Proper Maintenance of Capital Asset Records: Make It a Year-round Activity

Accounting for capital assets generally is not on a school district’s radar for day-to-day accounting. Usually, capital asset workpapers are completed at the end of the audit. Because they are presented only at a district-wide level, they are frequently overlooked. However, these assets are often one of the largest amounts on the financial statements. Proper accounting for capital assets is important to ensure that this balance is accurate and represents actual assets held by the school district.

Managing the capital asset listings

Capital asset listings are generally very large and may contain items from the formation of the school district. Additions during the year are identified through items coded to a capital outlay object code (6000). These transactions should be reviewed to determine which of them exceeds the school district’s capitalization policy and should be added to the listing to begin depreciation. The Michigan Public School Accounting Manual (Bulletin 1022) provides major class codes for land, building and additions, site improvements, equipment and furniture, vehicles other than buses, school buses, educational media and textbooks, construction in process, and other capital assets.

Capital asset disposal

While additions are straightforward to identify, disposals are not as simple. Many times, the disposal of a capital asset does not result in the school district receiving proceeds; therefore, items may be removed, and the business office will not know about the transaction. Capital asset policies should be established to define proper disposal procedures. The business office must communicate the policies throughout the school district to ensure that all information is properly reported.

A physical inventory of assets purchased in whole or in part under a federal award must undergo a physical inventory a least once every two years. The school district may want to consider performing a full capital asset inventory at this time. Procedures usually include the tagging of equipment with barcodes and updating asset valuations to ensure the listing is as accurate as possible.

Capture as much identifying information as possible

What type of information should be on the listing? As much identifying information as possible! To help combat the disposal issue noted above, assets should be easily distinguishable. The description should include the location, serial number, date added, original invoice information, etc.

If the equipment was purchased with federal funds, the school district is required to include the following in the property records:

a description of the property
a serial number or other identification number
the source of funding for the property (including the FAIN)
who holds the title
the acquisition date
cost of the property
percentage of federal participation in the project costs for the federal award under which the property was acquired
the location, use, and condition of the property
any ultimate disposition data including the date of disposal and sale price of the property (2 CFR 200.313(d)(1))

Clear, enforced policies are vital

Clear policies should be established and enforced by the school district to ensure that the balance is accurate. Review throughout the year can help eliminate any year-end headaches and make updating the records much less of an administrative burden. Yeo & Yeo has several solutions to assist in the proper maintenance of the capital asset listing and we would be happy to help.

One option business owners choose for succession planning is an employee stock ownership plan (ESOP). ESOPs can empower and retain employees as well as provide tax savings, but careful consideration needs to be given to how and when these plans are valued. The value of the privately held stock is subject to standards put in place by both the Internal Revenue Service and the Department of Labor. Both organizations have employed fair market value as the standard value, otherwise known as the price the stock would trade for on the open market.

ESOPs require valuations at different times and for different reasons. A company that is considering starting an ESOP would want to have a valuation performed before they go through the steps of establishing an ESOP so they will know an approximate value of the company and can compare this option to other alternatives they are considering.

A valuation would also need to be done anytime the ESOP is engaging in a security transaction to verify that the transaction is occurring at fair market value. The IRS does not allow a company to take a deduction for an ESOP contribution unless the ESOP has received shares worth the amount of the deduction.

Finally, a valuation needs to be performed each year to determine the value of stock that is owned by employees. If a plan participant, beneficiary, or retired employee would like to sell their stock, they would sell the stock back to the trustee at the price per share during this time.

Valuations for an ESOP are different from the average valuation in that they require additional analysis and disclosures. They also must satisfy Department of Labor requirements. It is important to make sure that when engaging in these types of transactions, you are working with a valuation analyst who is aware of these additional requirements to make sure your plan is compliant.

An array of tax-related limits that affect businesses are annually indexed for inflation, and many have increased for 2020. Here are some that may be important to you and your business.

Social Security tax

The amount of employees’ earnings that are subject to Social Security tax is capped for 2020 at $137,700 (up from $132,900 for 2019).

Deductions

Section 179 expensing:
- Limit: $1.04 million (up from $1.02 million for 2019)
- Phaseout: $2.59 million (up from $2.55 million)

Income-based phase-out for certain limits on the Sec. 199A qualified business income deduction begins at:
- Married filing jointly: $326,600 (up from $321,400)
- Married filing separately: $163,300 (up from $160,725)
- Other filers: $163,300 (up from $160,700)

Retirement plans

Employee contributions to 401(k) plans: $19,500 (up from $19,000)
Catch-up contributions to 401(k) plans: $6,500 (up from $6,000)
Employee contributions to SIMPLEs: $13,500 (up from $13,000)
Catch-up contributions to SIMPLEs: $3,000 (no change)
Combined employer/employee contributions to defined contribution plans (not including catch-ups): $57,000 (up from $56,000)
Maximum compensation used to determine contributions: $285,000 (up from $280,000)
Annual benefit for defined benefit plans: $230,000 (up from $225,000)
Compensation defining a highly compensated employee: $130,000 (up from $125,000)
Compensation defining a “key” employee: $185,000 (up from $180,000)

Other employee benefits

Qualified transportation fringe-benefits employee income exclusion: $270 per month (up from $265)
Health Savings Account contributions:
- Individual coverage: $3,550 (up from $3,500)
- Family coverage: $7,100 (up from $7,000)
- Catch-up contribution: $1,000 (no change)
Flexible Spending Account contributions:
- Health care: $2,750 (up from $2,700)
- Dependent care: $5,000 (no change)

These are only some of the tax limits that may affect your business and additional rules may apply. If you have questions, please contact us.

Perhaps you’re an investor in mutual funds or you’re interested in putting some money into them. You’re not alone. The Investment Company Institute estimates that 56.2 million households owned mutual funds in mid-2017. But despite their popularity, the tax rules involved in selling mutual fund shares can be complex.

Tax basics

If you sell appreciated mutual fund shares that you’ve owned for more than one year, the resulting profit will be a long-term capital gain. As such, the maximum federal income tax rate will be 20%, and you may also owe the 3.8% net investment income tax.

When a mutual fund investor sells shares, gain or loss is measured by the difference between the amount realized from the sale and the investor’s basis in the shares. One difficulty is that certain mutual fund transactions are treated as sales even though they might not be thought of as such. Another problem may arise in determining your basis for shares sold.

What’s considered a sale

It’s obvious that a sale occurs when an investor redeems all shares in a mutual fund and receives the proceeds. Similarly, a sale occurs if an investor directs the fund to redeem the number of shares necessary for a specific dollar payout.

It’s less obvious that a sale occurs if you’re swapping funds within a fund family. For example, you surrender shares of an Income Fund for an equal value of shares of the same company’s Growth Fund. No money changes hands but this is considered a sale of the Income Fund shares.

Another example: Many mutual funds provide check-writing privileges to their investors. However, each time you write a check on your fund account, you’re making a sale of shares.

Determining the basis of shares

If an investor sells all shares in a mutual fund in a single transaction, determining basis is relatively easy. Simply add the basis of all the shares (the amount of actual cash investments) including commissions or sales charges. Then add distributions by the fund that were reinvested to acquire additional shares and subtract any distributions that represent a return of capital.

The calculation is more complex if you dispose of only part of your interest in the fund and the shares were acquired at different times for different prices. You can use one of several methods to identify the shares sold and determine your basis.

First-in first-out. The basis of the earliest acquired shares is used as the basis for the shares sold. If the share price has been increasing over your ownership period, the older shares are likely to have a lower basis and result in more gain.
Specific identification. At the time of sale, you specify the shares to sell. For example, “sell 100 of the 200 shares I purchased on June 1, 2015.” You must receive written confirmation of your request from the fund. This method may be used to lower the resulting tax bill by directing the sale of the shares with the highest basis.
Average basis. The IRS permits you to use the average basis for shares that were acquired at various times and that were left on deposit with the fund or a custodian agent.

As you can see, mutual fund investing can result in complex tax situations. Contact us if you have questions. We can explain in greater detail how the rules apply to you.

Welcome to Everyday Business, Yeo & Yeo’s podcast. We’ve had the privilege of advising Michigan businesses for more than 95 years, and we want to share our knowledge with you.

Covering tax, accounting, technology, financial and advisory topics relevant to you and your business, Yeo & Yeo’s podcast is hosted by industry and subject matter professionals, where we go beyond the beans.

On episode four of Everyday Business, host David Jewell, tax partner in Kalamazoo, is joined by Terrie Chronowski, Tax Supervisor in our Saginaw office. Her expertise lies in all things related to individual income tax. Another guest is Jeff McCulloch, President of Yeo & Yeo Technology. Jeff shares some tips from an IT security standpoint, and how taxpayers can best protect personal information.

Listen in as David, Terrie, and Jeff discuss all things security that you should consider this tax season and beyond.

How do taxpayers most often find out that their identity or social security number has been compromised, and what should you do if your Social Security number is stolen and being used? (2:15)
How can you protect your information from a technology perspective? (7:18)
Should you use free public Wi-Fi? (15:17)
Information we share with our clients to keep them secure. (19:45)

Thank you for tuning in to Yeo & Yeo’s Everyday Business Podcast. Yeo & Yeo’s podcast can be heard on Apple Podcasts, PodBean and, of course, our website. Please subscribe, rate and review.

For more business insights, visit our Resource Center and subscribe to our eNewsletters.

DISCLAIMER
The information provided in this podcast is believed to be valid and accurate on the date it was first published. The views, information, or opinions expressed during the podcast reflect the views of the speakers. This podcast does not constitute tax, accounting, legal or other business advice, or an advisor-client relationship. Before making any decision or taking action, consult with a professional regarding your specific circumstances.

Welcome to Everyday Business, Yeo & Yeo’s podcast. We’ve had the privilege of advising Michigan businesses for more than 95 years, and we want to share our knowledge with you.

On episode three of Everyday Business, host David Jewell, tax partner in Kalamazoo, is joined by Kelly Brown, a tax manager in our Saginaw office. Listen in as David and Kelly discuss the tax code credits and deductions and how you can strategize around education expenses.

Review the American Opportunity Tax Credit and the Lifetime Learning Credit. (2:05)
Strategy for tax credits and how parents can shift tax breaks to their children. (6:22)
Review of college savings programs and their benefits. (9:12)

Thank you for tuning in to Yeo & Yeo’s Everyday Business Podcast. Yeo & Yeo’s podcast can be heard on Apple Podcasts, PodBean and, of course, our website. Please subscribe, rate and review.

For more business insights, visit our Resource Center and subscribe to our eNewsletters.

Welcome to Everyday Business, Yeo & Yeo’s podcast. We’ve had the privilege of advising Michigan businesses for more than 95 years, and we want to share our knowledge with you.

On episode two of Everyday Business, host David Jewell, tax partner in Kalamazoo, is joined by Andrew Matuzak, tax manager in the firm’s Saginaw office. Listen in as David and Andrew discuss the new SECURE Act and the extensions taxpayers need to know about.

SECURE Act changes taxpayers will face. (2:16)
When will the SECURE Act changes take effect? (4:50)
Rules for Stretch IRAs. (5:34)
Appropriations bill extensions, key deductions, and credits. (6:30)
Planning strategies for new Appropriations bill provisions. (8:49)
Tax credits that are available for small businesses because of the SECURE Act. (10:50)

Thank you for tuning in to Yeo & Yeo’s Everyday Business Podcast. Yeo & Yeo’s podcast can be listened to on Apple Podcasts, PodBean and, of course, our website. Please subscribe, rate and review.

For more business insights, visit our Resource Center and subscribe to our eNewsletters.

Many people who launch small businesses start out as sole proprietors. Here are nine tax rules and considerations involved in operating as that entity.

1. You may qualify for the pass-through deduction. To the extent your business generates qualified business income, you are eligible to claim the 20% pass-through deduction, subject to limitations. The deduction is taken “below the line,” meaning it reduces taxable income, rather than being taken “above the line” against your gross income. However, you can take the deduction even if you don’t itemize deductions and instead claim the standard deduction.

2. Report income and expenses on Schedule C of Form 1040. The net income will be taxable to you regardless of whether you withdraw cash from the business. Your business expenses are deductible against gross income and not as itemized deductions. If you have losses, they will generally be deductible against your other income, subject to special rules related to hobby losses, passive activity losses and losses in activities in which you weren’t “at risk.”

3. Pay self-employment taxes. For 2020, you pay self-employment tax (Social Security and Medicare) at a 15.3% rate on your net earnings from self-employment of up to $137,700, and Medicare tax only at a 2.9% rate on the excess. An additional 0.9% Medicare tax (for a total of 3.8%) is imposed on self-employment income in excess of $250,000 for joint returns; $125,000 for married taxpayers filing separate returns; and $200,000 in all other cases. Self-employment tax is imposed in addition to income tax, but you can deduct half of your self-employment tax as an adjustment to income.

4. Make quarterly estimated tax payments. For 2019, these are due April 15, June 15, September 15 and January 15, 2021.

5. You may be able to deduct home office expenses. If you work from a home office, perform management or administrative tasks there, or store product samples or inventory at home, you may be entitled to deduct an allocable portion of some costs of maintaining your home. And if you have a home office, you may be able to deduct expenses of traveling from there to another work location.

6. You can deduct 100% of your health insurance costs as a business expense. This means your deduction for medical care insurance won’t be subject to the rule that limits medical expense deductions.

7. Keep complete records of your income and expenses. Specifically, you should carefully record your expenses in order to claim all the tax breaks to which you’re entitled. Certain expenses, such as automobile, travel, meals, and office-at-home expenses, require special attention because they’re subject to special recordkeeping rules or deductibility limits.

8. If you hire employees, you need to get a taxpayer identification number and withhold and pay employment taxes.

9. Consider establishing a qualified retirement plan. The advantage is that amounts contributed to the plan are deductible at the time of the contribution and aren’t taken into income until they’re are withdrawn. Because many qualified plans can be complex, you might consider a SEP plan, which requires less paperwork. A SIMPLE plan is also available to sole proprietors that offers tax advantages with fewer restrictions and administrative requirements. If you don’t establish a retirement plan, you may still be able to contribute to an IRA.

Seek assistance

If you want additional information regarding the tax aspects of your new business, or if you have questions about reporting or recordkeeping requirements, please contact us.

Yeo & Yeo’s eBook, Essential Nonprofit Policies, outlines some policies that all nonprofits should consider establishing, and the key components those policies should include. Ultimately, well-thought-out policies will help create defined processes that will decrease confusion and streamline operations for your organization. Documented policies will also help you respond to risk and reassure donors.

Once established, policies will promote appropriate and consistent decision-making and behavior that aligns with your organization’s mission.

In general, government contracts are awarded to the lowest bidder. Yet prevailing wage laws require contractors to pay wages that are comparable to those for similar work in the same city or geographical area. Such laws can make it difficult for contractors to win public projects.

However, you may have an opportunity to reduce costs and make your bids more competitive by leveraging fringe benefits. Let’s look at this strategy.

Cash Can Drive Up Costs

Prevailing wage rates — which are established by the U.S. Department of Labor or a relevant state agency — contain both a basic hourly rate (paid in cash) and a fringe benefit component. Government contractors typically can choose whether to pay the fringe benefit component of the prevailing wage in cash or to use those amounts to fund one or more “bona fide” employee benefit plans.

You may be tempted to pay fringe benefit amounts directly to employees in cash. After all, this option offers simplicity and administrative convenience. But it can also drive up your costs, making it more difficult to bid competitively. That’s because cash wages are subject to a variety of payroll liabilities, including:

Social Security and Medicare taxes (FICA),
Federal unemployment taxes (FUTA),
State unemployment taxes (SUTA),
Workers’ compensation insurance, and
Public liability insurance.

Depending on your state, these expenses can increase your labor costs by 25% or more.

For most contractors, funding employee benefits is a far more cost-effective strategy. Eligible benefit programs include health and disability insurance; life insurance; retirement benefits, such as 401(k) or profit-sharing plans; and paid time off. Contributions to employee benefit plans avoid payroll liabilities, significantly reducing your labor bid costs.

Some Examples

Suppose that a worker is entitled to a prevailing wage of $50 per hour, which includes a $35 base wage and a $15 fringe benefit. If you pay the entire $50 in cash (and assuming the payroll burden in your state is 25%), your labor cost is $62.50 per hour [$50 + (0.25 × $50)].

On the other hand, if you pay the fringe benefit component by funding one or more employee benefits, your labor cost is only $58.75 per hour [$50 + (0.25 × $35)]. Multiply the savings by dozens or hundreds of employees working 40 hours a week for several years and your bid costs are reduced by thousands, even hundreds of thousands, of dollars.

You can even use existing benefit plans to meet fringe benefit obligations. Let’s say, in the above example, that you sponsor a group health plan and your premium contribution is $500 per month or $6,000 per year. Assuming the worker in the example works 2,080 hours per year (40 hours per week × 52), the value of the health benefits is $2.88 per hour, which is credited toward the employee’s $15 fringe benefit.

In this second example, the health plan covers only a portion of your fringe benefit obligation. If you wish to avoid paying fringe benefits in cash, consider other types of benefits — including employer contributions to retirement plans — to make up the difference.

Satisfy Wage Obligations

To ensure that fringe benefits satisfy your prevailing wage obligations, it’s important to design your benefits program carefully. Remember, credit toward fringe benefit obligations is only available for “bona fide” benefits. It’s not available for use of company vehicles, tools, mobile phones, travel expenses or benefits a contractor is legally required to provide.

Contrary to popular belief, contractors can use self-funded health plans to offset fringe benefit obligations. To be eligible, however, these plans must meet several requirements, including a funding arrangement that provides for irrevocable contributions.

Note that penalties for prevailing wage violations can be harsh. For example, under the Davis-Bacon Act they may include fines, contract termination, “debarment” (that is, exclusion from future federal contracts for up to three years) and withholding of contract payments to cover unpaid wages and other damages. What’s more, contractors or subcontractors that falsify payroll records or solicit kickbacks of wages are subject to civil and criminal prosecution.

Rules Are Complex

If you regularly bid on government contracts, take a look at how you pay fringe benefits to learn whether cost-cutting opportunities exist. Because the rules governing prevailing wages are complex, be sure to talk with your professional advisors before making major changes to the benefits you offer.

In January, many companies are preoccupied preparing budgets, forecasts and performance-related goals for the year. So, it’s all too easy to overlook plans for preventing fraud. But to avoid financial losses and maintain a healthy organization, you need to give your fraud prevention efforts some attention this month. Here are five things your business can do to reinvigorate your internal controls and other fraud deterrents.

1. Revisit Your Fraud Risk Assessment

A fraud risk assessment (FRA) is a document that captures the threats facing your organization, as well as the internal controls you have in place to mitigate such risk. To ensure your FRA delivers the most value, assign ownership of every internal control to an individual within your company. If an internal control requires changes to improve its effectiveness, the individual who “owns” that internal control should assume responsibility for the update.

If your fraud risk assessment is older than 12 months, or you think the risk environment has changed, consider conducting a new risk assessment.

2. Educate Employees

Your first line of defense against fraud is your employees. If you haven’t provided training recently, it’s time to get employees back into the “classroom.” Fraud prevention training should cover the types of occupational and external fraud facing your company, including cybercrime.

Also educate workers about what steps they should take if they spot or suspect fraudulent activities. And make sure your employees clearly understand what your company is doing to detect and prevent fraud, and the potential consequences of stealing — for example, dismissal or legal action.

3. Address Past Incidents

If your business experienced fraud last year, your executive team should review the incident and ensure they understand what happened and what your company is doing to prevent it from happening again. The postmortem should consider people, process and technology failings. Also discuss whether the problem is your internal controls or adherence to the controls. In many organizations, fraud occurs despite the existence of detailed controls because owners and managers neglect to enforce them — or they routinely override controls themselves. If changes are needed, assign one person to take the lead and complete the process as swiftly as possible.

4. Keep Your Eyes Open

Some companies can go years without experiencing a fraud incident or fraud losses. If that’s your business, congratulations! But it’s important not to become complacent, particularly if you haven’t kept your anti-fraud measures current. Keep abreast of fraud reported by other businesses in your industry and geographic region and pay attention to alerts from federal agencies such as the Federal Trade Commission and FBI. Regular IT security updates are particularly critical, as cybercriminals are constantly devising security workarounds and launching new attacks on unwary companies.

5. Make Smart Hires

If your business plans to hire employees this year, make sure you screen candidates carefully. Allow enough time to thoroughly interview potential employees, check their references and perform background checks. The types of checks depend largely on the position. For example, you should review the credit reports of accounting staffers and others who will have access to financial functions. And you’ll want to perform criminal background checks on anyone who will work with children or other vulnerable populations, such as the elderly. If you simply don’t have the internal resources to investigate job applicants yourself, outsource the function to one of the many services that can do it for you.

New Year, New Opportunities

The new year is a good time to review past errors and challenges, such as fraud incidents, and take steps to improve. Take some time this January to review and bolster your anti-fraud program. Your financial advisors can provide you tips and, if required, recommend more comprehensive fraud prevention plans.

The cost of capital is a key part of valuing a business under the discounted cash flow (DCF) and capitalization of earnings (COE) methods. A business valuation expert discounts the subject company’s future normalized earnings using the cost of capital.

The cost of capital — also called the rate of return, “hurdle rate,” or “capitalization rate” — is based on the perceived risk of the investment. Risky companies (or investments) warrant a higher discount rate and, therefore, a lower value (and vice versa).

The Basics

The term “cost of capital” refers to the expected rate of return that the market requires to attract funds to a particular investment. This amount can be found using the COE and/or the DCF methods. A business can be financed with 100% equity or a blend of equity and debt financing.

In general, debt costs less than equity. Why? Debt holders receive regular economic benefits (interest and principal payments). But equity investors receive dividends only at management’s discretion, and they must wait until a sale to receive any capital appreciation.

Cost of Equity

Several market-based rates can be used to estimate the cost of equity. It typically includes the following components:

A risk-free rate, based on a long-term government bond,
A market risk premium, based on historical returns for a stock index over the risk-free rate,
A market size premium, based on the relative size of the subject company compared to the S&P 500, and
A company-specific risk premium based on the subject company’s financial performance, industry and other attributes.

The cost of equity is used as the cost of capital when the subject company is financed 100% with equity financing — or when the valuation expert discounts earnings available to only equity investors.

Weighted Average Cost of Capital

Conversely, when discounting the earnings available to both equity investors and creditors, professionals apply a blended rate that incorporates the cost of equity and the cost of debt. This rate is often referred to as the weighted average cost of capital (WACC).

The cost of debt is fairly straightforward: It’s based on the interest rate that banks charge companies for borrowing money. Interest rates have been near historic lows in recent years, so debt can be an inexpensive form of financing. But there are limits to the amount of debt financing creditors will allow, and the cost of debt gradually increases as companies become increasingly leveraged.

In addition, interest payments are generally deductible as a business expense, which further reduces the cost of debt. But, going forward, when valuing larger companies, it’s important to factor in limitations on interest expense deductions under the Tax Cuts and Jobs Act. (See “Tax Law Changes Affect the Cost of Capital” at right.)

Capital Structure

When using WACC as the discount rate in a DCF analysis, an expert can choose various capital structures. What’s appropriate depends on the characteristics of the company and the standard of value being applied.

For example, an expert can apply the subject company’s historical or expected percentages of debt and equity financing. This may be appropriate when valuing a minority interest that lacks the control needed to alter the company’s capital structure.

Alternatively, an expert may choose an industry average capital structure. This is generally more relevant when valuing a controlling interest in the business.

What’s Right for Your Business?

Small differences in the cost of capital can have a major effect on the value of your business. Contact a credentialed business valuation professional to help you get it right.

The Tax Cuts and Jobs Act (TCJA) has altered the cost of capital for many companies. So, if your company has historically used, say, a 14% “hurdle rate” to evaluate investment decisions, you might need to adjust that figure going forward.

For example, in situations where a business uses its tax savings from the TCJA to pay off debt or repurchase outstanding stock, it could affect the company’s expected capital structure. That is, its blend of debt and equity financing.

Companies that transition to more equity financing (by paying down debt) could potentially increase the overall cost of capital. That’s because the pre-tax cost of debt is generally less expensive than the pre-tax cost of equity. Those that transition to more debt financing (by buying back stock) would likely reduce their overall cost of capital.

The TJCA also limits interest expense deductions for larger companies to 30% of qualified business income. This limitation could increase the cost of debt — because less interest expense would be tax deductible. However, companies with average annual gross receipts of $25 million or less for the three previous tax years are exempt from this limitation. The rules also allow certain real estate and farming entities to elect out of the limitation rules.

For more information about how the TCJA affects your company’s cost of capital, contact a business valuation professional.

Nonprofits are unique in that they sometimes obtain cash (or other assets) without providing an exchange of commensurate value. Accountants know that as contribution revenue. Sometimes it is hard to determine if a transaction is contribution revenue or exchange revenue, or how to account for it, especially in cases involving government grants and contributions. ASU 2018-08 Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made explains clearly when revenue is exchange versus contribution.

Who is paying and who is receiving goods or services?

The first step in ascertaining the accounting is determining who is paying the money and who, if anyone, is getting goods or services from the transaction. If the nonprofit gets funds from a payor and provides that payor direct commensurate value in return, that is an exchange transaction. An example would be when you purchase a training class from your membership organization − you pay the value of what you are receiving. If the nonprofit gets funds from a payor and no value is paid out to anyone at that time, that is clearly a contribution. If the nonprofit gets funds from a payor, such as the federal government, with the purpose of the nonprofit providing the goods and services to a third party, the general public or a subsegment thereof, that is also a contribution. When the general public, or someone other than the payor, receives the goods or services, it is a contribution.

Transactions that include both a contribution and an exchange

Sometimes transactions include both a contribution and an exchange portion. For example, many zoos, museums, etc. have membership structures where for a certain amount you can get a family membership which provides unlimited entrances to the establishment for a year. However, there is another membership level where the cost is more than the family membership, and the “additional benefits” are really just getting your name published as being a higher class of member or a donor. In these instances, we may need to bifurcate the revenue. We need to determine what value is actually received for a membership, potentially that could be the cost of the regular family membership. The value received for the membership is exchange revenue, and the additional amount paid is a contribution. This is common when there are multiple levels of memberships, in sponsorship agreements, fundraising events, and many other places. Once you know what portion is contribution revenue and what portion is exchange revenue, you can start accounting for it.

Accounting for exchange transactions

The exchange revenue portion uses the same accounting as for-profits use. The revenue is recognized when, or as, the goods and services (performance obligations) are transferred. Any money collected before the goods or services are transferred is deferred revenue (a liability). If the goods or services are provided before the cash changes hands, an account receivable is recorded at the time the goods or services transfer hands. All exchange revenue amounts are unrestricted (without donor restrictions), because there is no donor involved. Under the new revenue recognition standards, significant disclosures, including the total amount of exchange revenue, will be required.

Although the actual accounting for exchange revenue is likely to be straightforward, the new revenue recognition rules will take significant time and effort to implement. In order to obtain the disclosures, each revenue transaction cycle needs to be analyzed in detail. In many cases, this will be a significant amount of time and effort without any material change in the revenue numbers. The distinction between exchange and contribution revenue becomes more important this year, even if all the revenue is recorded in the same fiscal year, due to these disclosures. See Yeo & Yeo’s Revenue Recognition for Nonprofits eBook for more details.

Accounting for contributions

The contribution accounting isn’t quite so straightforward. We know that it is contribution revenue, but we need to determine if it is conditional or unconditional. If the contribution transaction has both a right of return (or right of release) and a barrier, then the contribution is conditional and no revenue is recognized until the conditions are met. A right of return or right of release means the contributor can request the funds be returned or doesn’t have to pay the nonprofit the funds unless the barrier is met. The barriers are measurable performance-related barriers, stipulations related to the purpose of the agreement (not administrative reporting tasks), or limited discretion by the recipient (such as having allowable cost requirements narrower than what the organization or program as a whole could do). This is a new definition; likelihood of a condition being met is no longer a criteria in determining conditional versus unconditional.

If the contribution is conditional, revenue is not recorded until it becomes unconditional (the contributor no longer has a right of return or right of release because the barrier has been met). If money is received before the contribution becomes unconditional, it is recorded as a liability (advance or deferred revenue). Conditional contributions require, as has always been the case, that you disclose the amounts of conditional contributions and what the conditions are. This means for federal grants, for example, you will need to know the total amount of grants that have been granted but the funds have not yet been earned (presumably have not yet been requested). The disclosure would indicate that there is $X of conditional contributions subject to 2 CFR 200 requirements.

If the contribution is unconditional, it gets recorded as revenue as soon as the contribution is made, regardless of whether it is yet collected. It is recorded at the present value of future cash flows. That means not only short-term contributions receivable, but also long-term ones, are recorded. If an organization promises unconditionally to give the nonprofit $100,000 per year for five years, the present value of the full $500,000 is recorded as revenue and a contribution receivable in the year the promise is made!

Donor restrictions

You also must determine if there are donor restrictions as to the use of the funds. If the funds are to support a specific time period or a specific program (which is narrower in scope than the mission), they get recorded as with donor restrictions. If there is a multi-year contribution receivable, there is an implied time restriction that the amounts are not to be used until the year in which they are to be received, so that would be recorded as with donor restrictions. If the amounts are to be invested in perpetuity and only the income used, that would also be recorded as with donor restrictions. Note that many of the conditional contributions from the federal government are also with donor restrictions; they can only be used for certain programs. However, the condition and the restriction may both be satisfied at the same time. Because of this, there is a policy election for contribution revenues where the restriction and condition are both met at the same time; this can be recorded in either with or without donor restrictions and this policy election is separate from other with donor restriction contributions that are met in the same year.

In summary:

All exchange revenue is considered without donor restriction, because there is no donor. All cash collected for exchange revenue before the money is earned is a liability (deferred revenue). Exchange revenue never results in net assets with donor restrictions, as there is no donor.
Contribution revenue, once unconditional, can be with donor restrictions or without donor restrictions. Contribution revenue is recorded as soon as it becomes revenue, and not when the corresponding expenses are paid. If the contribution revenue is with donor restrictions, the release from restriction will be recorded when the expenses have been made that release the restriction. Contribution revenue is only a liability if it is a conditional contribution that was received and the conditions have not yet been met.

This distinction will become more important when the revenue recognition standards, and the related disclosure requirement to say how much revenue is from contracts (exchange), are implemented.

Hiring an accountant for your nonprofit organization is different from hiring one for a traditional, for-profit business. Nonprofit accounting has many nuances, and you will need someone who understands the mission-driven challenges surrounding donors, resources and sustainability. Look for the following five considerations in hiring an accountant for a nonprofit organization.

1. Passionate

Everyone on your team should be passionate about the organization’s cause and mission. When people are inspired by the work they are doing, they are more likely to work harder for you. No matter their role, everyone’s goal should align with that of the organization. All organization decisions must be viewed through the lens of accomplishing the organization’s mission.

2. Understands Fund Accounting

It is important for your candidates to understand fund accounting, which is different from traditional accounting. With a focus on accountability rather than profitability, a nonprofit accountant needs to be aware that the organization’s stakeholders are concerned with proper utilization and allocation of funds rather than a bottom line.

3. Understands Nonprofit Reporting and Compliance

Nonprofit organizations are exempt from federal income taxes, which means that they face more scrutiny and reporting requirements than for-profit organizations do. Your accountant will need to be familiar with the various reporting and compliance requirements, such as Form 990, Michigan License to Solicit, payroll taxes, sales tax, audits, etc. Also, many nonprofit organizations are grant recipients and must report to grantors. Your candidates should have a base knowledge of those reporting and compliance areas that affect the organization. When you interview candidates, be sure to ask technical questions that will show the depth of their understanding and experience.

4. Resourceful

For many nonprofit organizations, funds can be tight. Look for a candidate who is resourceful and excels at solving problems. These types of candidates typically enjoy a challenge and will look for new ways to resolve issues and overcome barriers the organization may be facing. Sustainability and cash flow are of utmost importance for most nonprofits in their drive to accomplish their mission, and your accountant should share in the quest for efficiency, quality, and continuous improvement.

5. Strong Communication Skills

Your candidates should be strong communicators. When it comes time to relay accounting information, they will need to be able to discuss the financial information and reporting with people who may not understand nonprofit accounting. Having strong communication skills will help the candidates do this efficiently and effectively.

It may take extra time to recruit strong candidates. Look for someone who has these strengths along with other experiences and skills to help support your organization’s goals. Hiring the right person can help your organization’s ability to grow and thrive for years to come.

Learn more about the services Yeo & Yeo provides for nonprofits.