The Grant Revenue Timing Question
Northbridge Community Health, a nonprofit, receives a $600,000 grant from a state agency in October Year 1 to fund a diabetes screening program running January through December Year 2. The award letter states the funds are restricted to program costs incurred in Year 2 and that unspent funds must be returned. Northbridge deposits the full $600,000 in November Year 1. In December Year 1 the finance director records the entire amount as revenue, arguing that 'cash is in hand and the award is signed.' Actual Year 2 program costs total $540,000; the remaining $60,000 is returned in February Year 3. The organization follows US GAAP for nonprofits and reports on a calendar year. The board is preparing audited statements and the auditor has flagged the December entry.
1. Evaluate whether recognizing the $600,000 as revenue in Year 1 is appropriate, and state the correct treatment.
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The Year 1 recognition is not appropriate. Under ASC 958, a contribution is recognized as revenue when the donor's unconditional promise is received, but a contribution that is conditional on a future event (here, incurring allowable Year 2 program costs) is not recognized until the condition is substantially met. The award is both restricted and conditional.
Correct treatment:
- Year 1: record cash $600,000 and a refundable advance / deferred revenue liability of $600,000. No revenue.
- Year 2: as $540,000 of qualifying costs are incurred, recognize $540,000 contribution revenue (released from restriction) against those costs.
- Year 3: the $60,000 returned is a reduction of the liability, not an expense; no revenue is ever recognized on it.
The finance director's 'cash in hand' reasoning confuses cash receipt with revenue recognition and ignores the return obligation.
2. The executive director asks whether the answer changes if the state agency had instead given an unconditional promise to pay $600,000 with no return provision, but still restricted to Year 2 program use. Explain.
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Yes, the answer changes in one important respect. An unconditional promise with only a purpose restriction (no return-of-funds condition) is recognized as revenue when the promise is received (Year 1), because the condition test is met. The restriction affects net asset classification, not the timing of revenue.
So in Year 1: contribution revenue $600,000, classified as net assets with donor restrictions. In Year 2, as the $540,000 of costs are incurred, net assets are released from restriction.
The distinction the exam tests: a condition (barrier plus right of return) delays revenue; a restriction (purpose or time) only affects classification. The original fact pattern has a right of return, so it is a condition.