To ensure delivery of timely information, please add <jobswatch@deweykaye.com> to your address book.
Wednesday, November 3, 2010
Dual-Entity Reporting: Don't Throw Out the Baby with the Bathwater
By Susan E. Maloney, CPA Audit Manager, McCrory & McDowell, LLC
In times of economic volatility and uncertainty, the challenges of fundraising have increased for virtually all nonprofit organizations. Nonprofit competition for limited dollars has intensified, and organizations must seek to communicate to the community their mission, value and commitment to responsible use of donated resources. In communicating with donors and funders, nonprofit organizations often face the challenge of presenting financial statements that are both accurate and yet allow the reader to clearly see the organization's level of need.
Nonprofit accounting standards require that certain financial holdings be shown in the financial statements as restricted assets. However, an inexperienced reader might erroneously conclude that such assets are available for use by the organization, when in fact, they may be restricted indefinitely. Likewise, donors may lack the experience to understand what they are reading when presented with a statement of net assets that shows a large restricted asset such as an endowment fund.
In an effort to present available operational resources as they truly are, an organization's financial managers may be considering the creation of a separate nonprofit entity, such as a foundation, where significant investment assets could be transferred and held, and/or where contributions from fundraising activities could be reported. This tactic of creating a two-entity structure could avoid the misconception that the original nonprofit organization is sufficiently funded, and accordingly, less in need than they may actually be.
However, based on nonprofit accounting standards, the above approach may not result in the organization's desired outcome--nonconsolidated financial statements. Accounting rules for consolidation of nonprofit entities are written to limit such a scenario from occurring. Consolidated financial statements are those that present financial information of two or more related entities in a combined format as a single reporting entity. Under Accounting Standards Codification 958-810-25, generally accepted accounting principles require that related nonprofit entities be consolidated for financial statement presentation if the following are present:
- An economic interest of one nonprofit entity by another. Examples of economic interests include the holding of assets for one entity by another, or the use of significant resources or assets of one entity to produce revenue or provide services for another.
- A controlling interest of one nonprofit entity by another. Controlling interest is generally defined as majority ownership or control such as majority voting interest on a board of directors.
A foundation created without considering the accounting rules above may require consolidation with the original operating nonprofit for external reporting purposes under generally accepted accounting principles, thus eliminating the intended benefit of creating the separate entity in the first place. In order for such a foundation not to be consolidated, the original nonprofit must generally have less than a majority control over the newly-created entity's board. This will effectively accomplish the goal of separating certain assets from the original nonprofit, but a decision to relinquish some board control is not without risk. The added costs of establishing a separate tax-exempt entity and additional audit and annual reporting requirements must also be considered. As with any significant organizational change, there are many legal, tax and other issues that must be assessed before implementing any change. If a foundation is a potential option for your organization, advice from experienced legal and financial consultants should be brought to bear throughout the process.
Sue Maloney specializes is audit and attest services for nonprofit organizations.
Sue can be reached at smaloney@mccmcd.com.
Dewey & Kaye