Finance Fundamentals

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

[email protected]

Twitter: @richardwolfcpa

richardwolfconsulting.com