As competition has increased in attracting donor funding, many not-for-profit organizations have looked to create separate partnerships and ventures in order to better serve their constituents. When these new entities are created, organizations must evaluate whether generally accepted accounting principles require these entities to be consolidated for financial statement presentation. Whether a not-for-profit should consolidate a related entity depends on two factors: economic interest and control.
An economic interest in another not-for-profit entity exists when another entity holds or provides significant services to the organization or the organization is responsible for another entity’s liabilities.
Control is the direct or indirect ability to determine the direction of an organization’s management and policies. An organization is determined to have a majority voting interest in the Board of another entity, and thus control of that entity, if it has the direct or indirect ability to appoint individuals that together constitute a majority of the votes of that entity’s Board. Thus, if one organization approves a majority of another entity’s Board, there is the indirect ability to determine the direction of that entity’s management and policies.
Depending on the existence of economic interest and control, the following conclusions can be reached:
A not-for-profit organization that has both an economic interest and control of another not-for-profit entity through a majority voting interest in the other entity's Board should consolidate that entity's activities into its financial statements.
If a not-for-profit organization has both an economic interest and control of another not-for-profit entity, but such control is through means other than a majority voting interest, such as through a contract or affiliation agreement, consolidation is permitted but not required.
A not-for-profit organization that has either an economic interest or control of another not-for profit entity, but not both, cannot consolidate that entity’s activities into its financial statements.
The structure of a relationship will ultimately determine whether a related entity is required to be consolidated into an organization’s financial statements. When establishing a relationship with a new entity, the concepts of economic interest and control should be considered in order to avoid unintended effects on an organization’s financial statements. Organizations should also evaluate existing relationships with related entities to ensure changes in relationship structure are incorporated into consolidation considerations.
Any federal tax advice contained in this communication (including any attachments): (i) is intended for your use only; (ii) is based on the accuracy and completeness of the facts you have provided us; and (iii) may not be relied upon to avoid penalties.
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