1. Improper Reporting of Net Asset Classifications and Corresponding Activity
Many non-profit entities struggle with accurately reporting unrestricted, temporarily restricted and permanently restricted net assets. Often, there are no procedures to identify and track the release of temporary restrictions, and there is no system in place to track or value donated goods, services and other non-cash contributions. Another common tendency is to record all contributions received during the period as if they were unrestricted and rely on audit adjustments at the end of the audit period to accurately report unrestricted, temporarily restricted and permanently restricted net assets. Unfortunately, this treatment results in inaccurate interim financial information reported to management, governing bodies and financial institutions that require interim reporting throughout the year. Ultimately, those overseeing the entity may be basing critical decisions on unreliable financial information.
To ensure proper reporting of unrestricted, temporarily restricted and permanently restricted net assets, implement policies and procedures surrounding proper recording and tracking of contributions and donated items. Procedures should include the following:
Compare contributions to supporting donation records to verify proper recording based upon the donor’s stated purpose and date of gift.
Ensure that promises to give over a future period are discounted to present value using appropriate discount rates and are recorded as temporarily restricted until payment is received
Review transactions periodically to identify satisfaction or expiration of temporary restrictions
Review and approve reclassifications between net asset categories (management)
Track donated goods, services and other non-cash contributions using pre-printed forms that contain:
Name of donor
Description of goods or services donated
Fair value, source of input and support for valuation
Signature of donor, and
Evaluation of accounting treatment in accordance with the organization’s policy
Those charged with governance and management should also periodically review financial statements, contributions and in-kind donations for accuracy and completeness. Consider incorporating the applicable procedures above into a period-end closing checklist. If your entity does not currently use a closing checklist, consider developing one. It can serve as a useful tool to track performance of critical controls and to ensure deficiencies do not fall through the cracks.
2. When Functional Expenses Become Dysfunctional
Allocations of functional expenses can be fraught with errors, from those as straightforward as formula or input errors, to more complicated errors due to flawed or outdated methodologies. To ensure an accurate allocation of functional expenses:
Thoroughly review the general ledger accounts to identify all indirect expenses that require allocation. Don’t forget to include common indirect expenses such as depreciation, utilities and interest.
Challenge any allocations of 100% of an indirect expense to management and general.
Review the method used for allocating indirect expense. Is the basis for the allocation reasonable? The allocation basis should be representative of the underlying function, and documentation supporting the selection of the allocation method and any assumptions made should be maintained.
Determine whether underlying data used in determining the allocation are current and complete. A time study conducted in 1972 provides little relevance to 2011.
Be consistent. Barring major organizational and technological changes, the allocation methodology must be consistent from year to year.
Reconcile totals in the allocation schedule to the general ledger and test the entire allocation spreadsheet for clerical accuracy.
As a final check, compare functional expenses to the previous years’ actual and budgeted amounts. Investigate and explain any variances.
3. Lack of Form 990 Policies and Procedures
In the Form 990, the IRS gathers information about whether an organization has written policies on document retention and destruction, acceptance of gifts, conflicts of interest and whistleblowers. Checking “no” to having these policies indicates to donors, potential donors and the IRS that the organization is lacking key governance controls. The IRS believes the absence of these policies presents greater opportunity for activities to go on that are not consistent with the organization’s exempt status.
As a best practice, implement written policies that address the key governance areas mentioned above. Check out the resources on Lindquist LLP’s non-profit page: http://www.lindquistcpa.com/nonprofit.htm for sample policies.
Of course, checking “yes” to having policies does not guarantee the structure for governance is adequate. Part of maintaining policies requires updating them when necessary, reviewing the organization’s activities to ensure procedures are carried out in accordance with the policies and ensuring the policies fit the organization based on the availability of the organization’s resources.
By implementing the suggestions above, your organization should experience fewer control deficiencies and, ultimately, a shorter management letter. Remember that management and Board oversight and review play a crucial role in having a sound control environment.