Connections for Success

 

03.24.16

Collaborative Activities: Are You Reporting Them Correctly?
Marva M. Flanagan

The simplest relationship between not-for-profit organizations for accounting purposes may be a collaborative arrangement. This is typically a contractual agreement in which two or more organizations are active participants in a joint operating activity. One example includes a hospital that is jointly operated by two not-for-profit health care organizations. Organizations in this type of agreement are vulnerable to significant risks and rewards that hinge on the activity’s success and should have a written agreement.

The 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 that is considered to be the principal for that specific activity. Generally, the principal is the entity that has control of the goods or services provided in the activity and should follow Generally Accepted Accounting Principles (GAAP).

Payments between participants should be presented according to their nature and follow accounting guidance for the type of revenue or expense that 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 or a merger. A merger takes place when the boards of directors of both not-for-profit organizations cede control of themselves to the new entity. The assets and liabilities of the two organizations are combined as of the merger date. Note that the accounting policies of the original entities must be conformed for the new entity, which is measuring and recognizing the assets and liabilities in the financial statements as of the merger date based on their carrying values.

Another option to joining forces is for the board of one organization to give up control of its operations to another entity, for example, by allowing the other organization to appoint the majority of its board members 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 fair value of the assets and liabilities of the organization that was acquired at the date of acquisition, with some exceptions. There are also some required disclosures in acquisition transactions.

In many cases, if a new legal entity is formed, it is primarily used 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 is important to look at which, if any, collaborator has control over the activity.

The benefits of collaborating with other not-for-profit organizations are usually clear, but the financial reporting rules are often more complicated.  Before entering in a binding agreement, organizations should seek professional advice. Your accountant can help you understand the rules and comply with your reporting obligations.

For more information on not-for-profit collaborative efforts, contact Marva Flanagan at [email protected], or call her at 312.670.7444. Visit ORBA.com to learn more about our Not-For-Profit Group.

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