Well over a year has passed since the Financial Accounting Standards Board’s new revenue recognition standard kicked in for public companies while nonpublic companies are adopting the standard for December 31, 2019 fiscal year ends. As we have been evaluating the impact of this standard with our clients, we know some institutions have identified certain aspects of this standard that raised questions to be researched and discussion points to be considered due to the nuances in the standard. As such, we believe it is time for a refresher.
As it pertains to postsecondary education, the crux of the standard is that the recognition of revenue should represent the amount an institution is expected to receive for the transfer of its promised services, or education, to the student. The standard thus requires an institution to apply a five-step process to its contracts with its students.
Let’s take a quick look at these steps, as well as the reporting considerations established by the standard:
Step 1: Determine if a contract exists with a student
Typically, institutions will have written enrollment agreements, so contracts are easily identifiable. Within these agreements, both parties agree to the pricing, payment and terms of the education with the ultimate completion of the program to earn a certificate, diploma or degree.
Step 2: Identify performance obligations
Institutions must determine what goods or services are within the contract and if they are distinct, meaning the student can benefit from a good or service on its own. If they are not distinct, they should be combined as one promise, or a performance obligation.
For institutions, the primary performance obligation is to provide a student with an education, and the enrollment agreement details the various charges of education, including tuition, books, lab fees, clinic revenue, application fees and dormitory fees, to name a handful. Therefore, institutions must use judgment to assess what distinct services are offered and whether specific charges exist or not.
Step 3: Determine the transaction price
In assessing the transaction price — which is the amount an institution is expecting to receive for the transfer of goods or services — considerations must include the price being charged and whether there is any variable consideration, such as discounts or credits, or if non-cash consideration exists. Institutional scholarships and refunds, for example, would be considered variable considerations and lead to a reduction of the transaction price.
Step 4: Allocate the transaction price
After determining the transaction price, institutions must allocate the price to the various obligations, if more than one exists. The respective prices for distinct obligations should be based on their standalone selling price, and if an obligation is not observable, it should be estimated.
This is a relatively easy area of judgment for institutions, as amounts charged to students are typically explicit in the enrollment agreement or the institution’s published catalog. We have seen a diversity in practice, whereas some institutions are estimating future tuition adjustments and other institutions are recognizing them as occurred. The structure of the institution, the amount of tuition earned as compared to the tuition adjustment schedule, and the potential impact revenue as of their fiscal year end all have a bearing on an institution’s assessment.
Step 5: Recognize revenue
The final step is to recognize revenue as it satisfies a performance obligation. For an institution, how the benefit of education is transferred to the student and determined if that benefit is at a point of time or over time. FASB’s guidance provides various indicators of transfer.
However, when it comes to the performance obligations of an education for the student, there is an important question: Would the education be transferred over time or upon completion of the diploma or degree? The key to this assessment is determining when the student actually starts to receive benefits, with the argument being that as a student progresses through courses, they are learning and increasing their knowledge of a subject matter. In addition, an institution has a right to payment as a student is in school and attending classes, and therefore revenue is earned over time for tuition. However, performance obligations secondary to education, such as the providing of books, laptops or a kit, may be earned at a point in time, as the student can benefit from those items immediately and independent of the education performance obligation.
Institutions utilizing institutional loans need to perform additional steps to determine if the loans are issued with a market interest rate and, if not, to determine if some portion of the tuition actually represents financing income, since the student has the right to pay over time.
From a pure reporting perspective, the faces of financial statements haven’t changed drastically under the new standard. Accounts receivable under the standard is consistent with past practices. The concepts of unearned revenue and deferred tuition still exist (defined as contract liability in the standard), but the standard required a “netting” presentation, meaning accounts receivable are interdependent with deferred tuition and should be netted down. The standard also defines contract assets, which represents unbilled tuition for an institution and is not very common from our experience.
There were more changes on the disclosure side of reporting, with a significant amount of qualitative and quantitative financial statement disclosures. This is aimed at allowing the users of the statements to get a clearer picture of the institution’s earning of revenue and the judgments used in its assessments, driving home the need for transparency and comparability among institutions.
Institutions should have been or should begin reviewing the following items to implement the new standard:
- Take stock of all current revenue-related contracts with students or other parties.
- Determine the various performance obligations contained within the contract, including assessing items which may be immaterial to ensure all performance obligations are captured. Assign a transaction price to all performance obligations, especially for items which are commingled under one tuition charge.
- Determine how revenue is currently being earned by performance obligation, comparing that to how it should be earned under the new standard using the five steps.
- Assess the institution’s revenue and student information systems to determine if any coding changes are needed to allow for revenue to be earned appropriately, and if coding cannot be updated, what manual process is needed.
- Review the impact of an institutional loan program.
- Determine the impact the new standard may have on the timing of the earning of revenue, which could impact an organization’s composite score ratio, debt covenant ratios or bonus plans. It’s possible an institution may have already noticed this impact.
- Plan for or execute employee training related to the changes.
- Document the revenue recognition process in detail through a formal policy.
Even when following the five-step process to the letter, there is more judgment involved in the new standard, and where there is more judgment, the greater the need for a well-documented process to support the institution’s stance on the earnings process. However, if you or your institution is in need of assistance in properly implementing the revenue recognition standard or any other financial reporting standard, a consultation from McClintock & Associates is only a call away.