By Lauren Kreutzinger, manager, VonLehman CPA & Advisory Firm
A collaborative arrangement may be the simplest relationship between nonprofits for accounting purposes. These are typically contractual agreements in which two or more organizations are active participants in a joint activity.
One example would be a private school that’s jointly operated by two religious organizations. Another would be a nonprofit that provides free clothing and operates a shop at the local homeless shelter.
It is important to note that the financial reporting rules in these arrangements depend on the type of collaborative relationship entered into by the parties.
Reporting costs and revenues
In any collaborative arrangement, the nonprofit considered the “principal” for the arrangement should report costs incurred and revenues generated from transactions with third parties on a gross basis in their statement of activities.
Generally, the principal is the entity that has control of the goods or services provided in the transaction. But Generally Accepted Accounting Principles (GAAP) should be followed for each particular situation.
The nonprofits should present payments between participants according to their nature, following accounting guidance for the type of revenue or expense involved in the transaction. Participants in a collaborative arrangement also are required to make certain disclosures in their financial statement footnotes. For example, they must report the nature and purpose of the arrangement and each organization’s rights and obligations.
When two nonprofits form a new legal entity
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 to the newly formed entity. The historical values of the assets and liabilities of the organizations are combined, and the accounting policies of the original entities must be brought into conformity for the new entity.
If one nonprofit cedes control to the other
Another option is for the board of one organization to cede control of its operations to another entity. For example: One nonprofit allows the other nonprofit to appoint the majority of its board as part of its decision to engage in cooperative activities. In such a case, an acquisition takesplace, with the remaining organization considered the acquirer. The remaining entity must record the acquisition based on the current value of the acquired organization’s assets and liabilities.
If there’s an excess of current value over original cost to the organization being acquired, that amount is recorded as a contribution. If the value is lower, the difference is generally recorded as goodwill not as an expense. But, if the operations of the acquired organization are predominantly supported by contributions and returns on investments, the difference is recorded as a separate charge in the acquirer’s statement of activities.
Let’s say your nonprofit assumes control of another entity and GAAP requires you to consolidate financial statements with the other. You should account for your interest in the other nonprofit and the cooperative activity by applying an acquisition method described in GAAP.
If the shoe is on the other foot, and it’s your nonprofit that cedes control of its operations to another entity, that 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, you must determine whether to establish a new basis for reporting assets and liabilities based on the other entity’s basis.
When the new legal entity houses a joint activity
In many cases, a new legal entity is formed only when the outcome is to house the cooperative activity instead of all activities of the organizations that are collaborating. This would be neither a merger nor an acquisition.
However, to determine the proper accounting treatment, it’s important to look at which, if any, collaborator has control over the activity.
Reporting your collaborative activities with other organizations in your financial statements is an important responsibility. Your VonLehman advisor can help you understand the rules and how to comply with your specific reporting obligations.
Lauren Kreutzinger is a manager with VonLehman CPA & Advisory Firm. She specializes in providing auditing, review, compilation, and business advisory services for a wide range of nonprofit organizations. She serves on the firm’s Nonprofit/Government Service Group and has achieved the American Institute of CPAs’ Nonprofit Certification. She frequently contributes nonprofit industry related content for the firm’s website and newsletters and has also presented at various nonprofit educational seminars hosted by VonLehman and other industry leaders.