The Equity Method of accounting for nonprofit investments is a financial reporting approach used when a nonprofit organization holds significant influence over another organization in which it has made an equity investment, typically through owning a substantial portion of the other organization’s voting stock or other ownership interests. This method is often employed by nonprofits that have invested in other entities, such as subsidiaries or joint ventures, where they have the ability to exert significant influence over financial and operational decisions.
Key aspects of the Equity Method of Accounting for nonprofit investments include:
- Significant Influence: The equity method is applied when the nonprofit has the ability to exercise significant influence over the financial and operating policies of the investee organization. Significant influence is generally presumed to exist when the nonprofit owns between 20% and 50% of the voting stock or ownership interests of the investee.
- Initial Investment: The nonprofit initially records the investment on its balance sheet at the cost of acquisition, including any associated transaction costs.
- Subsequent Valuation: The investment is carried on the nonprofit’s balance sheet at its initial cost plus or minus the nonprofit’s share of the investee’s net income or loss since the acquisition date. This share is based on the nonprofit’s ownership percentage in the investee.
- Equity Income: The nonprofit recognizes its share of the investee’s net income as “Equity in Earnings of Investee” in its income statement. This income is added to the nonprofit’s total revenue.
- Dividends and Distributions: Any dividends or distributions received from the investee are typically recognized as a reduction in the carrying amount of the investment on the nonprofit’s balance sheet. The nonprofit’s share of the investee’s net income and any dividends or distributions received together determine the investment’s carrying value.
- Disclosure and Reporting: Nonprofits using the equity method must provide appropriate disclosures in their financial statements. These disclosures include information about the nature and extent of their investments, the financial performance of the investee, and any significant intercompany transactions.
- Impairment: If the value of the investment is impaired (i.e., its fair value drops significantly below its carrying amount), the nonprofit should recognize a loss in its income statement. The carrying value of the investment on the balance sheet is adjusted accordingly.
It’s important to note that the equity method of accounting is used when the nonprofit holds significant influence but not control over the investee. If the nonprofit has control (usually ownership of more than 50% of the voting stock or ownership interests), consolidation accounting may be appropriate, where the financial statements of the investee are combined with those of the nonprofit.
Nonprofits should follow generally accepted accounting principles (GAAP) or other relevant accounting standards in their jurisdiction when applying the equity method of accounting for their investments. Consulting with accounting professionals or financial advisors can help nonprofits ensure that their investment accounting is accurate and compliant with the applicable standards.