Understanding how to manage your nonprofit's revenue is just as important as how you earn it. Nonprofit revenue recognition helps you advance your credibility and mission by accurately categorizing various income streams on your financial reports.
Beyond the value of efficient budgeting, revenue recognition is the key to building trust among donors and stakeholders. So, where do you start, and how do you avoid missteps?
Below, we're covering everything you need to know, including:
- The process of revenue recognition for nonprofits
- Revenue recognition key terms
- 5 mistakes to avoid with nonprofit revenue recognition
- What to know about the latest FASB standards
- Best practices to remain proactive and compliant
What is nonprofit revenue recognition?
Revenue recognition is a nonprofit accounting method that helps organizations clarify when they're earning income and when they should record different types of revenue under Financial Accounting Standards Board (FASB) guidance.
This guidance aims to help organizations report the most important and thorough information on financial statements. Revenue recognition principles aim to designate the nature, size, timing, and conditions of various income streams.
Revenue recognition for nonprofits
For nonprofits, managing donations, grants, and other fundraising activities requires specific protocols for reporting revenue. Building efficient and reliable financial documents strengthens relationships with supporters, grantmakers, board members, and other stakeholders who rely on updates to determine their level of involvement with an organization.
Any mistakes or inaccuracies on financial reports put you at risk for costly fines in the event of an audit. That's why it's essential to understand revenue recognition and ensure your organization follows the best practices we’ll outline below.
Revenue recognition key terms
There are a few key terms used in revenue recognition that will help you understand the process a bit more. As you become acquainted with the following definitions, you can start to see the intricacies and speak the language.
Exchanges
Exchanges are transactions where your nonprofit receives donations in exchange for something of commensurate value. Essentially, your organization receives payment in exchange for a good or service.
It’s important to note that commensurate value doesn’t exist when a transaction benefits the public. The newer clarification by FASB categorizes nonprofit grants as contributions, not exchanges.
Some examples of nonprofit exchanges are:
- Selling merchandise
- Offering services for donations or payment
- Providing membership programs for a fee or donation
- Ticket sales to fundraising events (even when they are free with an optional donation)
- Auctions and raffles where someone competes in a transaction expecting a chance to enter and possibly win in return
- Sponsorships
Exchanges are also known as reciprocal transactions. You should record revenue for these transactions only when the good or service is fulfilled.
If you were to host an event series, for example, and collect payment upfront, the revenue would be recognized between the ticket purchase and the series' duration until the final event concludes.
Contributions
Contributions are transactions in which the party donating receives no value in return. Of course, the gift of generosity and impact are valuable, but these transactions are categorized differently regarding revenue.
The key difference between contributions and exchanges is that a contribution is given without expectation of something in return.
Some examples of contributions are:
- Any direct donation
- Nonprofit grants
- Crowdfunding donations
- Peer-to-peer campaign donations (without prizes, swag, or expectation of anything in return)
- Corporate donations or employer matches
- Major donations
- In-kind donations
Contributions are often referred to as nonreciprocal transactions. Any revenue you make from contributions can be recognized and recorded on financial statements after a completed purchase or fulfilled conditions.
Contributions are typically recognized immediately without a service attached to the transaction.
Conditional transactions
Conditional donations are the last major term to know regarding revenue recognition. Both exchanges and contributions can be conditional, changing when you record them.
Some nonprofit grants or gifts are awarded under certain specifications that must be met to apply for funding. Similarly, an event may have performance expectations that determine the level at which a corporate sponsor will support it.
Knowing if your donations or various revenue sources have conditions is extremely important because this will change how you record them. A conditional contribution often has a barrier between the promise of funding or assets and the actual transfer.
Examples of conditional contributions may include:
- A nonprofit grant that can only be used for a specific project or beneficiary
- A donation with a timeframe for disbursement
- A donation match that kicks in only when a certain fundraising level is hit
Examples of conditional exchanges may include:
- A maximum bid established by an individual pursuing an auction item
- A sponsorship that is determined upon a certain performance outcome of an event
- Event tickets that are purchased under the promise of good weather (or otherwise refunded 100%)
If a contribution or exchange is conditional, revenue can only be recognized once all criteria are met. Recording revenue without considering conditional elements can lead to inaccurate financial documents and costly fines.
Nonprofit revenue recognition best practices to follow
It takes time and organized processes to build efficient and accurate revenue recognition. These best practices will help you prepare with diligence and a proactive mindset on compliance.
Be diligent about tracking revenue sources
As your nonprofit grows, the sources of revenue you have to sort out will become longer. Ensure you have an organized and trustworthy way to track every transaction and categorize revenue proactively in your nonprofit accounting software.
As you think about sources from investments to grants and donations to various campaign types, make sure to ask yourself:
- Is the source of this revenue receiving any kind of value? (if so, this is an exchange or reciprocal transaction)
- Can I guarantee this revenue source does not expect their gift(s) or a value that solely serves the public good? (If so, this is a contribution or nonreciprocal transaction)
Getting yourself in this thought pattern can help you designate your most common sources into the two main categories of revenue recognition. If revenue is received for multiple programs or purposes, allocate it accordingly based on the donor's intent or the purpose specified in the grant agreement.
Look closely for restrictions and conditions
Looking closely at unrestricted revenue and sources that may come with conditions will help you greatly. At any point where your nonprofit encounters a verbal or written contract with another party that introduces conditional revenue, be sure to record it.
You'll want to understand all conditional contributions and exchanges clearly and capture this information in your records. It's best to proactively mark each revenue source as conditional or unrestricted and return to your recordkeeping regularly to designate when conditions have been fulfilled.
That way, you can accurately record revenue in the correct timeframes for full compliance.
Monitor compliance standards and review reports
Accurate revenue recognition will help your nonprofit ensure transparency and accountability within your community. That requires regular monitoring of compliance standards.
Accounting standards to check in with for full compliance with the latest regulations include:
- Financial Accounting Standards Board (FASB)
- Accounting Standards Codification (ASC)
- Generally Accepted Accounting Principles (GAAP)
Once you're clear on new policies or practices, you can review your financial reports more precisely. Assigning an individual or team to cross-check all reports and revenue recognition decisions before submitting them will help you safeguard against risk.
5 nonprofit revenue recognition mistakes to avoid
1. Recognizing revenue at the wrong time
Revenue recognition is about timing, and recording transactions too early violates GAAP. Revenue has to be recognized when your nonprofit earns it, whether immediately through a contribution or at a future date with an exchange or conditional transaction.
Missteps can derail your budgeting and accounting processes while damaging your organization's reputation with stakeholders. It's always better to take your time and be sure than to rush and assume.
2. Misunderstanding cash and accrual accounting
Nonprofits can choose to use a cash accounting method or an accrual method. You have to know the difference and which process you want to continue with in the long run to recognize revenue accurately.
Cash accounting will recognize revenue when received, while the accrual method recognizes revenue when earned or promised. GAAP requires the accrual method, and many nonprofits find it easier to maintain a clear view of financials using it.
Whatever you choose, know how this will impact your revenue recognition practices to keep things consistent.
3. Tracking unrestricted and conditional funds together
It's important to separate unrestricted funds and conditional funds. Unrestricted revenue is recognized when the purchase is complete, quickly giving you access to funding.
You'll want to know how much-unrestricted revenue you have to work with at all times to use for overhead costs like:
- Staffing
- Training and development
- Technology and equipment
- Emergency funds
On the other hand, conditional revenue comes with restrictions that you'll want to track separately. That way, you'll avoid the complexity of having varying restrictions per transaction woven into all other revenue.
You want to see available funding and what's conditionally allocated to your budget at a moment's notice. Be sure to back up your data and keep copies of your reports in an emergency.
4. Recognizing revenue in multi-year grants
Some multi-year grants can be tricky for nonprofits to manage with revenue recognition. Every grant expense and remaining balance must be tracked precisely to avoid fines.
The added element of conditional contributions makes it harder to comply with the FASB guidelines and fund restrictions simultaneously. Avoid a complicated process or risks of mistakes by documenting the status of multi-year grants more meticulously and regularly.
Maximize your revenue with Zeffy
Nonprofit revenue recognition helps you prepare to diversify your fundraising strategy. The more ways you can source funding and get donations to fuel your mission, the more stability you can establish.
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