Archive for November, 2010

Revenue Recognition in the Non-Profit World

Thursday, November 11th, 2010

Frank Fabel, CPA

Most of you are probably familiar with IAS 18 on “revenue recognition”. Even if you are not: in most countries the national regulations are very similar to this concept. In short, IAS 18 says two things:

We can recognize revenue if its collection is reasonably assured and when we have earned it.


In a country, let’s call it “Far Far Away”, I met an accountant of an NGO who interpreted these two requirements as follows: “Collection is reasonably assured if I keep the cash in my hand. It is earned when I have the cash in my hand.“ In other words, the accrual basis IS the cash basis, under certain conditions. It is one more joke on the top that “Far Far Away” adopted already IFRS.


This was in marvellous “Far Far Away”. Now, I would like to switch to your place of business:


Imagine that you are an accountant of a non-profit organization and you have to find a policy of how to recognize revenue. Okay, many of our readers of this blog don’t have to imagine this, because they are accountants of non-profit organizations, and they have to build an accounting policy. From experience I know that the topic is “hot” in many organizations. Thus, I hope that we will receive some comments from your side at the end of the article!


If we talk about revenue recognition in the non-profit world, we must accept that there are many different approaches.

There are very little problems with the first requirement of IAS 18. It might be, like in the example above, that collection is only reasonably assured, if you keep cash in your hand. This depends from country to country. I hope that – at last in theory – most accountants agree that they might recognize revenue already when a contract with the donor is signed. And if you do not trust your donor, no standard of the world can force you to trust him. So if you do not trust your donor, you might recognize revenue later, for instance, when sent. And if you do not trust the international banking system, then you can recognize the inflow when received in your account. And if you do not trust your bank – well, then you should probably change the bank.

The bigger problem is the second half of IAS 18. What does it mean in the non-profit world – the word “earned”? I mean, in the non-profit world we do not sell anything. There is a mission, and it is the mission that makes things move, not the profit motive. There is no “earning process”.

In many countries, NPOs may recognize revenue only when spent. At first glance, this concept sounds a little strange: why so late? The rationale behind this attitude is the “principle of caution” – which is, because of historical reasons, popular for instance in Germany. In this line of argumentation, an NPO has “earned” its funds only once they are used in accordance with the statutes. Consequently, from this point of view, there is no profit at all. All incoming funds, without differentiating between membership fees, contributions, conditional and unconditional gifts, restricted and unrestricted funds would be first “parked” as a kind of liability. Only when expensed would they show up as revenue in the revenue and expense statement. It is clear that, under these conditions, revenue and expense statements would usually be balanced. It would be better to call this statement an “expense statement” – its feedback value is very limited.

Is there any help in the international standards in order to determine how we should interpret the “earning”-requirement of IAS 18?

Here comes the bad news: There is very little in IFRS that can help you. IFRS is silent on NPO accounting problems.

In other words, so far no commonsense has been reached in the accounting world about when an NGO should recognize revenue. Let’s look at an example:

A rich international foundation agrees to support three NGOs with a grant: one is situated in the USA, one in Germany and one in “Far Far Away”. In accordance with US GAAP, revenue could be recognized as an increase in restricted net assets, at the date when the contract is signed, in Far Far Away, when the funds are received, and in Germany, when the funds are spent. The difference in time of when revenue is recognized could easily be years. Is this comparable? No way!

US GAAP (and also other accounting standards influenced by the Anglo-Saxon traditions) favors the net asset concept. The idea is that an NGO is interested in determining how many of the net assets are bound in restricted funds, and how many funds are “free” , i.e. to the disposal of the board. In other words, in US GAAP the self-interest of the organization is the point from which accounting is developed. Continental Europe is more donor-driven. In the Anglo-Saxon concept, net assets are divided into unrestricted, temporarily restricted and permanently restricted net assets. Unrestricted net assets play a similar role like capital in profit organizations: It is in the interest of management to have some degree of independence. Grants and conditioned gifts must be recognized as temporarily restricted net asset, until the restriction is satisfied: Then a re-classification occurs.

Sometimes I have the impression that managers of NGOs stick to some kind of cash basis accounting, because they do not know the cash flow statement. If they knew what a cash flow statement is, it would probably be easier for these managers to agree on full accrual accounting. It seems as if many directors simply want to see this base line in accounting: money received, and money spent. Because nobody explained to them the purpose and the idea of the cash flow statement, these managers force accounting back into the riverbed of cash-based accounting. Am I wrong?

Thus, I would like to encourage accountants in NGOs: use full accrual, switch to an early revenue recognition in your NGO! You will see that it is very convenient to have a register for the agreed grant amount: you would simply register the contract amount as a receivable. It gives more information to managers; it adds predictive value to your accounts!

It could be that there will be some resistance from local auditors or authorities against this practice. In these cases, you can always show that there is nothing wrong with your approach: As long as the related funds are reflected separately, nobody could say that you overstate your “capital”. Is it forbidden to know more rather than less?  Moreover, you can overcome resistance from Board or Directors by presenting a cash flow statement.

Currently, there is an opportunity to influence the international standard setting process, as well in the framework of FASB and IASB.  So far, there have been exposure drafts for the oil and gas industry, for insurances and hedge funds, for the health care industry and for casinos. There even is a new standard for SMEs – but there is very little about the revenue recognition of NGOs.  This is not fair, as NGOs also operate in a globalized world and they would also like to have comparable data. Thus, I think, it is time for NGO accountants and auditors to take part in this discussion. I am looking forward to reading your comments.