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1.1 Keeping Financial Records
1. 2 Preparing Accurate and Meaningful Financial Statements
(a) "Non-Accountant Test"
1. 3 Budgeting and Anticipating Financial Problems
1.4 Safeguarding and Managing Financial Assets
1.5 Complying with Federal and State Reporting Requirements
1.6 25 Myths about Not-for-Profit Financial Management
(a) Accounting Principles
(b) Financial Reporting
(c) Budgets and Operating Reserves
(d) Financial Management
(e) Government Regulation
(g) And a Bonus Myth
Not-for-profit organizations are among the most influential and powerful institutions in our free society. They range in size from small, local organizations to large national and international ones. Their scope covers almost every activity imaginable-- health and welfare, research, education, religion, social organizations, and professional associations. They include foundations, membership societies, churches, hospitals, colleges, and political organizations. A recent study of the not-for-profit sector by Independent Sector, a support and advocacy organization for not-for-profits, estimated that there were, at that time, 1.4 million not-for-profit organizations in the United States, that their share of national income was 6.8 percent ($ 289 billion), and that they employed 10.4 percent of the national workforce (14.4 million paid and volunteer workers).
Typically, these organizations are controlled by boards of directors composed of leading citizens who volunteer their time. Where the organization is large enough, or complex enough in operation to require it, the board may delegate limited or broad operating responsibility to a part-time or full-time paid executive, who may be given any one of many alternative titles-- executive secretary, administrator, manager, etc. Regardless of size, the board will usually appoint one of its own part-time volunteer members as treasurer; in most cases, the treasurer is second in importance only to the chairperson of the board because the organization's programs revolve around finances. While not usually primarily responsible for raising contributions, the treasurer is charged with stewardship of these resources and with the responsibility of anticipating problems and difficulties.
The treasurer is usually a businessperson who is extremely active in both professional and community affairs and so has only a limited amount of time to devote to the organization. Where there is a paid executive, many of the operating duties and responsibilities of the treasurer can be delegated to this executive and, in large organizations, through this executive to a chief accountant or business manager. However, in small organizations there may be no chief executive to delegate to, and in the following pages this will be assumed to be the case, both because small not-for-profit organizations predominate, and because it simplifies the presentation. It will further be assumed that the treasurer is not an accountant and doesn't want to become one, but at the same time recognizes the need to understand something about the principles of not-for-profit accounting and, more important, financial reporting.
The treasurer has significant responsibilities, including the following.
1. Keeping financial records
2. Preparing accurate and meaningful financial statements
3. Budgeting and anticipating financial problems
4. Safeguarding and managing the organization's financial assets
5. Complying with federal and state reporting requirements
While this list certainly is not all-inclusive, most of the financial problems the treasurer will face are associated with these five major areas.
1.1 KEEPING FINANCIAL RECORDS
The treasurer is charged with seeing that the organization's financial records are maintained in an appropriate manner. If the organization is very small, the treasurer will keep the records, probably in a very simple and straightforward manner. If the organization is somewhat larger, a part-time employee-- perhaps a secretary-- may, among other duties, keep simple records. If the organization is still larger, there may be a full-time bookkeeper, or perhaps even a full-time accounting staff reporting to the chief executive and responsible for keeping the records of the organization. Regardless of size, the ultimate responsibility for seeing that adequate and complete financial records are kept is clearly that of the treasurer. This means that to some extent the treasurer must know what is involved in elementary bookkeeping and accounting, although not at the level of a bookkeeper or a CPA. Bookkeeping and accounting are largely matters of common sense and with the guidance provided in this book there should be no difficulty in understanding basic procedures and requirements.
The important thing to emphasize is that the treasurer is responsible for seeing that reliable records are kept. The detailed procedures to be followed may be delegated to others but it is up to the treasurer to see that the procedures are being followed and that the records are reasonably accurate. This is emphasized because frequently in large organizations the treasurer feels somewhat at a disadvantage being a volunteer with relatively few hours to spend and not an experienced accountant. The bookkeeping staff on the other hand is full-time and presumably competent. There is a natural reluctance for the treasurer to ask questions and to look at the detailed records, to be satisfied that sound bookkeeping procedures are being followed. Yet the responsibility is the treasurer's, and questioning and probing are necessary to ensure that the record-keeping function is being competently performed.
1.2 PREPARING ACCURATE AND MEANINGFUL FINANCIAL STATEMENTS
One of the most important responsibilities of the treasurer is to see that complete and straightforward financial reports are prepared for the board and membership, to tell clearly what has happened during the period. To be meaningful, these statements should have the following characteristics.
These statements must represent straightforward and candid reporting-- that is, the statements must show exactly what has happened. This means that income or assets should not be arbitrarily buried in some subsidiary fund or activity in such a way that the reader is not likely to be aware that the income or assets have been received. It means that if the organization has a number of "funds," the total income and expenses of all funds should be shown in the financial statements in such a manner that no one has to wonder whether all of the activities for the period are included. In short, the statements have to communicate accurately and clearly what has happened. If the statement format is confusing and the reader doesn't understand what it is trying to communicate, then it is not accomplishing its principal objective.
The characteristics just listed would apply equally to the statements of almost any type of organization, including a business. Unfortunately, financial statements for not-for-profit organizations frequently fail to meet these characteristics. There are a number of reasons for this. Probably the most important is that the treasurer is doing the job on a part-time basis and does not have the time to develop a new format or set of statements. It is easier to continue with what has been done in the past. Also there is a marked reluctance on the part of non-accountants to make changes in statement format because they lack confidence in their abilities to tinker with the "mysteries" of accounting. Furthermore, at just about the time that the treasurer is really becoming conversant with the statements and could start to make meaningful changes, his or her term may expire.
(a) "Non-Accountant Test "
Since the purpose of any set of financial statements is to communicate to the reader, a good test of whether they accomplish this objective is the "non-accountant test." Can these statements be clearly understood by any interested non-accountant of average intelligence who is willing to take some time to study them? After studying them, will he or she have a good understanding of the overall financial activities for the year? If not, then the statements are not serving their purpose and should be revised and simplified until they do meet this test.
There are illustrations of all types of financial statements throughout this book, as well as suggestions on how to simplify financial statements to make them more readable. If these suggestions are followed, the statements should meet the "non-accountant test."
1.3 BUDGETING AND ANTICIPATING FINANCIAL PROBLEMS
Another major responsibility of the treasurer is to ensure that financial problems of the organization are anticipated so that the board or membership can take steps to solve these problems on a timely basis. A budget carefully prepared by management and the board is the principal tool that should be used. Budgets can take many different forms, from the very simple to the fairly complex, and all have as their primary objective the avoidance of the "unexpected." Budgets and budgeting techniques are discussed in some detail in Chapter 21.
But there is more to budgeting than merely anticipating the activities of the coming year. Budgeting in a very real sense represents planning ahead for several years in an effort to foresee social and economic trends and their influence on the organization's program. This means that the treasurer must be a forecaster of the future as well as a planner. In many organizations this is done in a very informal, almost intuitive manner; in others, this function is more formalized.
1.4 SAFEGUARDING AND MANAGING FINANCIAL ASSETS
Unless the organization is very small there will be a number of assets requiring safeguarding and, again, it is the responsibility of the treasurer to be sure that there are both adequate physical controls and accounting controls over these assets.
Physical controls involve making sure that the assets are protected against unauthorized use or theft, and seeing that adequate insurance is provided. Internal accounting controls involve division of duties and record-keeping functions that will ensure control over these assets and adequate reporting of deviations from authorized procedures. Another function of internal control is to provide controls that will help remove undue temptation from the employees and volunteers of the organization. Chapters 24 and 25 offer guidance on these matters.
Another responsibility of the treasurer is to see that the organization's excess cash is properly invested to insure maximum financial return. One of the accounting techniques often followed by not-for-profit organizations is to combine cash from several funds and to make investments on a pooled basis. Chapter 27 discusses the technique of pooling of investments and discusses some of the physical safeguards that should be established.
1.5 COMPLYING WITH FEDERAL AND STATE REPORTING REQUIREMENTS
The treasurer and chief executive officer are also charged with complying with the various federal and state reporting requirements. Most larger tax-exempt organizations, other than churches, are required to file annual information returns with the Internal Revenue Service (IRS), and some are even required to pay federal taxes. In addition, certain organizations must register and file information returns with certain of the state governments even though they are not resident in the state. All of these requirements taken together pose a serious problem for a treasurer, who is usually not familiar with either the laws involved or the reporting forms used. Chapters 28, 29, and 30 discuss these requirements in some detail.
In addition, organizations that expend more than $300,000 a year that has been received, directly or indirectly, from the federal government, are required to have additional audit work done (under OMB Circular A-133) to determine whether the organization is complying with the requirements of its federal awards. These are complicated requirements, which are likely unfamiliar to most people. Chapter 31 discusses this subject further.
1.6 25 MYTHS ABOUT NOT-FOR-PROFIT FINANCIAL MANAGEMENT
(a) Accounting Principles
Fact: Most of not-for-profit accounting is no different. The only area which is truly unique to not-for-profits is accounting for voluntary contributions received. Businesses make gifts, but they do not receive them. Accounting for gifts received, especially pledges, restricted gifts, and non-cash gifts (gifts-in-kind) is sometimes complicated. See further discussion in Chapter 10.
Fact: Every business except the extremely small uses fund accounting. They just don't call it that-- they call it accounting by department, subsidiary, division, branch, profit center, product line, operating unit, or whatever. But all of these sub-units of a business are exactly the same, from an accountant's viewpoint, as funds in a not-for-profit. Only the terminology differs. Also, businesses normally do not present information for multiple sub-units in their published financial statements; not-for-profits often do present information for separate funds.
Fact: Depreciation is a method of allocating the cost of long-lived assets over the accounting periods that benefit from their use. Failure to include this allocated expense in the reported expenses of a period understates the extent to which the organization has "used up" its available resources in carrying out its activities during the period. Excluding depreciation will make it seem as if the costs of various functions are lower than they really are; unwise decisions about allocations of resources may result. See further discussion in Chapter 7.
Fact: Volunteer time is a valuable resource to a not-for-profit. Failure to record the receipt of this resource understates the extent to which the organization has been the beneficiary of community support. Similarly, failure to record the corresponding expense understates the extent to which the organization has utilized available resources in carrying out its functions. Thus unwise decisions about activities to be undertaken, and how they are to be financed, may result. Also, the organization may appear to outsiders to be less significant than it really is. See additional discussion in Chapter 10.
Fact: Reporting of any of the postage as program expense in this type of situation is possible only if certain specific criteria are met. The non-fundraising portion of the material must have genuine educational value to the particular group of people to whom the appeal is sent; the content of the educational material must include a "call to action" on the part of the recipients; the audience targeted by the mailing cannot have been selected primarily for its giving potential. See further discussion in Chapter 14, section 14.8( c).
(b) Financial Reporting
Fact: Many people on governing boards and in management are not as sophisticated about financial matters as people in similar positions in a business. People who achieve positions of leadership in not-for-profits are more likely to have done so because of technical expertise in the organization's program service fields or simply because they are highly motivated individuals interested in a particular cause. While they may be very smart people, their training and experience often has not included much exposure to accounting and finance. Thus their ability, and willingness, to plow through large quantities of financial data to extract the information they need for decision making is limited. They are more likely to obtain a practical understanding of the real financial situation of an organization, or the financial effects of proposed decisions, if they have clear, concise, relevant, and credible data, instead of quantities of often largely irrelevant data. See additional discussion in Section 1.2.
Fact: If the statements are carefully prepared, with an emphasis on what is really important for the reader to know, the statements do not have to be confusing. See the discussion earlier in this chapter and throughout this book. Financial statements should pass the "non-accountant" test-- see page 5. If the statements fail the test, the recipients of the statements must complain, emphatically, to the preparer of the statements until understandable information is received. However the reader is not excused from responsibility for making a reasonable effort to understand what is presented. Studying this book is one of the best ways for recipients to discharge that responsibility.
Fact: An auditor renders an opinion, not a guarantee. What the auditor is saying is that the statements are not significantly mis-stated (contain material departures from GAAP), but the auditor could not possibly do enough audit testing to be able to guarantee that $5 (or $500 in a large organization) was not mis-classified or missing, somewhere. The presumption is that a person who relies on the information in the audited statements as a basis for making a decision about the organization will make the same decision as would have been made if the person could somehow have had access to information that was completely accurate. See the discussion in Chapter 26.
Fact: While not as important to a not-for-profit as for a business, the "excess of revenues over expenses" (the number in a not-for-profit's financial statements equivalent to profit of a business) does have significance to management and the governing board of a not-for-profit, and to other readers of the financial statements. For example:
(c) Budgets and Operating Reserves
Fact: While a budgeted deficit is not something which should be undertaken lightly or regularly, it should not be dismissed out of hand. Circumstances where this can be appropriate include the following.
See further discussion of budgeting in Chapter 21.
Fact: When you plan to lose money in your program activities, it is more important to closely monitor costs so that you don't lose more than you planned. You originally limited the planned operating deficit to an amount you believed could be covered by budgeted contributions and endowment income, and if the deficit increases there is no assurance that donors will be found to make up the additional amount.
Fact: What most organizations call the "endowment" fund is really composed of three parts: true endowment, term endowment, and quasi-endowment. The true, or permanent donor-restricted endowment can never be spent. The term, or temporary donor-restricted endowment will be able to be spent after the passage of a stated amount of time or the occurrence of a specified event. The quasi-endowment, or board-designated endowment, is legally unrestricted and can be spent at any time if the governing board votes to do so. See the discussion in Chapters 10, 13, and 15. Some organizations fortunate enough to have accumulated fairly large unrestricted endowments may feel uncomfortable admitting to donors (or faculty, or orchestra members) that they have such large reserves. They believe that donors will be less likely to contribute (or faculty or orchestra members will demand higher pay) if the true financial picture is known. However, this is not justification for attempting to present a financial picture that is less rosy than is really the case. It is only fair to donors and others that they should have complete and fair financial information upon which to base their decisions.
Fact: A board cannot create a restriction where no donor-imposed restriction exists. A board can "designate" the unrestricted endowment; it can segregate the assets in a separate investment account; it can "appropriate" the assets for some future purpose (such as being held to produce investment income), but it cannot "restrict." Only an outside donor can cause the amount to be reported as restricted in the financial statements. Board-designated (the proper term) amounts must be reported as part of the unrestricted fund (or class of net assets). The reason for this is that anything a board votes to do, it can later vote to undo; so the so-called "board restriction" is not really legally binding the way a donor-imposed restriction is. A donor-imposed restriction can only be changed by the donor, if the donor can be located and is willing to lift the restriction. (There is a legal procedure, known as cy pres, which can lift a restriction, but this is very cumbersome, and will not be approved by a court except in very rare cases of extreme financial emergency.)
Fact: In this case, accounting rules will likely require that the financial data for the two organizations be combined for financial statement purposes, and readers will still see the entire amount of assets available for the benefit of the organization. See further discussion in Chapter 9.
Fact: Whether or not combination is required depends on the real nature of the relationship between the two organizations. Even if formal legal control does not exist, there may still be effective control through overlapping board membership, the parent having the power to appoint board members of the affiliate, or to dictate how the affiliate uses its resources. Combination may still be required. Even if combination is not required, the two entities are considered "related parties," and information about the existence of and transactions with the other organization is required to be included in each organization's financial statement footnotes. So donors will still be aware of the other assets held for the benefit of the parent organization.
(d) Financial Management
Fact: Every board member has a fiduciary responsibility for all of the affairs of the organization, including finances. While the treasurer may be charged with paying special attention to this area, that does not excuse any board member from exercising diligent oversight in this and all areas. See additional discussion in Chapters 1, 22, and 24 of this book, in Section 5.5 of the book Tax Planning and Compliance for Tax-Exempt Organizations by Jody Blazek (John Wiley & Sons), and in Chapter 3 of Financial Management for Nonprofit Organizations by Hankin, et al. ( John Wiley & Sons).
Fact: See the response to the previous myth. Management decisions made by these people can truly make or break an organization. Examples include decisions about which compositions an orchestra will perform, what hours to open the clinic, how many professors to hire in the department, and what kinds of objects to acquire for the collection. If these decisions are made without considering the financial consequences, the future of the organization will likely be placed in jeopardy. Unfortunately, such people may not give adequate consideration to the financial implications of their operating decisions.
Fact: Unfortunately, people do steal from organizations that serve the needy. If anything, internal controls are often more important to a not-for-profit than to a business. While controls are sometimes looked upon by people in the not-for-profit sector as nuisances that impede achievement of the organization's goals, reasonable controls will actually further that achievement. See the discussion in Chapter 24. Failure to establish and monitor adequate controls is a certain recipe for eventual organization failure. Also in Chapter 23 are examples of situations where weak controls almost destroyed (did, in one case) not-for-profit organizations.
Fact: Information generated by a computerized accounting system is only as good as: (1) the information that is put into the computer, and (2) the instructions by which the computer processes the data. Since both are very much subject to human error, computerized data should be scrutinized just as carefully as manual data to ensure it is complete and accurate. See additional discussion in Chapter 36.
(e) Government Regulation
Fact: Some not-for-profits do have to compute and pay income taxes. These include: those that have unrelated business income, private foundations, not-for-profits that have a for-profit subsidiary, and not-for-profits that are not tax exempt (there are some). Not-for-profits are also subject to most of the same requirements regarding payroll taxes as are businesses. In addition, organizations that have been granted "exempt" status by the IRS must always be careful to comply with the legal requirements for retaining that status. See further discussion in Chapter 28.
Fact: The Internal Revenue Service can and will hold board members and managers personally liable for unpaid payroll taxes, regardless of a declaration of bankruptcy or the corporate form of organization.
Fact: Having the net income after tax is better than having no in-come at all. Only if the organization receives a very large percentage of its total income from taxable activities will there be any concern about actually losing tax-exempt status. Filling out a tax return (Form 990-T-- see Chapter 29) is usually a small price to pay for a good source of income.
Fact: Most states require even organizations that merely solicit by mail or media in the state to register for conducting the solicitation. See the discussion and list of states in Chapter 30.
Fact: Some horses have bad teeth. For example, accepting a gift:
Fact: Sometimes, but not always. For example, suppose your charity is a recipient of funding from a local federated fundraising organization (such as United Way) that has a policy that if a member agency reports an unrestricted fund balance (net assets) amount in excess of one year's operating budget, the excess will be deducted from next year's allocation by the federated fundraiser. Further suppose that it is December 30th and you expect that your December 31 (your year end) unrestricted fund balance will be just about equal to one year's operating budget. Now suppose a major donor walks in the door and wants to make a large gift before year end (to get the personal tax deduction into the current year). Would you want the donor to make the gift unrestricted or restricted? If the gift is unrestricted it will increase your year-end fund balance above the one-year limit, and the federated fundraiser will deduct the amount from next year's allocation. Your donor has just effectively made a gift to the federated fundraiser; you get no benefit from it.
This illustrates the importance of open and frequent communications between accountants, management, fundraisers, and donors. If one party (the fundraiser, in this case) is not aware of all the consequences of various actions (soliciting unrestricted gifts), outcomes (the gift effectively ends up going to the federated fundraiser) can be other than what is best for the organization (more resources available for its programs). Accountants and managers must take steps to ensure that such open communication occurs.
(g) And a Bonus Myth
Fact: There is one. You're reading it.
Few positions have more opportunity to influence institutions that affect society than that of the volunteer treasurer of a not-for-profit organization.
In the past, many treasurers have struggled to perform their duties but have become mired in detail or lost in the intricacies of the apparently different accounting and financial principles applicable to not-for-profit organizations. One of the principal objectives of this book is to help the treasurers and chief executive officers of such organizations discharge their responsibilities in an effective manner with the least expenditure of time.