Look at ALL requirements of such grants, or you can get in trouble and may need to return the funds. This can get really sticky.
Look at ALL requirements of such grants, or you can get in trouble and may need to return the funds. This can get really sticky.
The idea of separation of duties is not that obvious for many organizations, specially the ones with tight budgets, having one person handle too many functions because it seems simple and straightforward. It’s usually a mistake.
The overall goal of separating duties is to have a system osf checks and balances to prevent losses and mistakes.
See the following articles about this topic:
The nonprofit tax form 990 contains interesting questions and requirements that should be reviewed by the board, not just by the financial people. I highly recommend to download and print the full form, even if the nonprofit doesn’t need to file it. You can check out the core pages at https://www.irs.gov/pub/irs-pdf/f990.pdf
Take a look at the 990 page 6- “Part VI Governance, Management and Disclosure “section” and what is asked in this page– it may be an eye-opener for many.
As you can see, this form raises good questions that may be used to improve operations. According to the instructions on the top, saying “yes’ to lines 2 through 7b requires explanations and management should review these items carefully.
Line 2 is about identifying people who may personally benefit from the organization, a possible private inurement situation, usually a no-no for tax-exempt organizations or a hefty excise tax. The take away here — be careful with business relations involving board members.
Line 5 is about the loss of assets, an intriguing item on the tax return. A “significant diversion of assets” according to the IRS is embezzlement, fraud, theft or other inappropriate use of funds that is the lesser of 5% of current annual gross receipts, 5% of total assets at year-end, or $250,000. According to a Washington Post report in 2013, more than 1,000 organizations marked “yes” here and most were for embezzlement. Besides giving details of the problem, it’s a good idea to also disclose any new internal controls used after the problem was disclosed to prevent it from happening again. Note that this is NOT confidential information.
Line 11 specifically asks about top management getting copies of the tax return and how reviews are conducted. The board must be engaged in this process, even if they are not financial people. They cannot say that they don’t know or understand the tax returns.
Line 12 asks about conflicts of interest while line 13 is about whistleblowing, and line 14 covers document retention and destruction policy. These lines underscore the need for written policies, and under the conflict of interest item, the need to monitor those regularly. The idea is to say “yes” to all of these. And the take away for management is to make sure these policies are followed up by procedures to make sure they’re not just “lip service.”
Line 18 reminds organizations to make certain forms available for review, as required by law. Such reminders are all over the tax form, including reminding nonprofits about reporting contractors and gambling winnings. Management could highlight those items and follow up on them with the finance department.
Also, note that the 990 asks for the nonprofit’s mission statement as the first line, and also on Part III- Statement of Program Services Accomplishments. The idea here is to match the mission statement to the programs. If an organization mission is to provide food for the homeless, but programs relate to buying books to schools, the nonprofit may be at risk to lose its tax-exempt status, which can be a major problem.
You can check the new edition of the book Nonprofit Finance A Practical Guide at https://goo.gl/M563u9
Nonprofit Finance: A Practical Guide is available now as a kindle book on Amazon:
Some organizations run on volunteers only, but many need employees to perform certain tasks. Since having employees is costly, it’s no surprise that payroll is usually the biggest expense in the financial statements. Running payroll can be difficult, and while many organizations contract out outside payroll services, some prefer to process it in-house. Some key risks and controls with payroll are:
Risk: Time sheets could contain wrong information.
In many organizations receiving government funds, everyone files time sheets—even the president—to support charging grants “real” salaries rather than estimated/budgeted ones. Fortunately, many organizations use computerized timekeeping devices and time sheets that once implemented, reduce errors and confusion significantly.
A traditional internal control is for nonprofits to require supervisory approvals on time sheets (manual or electronic) to make sure hours and overtime are authorized. Auditors typically verify if the time charged to a grant was allocated and authorized properly. If the auditor finds errors or no time sheets, or time sheets with no approvals, the scope of the audit is likely to increase, becoming more expensive.
Risk: Employees may be fictitious.
Each employee should file the proper paperwork with human resources and should visit the HR department personally. I know of a case where a program supervisor “hired” a relative part-time who was a “ghost employee.” The nonprofit paid the “employee” for six months, while the supervisor cashed the paychecks.
It was only after a problem with the time sheet of this person (all fake) that the human resources manager got involved, and the fraud was discovered. So, it’s crucial for HR to see and meet with all employees, including part-timers to be sure they’re real and are actually working for the organization.
Risk: Unauthorized payroll changes or increases happen.
To make sure payroll records are correct, department managers should review and sign off payroll registers regarding their department at least once a quarter. Many department managers get the dollar amount of their department’s payroll expenses through regular internal financial reporting, but not the details.
So, having managers verify payroll numbers, overtime, sick days, vacations, etc. is very helpful in keeping it all correct. If they see someone claiming overtime that the manager didn’t approve, he or she can follow up on it.
Controllers or accounting managers should review payroll registers and change reports to make sure the persons running payroll aren’t paying themselves unauthorized overtime or salary increases—a fraud I witnessed that could have been prevented had the controller taken a look at payroll reports regularly.
Risk: Paying terminated employees by mistake.
One issue I often see with payroll relates to nonprofits paying terminated employees because payroll staff didn’t know about the terminations. Once paid, it’s tough to get the money back. So, it’s important for human resources and managers to notify the payroll department when people quit or are let go. Staff may need to process final checks and update the payroll system.
Nonprofits may implement policies and procedures, including a checklist to follow when employees leave. Many details are involved, such as COBRA requirements that need to be handled correctly or the organization could be liable for fines.
Risk: Payroll information may leak.
Confidentiality is essential with payroll records. Nonprofits must keep all payroll-related documents, including time sheets, in safe, locked filing cabinets where only a few selected authorized personnel are allowed in. Similar security measures must be considered with access to the computerized payroll systems that should be very limited.
Nonprofits should hire people who are discreet and don’t discuss confidential matters with others in the organization. They should avoid using email when mentioning any sensitive payroll information because the system may not be secure enough.
Excerpt from book Nonprofit Finance – A Practical Guide Second Edition — https://goo.gl/M563u9
The second edition of my book, “Nonprofit Finance: A Practical Guide,” is out. It includes detailed coverage of FASB update regarding reporting, details about liquidity and other details effective in 2018. For example, the official financial reporting will show only two net assets, but internally, a nonprofit should maintain the three net assets separately and combine the temporarily and permanently restricted for reporting only.
Internal controls are covered in detail for cash, payables and computerized systems, giving ideas about how to minimize certain risks specific to the nonprofit sector.
Like the first edition, nominated for a McAdam Book Award, this second one has many examples and suggestions based on real-life experience, not just theories. It was written with both the accountant and the non-accountant in mind, so that people of different backgrounds can benefit from the material and put it to good use right away.
You can check the new edition at https://goo.gl/M563u9
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.
Note that conditions are different from restrictions:
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.
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.
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.
So, if an organization receives a pledge of $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 and the allowance account. Don’t double count pledges – once as revenue when the promise is made and again when payments are made.
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)
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 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.
For more information, check out the book “Nonprofit Finance: A Practical Guide – Second Edition”
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:
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.
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Not to be too paranoid here, but I just read an article about the Simi Valley Community Foundation whose former executive director stole over $45,000. According to the news, she forged a second signature on the checks used to pay her own mortgage. Sadly, this embezzlement cost the organization its reputation as it had to stop operations, at least for now. A total disaster.
It’s not clear how exactly the theft was discovered, but board members noted something odd, hired a forensic accountant to review the records, and went to the police with evidence of embezzlement. So, I give credit to the board for finding this out, but this theft had been going on for awhile.
So, what can a board do to prevent or identify financial fraud faster?
1- Knowledge –Get people on the board who understand financial matters and can ask the right questions. The board cannot have the obligation to fundraise and provide oversight only. Board members should have different backgrounds with least one person having the education and experience to really understand the information provided and ask good questions. Had this person been on the board of this Simi Valley nonprofit, the fraud may have been identified earlier.
2- Online Access –Have someone from the board check on the bank accounts of the organization online. He or she should review checks and deposits, looking for checks that don’t look right. Just having a policy about this review may deter fraud. Employees may think twice before forging signatures or doing something odd when they know that someone would be looking at the bank transactions regularly.
3- Pay attention –Listen to complaints from staff, donor, and vendors. Oftentimes, information that could be construed as gossip can be useful in pointing you in the right direction. People talk. Even though it’s not clear how the board of the nonprofit became aware of something wrong, my bet is that someone saw something and talked about it. Some nonprofits have started using hotlines for people to report possible fraud anonymously, a very good idea.
4- Variances –Pay attention to the actual vs. budget reports. Looking at this fraud, one may wonder how the $45,000 theft was classified and shown on the financial reports. The amount didn’t show up all at once, but it was likely classified as a budget item. So, if an overage is noted, the board should ask for back up documentations, such as bills.Talk only doesn’t explain financial issues.
5- System reports –Review new vendor/change vendor reports once a month to question any odd new vendor or changes. In this situation, the bank where the mortgage was paid to would have been added at a certain point to the accounting system. Had this report been reviewed, it may have flagged the bank as an odd vendor. Some accounting systems can send an email whenever a new vendor is added or changed, making this task automatic.
6- Bank reconciliations — Check on bank reconciliations, making sure they are done monthly. Keep an eye on deposits that are recognized in the accounting records, but don’t seem to be in the bank. Also, look at the detailed outstanding checklist. This can be done online using the accounting system and can be emailed to someone at the board. If a check shows up at the bank, but not on the accounting records of the organization, it could be a red flag.
7- Self-reliance –Don’t count on auditors to notice embezzlement. Audits are designed to assure reasonableness of financial statements and they may identify fraud, but not always, especially when done by management. When something seems wrong, not it, and don’t wait for the auditors to figure it out. Insiders are the first people to note things that don’t seem right.
8- Education — Educate all employees on fraud and embezzlement. Nonprofits should have this topic on its policies and procedures documentation and not be embarrassed about it. Fraud happens not just with stealing funds, but in other areas as well, such as equipment theft and overtime pay without authorization. Just showing this awareness and clarity over fraud may prevent it in the first place.
It’s a shame that nonprofit boards must be always on alert for fraud and embezzlement, but that’s the reality of the situation. Once a scandal happens, it’s hard for the organization to regain the trust and respect of donors, making it hard to move forward.
So, it’s time to talk about this issue openly and set up written policies and procedures with tasks specifically designed to prevent and identify fraud and theft. The ideas presented here won’t assure boards that they are safe from this issue, but are steps in the right direction. Each organization is different and I’m sure many will need more control features than the ones presented here. The crucial point here is that fraud signs cannot be ignored by the board.
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