Many nonprofit entities are contemplating merging with or acquiring another organization as a response to the troubled economy of late. Management of these nonprofits see the challenges presented to struggling organizations and consider mergers and acquisitions as a way to shore up finances, consolidate fundraising efforts and reduce administrative costs. Mergers and acquisitions are also looked at as a way to strengthen current skills, enter new markets and geographies, expand reach and improve efficiencies. New accounting guidance on mergers and acquisitions was recently introduced as SFAS No. 164, Not-For-Profit Entities: Mergers and Acquisitions and is now codified as part of FASB ASC 958. This new guidance establishes principles and requirements for how a nonprofit entity:
- Determines whether a combination is a merger or an acquisition
- Applies the carryover method in accounting for a merger
- Applies the acquisition method in accounting for an acquisition, including determining which of the combining entities is the acquirer
- Determines what information to disclose to enable the users of financial statements to evaluate the nature and financial effects of a merger or an acquisition.
The guidance is effective prospectively for mergers for which the merger date is on or after the beginning of an initial reporting period beginning on or after December 15, 2009, and prospectively for acquisitions for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 31, 2009. For illustration purposes, assume that a nonprofit entity with a June 30, 2010 year end enacts a merger on April 1, 2010. The merger guidance is effective on April 1, 2010. Now, assume that the same nonprofit goes through an acquisition on April 1, 2010. Since the acquisition took place prior to the beginning of the first annual reporting period that begins on or after December 15, 2009, (or July 1, 2010) the new guidance related to acquisitions would not be utilized.
Previously, nonprofit entities accounted for mergers and acquisitions by utilizing guidance developed for for-profit entities. The new guidance takes into account specifics relevant to the nonprofit industry and the many unique features in which they engage. Specifically, a nonprofit entity lacks the type of ownership interests that for-profit entities have, which generally focus on maximizing returns of shareholders. In addition, mergers and acquisitions by nonprofit entities generally do not involve transfer of consideration and are not fair value exchanges, rather they are nonreciprocal transfers.
How to determine whether a combination is a merger or an acquisition?
A merger is a combination in which the governing bodies of two or more nonprofit entities cede control of those entities to create a new nonprofit entity. Ceding control to a new entity is the primary definitive criterion for identifying a merger. To be considered a new nonprofit entity, the combined entity must have a newly formed governing body; thus, a new entity is not necessarily a new legal entity. Mergers are to be accounted for using the “carryover” method. Under the carryover method, the new combined entity’s initial set of financial statements, carry forward the assets and liabilities of the former combining entities, measured at their carrying amounts at the merger date. Under this method, there is no goodwill to be recognized. The financial statement measurement date commences with the effective merger date. The nonprofit entity that results from the merger is a new reporting entity with no previous operations that are to be reported. Thus, the new entity’s initial reporting period begins with the merger date, and the combined assets, liabilities and net assets of the combining entities are included in the statement of financial position as the opening books of that initial reporting period. The new entity shall disclose information that enables users of its financial statements to evaluate the nature and financial effect of the merger that resulted in its formation.
An acquisition is a combination where one nonprofit entity obtains control of one or more program activities or businesses. One entity that obtains control over the other is the definitive criterion for an acquisition. Under the acquisition method, essentially the same guidance is used as for-profit entities with the exception that unique features about a nonprofit are taken into account. Applying the acquisition method requires:
- Identifying the acquirer
- Determining the acquisition date
- Recognizing and measuring the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree
- Recognizing and measuring goodwill or a contribution received
The acquirer shall measure the acquired assets, and assumed liabilities of the former nonprofit at fair value upon acquisition date. Thus, the consideration of goodwill is treated differently depending on the type of nonprofit entity and whether the nonprofit entity is predominantly supported by contributions and returns on investment or whether it acts more business-like generating all or most of its revenue from fees for services. An illustration of the first would be a soup kitchen where the organization is supported by contributions. In this instance, the amount that what would otherwise be recognized as goodwill as of the acquisition date would be recognized as a separate component in its statement of activities. In essence, this constitutes an inherent contribution received because the acquirer receives net assets without transferring consideration. An illustration of the latter would be a nonprofit mental health provider that charges fees to cover its costs. The more business-like the organization, the more relevant information about goodwill acquired is to users of the financial statements. As such, the new guidance calls for acquiring entities that operate in a more business-like manner to recognize goodwill in the statement of financial position when it exists as of the acquisition date. Goodwill is measured as the excess of (a) over (b):
(a) The aggregate of:
- The consideration transferred measured at its acquisition-date fair value.
- The fair value of any noncontrolling interest in the acquiree.
- In an acquisition achieved in stages, the acquisition date fair value of the acquirer’s previously held equity interest in the acquiree.
(b) The net of the acquisition date amounts of the identifiable assets acquired and the liabilities assumed measured in accordance with this statement.
Note that it is not expected that goodwill will arise very often in practice, because most acquisitions involving nonprofit entities are not full fair value exchanges. In most cases, measurements used in nonprofit acquisitions will relate to measuring the fair values of the underlying assets acquired so that there is no goodwill that needs to be considered in the acquisition.
If you are contemplating a merger or acquisition, BeachFleischman can assist with any questions, guidance or implementation inquiries you have on the matter. Please contact a member of our nonprofit segment services team for assistance.