Related Entities

Collaborative Activities — Are you reporting them correctly?

More and more nonprofits are joining forces to better serve their client populations and cut costs, among other reasons. But such relationships can come with complicated financial reporting obligations. Your organization’s reporting requirements will depend on the type of relationship you enter.

Collaborative arrangements

The simplest relationship between nonprofits for accounting purposes is likely collaborative. These are typically contractual arrangements in which two or more organizations are active participants in a joint operating activity and vulnerable to significant risks and rewards that hinge on the activity’s commercial success. Examples include a hospital that’s jointly operated by two nonprofit healthcare organizations or organizations that share staff.

Each not-for-profit should report its costs and revenues from transactions with third parties (for example, sales) on a gross basis on its statement of activities (assuming the organization is the principal for the transaction, rather than an agent). The nonprofit that isn’t the principal may report such transactions on a net basis.

Payments between participants are presented according to their nature (for example, income or expense). Participants in collaborative arrangements also are required to make certain disclosures, such as the nature and purpose of the arrangement and the organization’s rights and obligations under it.

Mergers and acquisitions

In some circumstances, two organizations may determine that the best route forward is to form a new legal entity. A merger takes place when the boards of directors of both nonprofits cede control of themselves to the new entity. The assets and liabilities of the organizations are combined as of the merger date. Note that the accounting policies of the original entities must be conformed for the new entity.

If the board of directors of one organization cedes control of its operations to the new legal entity, an acquisition has taken place, with the new entity being the acquirer. No change to the accounting policies is necessary because they’re conformed with those of the not-for-profit that didn’t cede control.

The new entity must determine whether the operations of the acquired organization are expected to be predominantly supported by contributions and return on investments. If so, any excess of value in the acquisition transaction must be recorded as a contribution. The acquired organization must determine whether to establish a new basis for reporting its assets and liabilities based on the new entity’s basis. And that’s on the assumption that the reporting organization will present its own separate financial statements after the new entity assumes control. 

Ceded control without creation of a new legal entity

Another option is for the board of one organization to cede control of its operations to another entity (for example, by allowing the other organization to appoint the majority of its board) as part of its decision to engage in the cooperative activity — but without creating a new legal entity. 

If your nonprofit assumes control of the other, and generally accepted accounting principles (GAAP) require you to consolidate financial statements with the other entity, you must account for your interest in the other organization and the cooperative activity by applying an acquisition method described in GAAP.

If the shoe is on the other foot, 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) beginning on the “acquisition” date. If your nonprofit will present its own separate financial statements, you must determine whether to establish a new basis for reporting assets and liabilities based on the other entity’s basis.

Proceed with caution

The benefits of collaborating with other nonprofits are usually clear — but the financial reporting rules often are anything but.  We can help you determine and comply with your reporting obligations.

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