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Do You Know What a Pledge Really is?

Most nonprofit organizations are familiar with pledges, as people, businesses, and foundations make promises to give in the future. Many times these promises are the results of fundraising campaigns or appeals. Depending on the situation, the pledge could be for a general or specific purpose, such as for a new child-care program.

Pledges, both short and long-term, may be shown as “Pledges” or “Unconditional Promises to Give” on the Statement of Position.

Promises to give may or may not be real. For example, if a person notifies an organization that he is including the nonprofit in his will, this isn’t a pledge. The same situation exists if someone promises to pay a certain amount twenty years in the future—it’s not a pledge. In both cases, donors can easily change their minds; circumstances can change, making the promises hard to keep.

  • Promises to give must have no conditions to be recognized as real pledges.

Note that  conditions are different from restrictions:

  • Conditions determine if the amount will be given or not
  • Restrictions determine how to use the proceeds

Suppose there is a condition associated with a pledge — the money will be given only if a relative recovers from a serious disease. In this situation, the nonprofit records the pledge only after the condition is met, that is, the person recovers. This situation is tricky since a lot can change, and it makes good sense not to recognize this promise until it’s paid. Same if the condition is the occurrence of a major disaster in California— this pledge is conditional, and the nonprofit should not record it. Once a disaster hits California, then the pledge may be valid.  Managers should use common sense here.

Another example of a condition is a company matching donations made by employees. If an employee gives $10, the firm would also pay $10, matching the donor’s amount. As the employee donates, the condition on the firm’s pledge is lifted. Therefore, each time an employee pays, the organization recognizes a matching pledge.

The wording of a pledge is crucial to determine when a promise is conditional or just restricted. The key word in conditional pledges is “if.” Those are usually not recorded as real pledges by the nonprofit, although they may be filed for future follow up.

Once a pledge is determined to be valid, it can be unrestricted or restricted to a particular time or event, such as for a reading program happening in the future. The classification depends on donors’ intentions. A pledge made on a general appeal can be safely assumed to be unrestricted, while others specific to an individual program should be considered restricted.

Organizations must have pledge documents in writing whenever possible. If a donor doesn’t want to acknowledge the pledge, a thank you letter confirming the gift is a good idea. The letter can be simple and brief but should leave no doubt about the existence of the pledge and its intent.

Issues usually associated with pledges are collectability, pledges paid in installments and privacy of donors, all discussed next.

Collectability

As promises are to give in the future, pledges may not be all collectible, and most organizations aren’t going to sue to collect promised amounts because of PR issues. Therefore, by its nature, pledges are riskier than regular accounts receivable. As expected, a pledge due in a year is less risky than another one due in two or more years since a lot can happen in a year or longer.  Fundraising staff usually follow up on promises to pay, diplomatically, of course.

Due to the risk of default on pledges receivable, an Allowance for Uncollectible Pledges account is employed. It may be created and adjusted every year based on history. If an organization experiences 15 percent in uncollectible pledges, for instance, this percentage may be applied. It’s the same concept as the Allowance for Uncollectible Receivables in the for-profit world.

A strange situation with promises to give has popped up recently with a young, wealthy supporter promising to give a significant amount to an organization. As expected, people got excited, made a public PR deal with the pledge and started planning how to spend the money. Low-and-behold — it was all fake. The guy liked the attention, but was not wealthy and had no intention to fulfill the promise. The organization lost a lot of credibility with this deal. So, I recommend that nonprofits set up policies and procedures to evaluate significant pledges and to refrain from announcing it and making plans for it until all checks out.

Installments

Besides lump sum promises, nonprofits could also have pledges payable in installments; for example, a commitment of $25,000 payable at $5,000 a year for five years. In this case, organizations are to discount the payments to present value using a reasonable percentage. The discount is amortized as in the for-profit world. FASB ASC 820-10 (FASB 157) relates to this topic to be sure organizations evaluate pledges in a fair and acceptable manner.

  • Government and other grants aren’t considered to be pledges and are presented separately in financial statements.

So, if an organization receives a pledge for $30,000 payable in 5 years, apart is considered to be current pledge receivable, and the rest is non-current. In addition, revenue is recognized along with a discount plus the allowance account may be changed.             Don’t double count pledges – once as revenue when the promise is made and again when payments are made.

Privacy

Many times big donors want to keep their donations and personal information private. To this end, nonprofits should implement proper care so that the donor is acknowledged, donations are recorded, and the donor’s identity is kept secret. So, to assure privacy, donor databases need to be kept secure. Only a few people should possess access to the donors’ records.

As an example, a nonprofit organization I worked with had celebrities donating significant amounts of money, and they didn’t want their names, email addresses or other information available. Therefore, instead of inputting the real names and information in the database, the organization used the names “Anonymous 1,” “Anonymous 2,” etc. The nonprofit kept the real names and personal information under lock and key in a file cabinet accessible only by a couple of people. This low-tech setup worked well.

Note that a pledge is assumed to be a donation, not an exchange, so FASB ASU 2014-09 Revenue from Contracts with Customers doesn’t apply.

 

 

( Excerpt from Nonprofit Finance A Practical Guide– Second Edition, to be published soon)

Overhead Essentials

If the program is the heart of a nonprofit, overhead is its backbone. Overhead is known as general and administration costs and, in some circles, it includes fundraising as well. Since the definition of overhead may vary, you should be clear on what it means. For example, in government agencies, fundraising is usually not part of overhead, while other entities consider anything besides program costs, overhead.

Overhead rate on grants –Many grantors use “overhead rates” to reimburse nonprofits for administrative costs. This rate, a percentage, is usually calculated based on prior financial numbers and negotiated with grantors. The calculations can be complicated and detailed.

To decrease this complexity, the Federal government pays nonprofits a standard 10% overhead rate on their grants. This means that after reimbursing direct costs, it adds a 10% for overhead. If direct costs are $100, the reimbursement will be $110. This setup may be fine for smaller organizations, but not for larger ones that may negotiate a higher rate. The idea is for the overhead rate to cover costs that cannot be allocated easily to a program, like an electric bill for a building that houses many programs.

This rate should be reviewed every year to make sure that indeed the overhead rate is at least equal to actual overhead costs. If the rate of 10% reflects $100,000, but the actual overhead costs are $120,000, then the organization may need to negotiate a higher rate with the grantor for the next fiscal year.

Overhead requirement on grants and gifts–Another reason overhead is important is that it must be part of every grant proposal or gift. Some nonprofits have funds restricted for certain programs only with nothing much left over for overhead, forcing many to fundraise for overhead mostly. It’s a strange situation where an organization may have money to fund research programs, but cannot pay its phone bill and other basic needs. Quite real and disconcerting situation.

To avoid this issue, nonprofits have started to require a percentage for overhead to be included in the gift or grant or they cannot accept it. I have seen a large nonprofit say no to a large gift because of this issue.

Overhead should NOT be zero –Overhead exists for a reason and if it shows as zero on financial statements or tax forms, you have a problem.  It could be an accounting error in classification or not understanding what overhead is. Whether fundraising is included or not, there should be something allocated to overhead in items like insurance policies, salaries or supplies. Even if all employees are unpaid,  expenses exist that cannot be specifically assigned to a certain program and are part of overhead. While it’s understandable the wish to keep overhead costs low, it’s not realistic to keep it at zero.

The first thing to think about when someone mentions overhead is to understand what it means. That is very important to make sure everyone is talking about the same thing. The overhead definition and calculation may vary among grantors and even government agencies. So, ask questions about it, don’t assume anything and don’t forget about it in proposals.

 

Upcoming Changes to Nonprofit Reporting

Financial statements of nonprofits will look at bit different in 2018. The changes may not be that noticeable to the untrained eye, but they will happen due to FASB (Financial Accounting Standards Board) attempt to make financial reporting easier to understand. Even though current reporting rules have been in place for over 20 years, many people have complained that the financial statements of nonprofits are confusing not providing enough information to assess liquidity and ability to pay bills. This update, known as ASU 2016-14, focuses on these concerns.

“Not-for-profit organizations that will be affected include charities, foundations, colleges and universities, health care providers, religious organizations, trade associations, and cultural institutions, among others” (FASB.org)

The main changes regarding this accounting update are:

Only two classes of net assets

As you may know, net assets are elements that hold information about nonprofits, accumulating increases and decreases in revenues and expenses throughout the years. A nonprofit account always belongs to a net asset, traditionally classified as unrestricted, temporarily and permanently restricted. No more. After this update, we will have only two classifications of net assets:

1-Net Assets Without Donor Restrictions, comparable to the “old” unrestricted net asset
2-Net Assets With Donor Restrictions, combining the “old” temporarily restricted and permanently restricted net assets.

So, instead of reporting on three net assets, as has been the case until now, with statements showing three columns or lines, there will be only two net assets.  It doesn’t mean that the accounting of temporarily and permanently restricted net assets need to change internally, but these are now combined in the “official” financial statements.  Most likely, the reporting on the accounting software will need to be modified to accommodate the update requirements.

Underwater value of endowments 

Organizations may receive endowment funds that are held for long-term or perpetuity. When the fair market value of such investments is lower than the original value of the gifts, they are said to be “underwater.” Unfortunately, that has been the case with the volatility of the stock market and other losses. Currently, such losses are reported under the unrestricted net assets area. However, after this update, accumulated losses are to be shown within the endowment fund — net assets with donor restrictions.

Detailed information about endowments is also required as disclosures on the official financial statements, such as the current fair market value of the endowment, any amount required to be maintained, and any deficiencies of the underwater endowment fund.

Liquidity

Liquidity is the ability of a nonprofit to pay its bills, a valid concern to many donors and grantors. As many donors restrict gifts, it can be hard to determine if an organization has the money necessary to pay its current bills. Financial flexibility is essential for any nonprofit to be viable long-term, so this update requires disclosures about how an organization will be able to meet its financial obligations for the next 12 months. Specific resources available should be disclosed, such as prior year’s reserves and any money restricted by the board.

 

Challenges in Financial Planning of Nonprofits

Nonprofits need to plan for their future as any other firm. However, because of the nature of nonprofits, planning can be quite a challenge. While for-profits rely on the sale of goods and services, nonprofits must count on grants and donations for operations. Expenses are mostly related to programs and are very dependent on the income stream. Since the point of a nonprofit is not to generate profits, many don’t have that much left over after they spend all revenues. So detailed planning is a must. Some of the challenges of planning for nonprofits are:

Income uncertainty

Bills are a sure thing, but income may be received after a campaign, a gala event or gifts and grants. Nonprofits may not be able to ascertain the amounts and timing of such income as donors that may have given certain funds in the past may not be able to keep on giving at the same level. Grants may be cut or delayed with no prior notice. Also, grant income may decrease if auditors find noncompliance items and those could be substantial and unexpected. The key here is for the organization to learn of any changes in income stream the earliest possible time to be able to adjust for those.

Because of this instability, it’s always good for a nonprofit to keep a “cushion,” also known as a reserve to be used when the unexpected hits. Add a bit to budgeted expenses, just in case, and contact major donors and grantors to verify any changes in revenue.

Lack of financial knowledge

Many nonprofits are headed by kind people with the best intentions and good contacts. But too often the organization lacks financial education and experience. Basic financial concepts may be missing. Sometimes people are not aware that they need help in this area until something happens that doesn’t make sense to them. This vacuum can pose additional challenges on planning since many concepts may be new to management.

Boards of directors must have people with financial expertise to help in this process and provide guidance in these matters. Also, management should make efforts to learn about accounting and finance so that they can make right decisions. Usually, having a bookkeeper with some experience with nonprofits is not enough to see “the big picture.”

Lack of Time

Typically, nonprofit managers wear many hats, are hands-on, and there is no time to focus on planning and financial matters. It’s hard to think about financial planning and strategy when so many things need to be done today. The result is that usually information is pulled in a hurry and not analyzed, resulting in poor planning and errors.

It’s a good idea to have appointments and set schedules for managers to talk about planning and strategy, A bookkeeper or accountant can only do so much in financial planning. He or she needs input from various areas such as from managers regarding new programs and fundraising folks about new grants or changes in donations.

Planning for nonprofits pose particular challenges but can be done. Management can learn from past mistakes and try to get a better planning model moving forward.  The concept here is that nonprofits must take planning seriously and keep on improving it. Donors and grantors like to see a nonprofit planning ahead and not just putting off fires.

 

You can check out my books:

Nonprofit Finance: A Practical Guide — Nominated for a  2016 McAdam Book Award

15 Quick Tips on Becoming a Great Consultant  — Free on Kindle Unlimited

 

Ideas for Cash Controls

Cash is the riskiest asset of an organization. Why? Because it can be easily stolen or lost.

Below are some controls to prevent or identify these losses.

1-Two people should count any money before it’s deposited to be sure the total is correct.

2-Organizations should acquire a safe preferably bolted to the wall or floor with the code known to limited personnel to safeguard cash, checks not yet deposited, and other valuables.

3-Limit physical access to the area where money is received to just a few people.

4- Don’t keep cash, checks, or credit card slips on a desk or in another unsafe place that is easily accessible. Thieves typically look for petty cash in drawers under desk

5-Nonprofits should use their websites to collect money as much as possible.

6- Organizations should implement a policy indicating that no cash over a certain amount would be accepted.

7- When money is received, it must be deposited promptly in the bank after the count by two separate individuals to confirm the total amount.

8- Nonprofits should perform bank reconciliations, also known as cash reconciliations, every month to be sure all cash transactions have been accounted for correctly.

9- People outside accounting may answer phone calls or emails regarding complaints about payments not showing up in invoices or statements. The question would be– where’s the money these people sent in? The problem could be just an error or an unfortunate situation where money is stolen.

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.

Interested in CPE credits regarding nonprofits?  Online Practical CPE Courses

You can also check out my books:

Nonprofit Finance: A Practical Guide — Nominated for a  2016 McAdam Book Award

15 Quick Tips on Becoming a Great Consultant  — Free on Kindle Unlimited

Nonprofits Pay Income Taxes

It may come as a surprise to many, but nonprofits can have taxable income, known as Unrelated Business Taxable Income (UBTI).  Even if they get a tax exemption from the IRS.

If an organization has UBTI of $1,000, it must submit 990-T Unrelated Business. You can check out his form at the IRS website –https://www.irs.gov/pub/irs-pdf/f990t.pdf

The government defines taxable income as income not substantially related to the organization’s tax-exempt purposes or activities. The idea is to prevent nonprofit organizations from competing with for-profit firms unfairly. The tax due is known as Unrelated Business Income Tax (UBIT), and it conforms to the corporate tax rate. Often, an activity generates unrelated business income if it meets three requirements:

  1. It’s a trade or business
  2. It’s regularly carried on, and
  3. It’s not substantially related to furthering the exempt purpose of the organization.

For example, an organization runs a pizza parlor selling pizza to the public. The nonprofit’s mission and programs don’t relate to the parlor’s business. The nonprofit pays employees to run the pizza place. All this information points to the pizza parlor generating unrelated business income that’s taxable.

On the other hand, a humanitarian-service organization holds a bake sale. While the sale is unrelated to the mission, It’s likely to be tax-exempt if not “regularly carried on.” Nonprofit’s activities are considered regularly carried on if they show a frequency, continuity, similarity to comparable commercial activities of for-profit businesses.

Some unrelated business activities may not be taxed. For instance, if an organization sells donated items, or if volunteers perform all the labor involved in the business, proceeds are exempt from taxes.

Note that if the IRS notices too much UBTI, it may revoke the tax-exempt status, which can spell disaster for a nonprofit. To avoid this potential risk, organizations should consider the following:

  • Resources and volunteers must spend most of the time on the mission, not business activities
  • Most of the revenue must come from the public and mission-related programs. The percentage of business income should be minimal

 

Interested on CPE credits regarding nonprofits?  Online Practical CPE Courses

You can also check out my books:

Nonprofit Finance: A Practical Guide — Nominated for a  2016 McAdam Book Award

15 Quick Tips on Becoming a Great Consultant  — Free on Kindle Unlimited

 

 

Is Your Nonprofit Data Safe?

Many nonprofits keep confidential information on their computers, including sensitive data and items that cannot be lost. Membership or donor information, accounting data, and other confidential information should be safeguarded against snooping eyes.

A typical control here is to have a disaster preparedness plan, which includes a recovery strategy for the nonprofit’s functions. But that’s not enough.  Organizations should consider the following issues with software, hardware, and the cloud.

Software

Risks when dealing with software include unauthorized entry, loss of data, and confidentiality issues. Some internal control mechanisms to minimize these risks are:

  • Use anti-virus and firewall programs to prevent malware from infiltrating the system.
  • Do daily backups of all systems and keep the backed up file outside the premises.
  • Require IDs and passwords on all systems.
  • Acquire programs to identify and stop unauthorized entry using the Internet and other means.
  • Require information system’s authorization for program purchases to be sure the program is indeed needed and is compatible with existing software.
  • Once employees leave the organization, they should not have access to the nonprofit’s systems
  • Include security to prevent information systems personnel access to passwords or confidential information.
  • Create policies and procedures about computer usage and safety.

Hardware

The risks with hardware involve theft, maintenance, and obsolescence of the machines. Below are some controls to minimize these risks:

  • Place all equipment, including servers and printers, in a safe location.
  • Label all equipment with numbers and create a list of all equipment using the number and description.
  • Maintain this list, doing physical audits to identify equipment disappearances, losses and damages.
  • Centralize maintenance services and schedule them regularly.
  • IT management should approve purchases, retirement or sales of hardware.
  • Dispositions of old computers must be done carefully since they contain confidential information that may be recovered unless the nonprofit takes certain
  • Dispositions of old computers and peripherals must comply with laws to avoid poisoning the environment and possible fines.

Using the Cloud

Many nonprofits have been using accounting and other programs “in the cloud.” This means that organizations’ management and staff access these computerized programs through the Internet, making the software very convenient since employees can access the system anywhere as long as they have proper online connections, login IDs, and passwords.

-Organizations using old, unreliable equipment may benefit from the cloud since the data is not saved locally. If the server or individual computers stop working, the information is not lost and is still available.

However, there are risks associated with the cloud system. For example, the program may not be available online for long periods. So, before selecting a cloud system, check its reliability through Internet searches and word-of-mouth.

Once the organization decides to go online, management must trust the Internet provider to provide adequate security for the data, which may include donor information. Not surprisingly, data security of cloud systems is a major concern for both for-profit and nonprofit users.

Another issue with the cloud is the data transfer. If a nonprofit employs the cloud and then moves to another system, the existing data will need to be downloaded and transferred to another program. The cloud provider should allow for such transfers and help the organization in this matter, but some charge fees, so inquiries about this matter are beneficial to avoid surprises later.

Interested on CPE credits regarding nonprofits?  Online Practical CPE Courses

You can also check out my books:

Nonprofit Finance: A Practical Guide — Nominated for a  2016 McAdam Book Award

15 Quick Tips on Becoming a Great Consultant  — Free on Kindle Unlimited