Hurry Up and Wait!By Philip Marciano | September 12, 2020
Earlier this year when the world starting learning about COVID-19, no one would have predicted that the effect would be so significant that the Financial Accounting Standards Board (FASB) would grant an extension to effective dates that were already in effect. Although, even in a pre-COVID world, the FASB had delayed the effective dates of three standards (Credit Losses, Leases, and Derivatives and Hedging), so perhaps we should have seen this coming.
On June 3, 2020, the FASB voted and issued Accounting Standards Update (ASU) 2020-05 that granted a one-year effective delay for certain entities that had not yet applied the revenue recognition and lease guidance. Nonprofit organizations, like many entities, were struggling to ensure that they could cover their operating costs, so understandably, implementation of the revenue or lease standard was not their primary focus. For those organizations’ auditors, their focus was shifted to providing advice about obtaining Paycheck Protection Program (PPP) loans or other assistance that became available due to the pandemic. The delay of two major accounting standards was timely.
As a result, organizations now must consider what the impact of the delay in standards has on their financial statements and preparation for the adoption of the new standards. Although the delay gives more time to gather information and determine the effect (if any) of the standards, organizations should use the extra time wisely and not wait until the last minute to reach conclusions on the implementation effects.
The revenue standard requires organizations to re-evaluate their internal control systems to ensure that each contract and revenue stream is being evaluated to determine the effect that the new standard will have on their financial reporting. One of the biggest changes resulting from the revenue standard is the concept of variable consideration. Variable consideration requires an estimate of the amount of revenue the organization will recognize that is least likely to be reversed. It involves making probability assessments and looking at current facts and circumstances surrounding the revenue stream. Many organizations may struggle with this concept and will need to look outside of their finance departments for the expertise needed to help make a conclusion. The delay in the effective dates provides extra time to evaluate this concept and really solidify the method and inputs being used to make the estimate. Organizations that had already completed their assessment of the revenue standard may need to re-evaluate estimates because of COVID-19.
The delay in both standards allows for extra training time to help understand the new standards. Prior to the adoption date, your organization may not have received enough training or had enough time to attend training related to the adoption of the standards. Organizations should consider attending training that addresses nonprofit organization revenue streams.
Organizations and their auditors now have the benefit of hindsight since many other organizations did issue their financial statements prior to the delay being approved, which allows organizations to see how others were affected and to review the updated disclosures that pertain to the standards. Examples are critical when understanding accounting standards because they bring the standard to life in a real world context.
No Delay in Standard for Contributions
Another factor to keep in mind with the revenue recognition standard delay is that the FASB’s standard for contributions (ASU 2018-08) was not delayed. Even though the focus of ASU 2018-08 is on contributions and determining whether they are conditional or unconditional, the very first step is to determine if a revenue transaction falls within the scope of ASU 2018-08 and requires the organization to determine if each party in the transaction receives commensurate value. If the answer is “Yes,” then Topic 606, Revenue from Contracts with Customers, is applied. If an organization does not adopt Topic 606 early, then it must apply the guidance in effect prior to Topic 606 for exchange transactions.
In either case, organizations must analyze their revenue streams. In a nonprofit organization, revenue can be very complex because they are from multiple sources with many different types of contracts. Many organizations receive not only contributions, but could also receive grants (which look like contributions but could very well be exchange transactions), fee-for-service revenues that are paid directly by the customer, fee-for-service revenues that are paid by a third party, membership dues (which could partly be contributions and exchange transactions), special events revenue, donations of noncash items, and investment income. Compare that to a business entity that mainly deals in selling goods or services in a specific industry, and you will see that nonprofits have their work cut out for them when analyzing their revenue.
Start Analyzing Now
My suggestion is to start analyzing now (if you have not already). Look at the revenue you are currently receiving, analyze the contract and determine if the revenue recognition pattern will change after adopting Topic 606. Make sure you know whether the revenue stream applies to Topic 606 or ASU 2018-08. Determine how you are recognizing revenue now and compare that to the requirements of the new standard. The goal of the new standard is to depict the recognition of revenue to match the transfer of control to the customer. In many cases, financial statements do not require a restatement because the control transfers at the same point under the new standard as it did under the old. The biggest change because of Topic 606’s adoption is typically disclosure related. The challenge, of course, is taking the time to learn the standard and perform the analysis.
Take advantage of the extra time to review your contracts and determine if they need to be updated to address the new standard. Many companies changed their contracts to allow for revenue recognition patterns that would comply with Topic 606 and as a result have had less of an effect on their bottom line when it came time for adoption.
Lease Standard Considerations
Many of the same implementation and preparation concepts apply for the lease standard. With the extra time to prepare, an organization should be in the mindset of continual analysis. Each time a new lease is signed into agreement, the finance department should analyze how that lease will be treated when adopting the new standard.
The other difficulty with the lease standard is ensuring completeness (i.e., ensuring that an organization identifies all material leases). In larger organizations, this can be very difficult because there are thousands of transactions, many different locations and numerous lease agreements in effect at one time. Consider updating your software or creating a “lease captain” to manage an inventory of lease contracts.
The lease standard, like the revenue standard, also requires some judgment in certain situations. Determining the lease term under the new standard requires an analysis of economic factors and how certain the entity is to exercise the option to extend the lease.
Since public companies and some public nonprofits have already implemented the lease standard, an organization again has the benefit of seeing examples and applying those examples to their own financial statements. Organizations should ensure that finance department personnel involved in leasing attend training classes before starting the adoption process.
Other Considerations and Effective Dates
The final thought regarding implementation of these standards is to consider having your financial institutions involved in the process. Any changes to your financial statement ratios could affect your debt covenants, and you may need to work with your financial institution to update your debt agreements. Both the lease standard and the revenue standard could impact those ratios.
It is also important to keep in mind that the delay in the effective date is optional. If your organization was ready to implement, then you should continue to do so. Early adoption is still allowed under the revised ASUs. With the delayed effective dates, organizations should not slow down the analysis or preparation for implementing the new standards. All too soon, the extension will be over.
The new adoption date of the revenue recognition standard is now for annual reporting periods after December 15, 2019 (calendar year 2020 and fiscal years 2021). The new adoption date of the lease standard is for fiscal years beginning after December 15, 2021 and applies to entities in FASB’s “all other” category and public NFP entities that have not yet issued, or made available for issuance, their financial statements. Refer to ASU 2020-05 for further information regarding the delayed dates.
*This article will be published in the November/December 2020 issue of Taxation of Exempts (Thomson Reuters).
Click here to continue to read Nonprofit & Government Times, September 2020.
About Philip Marciano
Philip Marciano, CPA, CGMA, CGFM, Director in the Nonprofit, Government and Healthcare Group at Marks Paneth LLP, specializes in providing accounting and auditing services to clients within the nonprofit and government arenas. His experience includes engagements involving audit, attest and assurance services, Government Auditing Standards, Uniform Guidance, risk assessments, and internal control studies. Mr. Marciano regularly leads training sessions for professional staff within the firm and has given seminars on behalf of the New York... READ MORE +