 55-15) for direct benefits provided to donors at special events Examples 1 (see paragraph ) and 1 (see paragraph ) illustrate the need to assess the relevant facts and circumstances to distinguish between the receipt of resources in an exchange and the receipt of resources in a contribution The following table contains a list of indicators that may be helpful in determining whether individual asset transfers are contributions, exchange transactions, or a combination of both. Depending on the facts and circumstances, some indicators may be more significant than others; however, no single indicator is determinative of the classification of a particular transaction. Indicators of a contribution tend to describe transactions in which the value, if any, returned to the resource provider is incidental to potential public benefits. Indicators of an exchange tend to describe transactions in which the potential public benefits are secondary to the potential proprietary benefits to the resource provider. Indicators Useful in Distinguishing Contributions from Exchange Transactions Page 16 of 29

30 > Illustrations >> Example 1: Receipt of Resources in Exchange This Example illustrates the guidance in paragraphs through Not-for- Profit Entity A (NFP A) is a large research university with a cancer research center. NFP A regularly conducts research to discover more effective methods of treating cancer and often receives contributions to support its efforts. NFP A receives resources from a pharmaceutical entity to finance the costs of a clinical trial of an experimental cancer drug the entity developed. The pharmaceutical entity specifies the protocol of the testing, including the number of participants to be tested, the dosages to be administered, and the frequency and nature of follow-up examinations. The pharmaceutical entity requires a detailed report of the test outcome within two months of the test's conclusion. Because the results of the clinical trial have particular commercial value for the pharmaceutical entity, receipt of the resources is not a contribution received by NFP A, nor is the disbursement of the resources a contribution made by the pharmaceutical entity. Page 17 of 29

31 Appendix B: Excerpts from Accounting Standards Codification on Issue 2 Glossary Conditional Promise to Give A promise to give that depends on the occurrence of a specified future and uncertain event to bind the promisor. Donor-Imposed Condition A donor stipulation that specifies a future and uncertain event whose occurrence or failure to occur gives the promisor a right of return of the assets it has transferred or releases the promisor from its obligation to transfer its assets. Donor-Imposed Restriction A donor stipulation that specifies a use for a contributed asset that is more specific than broad limits resulting from the following: a. The nature of the not-for-profit entity (NFP) b. The environment in which it operates c. The purposes specified in its articles of incorporation or bylaws or comparable documents for an unincorporated association. A donor-imposed restriction on an NFP's use of the asset contributed may be temporary or permanent. Some donor-imposed restrictions impose limits that are permanent, for example, stipulating that resources be invested in perpetuity (not used up). Others are temporary, for example, stipulating that resources may be used only after a specified date, for particular programs or services, or to acquire buildings and equipment. Permanent Restriction A donor-imposed restriction that stipulates that resources be maintained permanently but permits the notfor-profit entity (NFP) to use up or expend part or all of the income or other economic benefits derived from the donated assets. Promise to Give A written or oral agreement to contribute cash or other assets to another entity. A promise carries rights and obligations the recipient of a promise to give has a right to expect that the promised assets will be transferred in the future, and the maker has a social and moral obligation, and generally a legal obligation, to make the promised transfer. A promise to give may be either conditional or unconditional. Restricted Support Donor-restricted revenues or gains from contributions that increase either temporarily restricted net assets or permanently restricted net assets. See Unrestricted Support. Stipulation A statement by a donor that creates a condition or restriction on the use of transferred resources. Unconditional Promise to Give A promise to give that depends only on passage of time or demand by the promisee for performance. Unrestricted Support Revenues or gains from contributions that are not restricted by donors. See Restricted Support. Not-for-Profit Entities Revenue Recognition Recognition Contributions Received Page 18 of 29

32 Donor-imposed restrictions place limits on the use of contributed resources and may affect an entity's performance and its ability to provide services. However, limitations on the use of donated resources do not change the fundamental nature of the contribution transaction or conclusions about when to recognize the underlying event. >> Conditional Promise to Give Conditional promises to give, which depend on the occurrence of a specified future and uncertain event to bind the promisor, shall be recognized when the conditions on which they depend are substantially met, that is, when the conditional promise becomes unconditional. Imposing a condition creates a barrier that must be overcome before the recipient of the transferred assets has an unconditional right to retain those promised assets. For example, a transfer of cash with a promise to contribute that cash if a like amount of new gifts are raised from others within 30 days and a provision that the cash be returned if the gifts are not raised imposes a condition on which a promised gift depends A conditional promise to give is considered unconditional if the possibility that the condition will not be met is remote. See paragraph for examples of conditions that are remote of occurrence A transfer of assets with a conditional promise to contribute them shall be accounted for as a refundable advance until the conditions have been substantially met or explicitly waived by the donor. Some entities transfer cash or other assets with both donor-imposed restrictions and stipulations that impose a condition on which a gift depends. If a restriction and a condition exist, the transfer shall be accounted for as a refundable advance until the condition on which it depends is substantially met. A transfer of assets after a conditional promise to give is made and before the conditions are met is the same as a transfer of assets with a conditional promise to contribute those assets. A change in the original conditions of the agreement between promisor and promisee shall not be implied without an explicit waiver (see paragraph ). >> Determining Whether a Promise Is Conditional or Unconditional Determining whether a promise is conditional or unconditional can be difficult if it contains donor stipulations that do not clearly state whether the right to receive payment or delivery of the promised assets depends on meeting those stipulations. It may be difficult to determine whether those stipulations are conditions or restrictions. In cases of ambiguous donor stipulations, a promise containing stipulations that are not clearly unconditional shall be presumed to be a conditional promise Absence of a specified time for transfer of cash or other assets, by itself, does not necessarily lead to a determination that a promise to give is ambiguous. If the parties fail to express the time or place of performance and performance is unconditional, performance within a reasonable time after making a promise is an appropriate expectation; similarly, if a promise is conditional, performance within a reasonable time after fulfilling the condition is an appropriate expectation. Promises to give that are silent about payment terms but otherwise are clearly unconditional shall be accounted for as unconditional promises to give. Other Presentation Matters Contributions Received Restricted support increases permanently restricted net assets or temporarily restricted net assets. A restriction on an NFP's use of the assets contributed results either from a donor's explicit stipulation or from circumstances surrounding the receipt of the contribution that make clear the donor's implicit restriction on use. Contributions with donor-imposed restrictions shall be reported as restricted support; however, donor-restricted contributions whose restrictions are met in the same reporting period may be reported as unrestricted support provided that an NFP has a similar policy for reporting investment gains and income (see paragraph ), reports consistently from period to period, and discloses its accounting policy. Implementation Guidance and Illustrations Page 19 of 29

33 Contributions Received > Implementation Guidance >> Distinguishing Between Donor-Imposed Conditions and Donor-Imposed Restrictions Distinguishing between a condition stipulated by a donor and a restriction on the use of a contribution imposed by a donor may require the exercise of judgment. Conditional transfers are not contributions yet; they may become contributions upon the occurrence of one or more future and uncertain events. Because of the uncertainty about whether they will be met, conditions imposed by resource providers may cast doubt on whether the resource provider's intent was to make a contribution, to make a conditional contribution, or to make no contribution. As a result of this uncertainty, donor-imposed conditions should be substantially met by the entity before the receipt of assets (including contributions receivable) is recognized as a contribution. In contrast to donor-imposed conditions, donor-imposed restrictions limit the use of the contribution, but they do not change the transaction's fundamental nature from that of a contribution If donor stipulations do not clearly state whether the right to receive payment or take delivery depends on meeting those stipulations, or if those stipulations are ambiguous, distinguishing a conditional promise to give from an unconditional promise to give may be difficult. First, review the facts and circumstances surrounding the gift and communicate with the donor. If the ambiguity cannot be resolved as a result of those efforts, presume that a promise containing stipulations that are not clearly unconditional is a conditional promise to give. However, if the possibility that the condition will not be met is remote, a conditional promise to give is considered unconditional. For example, a stipulation that an annual report must be provided by the donee to receive subsequent annual payments on a multiyear promise is not a condition if the possibility of not meeting that administrative requirement is remote A challenge grant is a common form of a conditional promise to give. For example, a resource provider promises to contribute $1 for each $1 of contributions received by a not-for-profit entity (NFP), up to $100,000, over the next 6 months. As contributions are received from other resource providers, the conditions would be met and the promise would become unconditional. For example, if $10,000 is received in the first month from donors, $10,000 of the conditional promise would become unconditional and should be recognized as contribution revenue. >> Promises to Give Certain promises become unconditional in stages because they are dependent on several or a series of conditions milestones rather than on a single future and uncertain event and are recognized in increments as each of the conditions is met. Similarly, other promises are conditioned on promisees' incurring certain qualifying expenses (or costs). Those promises become unconditional and are recognized to the extent that the expenses are incurred. A portion of those contributions shall be recognized as revenue as each of those stages is met. Page 20 of 29

34 Appendix C: Excerpts from UK Charities SORP FRS 102 Module 5 Recognition of income, including legacies, grants and contract income Introduction 5.1. Income is the inflow of economic benefits to a charity from the activities that it undertakes. Income is an inflow of resources that results in an enhancement to the charity s assets or a decrease in its liabilities Charities should refer to sections 23, 24 and 34 of FRS 102 for more information. This module applies to all charities and sets out: understanding the nature of income; general rules for income recognition; general principles for recognising income from donations and grants; identification of terms and conditions; performance-related conditions; other terms and conditions that limit the recognition of income; deferring income where conditions that limit recognition are not met; terms and conditions that do not prevent recognition; recognising income from legacies; income from donated goods, facilities and services; income from contracts for the supply of goods and services; income from membership subscriptions; income from interest, royalties or dividends; settlement of insurance claims; and disclosures and notes to the accounts. Understanding the nature of income 5.3. There are two broad categories of income: income from exchange transactions (contract income) and income from non-exchange transactions (gifts). It is important for charities to distinguish between the two as they are recognised differently in a charity s accounts Income from exchange transactions is received by the charity for goods or services supplied under contract. The income the charity receives is approximately equal in value to the goods or services supplied by the charity to the purchaser. The essential feature of income from a non-exchange transaction is that the charity receives value from the donor without providing equal value in exchange Income from non-exchange transactions (gifts) are donations of money, goods, facilities or services which are given freely to the charity by a donor. Grants are a form of non-exchange transaction where the grant-maker awards a grant without receiving equal value in exchange. However, even though grants are classified as non-exchange transactions, a grant may be presented as income from charitable activities where the payment is made to secure the provision of particular goods or services A donation or grant that can be used for any purpose of the charity is unrestricted income. However, a donation or grant may be restricted to a specific purpose of a charity. A restriction may result from a specific appeal by the charity, or from the decision of the grant-maker or donor to support a specific purpose of the charity rather than making funds available for the charity s general use. Simply because a grant is restricted to a particular purpose of the recipient charity does not mean it should be recognised as a performance-related grant. Restricted grants that are not subject to performance-related conditions, are included within the SoFA heading Income from donations and legacies Transactions must be accounted for and presented in accordance with their substance and not simply their legal form. Charities must therefore consider the substance of any conditions attaching to donations or grants and to the substance of any contractual terms when determining their Page 21 of 29

35 entitlement to income. Similarly, the substance of any restriction placed on the use of income must be considered when determining whether or not income is presented as restricted funds in a charity s accounts. In particular, a charity should consider: Whether entitlement to income is subject to fulfilling performance-related conditions. Performance-related conditions distinguish a contract or performance-related grant from an unconditional gift or grant. The terms of a donation or grant that impose a restriction on use which is narrower than the general purposes of the charity. Terms placed on gifts that limit a charity s discretion over how income must be used are presented as restricted income in the accounts. The terms of a contract may limit payments to amounts expended by the charity on purposes specified in the contract and restrict the charity s use of any surplus. Income that is restricted by contractual terms may be presented as restricted in the accounts if the restrictions are in substance the same as would apply to a restricted donation or grant. The terms of a gift that require it to be held as endowment that must be invested and not spent. Material endowment funds must be presented as a separate class of restricted funds. General rules for income recognition 5.8. Income is recognised in the statement of financial activities (SoFA) when a transaction or other event results in an increase in the charity s assets or a reduction in its liabilities. Income must only be recognised in the accounts of a charity when all of the following criteria are met: Entitlement control over the rights or other access to the economic benefit has passed to the charity. Probable it is more likely than not that the economic benefits associated with the transaction or gift will flow to the charity. Measurement the monetary value or amount of the income can be measured reliably and the costs incurred for the transaction and the costs to complete the transaction can be measured reliably All income must be reported gross when raised by the charity (or by volunteers working at the charity s direction) or its agents. Any fee charged for fundraising by a third party and deducted from the amount collected before it is remitted to the charity must not be offset against fundraising income recognised in the accounts but be reported as a fundraising expense. However, in the case of individuals not employed by, or contracted by, the charity who are acting on a purely voluntary basis and outside of the charity s control, the charity recognises the net amount remitted. General principles for recognising income from donations and grants Income from donations or grants is recognised when there is evidence of entitlement to the gift, receipt is probable and its amount can be measured reliably. The use of the accrual model option (section 24 of FRS 102) for the recognition of income from government grants is not permitted by this SORP In the case of a grant, evidence of entitlement will usually exist when the formal offer of funding is communicated in writing to the charity. However some grants will contain terms or conditions that must be met before the charity has entitlement to the resources In the case of a donation, entitlement usually arises immediately on its receipt. However, some gifts may include terms or conditions which must be met before the charity is entitled to the resources. Identification of terms and conditions Charities need to identify donations or grants that are subject to terms or performance-related conditions or other conditions that must be met before there is unconditional entitlement to the gifted resources Not all terms or conditions attaching to a grant or donation prevent its recognition as income. A term or condition that simply restricts the use of a grant or donation does not affect a charity s entitlement to the gift and recognition of income. However, a restriction does affect how the gift or Page 22 of 29

36 grant is reported in the accounts. For more information refer to the SORP module Fund accounting When accounting for grants and donations, charities should identify: those donations and grants that are subject to performance-related conditions; and other terms or conditions that may prevent income recognition. Performance-related conditions Grant funding agreements may contain conditions that specify the services to be performed by a charity in receipt of a grant. For example, the grant may be in the form of a service level agreement where the conditions for payment are linked to the achievement of a particular level of service or the units of output delivered. The performance-related conditions contained in a funding agreement might, for example, specify the number of meals provided or the opening hours of a facility used by beneficiaries. Income must only be recognised to the extent that the charity has provided the specified goods or services as entitlement to the grant only occurs when the performance-related conditions are met Although performance-related conditions can apply to any form of gift, in practice it is unusual to see performance-related conditions apply to donations A restriction on the use of a grant or donation to a particular purpose or activity of a charity does not create a performance-related condition. A restriction creates a requirement that limits or directs the purpose for which a resource may be used but it does not require a specific level of performance or output from the recipient charity It is important at the outset of any arrangement that the charity identifies whether the funding agreement is a performance-related grant or a contract. This is important because the consequence of non-compliance with performance-related conditions and the liability for nonperformance of a contract differ. The law of contract provides for the buyer to seek costs, damages and recompense for any failure or breach of contract by the seller, whereas a breach of grant conditions may lead to a partial or full repayment of the grant when repayment terms apply to the grant. Other terms and conditions that limit the recognition of income Performance-related conditions are not the only conditions that may apply to donations and grants. For example, a grant may be conditional on a charity obtaining matched funding, or subject to a successful planning consent. Meeting these conditions would not be wholly within the control of the recipient charity and the outcome of the specified event is uncertain. The charity would not have unconditional entitlement to the income until these conditions were met Donor imposed conditions may also specify the time period over which the expenditure of resources on a service can take place. Specification of a time period may amount to a pre-condition for use that limits the charity s ability to spend a grant or donation until it has performed the activity related to the specified time period. For example, a condition might specify the provision of a number of training weeks or the completion of a number of work placements in a particular period Time-related conditions may be implied. For example when a multi-period grant is approved and is to be paid on the basis of agreed annual budgets, the charity may not be entitled to spend part or all of that income in advance of its budgeted year(s) without the further prior approval of the grantmaker. Deferring income where conditions that limit recognition are not met Where terms and conditions have not been met or uncertainty exists as to whether the recipient charity can meet the terms or conditions otherwise within its control, the income should not be recognised but deferred as a liability until it is probable that the terms or conditions imposed can be met. Page 23 of 29

37 5.24. A grant that is subject to performance-related conditions received in advance of delivering the goods and services required by that condition, or is subject to unmet conditions wholly outside the control of the recipient charity, is accounted for as a liability and shown on the balance sheet as deferred income. Deferred income is released to income in the reporting period in which the performance-related or other conditions that limit recognition are met When income from a grant or donation has not been recognised due to the conditions applying to the gift not being wholly within the control of the recipient charity, it should be disclosed as a contingent asset if receipt of the grant or donation is probable once those conditions are met. Terms and conditions that do not prevent recognition When meeting terms or conditions are within the charity s control and there is sufficient evidence that they have been or will be met, then the income must be recognised. Terms or conditions such as the submission of accounts or certification of expenditure are administrative requirements and would not prevent the recognition of income A donation or grant without conditions should not be deferred even if the resources are received in advance of the expenditure on the activity funded by them. The timing of the related expenditure is at the discretion of the charity and the income cannot be deferred simply because the related expenditure has not been incurred. For example where a donation or grant is given specifically to provide a fixed asset or a fixed asset is donated (a gift in kind), the charity is normally entitled to that income when it is receivable. At this point, all of the income must be recognised in the SoFA and not deferred over the life of the asset Similarly, a condition that allows for the recovery by the donor of any unexpended part of a grant does not prevent recognition. Instead, a liability to any repayment is recognised when repayment becomes probable. Page 24 of 29

38 Appendix D: Illustrative Example of a Flowchart for Alternative 1 1. Appendix D demonstrates an example of a flowchart that could be developed on the basis of Alternative 1 in this handout (clarify existing guidance). This flowchart demonstrates the questions that an entity would need to go through to determine how to account for grants and contracts. The appendix also identifies areas that the Board could consider to clarify the guidance. If the Board chooses Alternative 1, the staff will bring forth a further analysis at a future meeting that will explore possible improvements to the existing guidance. 2. The following steps have been identified: (a) Step 1: Does the transaction fall under Topic 606? (b) Step 2: If the transaction is a voluntary nonreciprocal transfer of resources (received or promised), are there conditions associated with the resources received (or promised)? (i) Conditions are stipulations that specify one or more future and uncertain events for which occurrence or failure to occur gives the transferor (promisor) a right of return of the assets transferred or releases the promisor from its obligation to transfer the promised assets. (c) Step 3: Is a restriction present? (i) A restriction is a stipulation that only limits the use of the transferred (promised) funds. Those stipulations may limit the purpose(s) for which the funds may be used, the time for which they become available for use, or both. Page 25 of 29

39 1 2 Does the transaction fall under Topic 606, Revenue from Contracts with Customers? No It is a nonreciprocal transaction. Apply the contribution guidance within Subtopic , Not-for-Profit Entities Revenue Recognition. Are there conditions associated with the resources received? Yes Yes 3 Apply Topic 606 guidance. It is a conditional contribution. Does the grant have a time or a purpose restriction? Step 1 Improvements to Be Examined at This Decision Point: 1. Re-examine indicators in paragraph Emphasis/examples on direct, commensurate benefit to resource providers 3. Clarification that benefit to the general public or a benefit of furthering a mission does not constitute a direct benefit to the government (therefore, would not be characterized as a reciprocal transaction under Topic 606) 4. Re-examine/reinforce terminology (contributions include donations, gifts, and grants). Steps 2 and 3 3 No It is an unconditional contribution. Does the grant have a time or a purpose restriction? No It is an unconditional, unrestricted contribution. Ye s No It is a conditional, unrestricted contribution. It is an unconditional, restricted contribution. Ye s It is a conditional, restricted contribution. Improvements to Be Examined at These Decision Points: 1. Re-examine key definitions (for example, condition and restriction) 2. Provide illustrative examples of transactions in which the guidance is not clear and there is diversity in practice 3. Re-examine the notion of uncertainty or remote 4. Consider incorporating language from UK Charity SORP on performance conditions. Page 26 of 29

40 Appendix E: Illustrative Example of a Flowchart for Alternative 2 1. Appendix E demonstrates an example of the additional steps that an NFP would need to take under Alternative 2 (define grants and contracts and account for them separately) as opposed to Alternative 1. The appendix also identifies areas that the Board could consider to clarify the guidance. Similar to Alternative 1, if the Board chooses Alternative 2, the staff could bring forth a further analysis at a future meeting that would explore possible improvements to the existing guidance. 2. Under Alternative 2, the same steps would need to be followed as demonstrated in Alternative 1 with two additional steps as follows: (a) Step 1(a): Is the transaction a grant or contract? (i) (ii) This is an additional step that would need to be added (in comparison to Alternative 1) for an NFP to determine whether the transaction should be accounted for as a grant or contract or a contribution under Topic 958. This alternative could also require a modification of the term contribution to narrow the definition. (b) Step 1(b): Apply the guidance to account for grants and contracts. (i) Additional guidance would need to be developed to account for the separate grants and contracts. Page 27 of 29

41 Step 1 1 Does the transaction fall under Topic 606, Revenue from Contracts with Customers? Yes Apply Topic 606 guidance. Same improvements as under Alternative 1. Steps 1(a) and 1(b) 1(a) 2 3 No It is a nonreciprocal transaction. Is the transaction a grant or contract (or other terminology)? No Apply the contribution guidance within Subtopic , Notfor-Profit Entities Revenue Recognition, for contributions. Same decision points for conditions and restrictions as in Alternative 1. Yes 1(b) Apply the guidance developed for grants and contracts. Unique to Alternative 2 Improvements to Be Examined at These Decision Points: 1.Step 1(a): Determine how to distinguish between a grant or contract and a contribution. (Guidance on performance conditions may be more appropriate in Step 1(a) than in Steps 2 and 3.) Would need to consider amending the definition of contribution. 2. Step 1(b): Would need to develop guidance on how to account for grants and contracts. May build off paragraph being struck out by Update , but that guidance is vague and general Could look to IAS 20. Steps 2 and 3 Same improvements as under Alternative 1. Page 28 of 29