How Not-For-Profit Organizations Can Prepare for an Audit

Nonprofit Accounting ResourcesAre you a nonprofit prepping your books for the next fiscal year? Here are five of the biggest mistakes I continually see not-for-profit organizations make – leading up to their audit.

1) They don’t track restricted grants, gifts and donations.

Many of the grants, gifts and donations not-for-profits receive are contingent on the demands of the donor. The restricted money is only received if the not-for-profit can prove the donation followed the restricted guidelines. Tracking this workflow now will better prepare your organization for any future audit.

2) They lack a digital archive system.

Every audit season, many not-for-profits waste time scouring their offices for months-old documents. June is a great time to ask your organization how these documents are stored. If your documents from last year are stored away in dusty filing cabinets, you are likely putting your not-for-profit organization at a disadvantage with any audit. Working a digital archive system into your budget now will save your team money and resources over the long-term.

3) They don’t track petty cash.

Every not-for-profit is continuously looking to minimize expenses. This means every penny must be accounted for. Yet, over the years, I’ve seen small and large not-for-profit organizations lack systems that track receipts and expenses for petty cash. Many not-for-profits waste hours on arbitrarily attempting to match expenses to calendar items, credit card statements or memory. This system, or lack thereof, paves the way for irregular expense accounting — a huge red flag to auditors. This fiscal season, your not-for-profit should work a simple expense application into the budget. Receipt Bank and Expensify are good platforms to sample.

4) The organization has incorrect reporting.

Pledges from donors are just that — a gift to be received at some time in the future. Future earnings are supposed to be accounted for as “Receivables and Income.” However, not-for-profits sometimes report pledges as cash and income as they are received. This incorrect reporting results in disparities in income and assets. Income is accounted for in the incorrect period, and assets of the year are incorrectly stated. Not-for-profits will run more accurate financial reports, and be better prepared for audit, by properly accounting for pledges.

5) There’s no tracking system for signed and initialed documents.

Auditors frequently request documents that verify an approval process via signatures and initials. Most not-for-profits tend to overlook the workflow process of these documents. This leads to a hard time finding any documents that show the accountability of a person. To aid the approval process, your finance team should invest in a cloud-based system with built-in oversight approval. Bill.com, Expensify and Concur are a few payable tech solutions that are worth the investment this fiscal year.




Nonprofit CFOs: Keep Your Staff Engaged With These 3 Tips

Nonprofit CFO Advice - Tips for Running a NonprofitThe nonprofit sector is the third-largest employer in the United States and continues to grow, so it is more crucial than ever for business owners to boost job satisfaction and retention. The good news is most nonprofit employees are happy (85% are satisfied, highly satisfied, or extremely satisfied). Nonetheless, any CFO’s goal should be to shift the standard from simply satisfied to truly engaged so staff will stay on at the organization.

What Does Engagement Entail?

Engagement in a broad sense can be defined as a level of commitment and involvement. While satisfaction is often used interchangeably, engagement extends further. Employee engagement requires willingness to expend extra energy and time toward achieving the organization’s goals, and the employee must also believe that those goals mirror his or her own. This is especially important at not-for-profits, given their limited resources and smaller budget when compared to their for-profit counterparts.

The challenge for nonprofit C-level staff is to create an organization where employees are engaged and stay for the long-term. But in order to make changes, you need to know what can and needs to be changed. Although 90% of business executives understand the importance of retaining staff, less than half have any idea of how to do it. The necessary responses are multifold, but the following 3 areas should be significant considerations for those directing a not-for-profit organization.

1.     It Starts at the Top

As the business owner or director of a nonprofit, you need to demonstrate the value of engagement yourself first. According to Dr David Dye of Deloitte Consulting LLP, “When the CFO leads on an issue, it gets more attention than when it’s sponsored just by HR.” If you want your staff to be engaged, you have to be their example. Every day. Inspire your employees with your words, communication, and action. This is essential for creating a real culture of engagement for your organization.

But it’s also vital that engagement with the work and other employees trickles down throughout the organization. If managers below the C-level don’t all seem committed to functioning as a team with the staff they are responsible for, your example will make a limited impact. The problem is, your managers may not realize this, or they may not realize that they’re not doing this effectively.

Managers have a habit of overestimating just how effectively they communicate on a daily basis with their employees. 87% of supervisors stated they had an open-door policy, while just 64% of employees agreed. Though 68% of managers stated they consistently held meetings, only 45% of their employees reported that they met their managers on a regular basis. Engagement has to flow down the command chain on a daily basis for all staff to see it and start to embody it themselves.

2.     Making Your Mission Key

Passion separates employees at nonprofits from other industries; “A strong affinity for the organization’s mission” continuously rates as the top relationship to an employee’s job satisfaction in nonprofits, whereas it ranks 20th out of 25 factors in for-profit sectors. This is a real edge for nonprofits, as it’s been proven that mission-driven companies have a 40% higher level of staff retention. The key is to bring your mission to the forefront of your operations so that your employees can really appreciate it, connect with it, and become more engaged with work as a result.

And it’s not just about what your not-for-profit is trying to do for society. How your organization operates on a daily basis is of great importance to your staff, too. This is why it’s essential to ensure you have the right culture in place. The organization’s culture will be determined by the values that are expressed by leadership, as we have previously discussed. So, the desired beliefs of the nonprofit must be clearly stated, reinforced, and celebrated. When an employee acts in a manner consistent with those desired core values, management should recognize and praise that employee. This is especially true as more millennials (18-35 years old) enter the workforce, for whom “positive culture” and “a calling in work” are vital mindsets. If team members think they’re on the right track, they’ll enjoy a boosted morale – while your nonprofit enjoys better staff retention rates.

3.     The Many Forms of Compensation

Without putting too fine a point on it, money matters. Nearly half of employees report dissatisfaction with their pay given their skill set and effort exuded. You should strive to match individual wages with expectations and needs. But studies have also shown that while increasing wages to meet employee expectations drastically improves morale, boosting wages beyond that level has a flat effect on job satisfaction. In other words, employees find it more important to be appropriately paid than to make more money overall.

Given the difficulty and apparently limited effectiveness of increasing nonprofit salaries, CFOs should explore alternative financial vehicles for staff retention. The Merrill Lynch Retirement Study reports that younger employees are going to become more dependent on their savings and investments, as opposed to social security, to support themselves during retirement. By offering retirement and death benefit plans, nonprofits can tap into staff needs, and retain key talent without having to augment pay.

Customized financial wellness programs are another potential offering. With their individual tailoring to each employee’s situation, these programs can save staff a considerable amount of money. Not only does this create goodwill towards your company and encourage employees to stay on, but it doesn’t bite into your equity either. This kind of cost-effective retention solution is ideal for a cash-strapped nonprofit organization.

Encouraging Engagement for the Future

This checklist is but a start for CFOs who want to lead a nonprofit where enthusiastic employees work hard, emulate a culture of engagement, and stay on. The best part is, none of these changes cost you any of your equity.

But don’t overlook these tips as quick fixes for later. Only 55% of nonprofit employees plan to stay with their current organization beyond the next two years. Make sure that’s not the case at your not-for-profit by giving your staff the right example, the right mission, and the right benefit package today.

Where do you see a need to improve at your nonprofit? Let us know in the comments section.

How Will the New Guidance for Financial Statements Impact Nonprofits?

Nonprofit Financial Statements After almost four years of research, analysis, and debate, the Financial Accounting Standards Board (FASB) released its highly anticipated update on financial reporting for nonprofits. The update, which was officially released on August 18, 2016, has been designed to “help not-for-profits tell their story through their financial statements.”

The existing guidance has been in effect since 1993, and while it has held up well over that time, “stakeholders expressed concerns about the complexity, insufficient transparency, and limited usefulness of certain aspects of the model,” said FASB Chairman Russell Golden. “The new guidance simplifies and improves the face of the financial statements and enhances the disclosures in the notes,” he added.

Basically, the Accounting Standards Update, designated ASU No. 2016-14, decreases the number of net asset classes from three to two. The new classes will be:

  • Net assets with donor restrictions
  • Net assets without donor restrictions

The update will change the way all not-for-profits (NFPs) classify net assets and prepare their financial statements.

Different Classifications of NFPs

All nonprofits, from the local soup kitchen, to major colleges and universities, have been using the same financial statements for the last 20 years. While good, at the behest of stakeholders, the FASB saw the need to make improvements to the existing model.

The new guidance applies to all NFPs, including: 501c3, 501c4 and 501c6 entities.

  • 501c3 – This is the most common classification of nonprofits. To qualify as a 501c3, an organization must fit into an “exempt” purpose as defined by the IRS. These include charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competitions and preventing cruelty to children or animals.
  • 501c4 – There are only two types of organizations that will qualify as a 501c4 organization: social welfare organizations and local associations of employees. Social welfare organizations can include homeowner associations and volunteer fire companies if they fit the exemptions.
  • 501c6 – The 501c6 designation is for qualifying business leagues, chambers of commerce, real estate boards, boards of trade and any professional football leagues, that are not organized for a profit.

There are actually 29 different types of NFPs identified by the tax codes, but these are the three most common entities. Regardless of the classification, all nonprofits will be required to follow the new financial statement requirements.

The FASB has produced a video, explaining why the standard needed to receive a makeover.

Details of the New Guidance for Nonprofits’ Financial Statements

The update was designed to help not-for-profits provide more relevant information about their resources, and any changes in those resources to donors, grantors, creditors, and other users, in effect to “better tell their stories.”

The FASB believes that the update, not only simplifies and improves communications with stakeholders, it should also reduce certain costs, related to the complexities in preparing their financial statements.

Specifically the new standard:

  • Will allow “underwater endowments,” those that are now worth less than when they were originally gifted, to be classified in net assets with donor restrictions.
  • Continues to allow preparers to choose between the direct method and indirect method for presenting operating cash flows. However, if the direct method is used, it is no longer mandatory to present the indirect method reconciliation.
  • Requires NFPs to be more transparent regarding providing information on how it manages its liquid resources and liquidity risks. A classified statement of financial position may be an effective way for organizations to comply with many of the new disclosure requirements.
  • Requires reporting of expenses by function and nature, as well as an analysis of expenses by both function and nature.
  • Requires that a net presentation of investment expenses against investment return appear on the face of the statement of activities.

When Do the Changes Take Effect?

The changes will take effect for annual financial statements issued for fiscal years beginning after Dec. 15, 2017, and for interim periods within fiscal years beginning after Dec. 15, 2018.

This is just “Phase 1,” of the FASBs project to revamp financial statements for nonprofits. The organization says there will be a “Phase 2.” Phase 2 is slated to address ways to improve operating measures and provide enhanced alignment between the statement of activities and statement of cash flows. The FASB has not indicated any timeframe for the completion of the second phase.

Certainly, these new regulations will have a significant impact on all nonprofit organizations and those stakeholders who rely on their financial statements. While the changes were designed to simplify financial reporting for NFPs – and in the long run, they will – getting used to the new requirements could still be complex. The earlier you begin working with your tax professional, the easier it will be to implement the necessary changes to ensure your financial statements will be in compliance with the new standards when they take effect.

 

Updated Standards for Nonprofit Financial Reporting

Nonprofit Financial Reporting TipsOn August 18, 2016, the Financial Accounting Standards Board (FASB) released Accounting Standards Update (ASU) 2016-14 changing the way nonprofits prepare their financial statements.  FASB’s overall goal in solidifying these changes was to improve financial reporting for nonprofits so that outsiders can more easily understand the organization’s financial position.  FASB accomplished this goal by changing the net asset classifications, enhancing the statement of cash flows, clarifying information regarding liquidity and availability of cash, simplifying the reporting of investments, and adding consistency across organizations on reporting expenses by function and nature.

Net Asset Classifications

Under the new Standards, FASB attempts to ease confusion over the net asset nomenclature by completely changing the names of the three existing net asset classifications.

  • “Unrestricted” net assets will now be termed “Net Assets without Donor Restrictions”.
  • Both “Temporarily Restricted” and “Permanently Restricted” net assets will be renamed “Net Assets with Donor Restrictions”.

Any Board of Director designations, such as funds that are “restricted” by the Board, will need to be fully disclosed – including listing the purpose of the restriction and the amount.  Organizations will also have to disclose the type, purpose, and amounts for all donor restrictions.

Endowments will be included in “Net Assets with Donor Restrictions” and any underwater endowments will need to be disclosed by listing the current fair value of the endowment less the original value of the donation, as well as the organization’s policy regarding appropriating funds from these underwater endowments.

Statement of Cash Flows

Nonprofits will now be able to use either the direct or indirect method of reporting cash flows.  Previously, nonprofits who used the direct method had to provide the indirect method as well; however, under the new Standards, this additional reconciliation will no longer be required.  Thus, FASB is allowing organizations to use the method that is most beneficial to the organization as opposed to mandating one methodology over another.

Liquidity and Availability of Cash

Under the new Standards, FASB is now requiring nonprofits to provide a qualitative description of how the organization manages its resources in order to meet liquidity needs and manage liquidity risk, as well as a quantitative description of the financial assets available for general expenditures within one year of the balance sheet date.  (A financial asset being cash, evidence of ownership interest in an entity, or a contractual agreement with another entity that clearly shows the organization’s intent to receive cash or an exchange of a financial instrument).  Organizations should note that an untapped line of credit does not meet FASB’s definition of a financial asset.

Essentially, FASB wants nonprofits to disclose how much the organization has available at the date of the balance sheet to meet cash needs for one year.  As this change will affect all organizations and will be the most onerous of the changes implemented by ASU 2016-14, FASB is not requiring organizations to provide comparative information in the first year that these Standards are implemented.

Reporting Investment Returns

Under the new guidance, organizations will now have to report net investment returns on the Statement of Activities.  Thus, external costs for investments plus all direct internal costs associated with the strategic and tactical activities involved in generating investment return (such as salaries, benefits, travel costs, and other costs associated with staff who are responsible for the development and execution of the organization’s investment strategy) will be netted against the actual investment income listed on the Statement of Activities.  These expenses will therefore not show up under “expenses” but in “revenues”.

Reporting Expenses by Function and Nature

Lastly, one additional change made by ASU 2016-14 is the requirement that all organizations complete a Statement of Functional Expenses as part of their annual financial statements.  This information can be presented as a standalone Statement, on the face of the Statement of Activities, or in the footnotes.  Due to the change in the reporting of investment returns (described above), investment expenses should not be included in the Statement of Functional Expenses.  In addition, FASB is requesting that organizations disclose how the organization allocates costs among program and support functions.  For example, if rent is allocated to programs based on level of effort, this specific methodology should be disclosed in the footnotes so that readers do not assume these costs appear solely in General and Administrative Costs.  During the first year that these Standards are implemented, FASB is not requiring organizations to provide comparative information on the Statement of Functional Expenses.

Implementation

ASU 2016-14 is effective for fiscal years beginning after December 15, 2017; thus, for most organizations, the financial statements starting in 2018 will need to be prepared using the new Standards.  However, FASB is allowing organizations to adopt the new Standards earlier, and, according to most auditors, early adoption should be exercised specifically by organizations that currently have “underwater” endowments.

FASB is currently considering additional changes to nonprofit financial reporting which are expected to address standard operating measures; however, no timeline has been set by FASB for deliberating these proposed changes.  Given the fact that ASU 2016-14 is FASB’s most comprehensive revision to nonprofit financial reporting since FAS 116 and 117 issued over 20 years ago, nonprofits should expect additional changes to come as FASB attempts to improve overall nonprofit financial reporting.

Fund Accounting for Nonprofits: What Is It and How Does It Work

Fund Accounting for Nonprofits: What Is It and How Does It WorkThe concept of fund accounting is one of the main differences between for-profit and nonprofit accounting. Its name comes from the fact that revenues and expenses are segregated in the accounting system into “funds” for the purpose of tracking each fund separately – primarily for reporting purposes.

As opposed to for-profit organizations which focus on profitability, nonprofits use fund accounting to focus on accountability, and the use of separate “funds” with their own ledger allows nonprofit organizations to more easily assess each fund individually. Depending on the nonprofit, a separate fund is typically established for each of the organization’s various programs as well as its overhead, general administrative, and fundraising activities. To track such revenues and expenses separately, the organization will set-up in the fund accounting system and assign to these transactions a unique fund code. In most cases, the fund code will contain a string of unique identifiers – such as a code for the donor, grant, project, location, and so on. Depending on the organization, this code string may go by different names – a budget code, project code, cost center, or similar. But despite the nomenclature used by the organization, these identifiers essentially serve the same purpose — allowing the accounting staff to easily run queries and generate reports in the accounting system by any value in the code string.

An added benefit of fund accounting is that, by tracking revenues and expenses separately for each fund, organizations can easily see how donors’ funds are being spent. This is essential not only for the purpose of easily developing financial reports for those donors who require them as part of their grant agreement, but also for the purpose of tracking fund restrictions and generating accurate financial statements. For example, if an individual donates money to a nonprofit organization and limits how the organization can use the funds, that money is considered restricted solely for that purpose. When these funds are recorded in the fund accounting system, the accountant must designate whether the donated monies are restricted and assign the monies to a given fund code. As the organization spends the donated monies on the purpose for which they are intended, the revenues associated with these expenses are no longer restricted, and the corresponding revenues are reclassified from the restricted net asset account to the unrestricted net asset account. Thus, at any time, the accounting staff can easily determine, based on the expenses assigned to each fund, how much of a donor’s money is remaining and how much of the organization’s net assets is categorized as restricted versus unrestricted.

Of course, fund accounting does not only benefit the accounting staff, but also program managers who rely on such financial information in order to appropriately monitor their program’s resources.  By segregating revenues and expenses into separate funds, the accounting staff can more easily provide programmatic staff with updated spending information, budget variances, forecasts, burn-rates, and pipelines, as well as monitoring program spending against donor-imposed restrictions (such as restrictions on budget line-item flexibility) – all of which is essential to program managers and to ensure overall programmatic success.

Given the unique role of nonprofits in our society, there is understandably a focus on an organization’s programs and its programmatic outcomes. But there is also a strong need for nonprofits to monitor the availability of funds that are designated for each individual program. Doing so helps the organization see where funds are being spent and where the organization should focus its fundraising activities. It also allows nonprofits to individually assess programs for effectiveness and efficiency.  And the use of fund accounting is essential to nonprofits in achieving these objectives.

 

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