Revenue Recognition: Restricted Contributions vs. Deferred Revenue
Each nonprofit organization has donors or partners who have particular requirements or specific reasons for giving. They may want those funds to be used for a specific purpose, campaign, or after a specified time.
This adds an extra layer of complexity to bookkeeping, unique to nonprofit administrators. It's known as revenue recognition, which means appropriately recording and acknowledging your various streams of revenue in your books.
It's essential to understand how each form of revenue should be recognized in your records, but determining how to recognize it can be tricky, especially when that revenue recognition involves restricted donations and exchange transactions.
Below, we'll clarify precisely how to manage these.
Record as Restricted Contributions or Deferred Revenue?
In a nutshell, it comes down to how and when money needs to be spent and whether or not there is an exchange of value involved. To better understand, you need to know the difference between the two.
What are Restricted Contributions?
A restricted contribution (also known as restricted giving) is money given for a particular purpose. It is important to understand that charities are legally required to use restricted gifts as specified by the donor. These restrictions are on the use of the funds, timing and amount of expenses, or the investments of funds. Once the money is used for the declared purpose or at the right time, it is no longer considered a restricted fund.
It's important to note that donors are the only people who can restrict funds. So, even if a not-profit chooses to set aside or allocate certain donated funds for a specific or future purpose, this does not make those funds restricted. This is just a nonprofit managing its resources. And revenue recognition should clearly show this.
These strings-attached donations often occur when your organization is fund-raising for a specific cause, project, or program. Before attracting restricted contributions, make sure you understand the donor restrictions and the best practice to manage them.
Even if your organization were at risk of going under, these funds could not be touched for other than their designated purpose. The IRS nor the law would consider any situation dire enough to break this covenant you made with the donor. The charity does have an option to ask the donor to consent to modify the restriction, though.
On the accounting side, the restricted contribution is recognized as income in the year they have been received. The release from restrictions is reported on the Statement of Activities in the year the restrictions have been met.
What is Deferred Revenue?
This is money that is given for something in exchange later down the road. Deferred revenue is a liability for the money that has been received but has not been earned yet and is shown in the liabilities section on the Statement of Financial Position.
For example, an annual tuition fee is considered deferred revenue when received because the payment is made before the exchange for the service. Revenue recognition doesn't occur until the service is rendered; in this case, the money is used for tuition during the month it was meant to cover. Revenue recognition will occur each month the tuition fee is used/ services rendered.
On the accounting side, the entry is to the deferred revenue account for the annual tuition fee received. At the end of each month, the entry is recorded to recognize the monthly portion of tuition revenue and reduce the deferred revenue account balance.
A not-for-profit organization should give careful, consistent consideration to determine whether funds received are a contribution or exchange transaction as it is an essential step in differentiating between recording deferred revenue or temporarily restricted donations. A specialized nonprofit accountant can help you set up the internal process and share the guidance.
Katya Koteff, CPA, is the principal and founder of Koteff Accounting Group and specializes in working with nonprofits and socially-responsible businesses. Katya's work is grounded in building long-term trusted relationships with her clients through mutual respect and open and proactive communication.
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