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12.2 Exchange vs. nonexchange evaluation
Publication date: 27 May 2020
us NFP guide
ASC 958-605 includes a decision-making framework for distinguishing whether a transaction is exchange (reciprocal) or nonexchange (nonreciprocal). As shown in Figure NP 12-1, an entity should apply ASC 606 or other appropriate guidance to exchange transactions and ASC 958-605 to nonexchange transactions.
Figure NP 12-1
Decision framework—evaluating exchange vs. nonexchange
Decision framework—evaluating exchange vs. nonexchange
The ASC Master Glossary defines exchange as a reciprocal transfer between two parties (for example, when one entity acquires assets or services by surrendering assets or incurring obligations). In distinguishing between exchange transactions and contributions, the definition of contribution adds the concept of a commensurate value exchange.
Definitions from ASC Master Glossary
Exchange: An exchange (or exchange transaction) is a reciprocal transfer between two entities that results in one of the entities acquiring assets or services or satisfying liabilities by surrendering other assets or services or incurring other obligations
Contribution (excerpt): An unconditional transfer of cash or other assets, as well as unconditional promises to give, to an entity or a reduction, settlement, or cancellation of its liabilities in a voluntary nonreciprocal transfer by another entity acting other than as an owner…
In a contribution transaction, the resource provider often receives value indirectly by providing a societal benefit although that benefit is not considered to be of commensurate value. In an exchange transaction, the potential public benefits are secondary to the potential direct benefits to the resource provider. ASC 958-605-15-5A provides additional clarifying guidance on what commensurate value means, stating that in an exchange of commensurate value, a reciprocal flow of benefits occurs directly between the parties, for example:
- The goods or services provided directly benefit the resource provider or are for its own use.
- The resource provider obtains proprietary rights or other privileges, such as patents, copyrights, or advance and exclusive knowledge of research outcomes.
Example NP 12-1 illustrates the concept of an exchange of commensurate value.
EXAMPLE NP 12-1
Research arrangement—exchange of commensurate value
Research arrangement—exchange of commensurate value
PharmaCo conducts new drug research using its own scientists, but also funds research conducted by NFP entities and biotech companies to speed the development of new drugs. PharmaCo enters into a research arrangement with NFP Research Institute. Under the arrangement, PharmaCo has the right to review NFP Research Institute’s research and has the right of first refusal to license any compounds discovered. If PharmaCo opts not to license the compounds, NFP Research Institute can look for other buyers.
Is the arrangement between PharmaCo and NFP Research Institute an exchange of commensurate value?
Analysis
Yes, the transaction appears to meet the definition of an exchange. In this fact pattern, PharmaCo is in essence outsourcing research to NFP Research Institute. PharmaCo is providing resources in exchange for the entitlement to receive advance knowledge of research outcomes associated with compounds discovered by NFP Research Institute and the right of first refusal to license them. This entitlement gives PharmaCo a potential advantage in obtaining a proprietary interest in a compound, and therefore it has value to PharmaCo.
NFP Research Institute would account for the arrangement in accordance with ASC 606.
In contrast, if a resource provider does not receive commensurate value in exchange for the resources provided, the transaction would be nonexchange.
Example NP 12-2 illustrates a transaction that would not be an exchange of commensurate value.
EXAMPLE NP 12-2
Private foundation grant
Private foundation grant
University receives funding from Private Foundation to conduct scientific research for purposes of discovering planets. University is required to submit a summary of research findings to the foundation at the end of the study, but University retains all rights to the findings and has permission to publish them, if desired.
Is the arrangement between University and Private Foundation an exchange of commensurate value?
Analysis
In this fact pattern, Private Foundation does not receive direct commensurate value in exchange for the resources provided; the scientific research is for the benefit of society and not for the direct benefit of Private Foundation. University retains all rights to the research and findings; therefore, University and the general public receive the primary benefits.
This arrangement would be a nonexchange transaction accounted for under the ASC 958-605 accounting model.
At times, the benefits acquired by the resource provider in a transaction may be intangible, uncertain, or difficult to measure. This does not prevent a transaction from being classified as reciprocal, if it is commensurate with the value that a resource provider expects in exchange for the transferred resources, as described in ASC 958-605-55-5.
Excerpt from ASC 958-605-55-5
A resource provider may sponsor research and development activities at a research university and retain proprietary rights or other privileges, such as patents, copyrights, or advance and exclusive knowledge of the research outcomes. The research outcomes may be intangible, uncertain, or difficult to measure, and may be perceived by the university as a sacrifice of little or no value; however, their value often is commensurate with the value that a resource provider expects in exchange.
Figure NP 12-2 includes other factors to consider in evaluating whether arrangements are exchange or nonexchange.
Figure NP 12-2
Indicators of whether transactions are exchange or nonexchange
Indicators of whether transactions are exchange or nonexchange
Indicative of an exchange
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Indicative of nonexchange
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12.2.1 Revenue from government grants
ASC 958-605 provides explicit guidance that indicates that government grants with certain features would not be commensurate value exchanges. Most of those features focus on grants from federal government agencies, as many activities funded by the federal government are carried out for the public’s benefit, rather than in connection with obtaining proprietary benefits or goods and services for the government’s own use.
Prior to the adoption of ASU 2018-08, widespread historical practice considered many federal grants as exchange transactions. Figure NP 12-3 describes some of the historical justifications for that practice, along with the explicit clarifications added to ASC 958-605 (primarily in ASC 958-605-15-5A) by ASU 2018-08 to address that practice.
Figure NP 12-3
Comparison of historical practice on classification of federal grants as exchanges to new guidance introduced by ASU 2018-08
Comparison of historical practice on classification of federal grants as exchanges to new guidance introduced by ASU 2018-08
Rationale used to support treatment as exchange transaction
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ASU 2018-08’s clarifications
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The federal government does not make “donations;” thus, the use of contribution accounting for federal grants is not appropriate.
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Automatically defaulting to “exchange” treatment for federal grants is not appropriate. The type of resource provider should not override the substance of an arrangement with nonreciprocal characteristics.
As used in GAAP, the term “contribution” refers to nonexchange or nonreciprocal transactions. It is not focused narrowly on charitable donations.
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A government agency can carry out its mission through outsourcing certain activities to subcontractors. The value received in exchange is the discharge of the agency’s own responsibilities.
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In an exchange transaction, the resource provider benefits directly. If the general public receives the primary benefit from the activities, any benefits received by the resource provider would be indirect or incidental.
Neither the intangible benefits arising from having its mission furthered nor the positive sentiments arising from acting as a donor would constitute commensurate value received by a resource provider.
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Grant-funded activities that benefit the public at large are reciprocal, because “general public” is synonymous with “government.” Benefits received by the public at large are tantamount to benefits received by the government itself.
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The public and the government cannot be viewed as the same party for revenue recognition purposes.
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Notwithstanding historical practice prior to the adoption of ASU 2018-08, most federal grants received by NFPs are subject to the nonexchange (contribution) revenue recognition model.
Many federal grants are awarded on a cost-reimbursement basis. Because of requirements related to most federal grants, the ASC 958-605 model views federal grant cost-reimbursement arrangements as conditional contributions. Because conditions would be satisfied by incurring those same costs, the revenue recognition pattern would likely be similar to historical (pre-ASU 2018-08) accounting for exchange transactions.
The guidance on determining whether government grants are exchange or nonexchange transactions is illustrated in Example NP 12-3.
EXAMPLE NP 12-3
Federal research grant
Federal research grant
The National Institutes of Health (NIH), an agency of the federal government, announces the availability of awards for research projects involving certain infectious diseases. NFP Research Institute applies for and receives a $500,000 research award for this purpose.
Is the arrangement between NIH and NFP Research Institute an exchange transaction?
Analysis
Because the NIH is not receiving benefits in return (apart from the advancement of its mission), the arrangement would be nonreciprocal (nonexchange).
While this might appear similar to the “outsourcing” of research in Example NP 12-1, the focus of the distinction between an exchange transaction and a nonexchange transaction is on whether reciprocal benefits actually flow between the parties to an agreement. Unlike PharmaCo in Example NP 12-1, the NIH is not directly receiving goods, services, or intangible rights (e.g., a license to intellectual property) in return for the resources provided. Although the NIH’s mission is furthered by NFP Research Institute carrying out the research, that benefit is secondary to the benefit received by the general public.
The GAAP framework for classifying government grants as exchange or nonexchange is similar to that used by the Federal government in categorizing federal “extramural” activities (i.e., arrangements with non-federal entities). Federal law establishes parameters surrounding the three types of legal instruments that the federal government must use when funding extramural activity. A contract is used if the principal purpose of the funded activity is to provide something for the direct benefit or use of the federal government. (These transactions are referred to as “procurement arrangements.”) Because a contract is used to acquire something for the government’s direct benefit or use, there is a close correlation between this type of instrument and exchange transactions as discussed in ASC 606. If the principal purpose of the activity is to support or stimulate activities that are not for the direct benefit or use of the federal government, the arrangement is considered either a grant or a cooperative agreement. Those arrangements are closely correlated with transactions classified as nonexchange in ASC 958-605.
Some NFPs that enter into both exchange and nonexchange transactions with the federal government may display all the revenues in a single line in the statement of activities, using a caption such as “Grants and contracts.” When ASC 606 and ASC 958-605 revenues are combined in this manner, the amounts recognized under ASC 606 must be separately disclosed (for example, in notes to the financial statements), consistent with ASC 606’s requirement to present or disclose revenue from contracts with customers separate from other sources of revenue.
12.2.1.1 Government grant pass-through awards
Sometimes an NFP that receives a federal grant or cooperative agreement will pass a portion of the federal program funds to another entity that will provide goods or services related to the activity carried out with the federal funding (a “subaward”). Under federal regulations, “subawards” are either a subrecipient arrangement (if the subawardee is deemed to be carrying out part of the federal award) or a contractor agreement (if the subawardee is providing goods and services in a procurement relationship).
Subaward arrangements must also be evaluated for classification as exchange or nonexchange transactions under ASC 958-605.
From the perspective of the original (or “prime”) recipient of the federal award, the determination of whether the arrangement is an exchange transaction with or contribution to the subawardee will contemplate issues similar to those that must be considered when classifying relationships with subawardees as “subrecipients” or “contractors” for regulatory compliance purposes. While the purposes of the GAAP and regulatory analyses differ, we expect the results to be substantively consistent.
The subawardee must make an independent determination of the substance of the arrangement (as exchange or nonexchange) under the revenue recognition decision framework. While the classification assigned by the prime recipient for regulatory compliance purposes is important to consider, the subawardee cannot simply accept the prime recipient’s classification as determinative for GAAP purposes.
12.2.1.2 Distinguishing grants from transfers by third-party payers
Certain payments that might appear similar to government grants might instead be payments made by a government on behalf of a beneficiary who is a party to an exchange transaction, as described in ASC 958-605-15-6.
Excerpt from ASC 958-605-15-6
The guidance in the Contributions Received Subsections does not apply to the following transactions and activities:
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e. Transfers of assets (typically from a government entity) that are part of an existing exchange transaction between a recipient and an identified customer. Some examples include payments under Medicare and Medicaid programs, provisions of health care or education services by a government for its employees, and Pell Grants or similar state or local government tuition assistance programs. In those instances, an entity shall apply the applicable guidance (for example, Topic 606 on revenue from contracts with customers) to the underlying transaction with the customer, and the payments from the third parties would be payments on behalf of those customers.
One example is Pell Grants made by the federal government to students. In those situations, the government awards the Pell grant to a specific student but transmits the proceeds directly to the university on the student’s behalf. From the university’s perspective, the underlying revenue transactions (tuition, housing, etc.) arise from contractual arrangements between the university and the student. The government is simply facilitating the payment process.
Similar considerations apply to Medicare and Medicaid payments made to health care entities on behalf of specific patients. In those situations, the revenues arise from an exchange transaction between the patient and the health care provider. The payments are government benefits to the individuals that are transmitted directly to the health care provider. See ASC 958-605-55-14B through 14E for illustrations.
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