How to handle financial reporting for two
So, you’ve recently joined forces with another entity to boost efficiency, save money and better serve your constituencies. Sounds like a smart move. But does your accounting staff know how to report the activities of the two organizations? Much will depend on the nature of your new relationship.
How should you approach collaborative arrangements?
The simplest relationship between nonprofits for accounting purposes may be a collaborative arrangement. These are typically contractual agreements in which two or more organizations are active participants in a joint operating activity. Both entities are vulnerable to risks and rewards that hinge on the activity’s commercial success.
Costs incurred, and revenues generated from transactions with third parties, should be reported, on a gross basis in its statement of activities, by the not-for-profit that’s considered the “principal” for the specific transaction. The principal is usually the entity that has control of the goods or services provided in the transaction. Follow Generally Accepted Accounting Principles (GAAP) for your situation.
Payments between participants are presented according to their “nature,” following accounting guidance for the type of revenue or expense the transaction involves. Participants in collaborative arrangements also must make certain financial statement disclosures, such as the purpose of the arrangement and each organization’s related rights and obligations.
And if one organization relinquishes control?
Another collaborative 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. A new legal entity isn’t created. In fact, an acquisition has taken place. The remaining organization is considered the acquirer. The remaining entity must determine how to record the acquisition based on the fair value of the assets and liabilities of the nonprofit acquired.
If the value of the assets net of the liabilities received is greater than the amount paid in the acquisition transaction, the difference should be recorded as a contribution. If the value is lower than the price paid by the acquirer, the difference is generally recorded as goodwill. But, if the operations of the acquired organization are expected to be predominantly supported by contributions and return on investments, the difference should be recorded as a separate charge in the acquirer’s statement of activities.
What if your nonprofit assumes control of the other entity, and GAAP requires you to present consolidated financial statements? In this situation, you must account for your interest in the other organization and the cooperative activity by applying an acquisition method described in GAAP.
If it’s your not-for-profit that cedes control of its operations to another entity, that organization may need to consolidate your nonprofit (including the cooperative activity) beginning on the “acquisition” date. If your nonprofit will present separate financial statements, you must determine whether to establish a new basis for reporting assets and liabilities based on the other entity’s basis.
In many cases, if a new legal entity is formed, it’s used only to house the cooperative activity instead of all activities of the organizations that are collaborating. This would be neither a merger nor an acquisition. But to determine the proper accounting treatment, it’s important to look at which, if any, collaborator has control over the activity.
What about mergers?
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.
In these situations, the organizations’ assets and liabilities are combined as of the merger date. The accounting policies of the original entities must be conformed for the new entity.
New world order
In your new collaborative world, financial reporting will be different for you than it’s been in the past. Accounting rules can be complicated, but not impossible. Your CPA can help you navigate the new waters.