When your organization receives funds that are designated for a specific future project, do you have deferred revenue or a restricted donation? It’s a question that plagues many nonprofits since there are several factors to consider, and it’s important to know the difference since it will affect when the funds are recorded as revenue for accrual basis financials.
Restricted donations are recognized as revenue when the donation is made, even if the donor restricts the use of the funds for a specific project or timeframe. A true donation requires the donor to give up all rights to the funds with no expected direct benefit to the donor. Donors can restrict the use of a donation for a project within the scope of the organization’s exempt purpose, but they generally don’t get their money back if the organization isn’t able to use the funds as requested. The organization should give the donor the opportunity to specify a different use of the funds, but should not automatically return the donation if the anticipated use is not possible. Once the funds are used as intended or the time restriction is met, the funds are re-classified from restricted to unrestricted.
Deferred revenue derives from an exchange transaction where someone gives money with the expectation that the organization will provide something specific in return. Examples include fee for service activities, membership dues, tuition and often sponsorships. The funds received are shown as a liability until the transaction is complete and the organization has earned the revenue. The funds are not revenue when received since the organization has not get earned the revenue by completing the service. If the service is not provided, the funds must be returned to the funder.
The distinction can get blurry with some grant contracts. Reimbursement grants are nearly always recorded as deferred revenue if funds are received before they are spent. The revenue is only earned when the expenses have been incurred and the organization would have to return any excess funding that is not spent as budgeted in the grant contract. However, foundation grants are typically restricted donations since the foundation generally doesn’t require returning the funds, but wants to make sure the funds are used as intended. Foundation grants are typically recorded as revenue when awarded whereas reimbursement grants are recorded as revenue when the expenses have been incurred, which gives the organization the right to request reimbursement from the government agency.
Careful consideration of each funding arrangement is important so that revenue is recorded correctly throughout the year and the organization can avoid audit findings at year-end.
