Not-for-profit enterprises serve an organizational mission that differs from a typical business bottom line. Nevertheless, in many functions, they operate much like for-profit enterprises, with key differences. One important difference arises from the not-for-profit organization’s revenue sources, which require different considerations and financial reporting treatment. The item discussed below is not new to financial reporting for not-for-profit organizations; however, this matter must be considered whenever changes to existing grant agreements occur or a new funding source is secured. In certain circumstances, the answers are clearly defined and the appropriate response is evident, and in other situations, careful analysis and judgment are involved.
For those entities that receive federal funding, especially funding that is passed through from state and/or local agencies, determining the source of those funds and the applicable compliance requirements can be difficult. Identifying the funding as federal funding is only the first step required in considering all of the compliance requirements associated with the funding, and, ultimately reporting on that funding appropriately. A critical process that needs to be conducted is determining whether your agency has received and ultimately spends the funding in the capacity of a sub-recipient or as a vendor. Funds expended by a sub-recipient are required to be considered as federal dollars for purposes of determining the applicability of an audit conducted in accordance with OMB Circular A-133 (Single Audit), whereas funds expended in a vendor relationship are excluded. The audit process/focus and resultant cost can be significantly different where a single audit is required. While you might think the determination of a sub-recipient or vendor would be a straightforward process, actually a great deal of analysis and judgment comes into play.
Significant characteristics of a sub-recipient relationship are: Determining eligibility; program performance measured against federal program objectives; responsibility for programmatic decision-making; responsibility for compliance with federal program requirements; and using the funds to carry-out one of your organization’s programs—as opposed to providing goods or services to carry out a program of the entity from which you received the funding.
Significant characteristics of a vendor relationship are: Providing goods or services within normal business operations; providing similar goods and services within normal operations; operating in a competitive environment; providing goods or services that are ancillary to the federal program; and not being subject to compliance requirements of the federal program.
After consideration of the characteristics identified above, judgment is required to determine the appropriate classification as sub-recipient or vendor. A very important consideration is the substance of the relationship, more so than the form of the agreement. The result of your determination (vendor versus sub-recipient) will have an impact on the audit of your organization’s financial statements as well as your compliance with the requirements associated with funding you receive.
Consultation with your auditor regarding the analysis prior to the audit process can help eliminate a potentially unpleasant surprise for both parties.
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This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax-related matter.