What Development Teams Need to Know About Revenue Recognition

December 13, 2022

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For development teams at arts and culture organizations across the nation, revenue recognition has always been a challenge. In recent years, the task has become even more complex as revenue sources have grown ever more diverse.

Successfully attracting revenue is fundamental to any nonprofit’s ability to execute its mission. However, development teams are often guilty of overlooking the fact that the mechanisms by which this revenue is brought in is almost as important as the revenue itself. 

Revenue recognition is a complex element of finance. Failing to understand these nuances can create a disconnect between development teams and finance teams. These misunderstandings can necessitate material changes to financial statements when auditors arrive, resulting in an uncomfortable situation for all stakeholders. 

Understanding the intricacies of revenue recognition is key to the success of any development team. This article provides an overview of the key revenue recognition concepts development teams need to be aware of and shares strategies development teams can leverage to achieve the best possible outcomes for their organizations.  

Key Revenue Recognition Concepts

Arts and culture nonprofit organizations typically have a variety of revenue streams, which from an accounting perspective, must be treated differently. To understand how their fundraising efforts will impact the overall financial position of the nonprofit, it’s vital that development teams understand these key concepts. 

Contribution Revenue

Contribution revenue may come from individuals, corporations, or the government. Donations received by a nonprofit organization are typically classed as contribution revenue, and in most instances, revenue recognition is relatively straightforward. 

When issues do arise, they tend to stem from contributions that may have restrictions or conditions attached. 

Restricted vs. Unrestricted Contributions

Contributions can either be restricted or unrestricted, also known as with donor restriction and without donor restriction.

Restricted contributions may only be used for the purpose specified by the donor. If a donor provides a $1 million contribution but specifies it must be spent on African American Art, the nonprofit cannot use it for any other purpose. Restricted funds are presented separately from unrestricted funds in nonprofit financial statements

Unrestricted contributions may be used for any purpose. 

Exchange Transactions

An exchange transaction occurs when an individual or corporation exchanges money for goods or services of equivalent value. Examples of exchange transactions include ticket sales and memberships. In straightforward cases like these, the nonprofit’s finance team has been recognizing this revenue the same way for years. There tends to be little ambiguity. 

Challenges occur when a revenue source is characterized partly as an exchange transaction and partly as a contribution. Correctly assigning value to different elements of this arrangement demands significant nuance and is a central aspect of the wider revenue recognition process. 

Common Challenges in Revenue Recognition

Arts and culture nonprofits are complex entities with diverse revenue streams and high-value corporate partnerships that create complicated revenue recognition issues. Understanding the root cause of these issues is key to successfully navigating them.

Perhaps the most common challenge is a disconnect between the nonprofit’s development and finance teams. This is often evident in major sponsorship deals which blur the lines between contributions and exchange transactions. 

These sponsorships often come with a number of conditions. Take the example of a performing arts venue that solicits $100,000 from a corporate partner to sponsor a performance. In return, the corporate partner seeks some benefits: VIP tickets, their logo in the program, plus other minor concessions. Clearly, these benefits have tangible value. This means some portion of the revenue must be recognized as an exchange transaction, while some portion can be recognized as contribution revenue.  

Failing to proactively discuss this with the finance team is a common cause of frustration. While the development team believes they can recognize all $100,000 as contribution revenue, in reality, they might only be able to recognize half of that. These misunderstandings can lead to relationship breakdowns between development and finance teams. 

Complicating this issue further is the fact that many development teams are compensated based on their performance. They are often incentivized to recognize as much revenue as possible as contribution revenue. When the rules dictated by the finance team limit their ability to do this, it can cause significant frustration. 

In the worst instances, development teams may attempt to limit oversight by restricting the finance team’s visibility of certain documentation. When there is limited information on revenue, it’s generally considered a contribution. However, if an agreement shows up after the revenue has been recognized a certain way, auditors may make material adjustments to the nonprofit’s accounts––an end result that’s good for nobody.  

Best Practices for Revenue Recognition

To minimize any issues, it’s best for development and finance teams to proactively work together. There should be a review process and regular cadence of meetings for all financial agreements. This approach ensures development teams structure contractual agreements to achieve optimal financial outcomes. 

Adopting standardized contribution and sponsorship contracts also significantly streamlines the revenue recognition process. Depending on the donor, this may not always be possible, but using standard templates with minor adjustments for each contract fosters a much smoother revenue recognition process.

Embracing technology ensures key stakeholders across development and finance teams have visibility of upcoming revenue and the conditions attached to it. These platforms enable finance teams to review contracts and advise how revenue will be recognized, allowing development teams to negotiate changes before a contract is signed.  

The Importance of Revenue Recognition

Building a process to accurately recognize revenue might seem like a minor bookkeeping task but it actually has wide-reaching ramifications for nonprofit organizations. All revenue is reported in IRS Form 990––a tax filing that’s crucial to the long-term success of any nonprofit. 

Form 990 is viewed by the public, potential donors, and industry watchdogs. If you’re forced to make material changes to your filings because of revenue recognition issues, it could seriously damage your reputation. This underscores the importance of working with a nonprofit-focused accounting firm that truly understands revenue recognition in the arts and culture space. 

At Smith and Howard, we are a proud accounting partner to countless nonprofit organizations in the arts and culture space. Our specialized nonprofit accounting team has deep expertise in revenue recognition and serves as long-term strategic partners to leading arts and culture venues across the nation. 

To learn more about Smith and Howard’s nonprofit accounting services, contact us today.

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