As you prepare for this year’s upcoming audit of your charitable organization, have you thought about the entity’s related parties? Does one entity have the ability to influence the operating and financial decisions of the other? Perhaps one of the entities has an ongoing economic interest in the other. It is important to consider just how closely related these organizations are as the nature of their relationship could significantly impact the audit of your organization and result in consolidatedfinancial statements.
Evaluating related party relationships becomes extremely important as you prepare for an audit of a nonprofit organization. U.S. Generally Accepted Accounting Principles require the financial statements of two entities to be consolidated when certain conditions are met. We have summarized the guidance herein to help you assess whether you may meet these circumstances.
Guidance surrounding consolidation requirements of related nonprofit entities is found in Financial Accounting Standards Board Accounting Standards Codification 958-810. In short, consolidation is required when an organization has a controlling financial interest in another not-for-profit entity (“NFP”). If it is determined that there is no controlling financial interest, an organization may still meet the consolidation requirements if it possesses an economic interest and control.
A controlling financial interest is defined as a direct or indirect ownership of a majority voting interest or sole corporate membership in another not-for-profit entity. Examples of meeting this requirement would include: (1) If one NFP has a significant number of board members in common with another NFP, resulting in a majority voting interest; or (2) if one NFP is the sole member of the other, or has the same sole member.
If a controlling financial interest has not been determined, a second analysis must be performed to determine if your organization’s relationship with the related party organization meets the definition of economic interest and control.
The first requirement is economic interest, which exists when one NFP is responsible for the liabilities of the other entity or holds significant resources that must be used for the purposes of the other entity.Examples of economic interests include the following: (1) an NFP has the right to the operating results of the other entity; (2) an NFP is committed to provide funds for or guarantees debt of the other entity; or (3) an NFP raises funds on behalf of the other entity and all funds are required to be transferred to that entity or used at its direction.
If an economic interest exists, the last step is to determine whether the NFP controls the other. Control is defined as the direct or indirect ability to determine the direction of management and policies through ownership, contract, or otherwise. If both economic interest and control exists, then consolidation will be required.
We would be more than happy to assist you in evaluating whether your nonprofit organization and its related entity requires consolidation. Please feel free to contact Kristi Yanover at (858) 558-9200.