Consolidated financial statements and nonprofit organizations are not words that are commonly associated together. When most people think of consolidated financial statements, they envision large publicly traded companies or international parent companies with subsidiary companies doing business in the United States. So considering most structures of nonprofit organizations, it is conceivable that consolidated financial statements for nonprofit organizations is a foreign concept for most people.
We should start by emphasizing that nonprofit organizations prepare financial statements in accordance with Generally Accepted Accounting Principles (GAAP), which also governs the rules when consolidated financial statements are required. Tax returns for nonprofit organizations are prepared in accordance with Internal Revenue Service (IRS) Tax Codes, which vastly differs from GAAP. Separate legally established nonprofit organizations would typically file separate tax return with their respective financial information. However, for
GAAP compliant financial statements, there are rules that may require a nonprofit organizations to consolidate their financial information along with other entities and report as a one larger organization.
A controlling interest can exist through direct or indirect interest in another organization. Direct interest is simply when one nonprofit organization has ownership in another organization. Typically this occurs when one nonprofit organization is listed as the sole corporate member of the other organization. Indirect interest can exist when the nonprofit organization has a majority voting interest in the other organization. An example of this would when the board of the nonprofit organization is also the same board as the other organization with the ability to direct management.
If there is no controlling interest, the nonprofit organization needs to see if it has an economic interest and control of the other organization. An economic interest is defined as a relationship where an organization has the right to share in income, losses, and distributions from another organization. An economic interest would also exist if the nonprofit organization was also providing guarantees on debt issued for the other organization. Control of another organization is defined as having the ability to determine the direction of management, policies, and operations. Having an economic interest combined with control would trigger the requirement to prepare consolidated financial statements.
Here is an example of an economic interest situation combined with control – ABC Nonprofit provides job training to low-income unemployed participants through a federal grant ABC receives. The federal grant specifically states the funding is to be used solely for salaries and benefits of instructors providing job training. XYZ Nonprofit is setup as a charitable organization seeking donations to help assist low-income un-employed participants. The board members of ABC Nonprofit are also on the board of XYZ Nonprofit.
All donations received by XYZ Nonprofit are directed to ABC Nonprofit to assist the unemployed participants with necessities in obtaining a job (i.e. wardrobe, transportation, day care, etc.). In this situation, ABC Nonprofit has an economic interest over XYZ Nonprofit and control, which would mean consolidated financial statements are required.
The main driver for nonprofit organizations to prepare consolidated financial statements is control and sometimes it easy to overlook the relationship one nonprofit organizations has with other entities. The impact of consolidated financial statements are not usually felt by the nonprofit organization until the end of the year when the audit is being conducted, which typically leads to more work for both sides. It would be beneficial to have conversations with your auditor before the start of the audit about any potential relationships with other entities that may trigger a consolidated financial statements.
If you have any questions or would like more information, please contact Tom Huey at firstname.lastname@example.org or 844.4WINDES (844.494.6337).