May 2010 Not-for-profit New criteria for recognition of intangible assets by a not-for-profit organization Background In February 2008, the Accounting Standards Board amended Canadian Institute of Chartered Accountants Handbook Section (CICA) 1000, Financial Statement Concepts, to indicate that the matching principle could not be used to justify the practice of recording deferred costs on the balance sheet that didn t meet the definition of an asset. Examples of intangible assets provided in the accounting standards are focused on forprofit organizations and do not address the types of intangible assets that are more typical for not-for-profit organizations. Examples of intangible assets provided in the accounting standards include computer software, motion picture films, customer lists, customer or supplier relationships, and marketing rights. Not-for-profit organizations incur costs related directly to the future delivery of services or raising of funds. Some of these activities involve the development of an intangible asset. Other expenditures may continue to qualify to be recorded as inventory or as a prepaid expense (i.e., a prepayment for a service or supplies that expires with the passage of time or is used in the future). In the past, expenditures that did not involve the development of an intangible asset or qualify to be recorded as inventory or as a prepaid expense might have been deferred under generally accepting accounting principles (GAAP). This practice was supported by the matching principle; consequently, as a result of these changes in accounting standards, not-for-profit organizations must reconsider their accounting treatment of previously deferred costs to determine if they continue to be eligible for recognition as an asset. We believe the following are examples of activities where costs incurred may lead to the recognition of intangible assets by not-for-profit organizations: Fundraising event Season of plays or concerts Lottery Educational program Fundraising campaign for special purposes, such as to fund capital projects
To qualify for recognition as an asset, expenditures must have all of the following characteristics: They must embody a future benefit that involves a capacity to contribute directly or indirectly to future net cash flows or to provide services. The organization must control access to the benefit. The transaction or event giving rise to the organization s right to, or control of, the benefit has already occurred. CICA 3064, Goodwill and Intangible Assets, sets out criteria for an expenditure to qualify for recognition as an intangible asset. Although this section indicates that it does not apply to notfor-profit organizations, it provides useful guidance about the characteristics of an intangible asset. An intangible asset must be individually identifiable and separable. It must be something that is able to be distinguished from the general goodwill of an organization and is not an expenditure to develop the organization as a whole, or it must arise from contractual or other legal rights. The organization must control the intangible asset. In other words, the organization must have the power to obtain the future economic benefits flowing from the underlying resource and to restrict the access of others to those benefits. An example of when an organization does not have the power to obtain the future economic benefits would be customer relationships or skilled staff that are not protected by legal rights. There must be future economic benefits that will flow from the intangible asset to the organization. These benefits may include revenue from the sale of products or services, cost savings or other benefits resulting from the use of the asset by the organization. The cost of the intangible asset must be susceptible of reliable measurement. The expected future economic benefits must exceed the costs of developing the intangible asset. Judgment is required to estimate the value of the future benefits. Past experience of the organization would be an important consideration in estimating future benefits. We believe that the costs incurred by not-for-profit organizations described later in this publication may meet the definition of an asset and, specifically, an intangible asset when: They represent activities that are directed to creating something that is distinct and separately identified The organization controls access to the benefit, since they are the only entity that will receive the revenue that flows from the activities that created the costs The probability of future economic benefits can be clearly demonstrated or estimated based on past experience They can be measured reliably Whether the expected future economic benefits will exceed the costs of developing the intangible asset and therefore permit recognition as an intangible asset will depend on the individual circumstances, but generally past experience will be a good indicator. The costs included in acquiring or developing an intangible asset would include any directly attributable costs of preparing the asset for its intended use. These costs could include direct costs of products or services used in developing the asset, and costs of salaries and benefits arising directly from bringing the asset to its working condition. Costs associated with activities related to intangible assets may fall into two phases: a research phase and a development phase. In the research phase, an organization has not yet decided to proceed with the activities that would create an intangible asset, or cannot demonstrate that an intangible asset exists that will generate probable future economic benefits that will exceed the costs. Those costs incurred in the research phase should be expensed. The development phase begins once an organization can demonstrate that it is possible to proceed to develop an intangible asset, how future economic benefits will be generated and that it can reliably measure the costs attributable to the intangible asset. These direct costs can be capitalized. The cost of an intangible asset is amortized over the useful life of the intangible asset. The value of the intangible asset recorded on the balance sheet should be tested for impairment when indicators of loss exist. The test of impairment would include consideration of future cash flows and past experience to support these estimates of the future outcomes. 2 Not-for-profit
Salaries and benefits Staff of an organization may be involved with the activities noted on the following pages. For all or a portion of the salaries and benefits of these staff to be included in the costs recognized as an asset, the organization needs to demonstrate that the staff is directly involved in these activities. Generally, the activities should involve tasks that might otherwise have been contracted out. Selling costs The treatment of marketing-related costs also warrants some additional discussion. Accounting literature makes a distinction between selling costs and advertising and promotion costs. Advertising and promotion costs are generally expensed when incurred. However, GAAP does recognize that, in certain circumstances, selling costs can be included in the cost of an asset. For example, there is support in the accounting literature to include selling costs that are directly attributable to the earning of future revenue in the cost of an intangible asset. In addition, US GAAP makes a distinction between certain advertising and promotion costs that are directly related to the earning of revenue (e.g., a direct mail catalogue) and more generic advertising. Under the circumstances described below, we believe that this guidance can be used to support the recognition of selling costs (such as very targeted advertising and brochures) as an intangible asset. Intangible assets developed by notfor-profit organizations The following sets out examples of intangible assets that are developed by not-for-profit organizations and related comments. Season of plays or concerts Not-for-profit organizations may offer a season of plays or concerts. To present a season, a number of costs must be incurred, including the following: Renting or constructing sets Renting or making costumes Renting or buying scripts or musical scores Preparing the productions, including paying directors and performers during the rehearsal period Presenting the productions, including paying directors, technical staff and performers Selling costs, including promotional activities, such as material (e.g., advertising and brochures) and telemarketing that define the season to potential ticket purchasers Some of these costs are often incurred in the fiscal year before the season is presented. In some cases, the production-related costs might be incurred more than one year in advance. For example, deposits might be made on the rental of sets. Such costs meeting capitalization criteria would be initially recognized as an asset and charged to operating results over the period that the season is offered. Revenue related to the season, including the sale of tickets, sponsorships and government grants, is often received in advance. This revenue is deferred and recognized in operating results over the period that the season is offered. The existence of this advance revenue is helpful in demonstrating the cash inflows associated with these costs. Exhibitions presented by a gallery Museums and art galleries present temporary exhibitions. Costs are incurred to develop and present the exhibition. These costs are covered by revenue such as ticket sales, sponsorships and government grants. The following are examples of costs to present a temporary exhibition: Planning the exhibition Renting or constructing the cases and other material required to present the exhibition Obtaining the material to be included in the exhibition Selling costs, including promotional material such as advertising and brochures that describe the exhibition and its timing to potential ticket purchasers The timing of exhibitions is not always consistent with the organization s fiscal year. As a result, an exhibition might fall into more than one fiscal year. The costs involved in developing an exhibition may qualify for capitalization and subsequent amortization over the period of the temporary exhibition. Revenue related to temporary exhibitions is sometimes received in advance. It would also be deferred and recognized in operating results over the period of the exhibition. Again, the existence of this advance revenue is helpful in demonstrating the cash inflows associated with these costs. Accounting for certain costs 3
Fundraising events Many not-for-profit organizations have fundraising events. Costs are incurred with the purpose of raising sufficient revenue to cover the costs of the event and make a net contribution to the organization. Examples of costs include: Renting a venue for the event Food Decor Planning of the event Selling costs, including promotional material such as advertising and brochures that describe the event to potential attendees Events are normally held on one day, and the associated costs would be recognized in operating results on that day. Revenue related to events is often received in advance. It would also be deferred and recognized in operating results on the date of the event (unless the event is to support a restricted purpose, in which case the net results would be recorded in deferred contributions if the deferral method is being used). Again, revenue received before the date of the event is helpful in demonstrating the cash inflows associated with these costs. Lotteries Some not-for-profit organizations present lotteries. Costs are incurred with the intention of selling sufficient tickets to cover the costs of the lottery and make a net contribution to the organization. Examples of costs include: Planning and carrying out the lottery (the conduct of the lottery is often outsourced) Prizes Selling costs, including promotional material such as brochures and advertising that describe the specific lottery and its timing to potential ticket purchasers Tickets must be sold before the draw. Lotteries may have earlybird draws and a final draw. The revenue would be deferred and recognized in operating results at the time of the final draw (unless the net proceeds are restricted, in which case they would be recorded as deferred contributions if the deferral method is being used). The eligible costs previously recognized as an asset would be charged to operating results on the day of the final draw. 4 Not-for-profit
Educational programs Some not-for-profit organizations offer educational programs. Costs are incurred with the expectation that students will enrol in a particular program and pay tuition fees. Examples of costs include: Developing a specific course or program Selling costs, including promotional material such as brochures and advertising that describe the specific course or program and its timing to potential students Costs related to advertising the general or specific educational programs of the organization and not specifically related to a particular course or series of courses, with the timing of those courses included in the material, would not be eligible for recognition as an asset. The eligible costs would be capitalized and amortized over the period during which the course or series of courses is offered. Tuition fees are usually received in advance. They would be deferred and also amortized over the period during which the course or series of courses is offered. Again, the existence of this revenue is helpful in demonstrating the cash flows associated with these costs. Special fundraising campaigns Not-for-profit organizations periodically undertake special campaigns, often to pay for the costs of a capital project or other special initiative. These campaigns are usually separate from annual fundraising activities that are carried out on an ongoing basis. The costs of annual campaigns generally would be expensed when incurred. Special fundraising campaigns typically span a number of years from the feasibility phase to the collection of the final pledge. They often move through a research phase before reaching the development phase. Costs may be incurred to determine whether it is feasible to carry out a campaign and whether enough funds might be raised to justify a campaign. Costs incurred during the research phase generally would not meet the criteria to justify capitalization and would be expensed. Once a decision has been made to proceed with a campaign (i.e., moves into the development phase) on the basis that sufficient funds can be raised at a reasonable cost and there is evidence supporting this conclusion, it is more likely that the criteria would be met to capitalize the costs. Examples of costs related to capital campaigns that might be capitalized include: Salaries and benefits of staff or costs of contract staff who are working directly on the capital campaign Materials (e.g., brochures) that set out what is covered by the campaign and the recognition available to people who donate Costs of consultants to help organize and define the campaign Assuming that the total projected capital campaign expenses are reasonable compared to the projected proceeds from the campaign, these costs would be amortized over the period that campaign proceeds are received (generally based on the estimated total expenses as a percentage of the total campaign proceeds times the cash donations received in a particular year) and offset by recognizing an equal amount of capital campaign proceeds as revenue. Unless very specific to the capital campaign, the costs of advertising generally would be expensed. Direct mail US GAAP permits asset recognition for expenditures such as direct mail costs when a link can be made between such costs and related revenue generation. Provided organizations can demonstrate a clear and close link between direct mail program costs and revenue, such costs may be capitalized as an asset. Accounting for certain costs 5
Presentation of intangible assets Generally, we would suggest costs recognized as an intangible asset on the balance sheet be presented as other assets. We believe that, where there are different types of costs related to an activity, some of which might represent prepaid expenses or inventory, they can be presented together in the other assets category. The classification between current and non-current assets would depend on the expected timing of realization. Current assets generally are expected to be realized in the next operating cycle. Since GAAP does not permit the deferral of costs based on the matching concept, but does permit the recognition of intangible assets developed by an entity, care should be taken to properly describe the assets and avoid references to deferred costs. If the costs included in other assets are significant, there should be a note that describes the accounting policy for these costs. The following is a sample accounting policy note that could be tailored to the specific circumstances of an organization: Summary of accounting policies Other assets Costs directly related to the development of [describe the qualifying intangible asset (e.g., future performance seasons, future exhibitions, future fundraising events or future lotteries)] are presented as other assets when the organization can reliably demonstrate that there is a future economic benefit associated with these costs. These costs are expensed over their useful life, which for [specify qualifying intangible asset] is [specify appropriate period (e.g., when the lottery/special event is held or over the period in which the performance season/exhibition is held)]. Such costs are expensed immediately when there is insufficient evidence that the costs are recoverable. In addition, if the costs are significant, there should be a note that describes the nature of the costs. The following is a sample note: X. Other assets Other assets consist of costs related to [describe the qualifying intangible asset (e.g., future performance seasons, future exhibitions, future fundraising events or future lotteries)]. If there is more than one type of cost included in other assets, a table could be provided. 6 Not-for-profit
Transitional considerations If an organization s financial statements include costs now being recognized as an intangible asset that were previously described as prepaid expenses or deferred costs, the financial statements should include a reference to a change in accounting policy. The following is a sample note that assumes that all costs previously recorded on the balance sheet can continue to be capitalized as intangible assets. This note would need to be tailored to the specific circumstances of the organization: Changes in accounting policies In February 2008, the Accounting Standards Board amended CICA 1000, Financial Statement Concepts, to clarify that assets not meeting the definition of an asset are not permitted to be recognized on the balance sheet. The organization has reviewed costs recorded on the balance sheet and determined that no adjustment is required to the financial statements. An accounting policy note has been added with respect to the accounting for [specify qualifying intangible asset] and certain amounts on the balance sheet have been reclassified. Conclusion The changes to the CICA Handbook require organizations to carefully review the types of costs that have been deferred in the past to ensure that they continue to qualify to be recognized as an asset. When costs do qualify, changes may be required in connection with the presentation of the costs on the balance sheet. If costs no longer qualify, the change in accounting policy should be adopted retroactively with restatement. Learn more For more information, contact Martha J. Tory Partner, Ernst & Young LLP Director, Not-For-Profit Organizations 416 943 3678 or any Ernst & Young professional. Accounting for certain costs 7
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