Sponsorships often represent a significant revenue source for nonprofit organizations in the arts and culture space, bringing in crucial funding that helps the organization support a variety of program activities. At their most basic level, sponsorships may be direct cash contributions with no restrictions, but in more complex cases sponsorship revenue can be tied to events with specific performance criteria.
Correctly accounting for sponsorship revenue requires financial leaders of nonprofit organizations to have a clear understanding of accepted revenue recognition processes. Incorrectly recognizing sponsorship revenue immediately when it should be deferred to a later accounting period can expose nonprofits to significant challenges. In the worst cases, this can result in material financial misstatements and/or control deficiencies that jeopardize the reputation of the organization.
With such high stakes, nonprofit organizations must embrace a systematic approach to recognizing sponsorship revenue. This promotes alignment between all key stakeholders and ensures nonprofits are equipped to make the correct decisions when it comes to recognizing or deferring sponsorship revenue.
In the arts and culture space, nonprofit sponsorships are frequently tied to certain events. These events may include fundraising galas, special performances, golf tournaments, or other annual events. Additionally, corporations often sponsor specific exhibits or programs on an ongoing basis.
Event-based sponsorships such as fundraising galas typically involve some form of performance obligation. For the sponsorship revenue to be released by the sponsor, certain criteria must be met, such as the staging of the event. Only once these criteria have been satisfied should nonprofits recognize this sponsorship revenue.
Sponsorships may be in-kind sponsorships. This occurs when a sponsor provides a noncash benefit, such as property rental, professional services, advertising, or any other type of noncash property. With such a variety of sponsorship opportunities, nonprofit organizations should work to develop clearly defined policies that outline the forms of sponsorship they are willing to accept.
The revenue recognition process is often complicated further by the presence of exchange transactions. An exchange transaction occurs when a sponsor receives some level of benefit in return for their contribution.
This is often the case for event-based sponsorships: perhaps a sponsor pays $5,000 for a table at a museum’s annual fundraising gala and receives food and entertainment benefits valued at $2,000. In this instance, the nonprofit should recognize revenue of $3,000 as a contribution and $2,000 as an exchange transaction.
Direct contributions where the sponsor receives no benefit are considered non-exchange transactions. Defining the value of any benefits sponsors derive from a sponsorship is vital to correctly categorizing and recognizing all sponsorship revenue.
The timing of sponsorship revenue recognition is central to the accuracy of the nonprofit’s financial statements. These nonprofit financial statements are often viewed by donors, patrons, and organizations tasked with awarding grants.
Ensuring the highest levels of precision is therefore very important to nonprofit organizations. Incorrectly recognizing sponsorship revenue too early is a common pitfall––one that organizations should be keen to avoid.
The decision of when to recognize sponsorship revenue and when to defer it into a future accounting period boils down to two key issues:
Sponsorship contracts can become rather complex as the contract can have both characteristics of exchange and nonexchange components. Nonprofits sometimes receive sponsorship dollars for an event that won’t take place until the next fiscal year. Per Generally Accepted Accounting Principles (GAAP), the receipt of cash does not always mean that revenue should be recognized. In instances where events are due to take place in the future, nonprofit organizations should defer revenue into the accounting period when the event will take place.
While adopting revenue recognition best practices is certainly important from an accounting and internal controls perspective, it’s also important in an operational sense. During the COVID-19 pandemic, many nonprofit organizations had planned events throughout 2020 with pre-agreed sponsorships. When the pandemic set in, nonprofits were forced to cancel these events and the sponsorship revenue initially agreed for these events failed to materialize or were negotiated with donor to redesignate as a contribution or defer to a future event.
At Smith + Howard, our team typically encounters revenue recognition issues while auditing nonprofit financial statements. More often than not, these challenges are attributable to the lack of clear revenue recognition policies and frameworks.
Issues frequently stem from a lack of alignment between development teams and internal finance teams. These two departments have different incentives: development teams are eager to recognize as much revenue as possible, while finance teams are focused on accurate reporting. A cohesive revenue recognition policy bridges this gap and ensures both development and finance teams take a unified approach toward correctly accounting for sponsorship revenue.
A standardized, scalable approach to negotiating, accepting, and processing sponsorship agreements is an important step in ensuring accurate revenue recognition. This is especially important when sponsorship contracts have certain conditions or performance obligations. These frameworks should be reviewed periodically and updated over time to adapt to the evolving fundraising needs of the nonprofit organization.
Sponsorship agreements should always be documented in writing to ensure clarity on the terms of the sponsorship agreement and the appropriate timing of revenue recognition. This not only streamlines revenue recognition: it’s good internal governance and ensures the organization is pursuing sponsorships that are closely aligned with its mission.
Adopting a proactive approach toward revenue recognition is a vital step for nonprofits looking to promote higher levels of financial accuracy across their organization. At Smith + Howard, we often discover revenue recognition issues during the audit process. In these instances, our team provides clear recommendations to the nonprofit’s board of directors outlining all relevant internal controls that should be implemented to prevent recurring issues.
We encourage all nonprofit organizations to contact us proactively if they have any questions about specific sponsorships. It’s our goal to be responsive to the needs of the nonprofit accounting community and provide accurate, timely information throughout the year: not just during an audit.
To that end, our nonprofit accounting team invests significant time in producing webinars, events, and other educational materials that help our community stay up to date on all the important issues in the nonprofit accounting world.
To learn more about working with Smith + Howard’s nonprofit accounting team, contact an advisor today.
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