In this video, we walk through 5 BAR practice questions on the nonexchange revenue using accrual basis. These questions are from BAR content area 3 on the AICPA CPA exam blueprints: State and Local Governments.
The best way to use this video is to pause each time we get to a new question in the video, and then make your own attempt at the question before watching us go through it.
Nonexchange Revenue Using the Accrual Basis
State and local governments receive revenue from many different sources. Before determining when revenue should be recognized, it is important to understand whether a transaction is an exchange transaction or a nonexchange transaction.
An exchange transaction occurs when each party gives and receives approximately equal value. For example, when a city charges a utility fee, an admission fee, or a fee for a specific service, the person paying the fee receives a direct benefit in return.
A nonexchange transaction occurs when a government receives resources without providing approximately equal value directly to the provider. Taxes, grants, fines, and donations are common examples. Although taxpayers benefit from government services generally, an individual taxpayer does not receive a specific amount of service equal to the taxes paid.
Nonexchange transactions are divided into four main categories: derived tax revenues, imposed nonexchange revenues, government-mandated nonexchange transactions, and voluntary nonexchange transactions.
Derived Tax Revenues
Derived tax revenue is generated by a taxable transaction or activity. In other words, the government’s revenue is derived from something else that occurred.
Sales taxes are derived from taxable purchases. Income taxes are derived from individuals and businesses earning taxable income. These revenues are generally recognized when the underlying taxable activity occurs, assuming the government can reasonably estimate the amount.
For example, if taxable retail purchases occurring during the year generate $280,000 of sales taxes for a city, the city recognizes $280,000 of sales tax revenue under accrual accounting. The city does not have to receive the cash before recognizing the revenue.
The entry would generally be:
Debit Sales Taxes Receivable $280,000
Credit Sales Tax Revenue $280,000
Imposed Nonexchange Revenues
Imposed nonexchange revenue is assessed directly by a government and is not generated by a separate taxable transaction. Property taxes, fines, and penalties are common examples.
Property taxes are imposed on property owners based on the value of their property. Fines and penalties are imposed when an individual or organization violates a law or regulation.
Imposed nonexchange revenue is generally recognized in the period for which the taxes or other assessments were imposed, provided the government has an enforceable legal claim. For example, property taxes levied specifically for the following fiscal year are not recognized as current-year revenue merely because the levy occurred or the cash was collected early.
Government-Mandated Nonexchange Transactions
A government-mandated nonexchange transaction occurs when one government requires another government to perform a particular program or activity and provides resources to help pay for it.
For example, a state may require a city to operate an emergency-preparedness program and provide funding for that purpose. The city recognizes the revenue when it satisfies the applicable eligibility requirements.
Eligibility requirements may include characteristics of the recipient, reimbursement requirements, or an obligation to perform a particular program. Receiving an award does not automatically result in revenue if the city has not yet qualified for the resources.
Voluntary Nonexchange Transactions
Voluntary nonexchange transactions occur when a government, private organization, or individual willingly provides resources without receiving approximately equal value in return. Donations and many grants fall into this category.
These transactions may contain time requirements or contingencies that must be satisfied before revenue can be recognized. For example, a foundation may promise to donate $300,000 if a city raises $100,000 of matching funds. If the agreement requires the full match and the city has raised only $92,000 by year-end, the contingency has not been satisfied. The city generally would not recognize the $300,000 of revenue yet.
Once the city raises the required amount and satisfies any other requirements, the award is no longer contingent and may be recognized.
Some matching agreements allow revenue to be earned gradually. If a foundation agrees to match donations dollar for dollar up to $300,000, a city that raises $190,000 may qualify to recognize a $190,000 receivable from the foundation. The exact treatment depends on the terms of the agreement.
Time Requirements and Accrual Accounting
A time requirement specifies when resources may be used or the period to which they apply.
Suppose a city receives a $500,000 grant during the current year, but the agreement states that $320,000 may not be used until the following fiscal year. If all other requirements are met, the city recognizes only the portion available for use during the current year. The future-period portion is recorded as a liability until the time requirement is satisfied.
The entry might be:
Debit Cash $500,000
Credit Grant Revenue $180,000
Credit Unearned Grant Revenue $320,000
Receiving cash early does not override a time requirement, eligibility requirement, or contingency.
However, once all applicable requirements have been satisfied, accrual accounting does not require the revenue to be collected within a certain period. The government can recognize revenue and record a receivable even if the cash will not be received until later.
This is the key distinction between accrual and modified accrual accounting. Modified accrual generally requires revenue to be measurable and available. Accrual accounting does not apply the availability requirement. Under accrual accounting, the focus is on whether the taxable activity occurred and whether all applicable time, eligibility, and contingency requirements have been satisfied.
