FINANCE FUNDAMENTALS February 29, 2012
Richard Wolf, CPA
Objectives
Characteristics of nonprofits and responsibility for
financial information
Basic review of accounting principles
Financial statements
Different members of the finance team
Financial policies for nonprofits
Communicating financial results
Nonprofit tax
Characteristics of Nonprofits
Vary in their missions but share three characteristics
that are present in varying degrees and distinguish
them from investor-owned entities:
Receive contributions of resources
Provide goods and services, or both, for reasons other
than to make a profit
No ownership interests
Responsibility for Financial Information
Management is responsible for the content of the
organization’s financial information including
adopting sound accounting principles
Management should establish and maintain controls
over the authorization, recording, processing, and
reporting of transactions
Board of directors is responsible for management
oversight
COSO framework
Basic Review of Accounting Principles
Definition of Accounting
Accounting is an information and measurement system
that identifies, records, and communicates relevant,
reliable, and comparable information about an
organization’s business activities. (John Wild, Ken Shaw, Barbara Chiappetta. Fundamental Accounting Principles, 19th Edition. 2009.)
Generally Accepted Accounting
Principles (GAAP)
Financial accounting practice is governed by concepts
and rules known as generally accepted accounting
principles (GAAP)
Accounting standards for nonprofits are set by the
Financial Accounting Standards Board (FASB)
Basis of accounting:
Accrual (GAAP)
Cash basis
Modified cash basis
Accrual Basis
Under the accrual basis, revenue is required to be
recorded when earned and expenses are recorded
when incurred
“Earned” revenue includes receipt of a contribution
or a promise to receive contributions
Accounts receivable
Accounts payable and accrued expenses
Cash Basis
Under the cash basis, revenue is required to be
recorded when received and expenses are
recorded when paid
No accounts receivable
No accounts payable and accrued expenses
Modified Cash Basis
Modified cash basis is essentially the cash basis which
incorporates “modifications….having substantial
support”
A modification has substantial support if both the
following conditions are met:
It is equivalent to the accrual basis of accounting
It is not illogical
Basic Financial Statements
Three or four basic financial statements depending
on the type of organization
Statement of Financial Position (Balance Sheet)
Statement of Activities
Statement of Cash Flows
Statement of Functional Expenses (only required for voluntary
health and welfare organizations although many other organizations utilize this
statement)
Statement of Financial Position
Might also be referred to as a “balance sheet”
Reports the organization’s assets, liabilities, and net
assets at a point in time
Focuses on the organization as a whole
Assets = Liabilities + Net Assets
Three classes of net assets
Unrestricted
Temporarily restricted
Permanently restricted
Temporarily Restricted Net Assets
Use is limited by either donor-imposed
Time restrictions, or
Purpose restrictions
As the donor-imposed restrictions expire or are
removed by actions of the organization, temporarily
restricted net assets are reclassified to unrestricted
Permanently Restricted Net Assets
Must be maintained by the organization in
perpetuity
Does not expire with the passage of time and
cannot be removed or fulfilled by organization
actions
Can only be changed by the donor
Unrestricted Net Assets
Net assets that are neither temporarily restricted
nor permanently restricted
All net assets whose use has not been restricted by
donors
Board designations, which are voluntary board-
approved segregations of net assets for specific
purposes, projects, or investments, are also part of
unrestricted net assets
Statement of Activities
Reports the results of operations (revenues and
expenses) and change in net assets over a period
of time
The change in net assets must be presented in total
and also by net asset class
Statement of Cash Flows
Provides information about the cash receipts and disbursements of the organization over a period of time
Cash receipts and disbursements from operating activities, financing activities, and investing activities
Statement is a bridge from accrual basis to the flow of cash
Two main types:
Direct method
Indirect method
Statement of Functional Expenses
Provides information about the organization’s expenses by function and natural classification
An organization’s functions are broken out by program services and supporting services
Supporting services include:
Management and general
Fund-raising
Examples of natural classification are salaries, occupancy, depreciation, and repairs and maintenance
Footnotes To The Financial Statements
Footnotes are an integral part of the financial statements
Examples of footnotes include:
Description of organization
Summary of accounting policies
Tax exempt status
Detail of investments
Property and equipment
Leases
Debt (loan details including future maturities)
Concentrations
Assets
Tangible, intangible, or future benefits to the nonprofit
Many nonprofits classify their assets and liabilities as
current and noncurrent
These designations refer to how quickly they are
expected to be converted into cash
Current assets are expected to be converted within one
year
Other nonprofits list their assets in order of liquidity
Assets - Examples
Cash – includes highly liquid investments with original maturities
of three months or less
Accounts Receivable
Unconditional Promises to Give – discounted to their net
present value
Inventories
Investments
Property and Equipment
Liabilities
Reflect organization’s obligations to provide assets,
products, or services to others
Accounts payable and accrued expenses
Notes payable and other long-term debt
Deferred revenue – cash received in advance of
providing goods or services
Contributions
May take the form of cash, investments, goods,
services, right to use space, etc.
They can be received at the date of donation or
may be in the form of a pledge for a future
contribution
Recorded at fair value at the date of donation
In-kind contribution – gift of goods to the nonprofit
Contributed Services
Should be recognized as contributions if they create
or enhance a nonfinancial asset (such as property or
equipment), or
They meet all of the following criteria:
The service requires specialized skills
The service is provided by individuals who possess those
skills
The service would typically need to be purchased if not
contributed
Financial Statement Options
Audit
Highest level of service provided by CPA
Provides reasonable assurance that the financial statements are free of material misstatement
Auditor seeks to understand the nature of an organization, reviews and evaluates internal control procedures, tests underlying accounting records
May identify weaknesses in internal control system
Does not provide guarantees that no fraud exists
Financial Statement Options, cont.
Review
Less assurance than an audit
Typically a lower fee due to less work required
Provides limited assurance that there are no material
modifications that should be made to the financial
statements
Compilation
Does not express an opinion or provide any assurance about
the fairness of a set of financial statements
Finance Team
Treasurer – Typically the officer of the organization
assigned the primary responsibility of overseeing
the management and reporting of an organization’s
finances. May or may not be a paid employee.
CFO
Controller
Bookkeeper
Finance Team
Finance Committee – supports development of
annual budget; monitors spending; provides
commentary on the “financial health” of the
organization to the board
Audit Committee – monitors the effectiveness of
internal controls; reviews scope of audit;
recommends the selection, retention, or termination
of auditors to the board; reviews Form 990
Financial Policies
Investment Policy
Internal Control Procedures
Purchasing Practices
Unrestricted Current Net Assets (Reserves)
Investment Policy
Helps defines the organization’s investment goals
and the financial risks the organization is willing to
take to achieve those goals
Investment policies should include:
Goals of the investment program
Investment objectives, risks and return (target rates)
Investment guidelines and constraints
Allocation of assets
Monitoring and control procedures
Internal Control Procedures
Internal control is the plan of an organization and
all of the coordinate methods adopted within a
business to:
Safeguard its assets;
Check the accuracy and reliability of its accounting
data;
Promote operational efficiency; and,
Encourage adherence to prescribed managerial
policies.
Internal Control Procedures, cont.
Not designed to uncover dishonesty and fraud
Internal control system is designed to detect and correct errors (mostly honest mistakes)
Internal Control Structure has five components:
Control environment
Risk assessment process
Information controls
Communication controls
Monitoring controls
Control Activities
Segregation of Duties
Individuals should not be put in situations in which they
could both perpetrate and cover up fraudulent
activity by manipulating the accounting records
The functions of authorizing a transaction, recording
the transaction, and taking physical custody of assets
related to a transaction should be kept separate
For example, the AP department can authorize
payment only after a purchase order is obtained
from another department
Purchasing Practices
Serves as a tool for maximizing available resources of funds, personnel, and time
Procedures should be inclusive of different types of purchasing, not just major purchases
Consideration must be given to: Routine purchases of supplies
Major equipment/furniture
Service contracts
Leasing of space
Reimbursement of expenses
Travel
Services (insurance, legal, accounting)
Others
Unrestricted Current Net Assets
Formerly known as reserves or reserve funds
What are optimal fund levels for the organization?
Provides a cushion for the organization in times of need
Nonprofit strives to have unrestricted current net assets available for a set amount of time (i.e., 120 days)
Having large amounts of unrestricted current net assets on hand is also considered to be a poor management practice
Communicating Financial Results
Who is the audience?
Management
Board of Directors
Public
Grantor
What level of detail is required? How frequently does it need to be communicated?
Weekly cash report
Monthly financials
Annual financial statements
Budget vs. Actual – How did the actual results
compare with the budget during the period?
What are the key metrics that are important to your
audience?
Number of members
Museum visitors
Contribution Dollars? # of contributors?
Program Revenue and Expense
Communicating Financial Results, cont.
Nonprofit Tax
Nonprofit is a type of organization, not-for-profit is a
type of activity, and tax-exempt is a status granted
by the IRS
Different types of tax-exempt organizations:
501(c)(3) – religious, educational, charitable, scientific,
literary
501(c)(4) – social welfare organizations
501(c)(6) – trade associations, business leagues
501(c)(7) – social and recreational clubs
Unrelated Business Income Tax
An organization is subject to tax on certain activities
to the extent the activities produce “unrelated
business income”
Income is unrelated business income if the activity:
Constitutes a trade or business;
Is regularly carried on by the organization; and
Is not substantially related to the performance of the
organization’s exempt function
Exceptions to UBIT
Convenience exception – primarily for the convenience of
its members, employees, customers, etc.
Volunteer exception – substantially all work is performed
without pay
Sales of donated merchandise
Qualified sponsorship payments – any payment received
by a person engaged in a trade or business to the extent
the person does not arrange for or expect to receive a
substantial return benefit
Advertising Income
Almost always UBIT
Special rules to calculate – direct and indirect costs
May need to allocate a portion of dues to
circulation income
Form 990 Basics
Form 990 – “Information Return”
Due date of the return – 15th day of the 5th month
following the end of the organization’s taxable year
Extensions – Automatic 3-month extension and an
additional (not automatic) 3-month extension
Form 990, 990-EZ (gross receipts < $200k and total
assets < $500k) and “e-Postcard” (990-N) (gross
receipts $50,000 or less)
Filing Form 990
Consists of a core form with 11 parts and 16
schedules
Not all of the schedules will be required for each
organization
What is the organization’s “story”?
Form 990 Information Requested
Financial data
Governance policies – heavily scrutinized by the IRS
and watchdog agencies (part VI of Form 990)
Compensation
Relationships
Transactions with insiders
QUESTIONS?
Instructor Contact Information
Richard L. Wolf, CPA, CGMA
Twitter: @richardwolfcpa
richardwolfconsulting.com