Are You Reporting Them Correctly?
An increasing number of nonprofits are forging relationships in order to better serve their client populations, as well as decrease costs. However, such relationships can result in complex financial reporting obligations. The reporting requirements for your organization depend on the type of relationship that is entered into.
The most basic relationship between nonprofits for accounting purposes is the collaborative arrangement. These are typically contractual agreements where two or more organizations are active participants in a joint operating activity. Both nonprofits are vulnerable to significant risks and rewards that are contingent on the activity’s commercial success. For example, a hospital that is operated jointly by two nonprofit health care organizations, or multiple organizations that work together to develop and produce a new medical product.
Expenses incurred and revenues generated from transactions with third parties should be reported on a gross basis on the statement of activities of the nonprofit that is considered the “principal” for the transaction in question. Generally, the principal is the organization that has control of the goods or services provided. However, generally accepted accounting principles (“GAAP”) should be followed for your particular situation.
Payments between participants in the collaborative arrangements are presented according to their nature (according to accounting guidance based on the type of revenue or expense the transaction involves). Participants are also required to make certain disclosures, including the nature and purpose of the arrangement, as well as each organization’s rights and obligations.
Circumstances arise where two organizations determine that the most beneficial decision going forward is to form a brand new legal entity. A merger occurs when the boards of directors of two nonprofits cede control of their individual organizations to this new entity. The assets and liabilities of the nonprofits are combined as of the date of the merger. The accounting policies of the original entities must be conformed to the new entity.
Ceded Control Without Creation of a New Legal Entity
There is another option, the board of one organization can transfer control of its operations to an outside entity (for instance, by allowing the other organization to appoint the majority of its board) as part of its engagement in the cooperative activity — but without having to create a new legal entity. In these cases, an acquisition has taken place. The organization that remains is considered the acquirer. The remaining entity records the acquisition based primarily on the current value of the assets and liabilities of the organization that is acquired.
A contribution is recorded if there’s an excess of value in the acquisition transaction. Conversely, if the value is lower, the difference is usually recorded as goodwill. If the operations of the acquired organization are expected to be substantially supported by contributions and return on investments, the difference is recorded as a separate charge in the acquirer’s statement of activities.
If your nonprofit assumes control of another, and GAAP requires consolidated financial statements with the other entity, you should account for the interest in the other organization and the cooperative activity by applying an acquisition method described in GAAP.
When the situation is reversed, and it’s your not-for-profit that cedes control of its operations to another entity, the other organization may need to consolidate your organization (including the cooperative activity) starting on the “acquisition” date. If your nonprofit will present its own separate financial statements, determine whether to establish a new basis for reporting assets and liabilities based on the other entity’s basis.
New Legal Entity to House Only This Collaboration
There are many cases where, if a new legal entity is formed, its only purpose is to house the cooperative activity instead of all activities of the organizations that are collaborating. These are neither mergers nor acquisitions. In order to determine the proper accounting treatment, it’s critical to look at which, if any, collaborator has control over the activity.
Proceed with Caution
The benefits of collaborating with other nonprofits are usually clear. However, the financial reporting rules could be anything but. Your accountant can advise you about the rules and help you comply with your nonprofit’s reporting obligations.
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