The Financial Accounting Standards Board (FASB) has released ASU 2017-02, “Clarifying When a Not-For-Profit (NFP) Entity That is a General Partner or a Limited Partner Should Consolidate a For-Profit Limited Partnership or Similar Entity.” That’s a long title for an update that’s relatively narrow in scope, as it will primarily impact NFPs that serve as a general partner through a qualified affordable housing arrangement. This ASU was adopted after FASB became aware of complications with how NFP organizations would apply ASU 2015-02.
The ultimate impact of ASU 2017-02 will be dependent on whether NFPs have already adopted the amendments in ASU 2015-02. If the organization has not adopted the guidance in ASU 2015-02, then the overall impact is minimal. Organizations that have adopted ASU 2015-02 would apply the amendments retrospectively to all relevant prior periods beginning with the fiscal year in which the amendments in ASU 2015-02 were initially applied. The ASU 2017-02 is effective for NFPs for fiscal years beginning after December 15, 2016, with interim periods within fiscal years beginning after December 15, 2017. Early adoption is permitted.
ASU 2017-02 seeks to clarify ASU 2015-02 and avoid different applications of the consolidation guidance. To that end, key definitions used in applying the consolidation guidance — such as “kick-out rights,” “participating rights,” and “protective rights” — have been added to the glossary. Essentially, a general partner, regardless of ownership percentage, will consolidate a partnership under the presumption of control unless control is provided to the limited partner through kick-out rights or participation rights that allows the limited partner(s) to effectively participate in certain significant financial and operating decisions that occur in the ordinary course of business and are significant factors in directing the activities.
While determining the impact of kick-outs is rather straightforward, less clear is the application of substantive participating rights provided through the partnership agreement. The new ASU repeated the following examples of substantive participating rights, initially from EITF -04-5, that overcome the presumption that the general partner controls the partnership. These examples do not necessarily constitute an all-inclusive list:
- Selecting, terminating, and setting the compensation of management responsible for implementing the limited partnership’s policies and procedures
- Establishing operating and capital decisions of the limited partnership, including budgets, in the ordinary course of business
These rights allow the limited partner to have a sufficiently “large voice” in partnership operations, thus allowing for the presumption of general partner control to be overcome.
The consolidation guidance is applied when the NFP becomes a general partner, and for each reporting period for which consolidated financial statements are prepared. This requires the general partner to reassess whether the limited partner has gained additional rights that allow them to effectively overcome the presumption. If the presumption is overcome, then the NFP would account for its investment under the equity method of accounting. Each partnership investment must be evaluated separately and an NFP may end up with consolidated and unconsolidated partnerships after applying the consolidation guidance. The reference to partnerships in this article applies to similar legal entities, e.g., LLCs.
A reporting entity should review their investments in unconsolidated and consolidated entities in light of this consolidation guidance and determine whether the limited partners’ participating rights are substantive and if substantive kick-out rights are present. Documentation should be maintained to support the decisions made, along with references to the relevant sections in the partnership agreement. An NFP with consolidated financial statements may want to classify the assets and liabilities of the consolidated partnership separately on their statement of financial position to help users of the financial statements understand and clearly identify the financial position of the NFP parent. As NFPs apply this guidance, we will see if FASB provided enough clarification to improve the consistency of NFP financial statements.
This article focused on the NFPs that serve as a general partner; however, ASU 2017-02 also addresses when limited partners should consolidate a partnership. For more guidance on this update and how it may affect your organization, contact your Clark Schaefer Hackett advisor.