Rethinking Nonprofits’ Disaster Planning

Recently, Bryan McQueenly raised a provocative issue to his neighbors in an op-ed in the Ventura County Star. In The Real Costs of Disasters for Nonprofits, this Southern California-based CEO of a 501(c)(3) asserts that the reality of recurring – and, indeed escalating – natural disasters poses a serious threat to the short- and long-term viability of most Golden State nonprofits.

Like other residents of Ventura County, he knows first-hand about the devastation brought by natural disasters to the community at large and, particularly, to the local nonprofits who are expected to bear a good part of the load of disaster aid and relief.

In his county, the year 2018 began with catastrophic mudflows and ended with worse-than-usual wildfires. As a piece in the Los Angeles Times made clear, “whether fire or earthquake, mudslide or drought, natural disaster is an inextricable part of the California experience.” And, of course, there are man-made disasters like the mass shooting in Ventura in 2018.

Mr. McQueeny lauds the emergency response by “first responders, the nonprofit community and the people of Ventura County,” but argues that the burden is unsustainable. “The immediate costs of the crises can be measured in buildings burned, people displaced, those injured and lost. Those tragic losses are compounded by longer-term costs that can be harder to quantify. For nonprofits, this can trigger yet another catastrophe.”

Insufficient Safety Net

The vast majority of nonprofit organizations are severely underfunded; they operate on a shoestring. Some 53% of nonprofits have three months or more less of cash on hand.” A significant reason is that “governments rarely or never cover the full costs of a program for 70 percent of nonprofits.” Foundations and private donors “do only slightly better, covering the full costs of a program 48 percent of the time.” These funders want to support direct program costs, and have traditionally balked at paying for overhead or general operating support – although, as we and others have reported – there is a push to change the negative thinking about this “overhead myth.”

On a normal day, the philanthropy sector is somewhat “fragile and vulnerable.” Throw into that mix just one emergency and “nonprofits that are already stretched can break.” Just a single crisis can mean massive evacuations and dislocations as well as damage to physical facilities and necessary utilities services. There is immediately a giant leap in demand for services by the nonprofits, on top of the damage and losses suffered directly by these organizations.

Disaster Planning Must Change

Mr. McQueenly’s key point in his op-ed is that a community’s nonprofits are needed as part of an area’s critical infrastructure. The “long-term health” of the philanthropy sector must be protected as part of the overall disaster planning. Funders must rethink and reconsider objectives in light of the reality of recurring disasters.

In particular, there should be an understanding of the true, full costs that arise in the immediate hours, days, and weeks following a community-wide emergency –  in addition to actual physical damage. They include, for instance, costs for evacuation, overtime, emergency care, and shutdowns when service delivery is interrupted.

They also include significant disruptions and changes in donation patterns for area nonprofits; routine donations are supplanted by money contributed for emergency response. There is often a decrease in annual support because of the emergency response, donor exhaustion, and “long-term shifts in giving patterns caused by the destruction of thousands of homes and businesses.”

Conclusion

Just as it’s important for funders to correct the traditional imbalance in support for direct program costs vs. overhead, it’s also critical for grantmakers and donors in disaster-prone areas to take into account (and allocate money for) the special, catastrophic costs arising from these predictable and expected crises.

The rationale for “funding for emergency response is no different” than the arguments set out in favor of increased general operating support funding. “Now is not the time for foundations to micro‐manage or second‐guess nonprofits. It is time for full‐throated support of a critical partner which can fill the gaps ripped open by a crisis.”

Gifts in Kind: What Nonprofits Should Know

Charitable donations come in different forms; while cash is king, other types of contributions are useful, too.  Among them are “gifts in kind,” sometimes also called “in-kind gifts” or “in-kind donations.”

   Different Types of Charitable Gifts

A cash contribution is, for many reasons, the preferred type of gift. It’s simple and straightforward and provides the organization with the means to buy any goods or services it needs, to carry on any of its activities, or to provide benefits or services to the beneficiaries it serves. There is no question about fair market value; cash is cash.The reporting and accounting issues are minimal and uncomplicated.

But in-kind gifts can be equally important and valuable to a 501(c)(3). There are, however, special issues and rules for accounting and reporting.

Simply put, it is a form of charitable giving in which a donor does not give money to buy goods and services the donee-organization needs but, instead, gives the goods and services themselves.   

There are three general types of in-kind gifts:

  • Goods/Property:  Examples in this group are office furniture, computer hardware and software, and supplies. This category also includes intangible property like contributions of patents, royalties, and copyrights as well as items can be offered at fundraising special events like auctions.   
  • Services: Examples include free or discounted use of office or meeting space and administrative services like printing and copying.
  • Expertise: Examples include donated professional services (legal, accounting, consulting) and social media or web-design help. Depending on the mission of the organization, it can also include a broader range of expert services like medical personnel or others donate their abilities to carry out certain programs or activities.

   Special Accounting Issues for Gifts in Kind

There are distinct issues for in-kind gifts compared with cash donations in terms of when and how they are reported in the organization’s accounting records and on government filings.

  Timing of Gifts

A special issue in connection with gifts in kind is determining when the donation is “recognized” for accounting purposes. Generally, if the item is property, then the charitable contribution is recorded when the donor turns it over without condition and without getting anything in return.

A gift of donated services is generally “recognized” if the services (a) create or increase the value of a nonfinancial asset, or (b) require specialized skills, are given by a donor possessing them, and are of a type that would need to be purchased in any event. An example is a CPA who performs services for the 501(c)(3) at no charge. On the other hand, if a hospital has volunteers who provide comfort and convenience services to patients, their donated services would not be recorded in the financial statements because these are not specialized skills that the organization would have to pay for otherwise.

  How Gifts are Recorded

An in-kind gift is recorded in the books and records at fair market value as contribution revenue and also as an asset or expenses in the period received.

The value of tangible personal property donated should be recorded as the price the organization would otherwise pay for the goods at retail. The fair value of services donated can be calculated on the basis of the regular professional hourly rate of the donor. For instance, if a lawyer donates 4 hours and that person’s regular hourly rate is $300, then the 501(c)(3) should record contribution revenue in the amount of $1,200 and also record a corresponding expense for professional fees.

If the in-kind gift is goods or services provided at a discounted rate, the amount recorded as contribution revenue (and as the corresponding expense) is the difference between market rate and the discounted rate.  

  Additional Information

The recommended practice is to report in financial statements not only the amounts of contributed services, but additional information about the activities or programs connected with those services as well as the nature and extent of the services.

Donee-organizations also often include – for general information purposes – amounts of donated services and their estimated value that were received but were not recognized as revenue as well as an estimated value. This would refer to activities like the hospital volunteers who are not professionals.

  Form 990s

In-kind gifts of tangible property are reportable on the organization’s annual Form 990 under the category of “gifts, grants, contributions, or membership fees.” Certain types of gifts including those valued at more than $25,000, or art, historical items, or other special assets, are reported on additional forms.

Donated services are not reported on Form 990, but the value of that service is shown as a “reconciling item” on the annual information return.

  Conclusion

These are general guidelines only. An organization that receives non-cash donations should seek professional advice to help with these accounting and reporting duties.

Government Contracts with Nonprofits: Update

Back in March 2015, we alerted nonprofits with government contracts about a development that should interest them.
It was a story with snooze-inducing buzzwords: “overhead,” “reasonable indirect costs,” and “cost allocation rules.”  In New Year, New Accounting Rule: But Don’t Sleep Through This One, we explained that the Office of Management and Budget (OMB) had issued new rules called OMB Uniform Guidance for much better reimbursement of nonprofit agencies performing services for community beneficiaries.
The U.S. government is the original source of an enormous amount of money that is disbursed to the states and local governments so the latter can, in turn, award their own grants and contracts to grantee-charities. Because of this flow-through mechanism, the problem of underpayment appears “in government awards at all levels and around the nation.”
The new federal rule became effective for all contracts entered into after December 26, 2014, that include federal dollars as part of the funding.  As of that date, all government entities that select nonprofits to deliver services must reimburse them for the “reasonable indirect costs” – sometimes called “overhead” or “administrative” costs  – they incur.
These new OMB rules were hailed as “a signature accomplishment of the … National Council of Nonprofits” and a “… a major victory for people who depend on nonprofits every day.” 
Even the Controller of the Office of Management and Budget waxed poetic about the  OMB Uniform Guidance: ‘[T]his historic reform will transform the landscape [for government grants and contracts]. . . for generations to come.’”
But, even when federal government officials first launched the OMB Uniform Guidance Rules, they included a specific caution to nonprofits; namely, that these charities “may encounter resistance from federal, state, or local employees, or other opposition based on lack of knowledge or understanding of these new rules.”  The advice: “Be proactive in enforcing these new rights….”

  Government Contracts Changes: L.A. Takes Lead

A year later, in Los Angeles Leads the Way Implementing New OMB Grant Rules,  we reported some good news about this program. The nation’s county with the largest population and the most nonprofits became the first jurisdiction in the United States to endorse and implement these new rules.
Supervisor Hilda Solis, formerly U.S. Secretary of Labor, had spearheaded this resolution through the Los Angeles County Board of Supervisors. She explained that, by ensuring that the government covers “…the full and reasonable cost for [nonprofit-provided] services,” L.A. County can significantly help their “nonprofit partners better serve their constituents and fulfill their important and irreplaceable missions.”
On March 3, 2016, the LA County Chief Executive Officer released an “official report” about successful steps to implement the new OMB Uniform Guidance.  

  OMB Uniform Guidance Survey

It hasn’t been all good news, though. During the fall of 2017, the National Council of Nonprofits sponsored a nationwide OMB Uniform Guidance Implementation Survey. Nonprofits with government grants and contracts were asked to answer questions about “how well the federal grants reforms from the Office of Management and Budget are being implemented.” State and county agencies were also surveyed.
In late November 2017, NCN reported early results: “There were ‘disappointing, but not particularly surprising, shortcomings’ by the government response.”

Government agencies and nonprofits alike reported … that the most frequent change they’ve noted since the implementation of the OMB Uniform Guidance is increased monitoring, a result that runs counter of the reform goal of shifting the focus from compliance to outcomes.

In addition, fewer than 20% of government agencies and nonprofits reported seeing changes in the reimbursement practices for indirect costs. That’s a significant problem, of course,  since the mandate was for “governments at all levels” to “pay nonprofits for some or all of their indirect costs.”  
Also, “there is a great deal of inconsistency –

across government agencies in how they reimburse nonprofits for indirect costs. Even those claiming that they follow the Uniform Guidance do not appear to be interpreting the rules correctly. One common government policy is to pay a nonprofit’s federal indirect cost rate if one exists or the ‘10 percent de minimis.’ However, only nonprofits that have never negotiated a rate with a government agency (not just a federally approved indirect cost rate) are eligible for the de minimis rate.

These results suggest “…that  more education at both the government and nonprofit levels is needed.”

  Conclusion

The policy of the OMB Uniform Guidance is a significant benefit to the nonprofit sector, but only if government entities implement them aggressively and train their officials and employees to carry them out evenly and in accordance with the purposes and mandate of this program. 

Accounting Controls for Nonprofits’ Cash

“According to a recent study by the Association of Certified Fraud Examiners,” we wrote in Charity Fraud: Embezzlement, But Much More, “the typical nonprofit organization loses an estimated 5 percent of its annual revenue to fraud.”

There is a false notion in the philanthropic world that theft is rare or, at least, less prevalent than in the for-profit sector. But “…charitable organizations – for a variety of reasons – are ‘tempting targets’ and present certain unique opportunities for wrongdoing.”

“Large amounts of cash and checks coming in from various sources” present opportunity for fraud by insiders. While a prudent organization may have systems in place generally to minimize theft or embezzlement, often the weak link in protection is a lack of adequate controls for handling cash.  

In Common Accounting Errors of Small Nonprofits, we explained that “even a new, small organization must create and maintain a basic accounting” sufficient to generate required tax or regulatory filings and to safeguards assets.  Directors should also watch out for and avert opportunities for pilfering.  Even “small expenditures like picking up a few office supplies or buying a pizza for volunteers is much easier to do with a petty cash fund.”  The best practice: “Handle the cash with care: Lock it up, authorize only a few people to make disbursements and require receipts for all expenditures.”

Cash-Controls Systems

In Ideas for Cash Controls, Sheila Shanker, CPA, MBA, observes that “[c]ash is the riskiest asset of an organization. Why? Because it can be easily stolen or lost.” Among her useful suggestions, especially for smaller nonprofits, are:

  • Have at least two people count cash before depositing it in organization account.
  • Install a bolted-down office safe with a code known only to limited people, and change the code from time to time. Keep cash and checks there; safeguard credit card slips that way, too.
  • In area where money is collected, restrict access to as few people as possible.
  • Whenever possible, collect money via the website instead of a person-to-person receipt situation.
  • Establish a policy limiting the amount of cash accepted in a single transaction.
  • Perform bank (cash) reconciliations each month.
  • Have someone outside the accounting department deal with calls or emails regarding complaints about money not being received or credited.

  Deterrent Controls

“Just knowing that an organization has controls in place to prevent cash theft or losses may be a deterrent to some people with bad intent. The key here is for the tasks to be done all the time, not just once in awhile to avoid problems down the road.”

Consider, for example, a sad case we highlighted in Charities and Embezzlement. Early in 2014, a “drama played out in Clinton Township outside of Detroit.” It was the Clinton Valley Little League that was robbed – of $300,000.” And “the embezzler was an unlikely criminal; the elementary school’s library clerk who was active in her church. She was ‘like everyone’s grandma in town.’ ” Like volunteers in many other small organizations, “she handled the cash” for more than six years. Over that time, she succeeded in regularly stealing small amounts.  This library clerk pleaded guilty and was sentenced to five years’ probation and restitution, ‘but the incident has left the town traumatized and divided.’

More specifically she accomplished this large theft by keeping no books at all for the little league’s finances. On top of that, she commingled the league’s money with her personal funds. But this case “… is hardly rare in the increasingly prosperous world of American youth sports, from which millions of dollars have been stolen in what public officials and nonprofit watchdogs say is a mounting swarm of corruption cases.” 

Conclusion

Theft “in nonprofit organizations is often easier than in for-profit businesses because people in charities are more trusting and ascribe good intentions to their fellow trustees and executives. ‘…[T]he person committing fraud is often described as the last one anyone would suspect….’”

What Should a Nonprofit Know About a Forensic Audit?

In Conflicts of Interest Can Lead to Big Problems, we discussed the significant troubles that have plagued the University of Louisville Foundation for several years.
“It’s not uncommon,” we explained, “for a major nonprofit institution like a university health care center to form a foundation to help raise funds and support the important work of the main organization. Many of these relationships proceed for decades with harmony and success, but there are sad exceptions.”
The University of Louisville and its related Foundation is one of those exceptions, not least because of the ill-advised overlap of key members of the senior staff of the University and the Foundation. Finally, the University ordered a costly forensic audit and, in June 2017, released the resulting 269-page report. “The ‘specific findings … are a simple statement of transactions and issues resulting in a complex and destructive situation.’”

  Audit: What Does it Mean?

The term “audit” may be a fuzzy concept for many nonprofit board members and staff.
One meaning of the word refers to the situation where a government agency – the IRS, in particular – requests the honor of your presence at an official examination of your books and records, operations, and documents.
“Audit” also refers to the type of services provided by an accountant. A “normal audit” typically refers to a “financial audit, which seeks to offer assurance that the financial statements of an entity are materially accurate and in compliance with Generally Accepted Accounting Principles (GAAP).”  In certain circumstances, a nonprofit organization may be required to arrange for a certified audit by an independent accountant.
A “forensic audit, sometimes also called a “forensic accounting” or a “fraud audit” is different both in purpose and procedure: One has the goal of determining the material correctness of the financial statements, and the other has the goal of uncovering fraudulent activity.

  What is a Forensic Audit?

A forensic audit is “specifically targeted at reviewing records for evidence of fraudulent activity.

A fraud audit is a separate engagement from a financial statement audit. In a fraud audit, there typically is an allegation of fraud or a fraud has already been discovered; the accountant is called in to gather evidence or to act as an expert witness in connection with legal proceedings relating to the fraud. He or she is not asked to give an opinion on the financial statements as a whole.

A forensic audit may be done to uncover a variety of types of fraud including, for instance: corruption, asset misappropriation, or financial statement fraud – or a combination of some or all.

  • Corruption: While conducting the fraud investigation, the auditor would look for evidence of conflicts of interest, bribery, extortion, or similar unlawful or unethical behavior
  • Asset Misappropriation: The auditor would investigate to uncover instances of theft of cash or property, directly or through devices like creating false invoices or making payments to nonexistent vendors, employees, or others.
  • Financial Statement Fraud: The auditor would try to check financial statements to see if there are inaccuracies or changes made to cover up poor performance, including – for instance – “intentional forgery of accounting records; omitting transactions …; nondisclosures of relevant details from the financial statements; or not applying the requisite financial reporting standards.”

  How is a forensic audit conducted?

A forensic auditor must have specialist training combining accounting expertise with knowledge of legal and evidence issues.
The techniques used for evidence collection range from the ordinary review of documents to applying computer-aided audit techniques to interviews of suspected wrongdoers.  
At the end of this process, a report is generated to present findings to the client. Since the investigation may result in either civil or criminal court proceedings, the auditor may have a role in that phase as well.

  Conclusion

Most nonprofits will never need a forensic audit. There are – unfortunately – enough reports of wrongdoing in the philanthropy sector that directors and staff should know about this particular investigative technique. See, for instance: “Charities in the Courtroom, Part 6: Audacious Embezzlement”; “Charities and Embezzlement”; and “Charity Fraud: Secret Billing Schemes.”
 
 

What’s Next After the Tax Exemption Letter?

There’s no shortage of books, articles, blog posts, website columns, and other sources of information about how to form a nonprofit corporation or how to get a tax exemption.
What happens, though, at the moment after all the initial work is done? The corporation has been formed; you have the fancy binder. The 1023 or 1023-EZ has been filed (and perhaps has been quickly approved). The initial board meeting has been held and the usual (recommended) formalities have been take care of.  
What then?  There’s much less written for those early days when the organization has to – well – get going.
One of the problems with the new Form 1023-EZ is that so little information is required up front, many founders and early boards do little serious planning about the nuts and bolts of the actual operation of the new 501(c)(3).

  Strategic Planning After Exemption Notice

Tax-exempt, 501(c)(3) organizations certainly don’t fit a single, standard mold. Some are tiny, with modest goals for the all-volunteer core group. Others are set to become complex institutions.
For small to mid-size groups, there are many areas to list for: research, professional advice, and initial planning. Here are some of them:

  • Fundraising

Most organizations want to jump head first into plans and action for raising start-up money. However, before any actual fundraising takes place, a California organization must file forms with the California Attorney General, and otherwise learn about and comply with specific rules for fundraising and events. The Attorney General’s website offers helpful information.

  • Initial Budgeting and Accounting System

Except for a sketchy estimated budget for the first few years required for the Form 1023 (and no budget information required at all for the 1023-EZ), many organizations have done no serious budget planning. It’s important to get that going immediately, with continual revisions, along with establishing even a simple accounting system with at least minimal, internal controls.

  • Establish Needs for Personnel

Particularly if the program objectives will require help beyond the founder(s) and board volunteers, it’s important to consider initial staffing needs, and determine if they will be: employees, consultants, volunteers, interns, board and non-board committee members, or advisory board members.

  • Location or Premises

Consider needs for office or program space, along with funding capabilities. Consider possibilities of donated or shared premises. Explore leasing options; note that commercial lease practice is different than residential leases. Evaluate need for special permits or licenses. Learn about property tax-exemption laws.

  • Initial Risk Management

Consult with nonprofit insurance specialists about the possible range of risks and liabilities including: officers & directors’ protection, premises and accident liability coverage, and other risk-related needs.

  • Additional Documents and Policies

Beyond the initial corporate documents (articles of incorporation, bylaws), every organization should adopt additional written policies related to governance, finance, compensation, conflicts of interest, employees, and others. See, for instance, “Written Governance Policies: Which Ones Should Nonprofits Have?” and “When the Revenue Agent Comes Calling.”

   Conclusion

The earliest days, weeks, and months of a new organization’s life cycle are critical times for in-depth planning for the actual launch of the group; that is, when the ideas turn into  program activities.

Do We Need to Have a CPA Audit Our Books?

Many small- to mid-sized 501(c)(3) organizations are often confused about their accounting and reporting duties. They may hear or read about an “independent audit” and wonder what that means and if it necessarily applies to them.
The simple answer is:

  • The IRS rules for charities do not include a requirement for an “independent audit”;
  • Some states require them in certain circumstances; and
  • Some grantors may ask for one.

    What is an Independent Audit?

First things first. Let’s pin down the definition of an “independent audit.” Generally, it is “an examination of the financial records, accounts, business transactions, accounting practices, and internal controls of a charitable nonprofit by an ‘independent auditor.’”
“‘Independent’ refers to an auditor/CPA who is not an employee” but “instead is retained through a contract for services.”
This independent professional “reviews the organization’s financial statements to determine whether they adhere to “generally accepted accounting principles” (GAAP).” Created by the Financial Accounting Standards Board (FASB), they are not law, but they carry significant weight. If GAAP are not followed, the auditor must note that fact.  
There must be a report issued “to the board of directors expressing a professional opinion about the organization’s financial practices; specifically, whether the financial statements: ‘fairly present the financial position of the organization” without any inaccuracies or material misrepresentations.’”

There are four types of reports that an auditor could issue: ‘Unqualified Opinion’ (this is the type of audit you hope for); ‘Qualified Opinion’ which signals that the auditors found one or two situations where the nonprofit is not following GAAP, or that the organization is following GAAP in most cases although perhaps not all, but overall there is not a material misstatement of any financial position(s); ‘Adverse Opinion’ (which signals that the auditors found a material misstatement or that overall the organization is not conforming to GAAP); or a ‘Disclaimer of Opinion’ report. Either one of the first two reports is preferable to either the adverse opinion or a disclaimer report. The Disclaimer report essentially signals: ‘Something prevented us from forming an opinion, therefore we refuse to do so.’ Receiving an Adverse Opinion or Disclaimer of Opinion can have a serious negative impact on efforts to obtain funding for your organization.

Independent Audit Requirements for CA Charities

The Council on Nonprofits has a helpful guide for each state’s requirement, if any, for an independent audit. About one-third of all states require nonprofits of a certain annual revenue size to be audited if they solicit funds from their state’s residents. The revenue thresholds vary from state to state.”
California’s statute on independent audits is the Nonprofit Integrity Act of 2004, California Government Code section 12586(e)(1). It was enacted after the huge corporate scandals (e.g., Enron, Worldcom) of the early 2000s; federal and state officials reacted by imposing new rules and regulations on all corporations, including nonprofits.
Fortunately, the threshold of this requirement is high: It applies to any charitable corporation in California with gross annual revenue of $2 million or more and that is already required to file reports with the Attorney General. It must be prepared by an independent CPA.  

  Independent Audit Required by Certain Funders

Whether or not state law applying to a particular organization mandates an independent audit, certain government agencies or other grantors may require one. For instance, the “federal Office of Management and Budget (OMB) requires any nonprofit that spends more than a designated amount in federal funds in a year (whether directly or by passing the money on to other nonprofits) to obtain what is termed a ‘single audit’ to test for compliance with federal grants management standards.” Some funders, including certain foundations, may require an independent audit; likewise, certain banks or other lenders may demand one.

  Conclusion

It’s good that an independent audit is not required in all cases because it’s expensive. Even for a small nonprofit, the fee might be $5,000 to $10,000 – and audit fees for larger nonprofits in major urban areas can exceed $20,000.

Charity Embezzlement: Thwart It With Good Controls

In “Charities and Embezzlement,” we discussed what to do as soon as embezzlement or fraud is discovered; namely, report it to the authorities and charity regulators.

Of course, an ounce of prevention is worth a pound of cure. As part of a comprehensive risk management plan, an organization should have certain internal controls in place to prevent employee theft. “Nonprofits are not defenseless against charitable asset diversion.”

     Effective Internal Controls

There is no “one-size-fits-all” model for every entity; appropriate precautions depend on the size and the complexity of the organization and its financial management systems.  But accounting and security experts generally suggest a number of steps that can be taken to prevent fraud and embezzlement or to detect it in progress.
These are among the most frequently recommended:

  • Dual Signatures and Authorizations

Require two signatures for every check over a specified amount, as well as two signatures on every authorization or other payment. If possible, have someone else – an administrative assistant, for instance – bring the checks to each of the signers, so there is an intermediary serving as a buffer.

  • Back-up Documentation

Require backup documentation – an invoice or document demonstrating the transaction is appropriate – for each request for a check or for a cash disbursement. For costs over a specified amount, require prior written approval from two people for credit card payments, and require documentary proof of the reason for the expense.

With credit cards, require prior written approval, again from two individuals, for costs estimated to exceed a certain amount. Require backup documentation demonstrating the need for the expense. The person using the card should not be the one approving the credit-card use. “Multiple layers of approval will make it far more difficult for embezzlers to steal from the organization.”

  • Segregation of Duties

“Hand-in-hand with multiple authorizations goes the segregation of duties.”  Create a system where different people: prepare payment records, authorize payments, disburse funds, reconcile bank statements, and review credit card statements. Make sure that duties concerning money coming into the organization are handled by more than one person. “No single individual should receive, deposit, record, and reconcile the receipt of funds.”

  • Automated Controls

Take advantage of available electronic notifications to alert more than one senior member of the organization about: bank account activity, balance thresholds, and wire notifications.

  Additional Controls

  • Fixed Asset Inventories

At regular intervals, conduct fixed asset inventories to determine if any equipment or other property are missing.

  • Audits and Board-Level Oversight

Schedule regular external audits to ensure these controls are effective. 

Establish audit committees of the board of directors, preferably with at least one person familiar with finance and accounting who will serve as primary monitor of these anti-fraud measures. In lieu of an audit committee, recruit a CPA or other financially knowledgeable person to serve on the board.

Periodically bring in an outside expert – for instance, a CPA experienced in conducting fraud audits and in evaluating internal control systems.

  • Encourage Whistleblowers

Draft and adopt a written whistleblower policy. In “Whistleblower Policy and Nonprofits,” we explained this requirement. An organization “must develop, adopt, and disclose a formal process to deal with complaints and prevent retaliation.” It must “take any employee complaints seriously, investigate the situation, and fix any problems or justify why corrections are not necessary.”  

Create a “comprehensive and vigorous compliance program, … tailored to the organization, with a written code of ethics,” and regular training. Include “real consequences for violations of the policy, have an effective reporting mechanism, and be periodically audited to ensure its effectiveness.”

   Conclusion

The kindly school library clerk, whose pilfering exploits were described in our earlier post, was able to walk off with $300,000 from the Clinton Valley Little League precisely because that tiny organization had neglected to put in place even a single item in this list of recommended controls.  

Make sure that your organization doesn’t make the same mistake.

Charity Boards and Accounting Literacy

Any expert in the philanthropy sector will tell you that it’s crucial for any and every charity board member to be actively involved in the affairs and activities of the organization.  Regular attendance at board meetings is key, of course, as well as participation in decisions on mission and program activities, but it’s important, too, for every director to be aware of, and understand, the charity’s finances.
Under the law of California and all other states, a charity director has fiduciary duties of care and loyalty.  California Corporations Code section 5231:

(a) A director shall perform the duties of a director,
including duties as a member of any committee of the board upon which
the director may serve, in good faith, in a manner that director
believes to be in the best interests of the corporation and with such
care, including reasonable inquiry, as an ordinarily prudent person
in a like position would use under similar circumstances.

In particular, each director should be given a copy of each year’s information return, Form 990 series, before it is filed with the Internal Revenue Service.

   Accounting Knowledge of Board Members

Tax-exempt, 501(c)(3) organizations come in all shapes and sizes. Similarly, board members range from novices with no prior experience in the nonprofit world or in business, to community leaders with many rounds of charity-board service under their belts.
But even successful entrepreneurs or business executives who sit on nonprofit boards may have little or no knowledge at all about the fundamentals of nonprofit accounting – which are different than regular business accounting.
And, just to let you in on a little secret, relatively few lawyers have a firm grasp of for-profit accounting principles much less nonprofit accounting concepts.
Many board members, then, regularly fail in their fiduciary duties because (a) they don’t know what they don’t know; accounting is just a big blur to them; or (b) they draw a blank when faced with nonprofit financial documents, but are reluctant to admit that they don’t understand the essentials of this branch of accounting.

   How is Nonprofit Accounting Different?

Unlike in a business where the goal is to make money for shareholders, the purpose of a nonprofit is to carry out a charitable mission, and to raise funds to do that work.
Because of that distinction, the accounting system that will work well for one will not necessarily be adequate for the other. Here are some illustrations and examples.

   Presentation of Financial Statements

There are differences in the financial-statement components:
For-profits   

  • Balance Sheet
  • Profit/Loss Statement
  • Statement of Cash Flows
  • Statement of Owner’s Equity

Nonprofits

  • Statement of Financial Position
  • Statement of Activities
  • Statement of Cash Flows
  • Statement of Functional Expenses
  • Change in Net Assets

Compare, for instance, the second item in each list. A business’ profit and loss statement shows income and expenses with either a profit or a loss as a result. The statement of activities for nonprofit organizations also shows income and expenses, but for nonprofits, income is not derived primarily from sales of goods or services, but rather it can be from sources of funds such as “fee for service”, gifts, grants, donations, and (hopefully) fundraising revenue. While nonprofit and for-profit businesses may have similar expenses — such as utilities, rent, payroll, and office supplies — nonprofit organizations also have something called “functional expenses,” where uses of funds are related to specific programs, with the net of sources of funds and expenses listed as either a surplus or a deficit.
Compare, also, the final item in each list. For-profits have a section for owner’s equity, but nonprofits (which do not have owners) have a net assets category instead. This net assets item “lists sources of funds and is broken down into  three areas: unrestricted net assets, temporarily restricted net assets, and permanently restricted net assets.”

       The “Functional Expenses” Requirement

Because of the nonprofit organization’s special purpose of using resources for its mission, it must “itemize expenses across management (general and administrative), fundraising, and program areas. These are called “functional expenses” and the IRS requires that they be reported.”
Having a cost-allocation plan is advisable; that is, “establishing a system that defines how [to] allocate expenses across the various functional areas and to specific programs.” If, for example, personnel carrying out administrative functions take up to 30% of office space, then an allocation of 30% of an expense like paper to the administrative function may be appropriate. “A cost allocation plan can be extremely useful in determining how much a program or activity actually costs and, done accurately, it gives a clearer picture of the organization’s finances.”

      Financial Accounting Standards No. 116

The Statement of Financial Accounting Standards No. 116 is issued by the Financial Accounting Standards Board (FASB). It discusses some additional points of interest unique to nonprofit accounting, including –

  • Contributions revenue: “how and when to recognize that revenue has been earned,” e.g., “unrestricted and restricted funds, donated goods, in-kind contributions, [and] pledges.”
  • Value of donated services: “services to be recognized include those that “(a) create or enhance nonfinancial assets or (b) require specialized skills, are provided by individuals possessing those skills, and would typically need to be purchased if not provided by donation.”

  Conclusion

A board member who finds any of this unfamiliar or confusing will want to get up to speed. Resources like those below can help are a good starting point:

  • FASB Statement of Financial Accounting Standards No. 116, “Accounting for Contributions Received and Contributions Made,” and No. 117, “Financial Statements of Not-for-Profit Organizations

And if you’d like more information on nonprofit accounting, you can reach out to the experts at For Purpose Accounting.