In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606), which provides guidance for recognizing revenue from contracts with customers. The core principle of ASU 2014-09 is that revenue should be recognized when promised goods or services are transferred to customers in an amount that reflects consideration for which entitlement is expected in exchange for those goods or services. ASU 2014-09 was originally effective for nonpublic entities for the year ended December 31, 2019. Due to the COVID-19 pandemic, FASB postponed the implementation for nonpublic entities for the year ended December 31, 2020, or the first fiscal year ending thereafter.
Higher education institutions offer a variety of goods and services to their students or “customers” including tuition, fees, housing, meal plans, etc. The new revenue recognition standard (ASC 606) provides guidance on the recognition of these arrangements under one revenue recognition model. It is important to note that certain types of transactions including contributions and grants are not included in the scope of this standard.
The five-step model includes:
- Identify the Contract with a Customer
- Identify the Performance Obligations in the Contract
- Determine the Transaction Price
- Allocate the Transaction Price to the Performance Obligations in the Contract
- Recognize Revenue when (or as) the Entity Satisfies a Performance Obligation
Step 1: Identify the Contract with a Customer
The standard defines a “contract” as an agreement between two or more parties that creates enforceable rights and obligations. Institutions should review and evaluate whether a contract with a student exists based on the following criteria. All of the following criteria must be met for a contract to exist under the scope of this standard.
- Approval and commitment of the parties
- Identification of the rights of the parties
- Identification of the payment terms
- The contract has commercial substance
- It is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods and services that will be transferred to the customer
Step 2: Identify the Performance Obligations in the Contract
The standard defines a “performance obligation” as a promise in a contract with a customer to transfer a good or service to the customer. Institutions will need to determine whether the goods and services (tuition, fees, housing, meal plans, etc.) are distinct goods and services or a series of distinct goods and services that need to be combined. A good or service is considered distinct if the student can benefit from the good or service on its own with other readily available resources and the institution’s promise to transfer the good or service is separately identifiable from other promises in the contract.
Step 3: Determine the Transaction Price
The standard defines the “transaction price” as the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to the customer, excluding amounts collected on behalf of third parties.
Institutionally funded scholarships and grants to a student represent a consideration payable and should be accounted for as a reduction to the transaction price (revenue). In cases where the student is awarded funds that exceed the cost of tuition, fees, housing and certain living expenses, the transaction price would be reduced to zero but the institution would not record a negative revenue. The portion of aid that exceeds the transaction price would be recognized as a scholarship expense rather than a reduction of revenue.
Step 4: Allocate the Transaction Price to the Performance Obligations in the Contract
When the institution has more than one performance obligation, the institution should allocate the transaction price to each performance obligation based on the amount of consideration the institution expects to receive for transferring the goods or services to the student. As tuition could be sold separately (for example: a commuter student), the standalone price for tuition would be used and no allocation would be necessary.
Step 5: Recognize Revenue when (or as) the Entity Satisfies a Performance Obligation
Institutions will need to determine whether they satisfy the performance obligations over time or at a point in time. Most institutions will likely recognize revenue ratably over the duration of the academic period. At the end of the institution’s reporting period, any performance obligation that has not been satisfied should be recognized as a contract liability on the statement of financial position.
Be proactive in reviewing your contracts with students to determine how this change will impact your institution. If you have any questions on the implementation of this standard, please feel free to reach out to YHB.