Funds Received in Advance: Contractual Obligations, Refundable Advances, and Deferred Revenue

Understanding how to classify not-for-profit funding sources

Navigating the landscape of not-for-profit accounting presents unique complexities and challenges, requiring careful attention to the nuanced treatment of various funding sources. One of the key issues that not-for-profit organizations can face is receiving funds prior to meeting a specific obligation. Should the obligation not be met, the funds need to be returned to the individual or organization who provided the funds. In order to provide clarity to the users of an organization’s financial statements, it is recommended that the organization categorize its obligations appropriately between contractual obligations, refundable advances, and deferred revenue.

Contractual obligations

• Recognized when an exchange transaction is present defined as an obligation to provide a good or service at some point in the future.
• Used when an exchange transaction relates to an organization’s mission.
• Removed from contractual obligations and recognized as revenue once the good or service is delivered.

A common example includes when a donor has purchased tickets to an event that is occurring in the future, especially beyond the current fiscal year.

Refundable advances

• Recognized when a nonexchange transaction is present.
• Conditional liabilities, meaning that an organization might be awarded a grant, but until a condition has been met, there is the possibility that the funds may have to be returned. The donor of the funds must describe the conditions to be met AND that there is right to return the advance if the conditions are not met.
• Removed from the refundable advance and recognized as revenue once a donor-imposed condition is met OR the donor explicitly waives the conditional requirement.

Common examples of conditions include:

• An organization receives cash from a grant from a donor under the condition that your organization must raise an equal amount. As it is not a guarantee that the organization will match the grant amount, the cash received is offset by a refundable advance.
• The donor to a low-income school district might have a requirement that the district should provide scholarships to a minimum of 50 students. Should the district fail to provide the specified number of scholarships, the donation would be required to be returned.

Deferred revenue

• Recognized when an exchange transaction is present.
• Used when an exchange transaction DOES NOT relate to the organization’s mission.
• Separately accounted for from contractual obligations.
• Removed from deferred revenue and recognized as revenue once the obligation of the exchange transaction is met.

An example includes an agreement between a corporation and a not-for-profit organization to lease space in the organization’s building for a corporate event at a future date. The corporate event does not contribute to the organization’s mission.

Similarities in contract obligations, deferred revenue, and refundable advances

While there are several key differences, contract obligations, deferred revenue and refundable advances do share some similarities, some of which are as follows:

• Cash is received by the organization.
• All are presented as a liability.
• Upon satisfying the requirements of the liability, then revenue can be recognized.

Summary

The value of differentiating between contractual obligations, deferred revenue and refundable advances allows for a more transparent look at an organization’s financial statements, as users will be able to differentiate where support comes from. To summarize, contract obligations are subject to providing a product or service and are related to the organization’s mission, whereas a refundable advance is determined by if a specific condition is met and is meant to be related directly to the organization’s mission. Deferred revenue does not directly relate to the mission of the organization and should follow Accounting Standard Codification 606 (ASC 606), rather than not-for-profit guidance.

It is also critical to maintain records of any contracts or donations that the organization receives and have a system in place to determine if there are any conditions in place that would prevent the recognition of revenue. Maintain correspondence with your donors to ensure that any conditions that are imposed are met and be sure to retain this information.

Questions on classifying funds received in advance for your nonprofit? Contact your Keiter Opportunity Advisor or Email | Call: 804.747.0000.