In the blog Revenue from Contracts with Customers we talked about some of the guidance for revenue recognition for nonprofits. One of the first issues addressed by the American Institute of Certified Public Accountants (AICPA) Not-for-Profit Revenue Recognition Task Force is Tuition and Housing Revenue. This is primarily addressed to institutions of higher education but could have applicability to secondary schools as well. The guidance for this issue is included in Chapter 8 of the new AICPA Revenue Recognition Audit Guide. Chapter 8 of the guide is devoted to nonprofit organizations. The analysis is broken down by the 5 steps in revenue recognition established by ASC 606.
Step 1: Identify the Contract
There are five criteria that must be met to establish that a contract exists for this guidance:
- The parties to the contract have approved it (in writing, orally, or in accordance with other customary business practices) and are committed to perform their respective obligations
- The entity can identify each party’s rights regarding the goods or services to be transferred
- The entity can identify the payment terms for the goods or services to be transferred
- The contract has commercial substance (that is, the risk, timing, or amount of the entity’s future cash flows is expected to change as a result of the contract
- It is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer
The institution will need to consider such practices and processes (including those related to the admission and registration of students) to determine whether an agreement has enforceable rights and obligations between the institution and the student.
Institutions will also need to consider whether either party has the unilateral right to terminate a wholly unperformed contract. If an institution receives a nonrefundable deposit from a potential student for enrollment or housing they should recognize a liability in the amount of the prepayment and the institution should stand ready to provide such instruction or housing as applicable. If the student does not ultimately enroll in the institution or move in to campus housing, the associated nonrefundable deposit will be forfeited.
Another factor in identifying the contract includes establishing the collectability of the tuition and housing charges. For a contract to exist, the institution must determine it is probable they will collect the tuition and housing charges in exchange for providing instruction and housing. This includes assessing the customer’s ability to pay and whether there are any expected price concessions—such as tuition or other discounts—to establish the correct price. There is also recognition that multiple sources of payment may exist, such as the student, their parents or grants.
In addition, an institution will need to determine if tuition and housing (or any other contracts entered into with the student) are contracted for in a single contract or in separate contracts, or whether separate contracts should be combined. An institution could also consider a portfolio approach as opposed to accounting for every separate contract. If applying the portfolio approach an entity shall use estimates and assumptions that reflect the size and composition of the portfolio.
Step 2: Identify the Performance Obligations
If tuition and housing are included in a single or separate contracts, or combined separate contracts, institutions will need to consider the promises included in the contract (or combined contracts) entered into with students and whether the promises are performance obligations which need to be accounted for separately. The AICPA believes that, in most cases, tuition and housing revenue are distinct services and therefore, separate performance obligations.
Step 3: Determine the Transaction Price
Determining the transaction price can include several components. This includes what might be different tuition or housing costs per student based on the category of student (senior, in-state, out-of-state, etc.), but also certain reductions to the standard price that might apply such as a scholarship. It is believed that generally reductions in amounts charged for housing or tuition are known and agreed to by the institution and the student prior to the recognition of revenue. The AICPA believes that such reductions would generally be recognized as the institution recognizes the revenue.
A student’s right to withdraw also affects the transaction price. Institutions may provide a stated period of time during which students may withdraw from classes without further financial obligation (beyond any nonrefundable deposit) which could result in a full or partial refund .Although it is impossible to determine on a case-by-case basis whether an individual student will withdraw, an institution will probably have estimates of withdrawals based on past experience. They would then update the measurement of the refund liability at the end of each reporting period for changes in expectations about the amounts of refunds and recognize corresponding adjustments as revenue (or reductions of revenue).
Step 4: Allocate the Transaction Price to the Performance Obligations in the Contract
The transaction price is allocated to each performance obligation in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for transferring the promised goods or services to the customer. The transaction price should be allocated to each performance obligation identified in the contract on a relative standalone selling price basis.
Regarding tuition and housing, institutions may sell tuition separately but rarely would they sell housing separately to a student who is not enrolled in classes. It may be easier to establish a standalone selling price for tuition than it is for housing. The transaction price will also include any consideration for reductions in amounts charged such as financial aid.
Step 5: Recognize Revenue When (or as) the Entity Satisfies a Performance Obligation
An entity shall recognize revenue as they satisfy a performance obligation by transferring a promised good or service to a customer.
It is assumed that generally students simultaneously receive and consume the benefits provided by the institution over time throughout the academic period and tuition and housing revenues would be recognized over that time frame (the academic period). Any liability established for a nonrefundable prepayment from a student would be recognized as revenue when it satisfies its performance obligation or when the student’s right to enroll or receive housing expires.
Financial Statement Presentation
The general ASC 606 guidance states that when either party to a contract has performed, an entity shall present the contract in the Statement of Financial Position as either a contract asset or contract liability, depending on the relationship between the entity’s performance and the customer’s payment. A contract asset is an entity’s right to consideration in exchange for goods and services that the entity has transferred to the customer. A contract liability is an entity’s obligation to transfer goods or services to a customer for which the entity has received consideration (or an amount of consideration is due) from the customer.
If the institution receives consideration or has the right to an amount that is unconditional before the service has been provided, the entity would record a contract liability as either cash or a receivable. If the institution provides the tuition or housing service before the customer pays or before they have an unconditional right to the consideration it is appropriate to recognize a contract asset or receivable for the services provided.
As with any asset it must be evaluated periodically for impairment. A refund liability may also need to be recorded for consideration received for which you do not expect to be entitled.
On the Statement of Activities, because revenue is recognized based on a transaction price (net of any reductions) presenting the gross amount as revenue is not allowed. However it is acceptable for institutions to disclose the amount of reductions in the revenue line either parenthetically on the face of the statement of activities, or in the notes to the financial statements.
Our next blog post, Tuition and Housing Revenue Examples, will present two examples of situations to illustrate the concepts presented here. For additional information on tuition and housing revenues, or any other matter affecting nonprofits, please feel free to contact Rob Eby, Greg Plotts or Craig Stevens at 301-231-6200.