Author Archive for Eric W


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“Other” Audits

We talk a lot about financial accounting, financial statements audits, and internal audit, but what about those “other” audits and financial reporting?  Occasionally, we organizations go through audits that don’t fit into our normal course of business.

For example, if an organization accepts or offers any Charitable Gift Annuities, they may need to register with the state as a provider of insurance.  With that comes annual reporting requirements and the periodic audit of those annual reports.  Organizations with retirement plans likely have their retirement plans audited.  IT systems may be audited as a part of the financial statement audit, and organizations that accept donations via credit card may have a PCI compliance audit.  Grant accepting organizations require an A-133 audit.  And, though we all pray they don’t happen, there’s also the possibility of the dreaded IRS audit.

At times the amount of regulations and number of audits can seem daunting.  In a given year, World Vision US and World Vision Int’l combined may have 7 to 10 external audits, plus additional voluntary and required reporting to groups such as Accord, InterAction, the ECFA, and the BBB.

How do we handle all this “other?”  First, as with all things, do it right the first time.  Audits are feared when you know you’ve done something wrong or when you’re unsure if you did it right.  Ensuring that we do our accounting and operation right the first time, to the best of our ability, takes a lot of stress out of audit and reporting, especially when the audits are out of the norm or unexpected.  This is where solid internal controls and policies/procedures come into play

Second, stay organized.  Keep lists or calendar reminders of all the audits and reports.  Have assigned point people for each audit.  Due dates occur throughout the year and do not always coincide with fiscal year end.  Keeping track of entrance dates, exit dates, deadlines, auditable year ends, etc. is very important.

Third, stay in scope.  With a new or infrequent audit, you may not understand exactly what they are looking at or why.  Before the audit begins, make sure that you have a good understanding of what the audit is covering.  Give the auditors the information that is within that scope, and keep conversations within the scope of the audit.  This helps keep the audit running smoothly and on time.

Four: be courteous.  Auditors/examiners are employees working a job, and likely have no personal interest in the audit outside of their job role.  Help make the job easy on both of you.

Finally, communicate.  If you don’t understand something, ask questions.  If the auditor brings up an issue, talk about it and investigate.  Your organization is unique and likely has a quirk the auditor has not come across before.  Take time to explain things as they come up, while the audit is in progress.  Don’t wait for the audit report.

See also:  A Good Audit Experience


Are Joint Costs Valid?

Charity Navigator last year issued a change to the financial metric reporting.  The tone of the statement by Charity Navigator brings up an interesting debate about what is or isn’t accurate reporting.   The statement by Charity Navigator is this:

“Joint Cost Allocation Adjustment

Generally Accepted Accounting Principles (GAAP) allow for organizations that follow SOP 98-2 or ASC 958-720-45 to report their specific joint costs from combined educational campaigns and fundraising solicitations and the IRS requires organizations to disclose this on the Form 990. In most cases, charities utilizing this technique allocate a small percentage of their solicitation costs to program expenses from fundraising expenses. However, we believe that donors are not generally aware of this accounting technique and that they would not embrace it if they knew a charity was employing it, nor does Charity Navigator. Therefore, as an advisor and advocate for donors, with rare exception, when we see charities using this technique we factor out the joint costs allocated to program expenses and add them to fundraising.”

Let’s break down this statement and address it in light of GAAP and IRS requirements:

“Generally Accepted Accounting Principles allow…utilizing this technique…”

This is an interesting choice of words by Charity Navigator.  They say that GAAP allow organizations to follow principles rather than require.  Charity Navigator is taking a stance here on where they see the importance of GAAP.  What they seem to be saying is that GAAP are a set of principles that are allowed, and organizations simply pick and choose which of the principles they would like to follow.  They also do not refer to them as accounting principles but rather, techniques, not a term I’ve heard used before.

I’d like to suggest that this is bad guidance to follow.  Don’t fall into the trap of thinking that you simply pick the principles that you like, follow those, and ignore the ones you don’t like.  If your organization has an activity that meets the criteria of joint costs/activities, you should report it as such.  Accounting records should not be massaged to influence watchdog rating criteria.

The guidance for Joint Activities is found in ASC 958-720-45, starting at paragraph 45-28.  Looking at paragraph 45-29, the guidance states, “If the criteria of purpose, audience, and content are met, the costs of a joint activity shall be classified as follows…”  The guidance here and in the following paragraphs does not seem to make any provision for organizations to elect or choose to follow this guidance.

For more information on accounting for joint costs, see our previous post Joint Costs and Joint Activities

For more information on functional expense reporting, see our previous post Functional Expense Reporting

The Form 990 line that Charity Navigator is referring to is Part IX, Line 26.  The instructions for this line refer only to specifics kinds of joint activities.  Per the Form 990 instructions, “An organization conducts a combined educational campaign and fundraising solicitation when it solicits contributions and includes, with the solicitation, educational material or other information that furthers a bona-fide non-fundraising exempt purpose of the organization.”  Given this specific criteria, it is possible that an organization would have joint costs allocations in their audited financial statements that would not be included on Line 26 of Part IX of the 990.  As always, check with your tax professional for advice.

“…charities…allocate…solicitation costs to program expenses…”

The wording that Charity Navigator uses to describe the process here, instantly influences the reader to a certain opinion as to what organizations are doing.  It’s subtle, but I think it’s important.  What CN is saying is that organizations are taking expenses from fundraising, and moving them to programs.  It makes it seem like organizations are doing some creative accounting.  But, this is not what is happening in most cases.

An organization following GAAP, is not moving expenses, but is rather reporting expenses in the correct bucket to begin with.  The expenses recorded under joint costs are program expenses because they are the expenses for running programs.  They are not fundraising expenses and therefore cannot have been moved from fundraising to programs.  By framing these expenses as having been moved, it places doubt in the mind of the reader as to the validity of the joint costs.  However, most organizations reporting joint costs are simply accurately reporting their expenses, and not moving anything.

Joint costs, along with the functional expense allocations in general, can and will be manipulated by some charities.  I’m not so naive as to think this doesn’t happen.  However, CN is singling out one line on the Form 990 as being “bad” (the only line they single out on the 990) and worthy of arbitrary reallocation with no input by charities as to the nature of the expenses.

“…add them to fundraising.”

Charity Navigator, once identifying all joint costs as invalid, takes the additional step of deciding for charities where the program costs should then be moved to.  They have decided on fundraising.  Given that joint costs can be programs, fundraising, or management & general, I find it curious that they have been able to determine that all program costs should be moved to fundraising, and not some or all to M&G.  Since the amount of costs spent on fundraising is a key metric for CN, representing about a third of the financial rating of an organization, this change could be critical for some organizations.

The risk that CN is trying to address is stopping organizations from misstating their functional expenses.  However, if an organization is already misstating their functional expenses, they will likely just stop reporting anything on Line 26 and easily avoid the new CN criteria.  The risk CN is trying to address will likely not be addressed with this change, it only hurts the organizations that are being truthful in their reporting and are following GAAP.

“…donors are not generally aware…”

Charity Navigator’s justification for this change is not a justification I would follow for the purposes of financial reporting.  The reason they give for altering charities’ financial statements is that (1) donors are not aware of it, (2) donors would not embrace the practice, and (3) CN does not embrace the practice.  In other words, CN does not approve of GAAP, therefore they are making the assumption that donors do not either, not that the donors are aware of it anyway.

Donor opinions are important and valid in determining practices in many areas of fundraising.  However, this is probably not sound practice for determining whether or not to follow GAAP.  The vast majority of donors do not understand most if not all accounting principles.  For instance, members of the general public likely don’t understand the Black-Scholes method for valuing stock options, but that doesn’t mean that the SEC should restate the financial statements of all companies that follow it.  Donors likely do not understand joint cost allocations or any of the functional expense allocations; therefore, it makes a very poor reason to restate organizations’ financials.

Why then is Charity Navigator making this change?

The answer can be found on Ken Berger’s blog, “Ken’s Commentary”.  Ken Berger, the president of Charity Navigator, was interviewed by Anderson Cooper.  During that interview, Cooper pointed out that CN had given a favorable 3 star rating to the National Veteran’s Foundation, an organization under investigation for shady fundraising practices, and asked if CN would review their rating.  Looking at NVF’s Form 990, you’ll find that 76% of their expenses are reported as joint costs.  It appears that CN’s reaction to being called out by Anderson Cooper was to address the low-hanging fruit: joint costs.  Ken Berger makes the statement in the comments of his blog that “We made a substantial upgrade of our metrics to minimize the chance we would run into a situation like this again.”  The addition of the joint cost adjustment was the only change to the CN metrics in 2012; therefore it is assumed this is what he is referring to.  By reallocating NVF’s joint costs, their rating was dropped to zero, and the problem resolved.  Unfortunately, the treatment given to this one bad apple seems to have been applied to all charities.

(Update 2.25.13 – In this article by the Chronicle of Philanthropy, Ken Berger states that about 50 charities lost ‘stars’ as a result of the rating change.  CN has gone back and reevaluated those charities by examining their websites to check for significant focus on education, and if so, reversed the rating change.  Of those 50, 11 charities have had the joint cost reallocation reversed and ‘stars’ restored.)

The number of watchdog groups is growing, and their influence and popularity is growing.  The work that they do to inform and educate donors is important, however, I urge you, do not let watchdog criteria decide your accounting practices and especially not your programmatic goals.  Follow GAAP, follow IRS guidelines, and report your finances truthfully.


Draft NFP Audit and Accounting Guide Released

*UPDATED 8/30/12 9:08am*

The AICPA has recently released their draft of the overhauled Not-for-profit Audit and Accounting Guide, and made it available for download and comment.  Unfortunately, the draft is not a redline version, so figuring out what has changed can be a little tricky in the 476 page document.

An article posted by the Journal of Accountancy gives some insight into changes included in the draft, and hopefully more articles come out soon by people who have time to cross reference the new draft with the old guide:

  • A greatly expanded section about reporting relationships with other entities. The guide will provide guidance and examples for reporting relationships with not-for-profit and for-profit corporations, limited liability partnerships, general partnerships, and financially interrelated entities.
  • New sections about reporting and measuring noncash gifts, including gifts in kind; contributions of fundraising materials, informational materials, advertising, and media time or space; below-market interest rate loans; and bargain purchases.
  • A greatly expanded section about municipal bond debt, including IRS considerations, third-party credit enhancements, capitalization of interest, extinguishments and debt modifications, and the effects of terms such as subjective acceleration clauses on the classification of debt.
  • New guidance for reporting the expiration of donor-imposed restrictions.
  • New section on the administrative costs of restricted contributions.
  • New section on programmatic investments.
  • Greatly expanded discussion about the legal and regulatory environment in which not-for-profit entities operate.

While there is sure to be many topics for discussion regarding the new draft (and I’ll leave topics for my fellow bloggers), there was one change I noticed that stood out to me as being a significant change.

Contributed Advertising Airtime

Paragraph 5.159 states two things:

1. “…the use of property, utilities, or advertising time are considered to be forms of contributed assets, rather than contributed services.

2. Recognition of advertising time as a contribution received “is unaffected by (a) whether the NFP could afford to purchase them or (B) whether they would typically need to be purchased by the NFP if they had not been provided by the contribution.

In current practice, contributed airtime is considered to be a contributed service and therefore, subject to the more stringent rules regarding recognition, namely that the organization must have been able to otherwise purchase and would have purchased.  This means that millions of dollars of previously unrecognized revenue and fundraising expenses, would theoretically now be recognized if organizations were to follow this guidance.

To see the effect of this, lets use an extreme example, the United Way.  For the year ended 6/30/10, the United Way recognized the following:

Total Revenue: 92,385,000

Program services expense:  85,456,000

General and Administrative expenses: 7,448,000

Fund-raising expenses: 2,090,000

Total Expenses: 94,994,000

*All numbers taken from United Way’s Financial statements for June 30, 2010, available here

In footnote 23, they also list three types of donated advertising that they receive which totals ~$65 million.  However, they currently do not recognize this as revenue because of “UWW’s inability to purchase such advertising.”  If these donations are now to be considered contributed assets, then the criteria for ability to pay would no longer apply and all would be recorded as revenue.  An open question would be whether this airtime would subsequently be considered a fundraising expense or a program service; but to make a more dramatic example, lets was considered it to be fundraising expense.  Their financials would dramatically change and might look something like this:

Total Revenue: 157,385,000

Program services expense:  85,456,000

General and Administrative expenses: 7,448,000

Fund-raising expenses: 67,090,000

Total Expenses: 159,994,000

*Please note these numbers are used only to provide an example and do not imply that this is the way United Way would record their revenue in the future or that United Way is under any obligation to follow this guidance

Revenue for the United Way would increase 70% to over $150 million and the fundraising ratio could potentially increase from just 2% to 42%.  Granted, most organizations do not have nearly as much donated airtime as United Way, and all this air time could possibly be considered program services, but this shows the extreme that this guidance could be taken.  Many organizations do receive donated airtime and there could be increases in revenue for several organizations.

The 990 Effect

The question that then comes to mind is, how does this affect the 990?  On the 990 contributed services are excluded from revenue/expense but other non-cash gifts are included.  The instructions for the 2011 form, Part VIII Statement of Revenue state “Contributions do not include…donations of services (such as the value of donated advertising space or broadcast air time).”  So as of now, donated air time is still excluded from the 990, but it will be interesting to see if the IRS follows the new guidance or remains different.  If the 990 stays the same, then we’ll have to watch for organizations that possibly could show large differences between their financial statement revenue and their 990 revenue.

The 990 is additionally important as it is the document that is used by watchdog organizations for evaluating charities.  While organizations financial statements may show a significant change, their 990 would likely stay the same.

In conclusion, it appears that this update to the Audit and Accounting Guide should be reviewed closely by organizations to see how the changes could affect them.  For those organizations that receive non-cash gifts, both assets and services, chapter 5 especially should be reviewed.  I’ll eagerly await other’s articles as more changes are found and discussed.


Be Creative

It is very easy as an accountant to lose sight of the big picture.  For those of us that work in U.S. or in another country away from the primary ministry as a part of a large organization, we generally work in cubicles, take few if any trips to “the field,” and have little interaction with the ministry of the organization other than anecdotal stories and expense invoices.  For those that do work in ministry countries, you may also be living in the capital city, working in a cube, holding a staring contest with a computer monitor.

In our world of Audit Risk Alerts and GAAP compliance, we can easily begin to think that following accounting guidance and producing sleek financial statements is the end goal.  We lose sight of the forest for the trees.  We push compliance to the detriment of the efficiency of the organization and the sanity of our coworkers.  Compliance is important.  GAAP must be followed.  I agree with both of those statements, and work hard at my organization to ensure that both stay true. But as accountants, and generally back office staff, we must work hard to remember why we are doing this as our visibility is limited.

Our ministry staff are working hard, overwhelmed with the burdens that I’m sure they face on a daily basis.  Our organization works internationally, with the poorest of the poor.  Our staff work in areas like South Sudan, and the DRC.  They are working with child soldiers, starving families, AIDS orphans, and victims of water-born illnesses.  In the midst of that they must also file expense reports, donor reports, grants reports, etc.  The question I ask is, how do we make this easier for them?  What can we do to help them have more time to concentrate on the program work they are doing?

I think accountants have the opportunity to be the most creative people in the organization (and in a good way, not the go-to-jail-for-fraud way) and this is why:  Being creative in an open space is easy.  It’s easy to “think outside the box” when there is no box to begin with.  Therefore, people in marketing and art and design departments of organization often get the credit for creativity.  In accounting and auditing, we are in a very constrained box.  To develop a truly creative, innovative idea that fits within the box we must use, we must be really creative.  We must think creatively inside the box.  This higher level of creativity is what gives accountants the opportunity to be the most creative employees.

By being creative in how we work, we can think about the end goal: the ministry and programs of the organization.  We can redesign processes, cut out unneeded burden, keep our financials in compliance so there are no unintended consequences, and keep our program workers focused on what they really need to be working on.

In conclusion, I challenge myself and the readers in two things:

(1)  Get to know your programs.  Invite members of your programs staff to speak to your accounting department.  Volunteer in local programs.  If possible take trips to field sites.  Ensure that you and your staff know what the organization does and what you are all working for.

(2) Be creative.  This isn’t something that is usually said to accountants, and it comes with a word of caution.  Don’t get so creative that you lose site of the rules and regulations that we must follow.  Getting your organization in trouble with auditors or the IRS can greatly diminish the impact of your organization.  But find ways to innovate inside the box.


A Good Audit Experience, Part II

Yesterday, I discussed some tips for NFP accounting departments for having a good audit experiences.  Today I wanted to give some tips to the external auditors, for working through their audits with clients.

Tips for the external auditors

  1. Clearly communicate issues and errors immediately.  Few things are more frustrating for a client then to have a problem, issue, or error reported late in the audit process.  If these issues are raised early, the client can manage expectations, and often can provide additional information/context which would mitigate the error.
  2. Be courteous of your client’s time.  Accounting departments at NFPs are generally short staffed.  Additionally, the latter half of the calendar year (when many audits take place) is the busiest time for many NFPs.  Understand that your clients are busy and have limited time available.  Clearly communicate your time needs to your clients.  Schedule interviews and walkthroughs ahead of time.
  3. Be proactive.  Schedule audit dates well in advance.  Send out request lists in advance.  Offer things to the client that they can get done early.  Keep the client informed of new accounting issues that you know will affect them.
  4. Be open and responsive.  The financial statements are those of the organization, and the organization knows how they run best, better than anyone.  Be willing to take the time and listen to the client’s explanations and expectations.  Give clients a chance to respond to errors, adjustment, and suggested changes.
  5. Know the business.  Each organization is unique.  Not for profits span a variety of industries, from hospitals, to universities, to relief and development organizations.  Get to know not just your client’s industry, but how they run their business.  This will greatly increase your ability to have a successful relationship with your client, identify audit and business risks, and add the most value to them.  This will enable you to exercise good judgment when evaluating the client, rather than simply applying stock audit procedures.
  6. Be creative.  You may not be able to get exactly what you want, or perform an audit procedure exactly the way the canned procedures states, especially if it is a new request.  Each client is unique.  New systems to track and report take time to put into place.  But if you think creatively, you can often identify information which provides good indicators to answer your questions and complete your procedures.
  7. Add value.  Audits can often seem to clients to be a hassle and a waste of time.  Change this attitude by adding value to the audit.  Partner with the organization, encourage them to discuss issues with you, provide access to CPE.  Concentrate on the important things.  Clients are generally not going to what to deal with small, trivial issues or “reviewer’s preference.”  When presenting issues to the client, ensure its importance; clearly explain the effect on the financial statements and the audit.
  8. Reversing entries ≠ fraud.  On most accounting systems, if an error is made to an entry, the only way to correct it is to post a reversing entry, then the correct entry.  Accounting systems are unforgiving.  Because of this, reversing journal entries are normal occurrences and generally not an indication of fraud.  Additionally, month end accrual entries are typically automatically reversed the next day.
  9. Communicate regularly.  Hold regular status meetings with your client when the audit is taking place.  During the off-season, keep in touch with your client about the audit, and new accounting issues that need to be addressed.
  10. Own the project management and timelines. (You will notice that this is also in the client’s tips). It is in both parties’ interest to create and stick to an efficient audit schedule. With both sides managing the timeline, due dates are easier to keep.  Schedule the audit well before you are to arrive at the client site (> six months).  Plan dates that you will be onsite and in the office.  Help the client determine the date that you will issue.  Plan for and schedule time for manager, partner and concurring reviews.

An audit can be a good experience for both sides.  We hope these tips help your next audit be a good experience for all.


A Good Audit Experience, Part I

Within our group here, we have many years of experience being external financial statement auditors and many years working in non-profit accounting, preparing financial statements, being audited, and conducting internal audits.  Seeing things from both sides of the table, we thought we’d offer some insights into working with auditors and not for profits, in order for both sides to have a good audit experience.  I’ve broken this up into two posts, to make it a bit more digestible.

Tips for the NFP accounting department (the client)

  1. Don’t fear audits.  When working as an auditor, I would often get the reaction from clients that we were someone to be feared and cautious around.  Auditors are there to do a job that you have hired them for.  Most of them are friendly, outgoing, fun-loving 20-somethings (and looking younger by the day).  There are no tricks and auditors will generally give you ample opportunity to explain yourself.  Be friendly and build good relationships with your auditors.
  2. See the auditors as partners.  Auditors have access to accounting resources, often well beyond what is available at a typical not-for-profit.  For instance, auditors visit several organizations throughout the year and therefore see the way that many orgs approach the same thing.  Additionally, they are backed by the other employees and partners of the audit firm who often have combined decades of experiences.  Many audit firms have members that are on FASB committees or other working groups, are presenting at conferences and teaching CPE.  The combined knowledge of the auditors is great.  Use this available resource to shore up your accounting practices, and interpret and apply new accounting standards.
  3. Be pro-active in communicating with your auditors. Stop by; see if they have any questions.  Schedule regular status meetings.  Bring issues to them. This may seem counter intuitive, but it builds trust and ensures any issues which arise are resolved quickly and don’t spin out of control.
  4. Be sure of your documentation and understanding.  The financial statements are yours, the organization’s.  Make sure that you understand the financial statements and therefore any changes that the auditors propose.  Also, much audit work is based on the documentation provided to the auditors.  When designing or evaluating your internal processes, make sure that each process and each transaction is well documented so that there will be an audit trail to follow.  An easy to follow audit trail will likely result in fewer questions from the auditors and answering questions will be easier.
  5. Provide what they need.  Auditors generally want the audit to be done as quickly as you do.  Since the audit is dependent upon information that you provide, the timeliness of the audit often depends on how quickly and fully the client provides information requested.  To make this easier, obtain the PBC or Audit Request List from the auditor at least a couple months ahead of the audit.  Review the list and assign tasks to applicable people in your departments.  Finally, have the documentation ready for the auditors when they arrive on site.  Additionally, if there are known samples that the auditors will be choosing, provide the listings that they will choose from in advance, so that you can have the sample documentation ready when they arrive.  Ask the auditors if there is anything else you can provide in advance.
  6. Own the project management and timelines. (You will notice that this is also in the auditor’s tips). It is in both parties’ interest to create and stick to an efficient audit schedule. With both sides managing the timeline, due dates are easier to keep.  Schedule the audit well before the auditors are to arrive (> six months).  Plan dates that they will be onsite and determine the date that you will issue.
  7. Feel free to push back.  Sometimes, the auditors will request something that was not planned, that would require a large amount of work to prepare, or seems out of line with the audit.  If you have a legitimate concern with an audit request, feel free to push back in a cooperative manner.  Explain your position, why you think the request is unnecessary, and ask the auditors what they are trying to achieve.  When you know what they are trying to achieve, you can often find an alternative that would be more useful.  Additionally, during a time when the audit is not occurring, schedule time to meet with the auditors to go over the Request List and suggest changes as necessary.  The audit will still have to occur, and the auditors will need to do their necessary procedures, but take the opportunity to make sure the audit goes well for both parties.
  8. Don’t take it personally. The auditors are not auditing you personally.  While you may be involved in key transactions, or in audit findings, it is not a mark against you.  The auditors are doing their job, working through procedures, and are not attempting to comment on anyone personally.
  9. Keep up to date.  Accounting rules are constantly changing so keeping up to date on changes and standards can seem daunting.  However, there are many resources available.  Most major CPA firms provide webcasts and CPE trainings that are often free to attend.  The AICPA publishes yearly audit and accounting guides and industry updates that can be purchased from their website.  Keeping up to date on issues will allow you to respond effectively and efficiently.

(Tomorrow, tips for the external auditors)


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