Nonprofits often hire accounting staff from for-profit companies who are surprised by GAAP differences between the two sectors. Most often, these differences are in revenue recognition for the simple reason that for-profit organizations lack donated revenue.
In accounting classes and training, “conservatism” and “revenue and expense matching” are constantly reinforced. At first look, these concepts appear to be violated in nonprofit accounting. GAAP requires revenue to be realized (recorded in the books) when earned. For example, when a one-year prepaid magazine subscription is purchased, the publisher recognizes 1/12 of the revenue in the first month and conservatively treats the remaining 11/12 as a “deferred revenue” liability – an “IOU” of sorts. The publisher recognizes additional revenue upon delivering the monthly magazine to the subscriber. Nonprofits organizations apply the very same concepts to earned revenues. When nonprofit arts subscriptions are sold for the next year, the revenue is deferred until shows are performed. So far, no GAAP differences exist.
But, “earned” is a tricky concept for contributions. When does a nonprofit “earn” a donation? GAAP answers the question by requiring donations to be realized when a credible donor pledges a specific amount. The pledge does not need to be collected, only promised. “Conservatism” seems tenuous since a nonprofit recognizes donated revenue merely at the point of the promise of a gift. Moreover, immediate revenue recognition is true even if the donor designates the funds for a future use and/or a future time period. For example, if a donor pledges $10,000 to purchase video equipment for a nonprofit’s project scheduled for the next year, the entire donation is recognized at the moment the gift is promised.
An accountant transitioning from a for-profit entity might then wonder why the “revenue and expense matching” principle is not applied, given that the project is “next year.” But is the matching principle violated? No! For a nonprofit, the “matching” concept is addressed by use of the “restricted” categorization. Gifts earmarked for a future time and/or purpose are designated as “restricted revenue.” Subsequently, when the donor’s requirements are met, the donation is reclassified from “restricted revenue” to “unrestricted revenue.”
Finally, nonprofit revenue transactions might have characteristics of both earned and donated revenue, which require sophisticated staff judgement for proper accounting treatment. Struggling with revenue recognition? Give us a call!