11
AFFILIATED ORGANIZATIONS

PERSPECTIVE AND ISSUES

Not-for-profit organizations are often associated with other organizations, either not-for-profit or for-profit. The association may result from many different types of relationships. Issues have arisen recently whereby the debt of a not-for-profit organization was moved to other affiliated organizations to present a picture of better financial health for itself. In applying the accounting principles discussed in this chapter, the reader should be aware that careful attention should be paid to make sure that all requirements for any affiliated organization are met.

In the not-for-profit world, true “ownership” of one entity by another rarely exists (although sometimes a not-for-profit will own an operating business which it either established or had donated to it). Affiliated organizations are more often related by agreements of various sorts, but the level of control embodied in such agreements is usually far short of ownership. For example, the “Friends of the Warsaw Museum” may exist primarily to support the Warsaw Museum, but it is likely a legally independent organization with only informal ties to its “parent.” The Museum may ask, but the Friends may choose its own time and method to respond. Further, the Museum may have no way to legally compel the Friends to do its bidding if the Friends resists.

The issue for donors is, if I give to the Friends, am I not really just supporting the Museum? Or if I am assessing the financial condition of the Museum, is it not reasonable to include the resources of the Friends in the calculation? Even though the Friends is legally separate, and even though the Friends does not have to turn its assets over to the Museum, isn't it reasonable to assume that if the Museum got into bad financial trouble, the Friends would help?

CONCEPTS, RULES, AND EXAMPLES

Types of Relationships Often Found

The fundraising affiliate of a “parent” organization. These are often named something like “The Friends of the [Museum],” “The [Symphony] Guild,” “The [School] Foundation,” and so on. They are found most often with cultural organizations such as museums, performing arts, and the like, and with health care and educational institutions. College alumni associations often perform this function for the college. Public universities usually use such an affiliate to raise funds that are kept out of the budgetary numbers submitted to the state legislature (which, if the affiliate were combined, might cause a reduction in the governmental appropriation to the college). Hospitals often do the same, with their purpose being to keep the assets out of the base used to calculate Medicare/Medicaid reimbursement rates. Some colleges also have affiliates set up to raise money for a particular college activity—often the athletic department (in which case they are often referred to as “booster clubs”); this allows the funded activity more financial flexibility than if it were limited to what it would be allocated under the organization's regular budgetary process.

The traditional federated fundraising organization such as United Way or a community arts fund also performs this kind of function. However, the question of consolidation rarely arises with such groups because they are usually completely independent of the groups for which they raise money. (The question of when a fundraiser is merely acting as an agent for another organization is germane to all of these kinds of organizations [controlled and noncontrolled], but that is a different issue.)

The asset-holding affiliate. Organizations that are in the fortunate position of having more assets than are immediately needed for activities, or that have large endowment funds, avoid having to answer embarrassing questions from prospective and previous donors about the organization's real need for gifts by placing the assets into a separate legal entity. Two other reasons sometimes cited for such an arrangement are that management of the investment portfolio is more efficient, and that the assets are (at least believed to be) protected against possible lawsuits resulting from program activities of the parent organization (especially in areas such as health care, child care, etc.).

A variation on this scenario occurs when a donor establishes a separate legal entity (a trust, foundation, or fund within a community or private foundation) and stipulates that the income from the fund is to go to a specified organization, usually in perpetuity. The supported organization may or may not have any authority over the investment management of the fund or over the amounts and timing of income distributions to it, or access to any of the principals of the fund.

Another similar situation involves the more common deferred giving arrangements, such as gift annuities, pooled income funds, or remainder trusts, which always terminate at some specified or determinable time (often upon the death of the donor or other life income beneficiary). The assets that fund such arrangements are sometimes under the control of the charity, sometimes of a third-party trustee.

The program activity affiliate. Some organizations set up legally separate affiliates to carry out certain program functions within the general area of the organization's activities. A university might have a research foundation specifically to work in a particular area of research. Funding of such organizations sometimes comes wholly from the main organization; sometimes funding is partly or entirely from sources specific to the affiliate. Other examples include a university publishing company or study center (the latter are often geographically separated from the main campus, such as Harvard's Villa I Tatti, an art study center in Florence, Italy); a hospital testing laboratory; a cemetery affiliated with a church; a broadcasting station affiliated with a university or with a religious organization; an overseas mission, university, hospital, convent, orphanage, monastery, or charitable organization affiliated with a religious denomination. Most university medical schools that include teaching hospitals have the hospital set up as a separate organization.

A variation on this theme is the affiliate that conducts “program” activities that are peripheral to those of the parent entity. Examples include those commonly referred to as “auxiliary activities” of a university (such as food services, recreational activities, parking facilities), or activities that support the operations of a hospital (such as a laundry, or an office building in which physicians affiliated with the hospital have their private offices). Other examples include pension funds, captive insurance companies, gift shops, welfare benefit plans, investment, or management companies.

Another variation is the “organization” that is legally part of the parent entity but is operated almost as if it were separate. Examples include guilds, circles, and similar church groups, committees set up to carry on certain activities such as annual fairs, dinner-dances, or other fundraising events. These often have separate bank accounts and “governing” boards that act very much like those of legally separate organizations. Accountability for the finances of such groups is often weak.

There are also organizations that are legally separate from the “parent” but are connected by informal relationships stemming from a mandatory organizational affiliation of their members. Examples include on- and off-campus student organizations at a college, such as fraternities, sororities, cultural organizations (drama club, glee club, etc.), student-edited publications, community service organizations, honor societies, academic and athletic clubs, and the alumni association. Such affiliated entities are often supported financially by the “parent” in ways such as having their administrative expenses paid by the parent. A variation on this theme is the corporate foundation, a not-for-profit controlled and funded by a for-profit. Most parent companies also pay all or most of their foundation's administrative expenses, in addition to making contributions to it.

Affiliates of a common parent. These include the major national charities and service organizations, many of them medically or youth-oriented (Cancer, Heart, Lung, United Way, Scouts, etc.). This is also found with some professional and trade associations such as the various medical, dental, legal, accounting, labor, and similar associations, and with national fraternal and civic organizations (Greek letter fraternities and sororities, Rotary, Lions, Kiwanis, etc.). Other examples include the various campuses of a state university system (New York and California are two of the largest). In some cases the state and local “affiliates” have little or no legal relationship with the national organization (the Institute of Management Accountants [IMA] is one example); in other cases the national closely controls the affiliates (the Arthritis Foundation is an example); one also sees every gradation in between.

Most religious denominations are also in this category as to the national organization and individual churches/parishes/synagogues, etc. In many denominations, there are also intermediate-level entities such as archdioceses (Roman Catholic), dioceses (Catholic and Episcopal), synods (Lutheran), or conferences (Methodist). The degree of control of the local entities by the national entity varies considerably. An additional complicating factor with religious organizations is the existence in some denominations of two different sets of governing rules: theological rules (sometimes referred to as “canon law”), and secular administrative rules based on civil law.

Definition of the Reporting Entity

There are two issues here, but they involve the same concepts. The issues are:

  1. Gifts to one organization (say, a fundraising affiliate) which are later passed through to another organization (the organization for which the affiliate raises money);
  2. When the financial data of affiliated entities should be combined with those of a central or parent organization for purposes of presenting the central organization's financial statements.

Of course if the data are combined, the question of pass-through gifts need not be addressed, since the end result is the same regardless of which entity records gifts initially.

The concept underlying the combining of financial data of affiliates is to present to the financial statement reader information that portrays the complete financial picture of a group of entities that effectively function as one entity.

A key determinant of whether consolidation of affiliates is appropriate is the degree of control exercised by one entity over another. Since the normal method of measuring such control (ownership of voting stock) does not usually apply in the not-for-profit environment, other factors must be used. Appendix A at the end of this chapter is a list of factors that the authors consider relevant for this purpose.

REPORTING OF RELATED ENTITIES

Not-for-profit organizations often have transactions with or investments in other organizations, both for-profit and not-for-profit, which are related to them or which can control their use of funds. This section of this chapter addresses four key areas in understanding the nature of these relationships and their impact on a not-for-profit organization's accounting and financial reporting.

The four key areas covered by this section are as follows:

  1. Related-party disclosures;
  2. Investments in for-profit entities;
  3. Financially interrelated not-for-profit organizations;
  4. Pass-through grants.

Chapter 24 describes new accounting guidance from the FASB related to the merger and acquisition of not-for-profit organizations.

CONCEPTS, RULES, AND EXAMPLES

Related-Party Disclosures

GAAP requires financial statements to include disclosure of material related-party transactions other than compensation arrangements, expense allowances, or other similar items in the ordinary course of business. The requirements are generally found in FASB ASC 850-10. Generally the disclosure should include the nature of the relationship, description of the relationship, the amount of the transaction, and the terms of the transactions. Related-party transactions are still another area recently receiving increased scrutiny as to adequacy of disclosure.

In addition, when one or more companies are under common control, the nature of the control relationship should be disclosed.

The FASB ASC Master Glossary defines a related party as an entity that can control or significantly influence the management or operating policies of another entity to the extent one of the entities may be prevented from pursuing its own interests. A related party may be any party the entity deals with that can exercise that control. Examples of related parties include (1) affiliates, (2) investments accounted for under the equity method, (3) trusts for the benefit of employees (for example, pension or profit-sharing trusts), and (4) members of management, the governing board, and their immediate families.

A related party may be any party that can exercise control or significant influence over an organization. Related parties of not-for-profit organizations may include the following:

  • Significant contributors (but only if they can significantly influence management or operating policies of the organization to an extent that the organization is prevented from pursuing its own interests);
  • Separate entities that solicit funds in the name of the organization and substantially all of the funds solicited are intended for the use of the organization;
  • Brother-sister organizations and certain national, state, and local affiliates;
  • Entities whose officers or directors are also members of another organization's governing board.

Transactions between related parties should be recorded in the same manner as transactions between unrelated parties. That is, their substance, rather than their form, generally should govern the accounting. The following are examples of common related-party transactions: (FASB ASC 850-10-05-3)

  • Sales, purchases, and transfers of property;
  • Services provided or received;
  • Property and equipment leases;
  • Loans or guarantees;
  • Maintenance of compensating bank balances for the benefit of a related party;
  • Allocations of common costs;
  • Filing annual group information and tax returns (for organizations that have established their tax-exempt status under a group exemption letter).

The following are examples of related-party transactions that are common to not-for-profit organizations:

  • Purchases of goods or services from board members;
  • Payments to, or receipts from, affiliates;
  • Office space leased from, or donated by, board members or related entities;
  • Personal assets guaranteed or pledged by the organization's board members.

GAAP has specific disclosure requirements relating to material related-party transactions. These disclosure requirements are identified later in this section.

Investments in For-Profit Entities

Not-for-profit organizations sometimes make investments in for-profit entities. In some cases, these investments are made to account for investments where the objective is a maximization of profits. For example, a not-for-profit organization that desires to invest in real estate may form a wholly owned, for-profit corporation that purchases and manages an office building. On the other hand, a not-for-profit organization may set up a for-profit subsidiary for tax considerations. For example, if a not-for-profit organization expects to generate a significant amount of unrelated business income through the sale of merchandise bearing its insignia or trademark (such as clothing, coffee mugs, etc.), there may be tax advantages to having these activities managed and accounted for through a for-profit subsidiary.

FASB ASC 958-810-15 provides the following guideline to not-for-profit organizations accounting for investments in for-profit entities:

  1. A reporting not-for-profit organization should consolidate a for-profit entity in which it has a controlling financial interest through direct or indirect ownership of a majority voting interest if the guidance in FASB ASC 810-10 requires consolidation. The manner in which the for-profit entity's financial position, results of operations, and cash flows are presented in the reporting organization's financial statements depends on the nature of the activities of the for-profit entity.
  2. A reporting not-for-profit organization should use the equity method in conformity with FASB ASC 323-10 to report investments in common stock of a for-profit entity if the use of the equity method is required.
  3. A not-for-profit organization with more than a minor interest in a for-profit real estate partnership, limited liability company, or similar entity should, subject to the fair value exceptions below, report its noncontrolling interests in such entities using the equity method unless that interest is reported at fair value in conformity with the guidance described below. A not-for-profit organization should apply the guidance in FASB ASC 970-323-25-2 (Real Estate Investments on the Equity Method of Accounting) to determine whether its interests in a for-profit partnership, limited liability company, or similar entity are controlling interests or noncontrolling interests. An NFP should apply the guidance in FASB ASC 323-30-35-3 to determine whether a limited liability company should be viewed as similar to a partnership, as opposed to a corporation, for purposes of determining whether there are noncontrolling interests in a limited liability company or a similar entity.
  4. A not-for-profit organization may be required to report an investment described above at fair value in conformity with paragraph 958-320-35-1 or may be permitted to make an election pursuant to paragraph 825-10-25-1 relating to financial interests. In addition, NFPs other than those within the scope of Topic 954 (health care entities) may be permitted to report an investment described above at fair value in conformity with Section 958-325-3, which describes GAAP for reporting of “other” investments.

NOTE: The following discussion describes two Accounting Standards Updates. The first, ASU 2015-02, describes certain changes to the consideration for consolidation for certain investment in limited partnerships and similar entities. The second, ASU 2017-02, applies to not-for-profit organizations and reinstates the original guidance for consideration for when a general partner should consolidate a for-profit limited partnership. The guidance is moved from Topic 810 to Subtopic 958-810 in the FASB Accounting Standards Codification.

In February 2015, the FASB issued ASU 2015-02 Consolidation (Topic 810) Amendments to the Consolidation Analysis, which amends the consolidation guidance in the following areas:

  1. Limited partnerships and similar legal entities;
  2. Evaluating fees paid to a decision maker or service provider as a variable interest;
  3. The effect of fee arrangements on the primary beneficiary determination;
  4. The effect of related parties on the primary beneficiary determination;
  5. Certain investment funds.

Not-for-profit organizations should pay particular attention to item 1 above, as it concerns consolidation requirements for limited partnerships and similar entities and addresses whether a general partner or the limited partners should consolidate a limited partnership. Not-for-profit organizations involved in affordable housing development sometimes encounter these accounting issues in reporting housing development fund corporations. A general partner is presumed to control a limited partnership, requiring consolidation. However, if the limited partners have certain rights, such as the removal of the general partner (kick-out rights) or the ability to participate in partnership decisions (participating rights), the control presumption can be overcome.

The amendments in this Update have the following three main provisions that affect limited partnerships and similar legal entities:

  1. There is an additional requirement that limited partnerships and similar legal entities must meet to qualify as voting interest entities. A limited partnership must provide partners with either substantive kick-out rights or substantive participating rights over the general partner to meet this requirement.
  2. The specialized consolidation model and guidance for limited partnerships and similar legal entities have been eliminated. There is no longer a presumption that a general partner should consolidate a limited partnership.
  3. For limited partnerships and similar legal entities that qualify as voting interest entities, a limited partner with a controlling financial interest should consolidate a limited partnership. A controlling financial interest may be achieved through holding a limited partner interest that provides substantive kick-out rights.

ASU 2015-02 is effective for fiscal years beginning after December 15, 2016, with earlier adoption permitted.

In January 2017, the FASB issued ASU 2017-01 Not-for-Profit Entities—Consolidation (Subtopic 958-810) Clarifying When a Not-for-Profit Entity That Is a General Partner or a Limited Partner Should Consolidate a For-Profit Limited Partnership or Similar Entity. ASU 2017-01 retains the consolidation guidance that was in Subtopic 810-20 for not-for-profit organizations by including it within Subtopic 958-810. Therefore, under the amendments, not-for-profit organizations that are general partners continue to be presumed to control a for-profit limited partnership, regardless of the extent of their ownership interest, unless that presumption is overcome. The presumption is overcome if the limited partners have either substantive kick-out rights or substantive participating rights.

To be substantive, the kick-out rights must be exercisable by a simple majority vote of the limited partners' voting interests or a lower threshold. For purposes of evaluating that threshold, the limited partners' voting interests should exclude voting interests held by the general partners, parties under common control with the general partners, and other parties acting on behalf of the general partners.

ASU 2017-01 also takes the guidance of ASU 2015-02 as to when limited partners should consolidate limited partners and replicates it in Subtopic 958-810 for ease of use. Also, the amended definitions of kick-out rights, participating rights, and protective rights have been added to the glossary section of Subtopic 958-810.

ASU 2017-01 is effective for fiscal years beginning after December 15, 2016, with early adoption permitted. Not-for-profit organizations that have not yet adopted the amendments of ASU 2015-02 are required to adopt ASU 2017-01 at the same time as ASU 2015-02.

Financially Interrelated Not-For-Profit Organizations

FASB ASC 958-810 provides guidance for accounting and financial reporting for not-for-profit organizations that are financially interrelated.

In most cases, not-for-profit organizations don't have voting ownership shares that may be purchased or acquired by other not-for-profit organizations. Accordingly, the rules applicable to whether to consolidate one not-for-profit organization with another are not as relatively straightforward as with for-profit investments and subsidiaries. How not-for-profit organizations that are financially interrelated combine, consolidate, or account for their relationship is based on concepts described by GAAP as ownership, control, and economic interest. These are described as follows:

Ownership interest in not-for-profit organizations may be evidenced in a variety of ways because a not-for-profit organization may have one of many different legal forms. For example, not-for-profit organizations may be in the legal form of corporations issuing stock, corporations issuing ownership certificates, membership corporations issuing membership certificates, joint ventures, partnerships, and other forms.

The FASB ASC Master Glossary defines control and economic interest as follows:

Control. The direct or indirect ability to determine the direction of management and policies through ownership, contract, or otherwise.

Economic interest. An interest in another entity that exists if (1) the other entity holds or utilizes significant resources that must be used for the unrestricted or restricted purposes of the not-for-profit organization, either directly or indirectly by producing income or providing services, or (2) the reporting organization is responsible for the liabilities of the other entity.

GAAP offers the following examples of economic interests:

Other entities solicit funds in the name of and with the expressed or implied approval of the reporting organization, and substantially all of the funds solicited are intended by the contributor or are otherwise required to be transferred to the reporting organization or used at its discretion or direction.

A reporting organization transfers significant resources to another entity whose resources are held for the benefit of the reporting organization.

A reporting organization assigns significant functions to another entity.

A reporting organization provides or is committed to provide funds for another entity or guarantees significant debt of another entity.

The following guidance for how financially interrelated not-for-profit organizations should be reported is based on the requirements described in FASB ASC 958-810.

  • Ownership of a majority voting interest. A not-for-profit organization should consolidate another not-for-profit organization in which it has a controlling financial interest through direct or indirect ownership of a majority voting interest, unless control is likely to be temporary or does not rest with the majority owner, in which case consolidation is prohibited by GAAP, which also provides the following example to define a majority voting interest: Entity B has a five-member board, and a simple voting majority is required to approve board actions. Entity A will have a majority voting interest in the board of Entity B if three or more Entity A board members, officers, or employees serve on or may be appointed at Entity A's discretion to the board of Entity B. However, if three of Entity A's board members serve on the board of Entity B but Entity A does not have the ability to require that those members serve on the Entity B board, Entity A does not have a majority voting interest in the board of Entity B.
  • Control and economic interest. A not-for-profit organization should consolidate another not-for-profit organization if the reporting not-for-profit organization has both control of the other not-for-profit organization, as evidenced by either majority ownership or a majority voting interest in the board of the other not-for-profit organization, and an economic interest in the other not-for-profit organization. If control is likely to be temporary or does not rest with the majority owner, consolidation is prohibited.
  • Economic interest but no control by majority ownership or majority voting interest. A not-for-profit organization may exercise control of another not-for-profit organization in which it has an economic interest by means other than majority ownership or a majority voting interest in the board of the other not-for-profit organization. In such circumstances, the not-for-profit organization is permitted, but not required, to consolidate the other organization, unless control is likely to be temporary, in which case consolidation is prohibited.
  • If a not-for-profit organization controls another organization in which it has an economic interest by means other than majority ownership or a majority voting interest in the board of the other not-for-profit organization and consolidated financial statements are not presented, the not-for-profit organization should make the financial statement disclosures required by GAAP.
  • Either control or economic interest. If either (but not both) control or an economic interest exists, the financial statement disclosures for related parties should be made.

Recent Guidance on Consolidations and Equity Method Guidance

In May 2008, an FASB Staff Position, which is now incorporated into FASB ASC 958-810-65 and 958-810-25, made several changes to the guidance on consolidation and the equity method of accounting. The range of matters covered by the FSP that affect current GAAP is broad and is summarized as follows:

  • Temporary control exception

    The exception to consolidation for related but separate not-for-profit organizations if control is likely to be temporary was eliminated. Consolidation of one not-for-profit organization by another not-for-profit organization shall be required, permitted, or prohibited, depending on whether there is control, an economic interest, or both, and depending on the nature of the control, regardless of whether that control is likely to be temporary.

  • Definition of majority voting interest in the board of directors of another entity:

    Questions have arisen about the definition and example of majority voting interest in the board of another entity. Those questions center on whether an organization has control by a majority voting interest in the board of another entity if it appoints board members who are other than its own board members, employees, or officers, and on whether the organization has temporary control by a majority voting interest in the board of another entity when it cannot appoint a majority of the other organization's fully constituted board but, for a period of time, it appoints a majority of the filled board positions because of temporary vacancies on that board.

    An organization shall be deemed to have a majority voting interest in the board of another entity if it has the direct or indirect ability to appoint individuals that together constitute a majority of the votes of the fully constituted board (that is, including any vacant board positions). Those individuals are not limited to the organization's own board members, employees, or officers.

  • Special-purpose lessors:

    Not-for-profit organizations, especially hospitals and universities, sometimes use leasing special-purpose entities (SPE). A not-for profit organization that is engaged in leasing transactions with an SPE lessor should consider whether it should consolidate the lessor. A not-for-profit organization should consolidate an SPE lessor if all of the following conditions exist: (FASB ASC 958-810-25-8)

    • Substantially all of the activities of the SPE involve assets that are to be leased to a single lessee.
    • The expected substantial residual risks and rewards of the leased assets and the obligation imposed by the underlying debt of the SPE reside directly or indirectly with the lessee through means such as any of the following:
      • The lease agreement.
      • A residual value guarantee through, for example, the assumption of first-dollar-of-loss provisions.
    • A guarantee of the SPE's debt.
    • An option granting the lessee a right to do either of the following:
      • To purchase the leased asset at a fixed price or at a defined price other than fair value determined at the date of exercise.
      • To receive the lessor's sales proceeds in excess of a stipulated amount.
      • The owner of record of the SPE has not made an initial substantive residual equity capital investment that is at risk during the entire lease term. This criterion would be considered met if the majority owner of the lessor is not an independent third party, regardless of the level of capital investment. To satisfy the at-risk requirement, an initial substantive residual equity capital investment should meet all of the following conditions:
        • It represents an equity interest in legal form.
        • It is subordinate to all debt interests.
        • It represents the residual equity interest during the entire lease term.

Disclosures

The following information about material related-party transactions (other than compensation arrangements, expense allowances, and similar items occurring in the normal course of business) should be disclosed:

  1. Nature of relationship (the name of the related party also should be disclosed).
  2. Description of the transactions and effects of such transactions on the financial statements for each period for which a statement of activities is presented.
  3. Dollar amount of transactions for each period for which a statement of activities is presented.
  4. Amounts due from or to related parties as of the date of each statement of financial position presented and, if not otherwise apparent, the terms and manner of settlement. Note that receivables from officers, directors, employees, or affiliates should be shown separately rather than presented under a general heading such as notes receivable or accounts receivable. If the organization presents a classified statement of financial position, amounts due from affiliated organizations or subsidiaries should be classified as current only if it is the organization's practice to liquidate them periodically and the current financial position of the affiliate or subsidiary warrants that treatment.
  5. For an organization that is part of a group that files annual group information and tax returns, the following information should be disclosed in the organization's separately issued financial statements: (FASB ASC 740-10-50-17)
    1. Aggregate amount of current and deferred unrelated business income tax or excise tax expense for each statement of activities presented.
    2. Amount of any tax-related balances due to or from affiliates as of the date of each statement of financial position presented.
    3. Principal provisions of the method by which the group amount of unrelated business income tax or excise tax expense is allocated to members of the group.
    4. Nature and effect of any changes in the method of allocating current and deferred unrelated business income tax or excise tax expense to members of the group and in determining the related balances due to or from affiliates during each year for which the disclosures in 1 and 2 are presented.

If the change in net assets or financial position could change significantly as a result of common ownership or management control of the reporting entity and other entities, the nature of the ownership or management control also should be disclosed, even if there are no transactions between the entities.

Because related-party transactions cannot be presumed to be conducted under competitive, free-market conditions, the preceding disclosures should not imply that the transactions were made on an arm's-length basis unless that representation can be substantiated.

The following information about for-profit subsidiaries and financially interrelated not-for-profit organizations should be disclosed:

  1. Where for-profit entities have been consolidated, any applicable disclosures that would be required by GAAP should be provided.
  2. Where for-profit entities are accounted for by the equity method, any applicable disclosures that would be required by GAAP should be provided.
  3. If a not-for-profit reporting organization controls a separate not-for-profit organization through a form other than majority ownership or voting interest and has an economic interest in that other organization, and consolidated financial statements are not presented, the notes to the financial statements of the reporting organization should include the following disclosures:
    1. Identification of the other organization and the nature of its relationship with the reporting organization that results in control.
    2. Summarized financial data of the other organization, including:
      1. Total assets, liabilities, net assets, revenue, and expenses;
      2. Resources that are held for the benefit of the reporting organization or that are under its control.
    3. The related-party disclosures required by GAAP.
  4. If consolidated financial statements of financially interrelated not-for-profit organizations are presented, they should disclose any restrictions made by entities outside of the reporting entity on distributions from the controlled not-for-profit organization to the reporting organization and any resulting unavailability of the net assets of the controlled not-for-profit organization for use by the reporting organization.

PASS-THROUGH GIFTS

The question concerning pass-through grants is, should gifts be recorded by the affiliate as its own revenue, followed by gift or grant expense when the money is passed on to the parent organization, or should the gifts be recorded as an amount held on behalf of the other entity? Such gifts are often called pass-through gifts since they pass through one entity to another entity.

Gifts to an organization that is only acting as an agent or intermediary for another organization should not be reported as gifts by the agent. The criteria would depend on the degree of control over the use of the gift, and active involvement in soliciting, processing, and distributing the gift by the first organization. If it has little control and little active involvement, it is likely an agent and should record the gift as an amount held for the other organization.

Certain resources received by not-for-profit organizations do not result in the recording of contribution revenue. Resources that are received in connection with these transactions (termed “agency” transactions) should be reported as liabilities, rather than revenue. Subsequent distributions to the designated third-party recipients should be reported as decreases to the liabilities. Accordingly, agency transactions do not affect an organization's change in net assets.

To determine the accounting for transactions in which an entity voluntarily transfers assets to a not-for-profit organization, it is first necessary to assess the extent of discretion the not-for-profit organization has over the use of the assets that are received. If it has little or no discretion, the transaction is an agency transaction. If it has discretion over the assets' use, the transaction is a contribution, an exchange, or a combination of the two.

Not-for-profit organizations sometimes enter into agency transactions in which a donor transfers assets to the organization as an agent for the ultimate benefit of a third-party donee.

An agency transaction occurs when an organization receives resources from a donor that it may only distribute to specifically identified individuals or entities in accordance with the instruction of the original donor. Otherwise, it must return the cash to the donor.

It may be difficult to distinguish an agency transaction from a contribution, although the role of “variance power,” as described below, is a key factor in distinguishing agency transactions from contributions. A transfer of resources may still be a contribution when a donor uses an intermediary organization as its agent or trustee to transfer assets to a third-party donee, when the intermediary can redirect the use of those resources.

Although the transaction between the donor and the donee may be a contribution, the transfer of assets from the donor is not a contribution received by the agent, and the transfer of assets to the donee is not a contribution made by the agent.

The recipient of assets who is an agent or trustee has little or no discretion in determining how the assets transferred will be used. For example, if a recipient receives cash that it must disburse to any who meet guidelines specified by a resource provider or return the cash, those receipts may be deposits held by the recipient as an agent rather than contributions received as a donee. Similarly, if a recipient received cash that it must disburse to individuals identified by the resource provider or return the cash, neither the receipt nor the disbursement is a contribution for the agent, trustee, or intermediary.

If a resource provider explicitly grants an organization unilateral power to redirect the use of transferred assets to another beneficiary (variance power), the transaction represents a contribution to the organization rather than an agency transaction.

A liability is an obligation to pay resources in the future. Accordingly, resources received in connection with agency transactions are reported as liabilities (rather than as contribution revenue). Subsequent distributions of the resources to the designated third-party recipients should be reported as decreases to the liabilities.

Some organizations receive resources as agents as their primary mission. This type of organization includes many foundations and federated fundraising organizations. Those organizations' cash flow statements may actually better reflect their activities because the outflows of resources (i.e., cash) from fundraising efforts are reflected on that statement.

Current GAAP requirements for handling these types of transactions are contained at FASB ASC 958-605-25 that concludes that whether the pass-through entity has variance power (i.e., can it redirect the grant to different ultimate beneficiaries?) determines whether the pass-through funds are accounted for as contribution revenue and contributions paid. Without variance power, the transaction is treated as an agency transaction, that is, with recognition only on the balance sheet.

Applicability. The GAAP rules apply primarily to transactions in which an entity (referred to as the donor) makes a contribution by transferring assets to a not-for-profit organization (referred to as the recipient organization) that accepts the assets from the donor and agrees to use those assets on behalf of, or transfers those assets (with or without investment income) to the beneficiary that is specified by, the donor. These rules also apply to transactions that take place in a similar manner but are not contributions because the transfers are revocable, repayable, or reciprocal.

In describing the accounting treatment for the basic transaction described here, GAAP defines three specific terms—intermediary, trust, and agent. (FASB ASC Master Glossary) These definitions are to assist financial statement preparers in determining whether a recipient organization is an intermediary, trustee, or agent, or whether the recipient organization is, in fact, a donee. Summaries of these definitions and accounting treatment implications are as follows:

  • Intermediary. This term is used to refer to those situations in which a recipient organization acts as a facilitator for the transfer of assets between a potential donor and a potential beneficiary. An intermediary is neither an agent nor a trustee as described below, nor is it a donor/donee relationship as contemplated by GAAP. If an intermediary receives cash or other financial assets, it recognizes the asset and a liability to the specified beneficiary. The asset and liability are measured at the fair value of the asset received. When an intermediary receives nonfinancial assets, it is permitted, but not required, to recognize the nonfinancial assets and corresponding liability in its financial statements. In these cases, the intermediary's accounting policy on recording nonfinancial assets should be consistently applied from year to year.
  • Trustee. A recipient organization acts as a trustee if it holds and manages assets for the benefit of a specified beneficiary in accordance with a charitable trust agreement. Although FASB ASC 958-605 establishes standards for when and how the specified beneficiary would report assets held by a charitable trust, it does not establish standards for a trustee's reporting of those assets.
  • Agent. An agent includes those instances where a legal agency relationship is established as well as those relationships in which an agent receives assets from a donor and agrees to use those assets on behalf of, or transfer those assets to, a specified beneficiary. A recipient organization acts as an agent for and on behalf of a beneficiary if it agrees to solicit assets from potential donors specifically for the beneficiary's use and to distribute those assets to the beneficiary. GAAP also considers a recipient organization to be acting as an agent if a beneficiary can compel the organization to make distributions to it or on its behalf.

With two exceptions, which are described below, a recipient organization that accepts assets from a donor and agrees to use those assets on behalf of, or transfer those assets to, a specified beneficiary is not a donee. (This rule also applies to any return on investment of these assets.) In these situations, the recipient organization should record an asset and a liability for cash and financial assets that it receives, measured at the fair value of the assets. When nonfinancial assets are received in this type of transaction, recording an asset and liability by the recipient is permitted, but not required. Whatever policy is adopted for nonfinancial assets should be disclosed and consistently applied.

The two exceptions to the above rules are described below. In these instances, the recipient organization would account for the transfer of assets as a donee (i.e., would record the receipt of assets as contribution revenue, instead of a liability). Subsequent transfers to the assets to the ultimate beneficiary would then be accounted for as expenses (decreases in net assets) instead of a reduction to a liability.

  1. A recipient organization acts as a donee (as opposed to an intermediary, trustee, or agent) if the donor explicitly grants the recipient organization variance power. Variance power is the unilateral power to redirect the use of the transferred assets to another beneficiary. GAAP is clear that the variance power must be explicitly granted, meaning that the unilateral power to redirect the use of the assets is explicitly referred to in the instrument that transfers the assets. In addition, the variance power must be unilateral, meaning that the recipient organization can override the donor's instructions without the approval of the donor, specified beneficiary, or any other interested party.
  2. If a recipient organization and a specified beneficiary are financially interrelated and the recipient organization is not a trustee, the recipient organization should record a contribution when it receives assets (financial or nonfinancial) from a donor that are specified for the beneficiary. GAAP provides the example of a foundation that exists to raise, hold, and invest assets for a specified beneficiary or for a group of affiliates of which the specified beneficiary is a member, generally is financially interrelated with the organization or organizations that it supports, and recognizes contribution revenue when it receives assets from the donor. A recipient organization and the specified beneficiary are financially interrelated if their relationship has both of the following characteristics:
    1. One organization has the ability to influence the operating and financial decisions of the other. The following are ways in which this influence may be demonstrated:
      1. The organizations are affiliates.
      2. One organization has considerable representation on the governing board of the other organization.
      3. The charter or bylaws of one organization limit its activities to those that are beneficial to the other organization.
      4. An agreement between the organizations allows one organization to actively participate in policy-making processes of the other, such as setting organizational priorities, budgets, and management compensation.
    2. One organization has an ongoing economic interest in the net assets of the other. If the specified beneficiary has an ongoing economic interest in the net assets of the recipient organization, the beneficiary's rights are residual. This means that the value of those rights increases or decreases as a result of the investment, fundraising, operating, or other activities of the recipient organization. A recipient organization may also have an ongoing economic interest in the net assets of the specified beneficiary. In that case, the recipient organization's rights would also be residual, meaning that their value changes as a result of the operations of the beneficiary.

The AICPA issued Technical Practice Aid (TPA) 6140.12, which addressed the issue of accounting for situations where not-for-profit organizations participate in activities where the donor (resource provider) determines the eligibility requirements for the ultimate beneficiaries and the not-for-profit organization must disburse to any who meet guidelines specified by the resource provider or return the assets to the donor. This guidance is now included in the AICPA Guide, paragraph 5.17. Examples of these types of programs include ones in which the not-for-profit organization receives assets, such as food, food vouchers, public transportation vouchers, and cash, and distributes the assets on behalf of the resource provider in exchange for a fee for performing that service. The question is whether the receipt and disbursement of assets under these types of programs should be recorded by the not-for-profit organization as revenues and expenses.

Receipts and disbursements of assets under such programs (other than any fees for performing the service) are agency transactions and are not contributions to the recipient not-for-profit organization. The following additional guidance was also provided:

  • A recipient organization that receives financial assets, such as cash or vouchers that can be exchanged for cash, should recognize its liability to the beneficiaries at the same time that it recognizes the financial assets received from the donor.
  • A receipt organization that receives nonfinancial assets, such as food vouchers or public transportation vouchers that are denominated either in dollar values or in nonfinancial terms, such as pounds of food or bus rides, that will not be settled in cash, is permitted, but not required, to recognize its liability and those assets provided that the not-for-profit organization applies its policy consistently from period to period and discloses its accounting policy.

Accounting by Beneficiaries

GAAP also provides guidance as to when specified beneficiaries would recognize their rights to assets held by recipient organizations. Specified beneficiaries should recognize their rights to assets (whether financial or nonfinancial) held by a recipient organization as an asset unless the recipient organization is explicitly granted variance power.

If the beneficiary and the recipient organization are financially interrelated organizations, the beneficiary should recognize its interest in the net assets of the recipient organization and adjust that interest for its share of the change in net assets of the recipient organization, similar to the equity method of accounting. If the beneficiary has an unconditional right to receive all or a portion of the specified cash flow from a charitable trust or other identifiable pool of assets, the beneficiary should recognize its beneficiary interest, measuring and subsequently remeasuring its interest at fair value. A valuation technique, such as the present value of the estimated expected future cash flows, should be used. In all other cases, a beneficiary recognizes its rights to the assets held by a recipient organization as a receivable and contribution revenue in accordance with the provisions of GAAP for recording an unconditional promise to give. If a donor explicitly grants a recipient organization variance power, the specified unaffiliated beneficiary should not recognize its potential for future distributions from the assets held by the recipient organization.

As mentioned above, when certain conditions are met, beneficiary organizations account for their interests in the net assets of recipient organizations in a manner similar to the equity method of accounting, which requires that the periodic adjustment of the investment be included in the determination of the investor's net income. The AICPA issued a series of Technical Practice Aids (TPAs) to assist not-for-profit organizations in implementing these aspects where a beneficiary and recipient organization are financially interrelated organizations within the meaning of FASB ASC 958-605, which are now included in Chapters 5 and 13 of the AICPA Guide. The following summarizes the provisions of these TPAs and is based on notes provided to the TPAs by the AICPA. Other than the guidance of TPAs 6400.38 and 6400.42 (which apply only to not-for-profit health care organizations and are described at the end of this section), the guidance of the other TPAs applies similarly to health care and non–health care not-for-profit organizations.

  • Beneficiary organizations should segregate the adjustment of the investment in accordance with APB 18 into changes in restricted and unrestricted net assets. This basic concept is fine-tuned by the additional TPAs described next. (TPAs 6140.14, 6140.15, 6140.16, 6400.36, 6400.37, and 6400.39)
  • In circumstances in which the beneficiary can influence the financial decisions of the recipient organization to such an extent that the beneficiary can determine the timing and amount of distributions from the recipient to the beneficiary, the existence of the recipient organization should be transparent in determining the net asset classifications in the beneficiary's financial statements. In other words, the recipient cannot impose time or purpose restrictions beyond those imposed by the donor. (TPAs 6140.14, 6140.16, 6400.36, and 6400.39)
  • In circumstances in which the beneficiary cannot influence the financial decisions of the recipient organization to such an extent that the beneficiary can determine the timing and amount of distributions from the recipient to the beneficiary, the existence of the recipient organization creates an implied time restriction on the beneficiary's net assets attributable to the beneficiary's interest in the net assets of the recipient (in addition to any other restrictions that may exist). Accordingly, in recognizing its interest in the net assets of the recipient organization and the changes in that interest, the beneficiary should classify the resulting net assets and changes in those net assets as temporarily restricted (unless donors placed permanent restrictions on their contributions). (TPAs 6140.15 and 6400.37)
  • In circumstances in which the beneficiary can influence the financial decisions of the recipient organization to such an extent that the beneficiary can determine the timing and amount of distributions from the recipient to the beneficiary and some net assets held by the recipient for the benefit of the beneficiary are subject to purpose restrictions (for example, net assets of the recipient restricted to the beneficiary's purchase of property, plant, and equipment), expenditures by the beneficiary that meet those purpose restrictions result in the beneficiary (as well as the recipient) reporting reclassifications from temporarily restricted to unrestricted net assets (assuming that the beneficiary has no other net assets subject to similar purpose restrictions). However, if there are also time restrictions that those net assets are subject to that have not expired (including time restrictions that are implied on contributed long-lived assets as a result of the beneficiary's accounting policy), these time restrictions must also be considered. If those net assets are subject to time restrictions that have not expired and the beneficiary has other net assets with similar purpose restrictions, the restrictions on those other net assets would expire in conformity with GAAP requirements. The TPAs specifically provide, however, that they do not establish a hierarchy pertaining to which restrictions are released first—restrictions on net assets held by the recipient or purpose restrictions on net assets held by the beneficiary. (TPAs 6140.17 and 6400.40)
  • In circumstances in which the beneficiary cannot influence the financial decisions of the recipient organization to such an extent that the beneficiary can determine the timing and amount of distributions from the recipient to the beneficiary and some net assets held by the recipient for the benefit of the beneficiary are subject to purpose restrictions, though not subject to time restrictions other than the implied time restrictions that exist because the beneficiary cannot determine the timing and amount of distributions from the recipient to the beneficiary, expenditures by the beneficiary that are consistent with those purpose restrictions should not result in the beneficiary reporting a reclassification from temporarily restricted to unrestricted net assets, subject to the exceptions in the following sentence. Expenditures by the beneficiary that are consistent with those purpose restrictions should result in the beneficiary reporting a reclassification from temporarily restricted to unrestricted net assets if (1) the recipient has no discretion in deciding whether the purpose restriction is met, or (2) the recipient distributes or obligates itself to distribute to the beneficiary amounts attributable to net assets restricted for the particular purpose, or otherwise indicates that the recipient intends for those net assets to be used to support the particular purpose as an activity of the current period. In all other circumstances, (1) purpose restrictions, and (2) implied time restrictions on the net assets attributable to the interest in the recipient organization exist and have not yet expired. (However, if the beneficiary has other net assets with similar purpose restrictions, those restrictions would expire in conformity with FASB Statement 116. The TPAs specifically provide, however, that they do not establish a hierarchy pertaining to which restrictions are released first—restrictions on net assets held by the recipient or restrictions on net assets held by the beneficiary.) (TPAs 6140.18 and 6400.41)

The following two TPAs apply only to health-care not-for-profit organizations:

  • In circumstances in which the beneficiary can influence the financial decisions of the recipient to such an extent that the beneficiary can determine the timing and amount of distributions from the recipient to the beneficiary, changes in the beneficiary's interest in the net assets of a recipient organization attributable to unrealized gains and losses on investments should be included or excluded from the performance indicator in conformity with Chapters 4 and 10 of the AICPA Audit and Accounting Guide, Health Care Organizations, in the same manner that they would have been had the beneficiary had the transactions itself. Similarly, in applying the guidance in Chapters 4 and 10, the determination of whether amounts are included or excluded from the performance measure should comprehend that if the beneficiary cannot influence the financial decisions of the recipient organization to such an extent that the beneficiary can determine the timing and amount of distributions from the recipient to the beneficiary, an implied time restriction exists on the beneficiary's net assets attributable to the beneficiary's interest in the net assets of the recipient (in addition to any other restriction that may exist). Accordingly, in circumstances in which the beneficiary cannot influence the financial decisions of the recipient organization to such an extent that the beneficiary can determine the timing and the amount of distributions from the recipient to the beneficiary, the beneficiary should classify the resulting net assets and changes in those net assets as temporarily restricted (unless donors placed permanent restrictions on their contributions) and therefore exclude those changes from the performance indicator. (TPA 6400.42)
  • In circumstances in which the recipient organization and the beneficiary are both controlled by the same organization, entities should consider the specific facts and circumstances to determine whether the beneficiary can influence the financial decisions of the recipient organization to such an extent that the beneficiary can determine the timing and amount of distributions from the recipient to the beneficiary. (TPA 6400.38)

In addition to the above guidance, the AICPA issued TPA 6140.19, which addresses the question of how a fundraising foundation (that is the recipient of contributions and is a not-for-profit organization subject to the AICPA Not-for-Profit Organizations Guide) reports, in its separately issued financial statements, distributions to a financially interrelated beneficiary that is a health care organization. Should the fundraising foundation report distributions to the health care organization in accordance with the AICPA Audit and Accounting Guide, Health Care Organizations, or should it report the distributions in accordance with the AICPA Not-for-Profit Entities Guide? TPA 6140.19 concludes that this fundraising foundation should follow the accounting and financial reporting requirements of the AICPA Not-for-Profit Entities Guide, rather than the AICPA Audit and Accounting Guide, Health Care Organizations, in its separately issued financial statements. The foundation should report distributions to beneficiary organizations as expenses or distributions to related organizations. This guidance applies regardless of whether the recipient organization and the beneficiary are under common control or whether one controls the other in a parent–subsidiary relationship.

Transfer of Assets That Are Not Contributions

GAAP specifies that a transfer of assets to a recipient organization is not a contribution and should be accounted for as an asset by the resource provider and a liability by the recipient organization if one or more of the following conditions exist:

  • The transfer is subject to the resource provider's unilateral right to redirect the use of the assets to another beneficiary.
  • The transfer is accompanied by the resource provider's conditional promise to give or is otherwise revocable or repayable.
  • The resource provider controls the recipient organization and specifies an unaffiliated beneficiary.
  • The resource provider specifies itself or its affiliates as the beneficiary, and the transfer is not an equity transaction.

For purposes of the last condition above, a transfer of assets to a recipient organization is an equity transaction if all of the following conditions are met:

  • The resource provider specifies itself or its affiliate as the beneficiary.
  • The resource provider and the recipient organization are financially interrelated organizations.
  • Neither the resource provider nor its affiliate expects payment of the transferred assets, although payment of investment return on the transferred assets may be expected.

If a resource provider specifies itself as a beneficiary, it reports an equity transaction as an interest in the net assets of the recipient organization, or as an increase to a previously recognized interest. If the resource provider specifies an affiliate as a beneficiary, the resource provider reports an equity transaction as a separate line in its statement of activities, and the affiliate named as beneficiary reports an interest in the net assets of the recipient organization. A recipient organization should report an equity transaction as a separate line in its statement of activities.

Disclosures

The following is a summary of the disclosure requirements when a not-for-profit organization transfers assets to a recipient organization and specifies itself or an affiliate as the beneficiary:

  • The identity of the recipient organization to which the transfer was made;
  • Whether variance power was granted to the recipient organization and, if it was, a description of the terms of the variance power;
  • The terms under which amounts will be distributed to the resource provider or its affiliate;
  • The aggregate amount recognized in the statement of financial position for those transfers and whether that amount is recorded as an interest in the net assets of the recipient organization or as another asset, such as a beneficial interest in assets held by others or a refundable advance.

In addition, not-for-profit organizations that disclose in their financial statements a ratio of fundraising expenses to amounts raised should disclose how that ratio is computed.

APPENDIX A CHECKLIST

Factors Related to Control Which May Indicate That an Affiliated Organization (A) Should Be Combined with the Reporting Organization (R), if Other Criteria for Combination Are Met

Control is defined as the “direct or indirect ability to determine the direction of management and policies through ownership, contract, or otherwise.”

Following is a list of factors that may be helpful to:

  • Not-for-profit organizations, in deciding whether to combine financial statements of affiliated organizations;
  • Auditors, in assessing the appropriateness of the client's decision.

Many of these factors are not absolutely determinative by themselves but must be considered in conjunction with other factors.

Factors Whose Presence Indicates Control Factors Whose Presence Indicates Lack of Control
Organization relationship:
  1. A is clearly described as controlled by, for the benefit of, or an affiliate of R in some of the following:
    • — articles/charter/bylaws
    • — operating/affiliation agreement
    • — fundraising material/membership brochure
    • — annual report
    • — grant proposals
    • — application for tax-exempt status.
 A is described as independent of R, or no formal relationship is indicated.
Governance:
  1. A's board has considerable overlap in membership with R; common officers.
 Little or no overlap.
  1. A's board members and/or officers are appointed by R, or are subject to approval of R's board, officers, or members.
 A's board is self-perpetuating, with no input from R.
  1. Major decisions of A's board, officers, or staff are subject to review, approval, or ratification by R.
 A's decisions are made autonomously; or even if in theory subject to such control, R has, in fact, never or rarely exercised control and does not intend to do so.
Financial:
  1. A's budget is subject to review or approval by R.
 Budget not subject to R's approval.
  1. Some or all of A's disbursements are subject to approval or countersignature by R.
 Checks may be issued without R's approval.
  1. A's excess of revenue over expenses or net assets or portions thereof are subject to being transferred to R at R's request, or are automatically transferred.
 Although some of A's financial resources may be transferred to R, this is done only at the discretion of A's board.
  1. A's activities are largely financed by grants, loans, or transfers from R, or from other sources determined by R's board.
 A's activities are financed from sources determined by A's board.
  1. A's bylaws indicate that its resources are intended to be used for activities similar to those of R.
 A's bylaws limit uses of resources to purposes that do not include R's activities.
  1. A's fundraising appeals give donors the impression that gifts will be used to further R's programs.
 Appeals give the impression that funds will be used by A.
Operating:
  1. A shares with R many of the following operating functions:
    • — personnel/payroll
    • — purchasing
    • — professional services
    • — fundraising
    • — accounting, treasury
    • — office space
 Few operating functions are shared; or reimbursement of costs is on a strictly arm's-length basis with formal contracts.
  1. Decisions about A's program or other activities are made by R or are subject to R's review or approval.
 A's decisions are made autonomously.
  1. A's activities are almost exclusively for the benefit of R's members.
 Activities benefit persons unaffiliated with R.
Other:
  1. A is exempt under IRC Section 501(c)(3) and R is exempt under some other subsection of 501(c), and A's purpose for existence appears to be to solicit tax-deductible contributions to further R's interest.
 A's purposes appear to include significant activities apart from those of R.
  1. A qualifies as a publicly supported organization under IRC Section 509(a)(3) by virtue of being a supporting organization to R.
 Factor not present.
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