More and more nonprofits are joining forces to better serve their client populations and cut costs. But such relationships can come with complicated financial reporting obligations. Your organization’s reporting requirements will depend on the type of relationship you enter.
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 organizations are vulnerable to significant risks and rewards that hinge on the activity’s commercial success. Examples include a hospital that is jointly operated by two nonprofit health care organizations or multiple organizations that are working together to develop and produce a new medical product.
Costs incurred and revenues generated from transactions with third parties should be reported, on a gross basis on its statement of activities, by the not-for-profit who is considered the “principal” for that specific transaction. Generally the principal is the entity that has control of the goods or services provided in the transaction, but follow Generally Accepted Accounting Principles (GAAP) for your particular 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 are required to make certain disclosures, such as the nature and purpose of the arrangement and each organization’s rights and obligations.
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.
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. In this case, an acquisition has taken place, with the remaining organization considered the acquirer. The remaining entity must determine how to record the acquisition based primarily on the current value of the assets and liabilities of the organization acquired.
If there is an excess of value in the acquisition transaction, it should be recorded as a contribution. If the value is lower, the difference is generally recorded as goodwill. However, 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.
If your nonprofit assumes control of the other, and GAAP requires 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 is 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.
New legal entity to house only this collaboration
In many cases, if a new legal entity is formed, it is 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 is important 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 — but the financial reporting rules often are anything but. Your accountant can help you understand the rules and comply with your reporting obligations.