Financial and Accounting Guide for Not-for-Profit Organizations / Edition 8

by John H. McCarthy, Nancy E. Shelmon, John A. Mattie

Overview

A completely revised and expanded edition of the nonprofit industry finance and accounting standard

Filled with authoritative advice on the financial reporting, accounting, and control situations unique to not-for-profit organizations, Financial and Accounting Guide for Not-for-Profit Organizations, Eighth Edition is recognized by professionals as the industry standard reference on not-for-profit finance and accounting. Prepared by the PricewaterhouseCoopers Not-for-Profit Industry Services Group, the book includes accounting, tax, and reporting guidelines for different types of organizations, step-by-step procedures and forms, and more. A new chapter on public debt has also been added.

• Presents the latest updates to regulatory reporting and disclosure changes in recent years
• Reflects the totally revamped and revised AICPA accounting and audit guide for not-for-profit organizations
• Addresses concerns of all nonprofit organizations, including health and welfare organizations, colleges and universities, churches and other religious organizations, libraries, museums, and other smaller groups
• Includes step-by-step procedures and forms, detailed explanations of financial statements, and a how-to section on setting up and keeping the books

Financial and Accounting Guide for Not-for-Profit Organizations, Eighth Edition is the completely revised and expanded new edition of the bestselling not-for-profit accounting guide.

Product Details

ISBN-13:	9781118083666
Publisher:	Wiley
Publication date:	03/06/2012
Series:	Wiley Nonprofit Authority Series , #6
Pages:	736
Product dimensions:	7.10(w) x 10.10(h) x 1.60(d)

About the Author

JOHN H. MCCARTHY served as the national leader of PricewaterhouseCoopers' Education and Nonprofit Practice before his retirement in 2005. Since then, he has served as the Senior Vice President for Administration and Finance at Northeastern University, an adjunct lecturer at Harvard University's Kennedy School of Government, and on the boards of several educational and nonprofit institutions.

NANCY E. SHELMON retired as a senior partner from PricewaterhouseCoopers in 2010 after more than thirty years working with not-for-profit and higher education clients. A frequent speaker at AICPA and state society conferences, she also served as a member of the AICPA's Not-for-Profit Expert Panel for eleven years and has worked with some of the most widely respected not-for-profit organizations in North America.

JOHN A. MATTIE serves as PricewaterhouseCoopers' National Education and Nonprofit Practice Leader. He currently serves on the Financial Accounting Standards Board Not-for-Profit Advisory Committee, and is the firm's representative on the AICPA Not-for-Profit Entities Expert Panel and the AICPA Government Audit Quality Control Center.

Read an Excerpt

CHAPTER 1

Responsibilities of Treasurers and Chief Executive Officers

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
(f) Contributions
(g) And a Bonus Myth

1.7 Conclusion

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.

• They should be easily comprehensible so that any person taking the time to study them will understand the financial picture. This characteristic is the one most frequently absent in the not-for-profit sector.
• They should be concise so that the person studying them will not get lost in detail.
• They should be all-inclusive in scope and should embrace all activities of the organization. If there are two or three funds, the statements should clearly show the relationship between the funds without a lot of confusing detail involving transfers and appropriations.
• They should have a focal point for comparison so that the person reading them will have some basis for making a judgment. In most instances, this will be a comparison with a budget, or figures from the corresponding period of the previous year.
• They should be prepared on a timely basis. The longer the delay after the end of the period, the longer the period before any necessary corrective action can be taken. The authors propose that two weeks after an interim month end and three weeks after year end are ample time to prepare at least summarized financial information.

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

• Myth 1: "Not-for-profit" accounting is very different from accounting used by for-profit organizations.

  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.

• Myth 2: Surely fund accounting is completely unlike anything in the for-profit world.

  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.

• Myth 3: Depreciation of fixed assets is simply a tax loophole for businesses and has no relevance to not-for-profits.

  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.

• Myth 4: Recording a value for donated services of volunteers is a waste of time since no cash is changing hands.

  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.

• Myth 5: As long as we send some educational material along with our fundraising appeals, the entire cost of the postage for mailing the appeal can be reported as program expense.

  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

• Myth 6: The more details of financial activities that are provided to the governing board and management, the better they will be able to manage the organization's affairs.

  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.

• Myth 7: Financial statements of not-for-profit organizations are always complicated and difficult for readers to understand.

  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.

• Myth 8: If the auditor's report does not refer to any departure from generally accepted accounting principles (GAAP), or contain any other unusual language, that means the financial statements are exactly correct in every detail.

  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.

• Myth 9: "Profit" is a meaningless number for a not-for-profit.

  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:

  1. This number helps in assessing whether the organization is better or worse off financially at the end of the current year than it was the previous year.
  2. It tells whether the organization "lived within its means" during the year.
  3. A large negative amount (or continuing smaller negative amounts) can be an early warning sign of possible future financial problems.
  4. A large positive amount may be an indicator that the organization could be doing more to achieve its purpose.
  5. Comparison of the actual to the budgeted amount can indicate the extent to which management engaged in adequate advance planning, and the extent to which it actually managed the organization's affairs to achieve the planned goals.

(c) Budgets and Operating Reserves

• Myth 10:A not-for-profit should never budget a deficit.

  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.

  1. The organization has unrestricted net assets in an amount far in excess of needs foreseeable in the near future, and resource providers (members, donors, fee payers, etc.) are questioning the organization's need for additional funding.
  2. The organization is pursuing certain sources of funding that appear likely to come through, and expenditure of certain budgeted expense items can be made contingent on actual receipt of the funding (i. e., if the funding is not received, these budgeted amounts will not be expended).
  3. An immediate need for the organization's services is so important (for example, relief for victims of a disaster) that the board is willing to commit to an activity even though funding is not presently in sight. There are adequate resources to survive in the short term, and the board makes realistic plans for quickly seeking the needed additional funding.
  4. A deficit can be budgeted in one program, if resources to cover the deficit are available from surpluses in other programs, or from contributions or endowment income. The extent to which the costs of program services are to be subsidized from other sources is a major policy decision which should be carefully considered by the board before a budget is approved.

  See further discussion of budgeting in Chapter 21.

• Myth 11: Since we lose money on every [patient we see in our clinic, concertgoer who attends our concerts, student who attends our college, etc.], it isn't very important to closely monitor the amount we spend to provide our services. We'll just make up the difference from contributions.

  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.

• Myth 12: No part of the principal of the "endowment fund" can ever be spent.

  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.

• Myth 13: But our board voted to restrict the unrestricted endowment so we can't spend it.

  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.)

• Myth 14: If we find ourselves with more unrestricted money than we have immediate uses for, or if we have a large restricted endowment, we can avoid having to explain to potential donors why we are so rich by simply moving all the excess assets into a separate "foundation" to be held for our benefit, so we don't have to show them on our balance sheet.

  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.

• Myth 15: But the foundation is a separate legal entity with its own tax-exempt status, a separate board, separate office, etc. If we don't actively control the other organization, surely we don't have to combine it.

  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

• Myth 16: Other board members can let the treasurer worry about the money.

  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).

• Myth 17: "Program" managers, such as the conductor of an orchestra, the nurse in charge of a clinic, the chair of a college history department, or the curator of a museum, can let the bookkeeper worry about the money.

  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.

• Myth 18: Since no one would ever steal from an organization that serves the needy, internal accounting controls are not important to a not-for-profit.

  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.

• Myth 19: Since computers never make mistakes, if we keep our books on a computer, the resulting financial statements will always be completely accurate.

  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

• Myth 20: Accountants for not-for-profits never have to worry about the Internal Revenue Service.

  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.

• Myth 21: If the bookkeeper fails to pay the withheld payroll taxes over to the government, board members and other managers are protected from personal liability if the organization is a corporation.

  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.

• Myth 22: If we would have to pay unrelated business income tax on the net income from a fundraising activity, we shouldn't conduct the activity.

  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.

• Myth 23: We don't have any assets or staff in [state], therefore we don't have to register before mailing our charitable solicitations to donors who live there.

  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.

(f) Contributions

• Myth 24: We should always accept every gift offered.

  Fact: Some horses have bad teeth. For example, accepting a gift:

  1. That is restricted for a purpose not consistent with the organization's purposes will likely divert the organization's attention from what it had previously decided should be its priorities.
  2. For a compatible purpose, but with onerous limitations on exactly how the activity is to be conducted, can result in the recipient effectively ceding control of its operations to the donor. (A major university recently returned $20 million to a donor that had insisted on such limitations.)
  3. From a donor with a bad public image, with whom the organization would be embarrassed to be publicly identified, may hurt the organization's other fundraising efforts. (Another university recently returned $500,000 to such a donor.)
  4. Of a building, without adequate provision for paying the on-going expenses of maintaining and operating the building, can expose an organization to considerable unbudgeted and unfunded liabilities.
  5. Of land, under which lies an old toxic waste dump, can require the organization to pay for cleaning up the waste.
  6. Annuity that requires the organization to pay out more than the value of the annuity is certainly not a good deal for the organization.
• Myth 25: Getting an unrestricted gift is always better than getting the same amount as a restricted gift, since then we decide how to use the money.

  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

Myth 26: There are no good books from which I can obtain an understanding of financial management for not-for-profit organizations.

Fact: There is one. You're reading it.

1.7 CONCLUSION

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.

Table of Contents

About the Authors xvii

Contributors xix

Preface xxi

Introduction Including the FASB Codification 1

Chapter 1 Responsibilities for Fiscal Management 5

1.1 Keeping Financial Records for the Organization 6

1.2 Preparing Accurate and Meaningful Financial Statements 6

1.3 Implementing a Budget and Anticipating Financial Problems 7

1.4 Safeguarding Financial Assets and Providing Effective Internal Controls 8

1.5 Complying with Federal and State Reporting and Regulatory Requirements 9

1.6 Communicating Fiscal Information to the Board of Directors and the Audit Committee 9

1.7 Ten Key Points to Consider in Not-for-Profit Fiscal Management 10

1.8 Conclusion 14

Part I Key Financial Concepts 15

Chapter 2 Accounting Distinctions between Not-for-Profit and Commercial Organizations 17

2.1 Stewardship versus Profitability 17

2.2 Principal Areas of Accounting Differences 18

2.3 Conclusion 22

Chapter 3 Cash- versus Accrual-Basis Accounting 23

3.1 Cash and Accrual Statements Illustrated 23

3.2 Combination Cash Accounting and Accrual Statements 27

3.3 Modified Cash Basis 29

3.4 Legal Requirements 30

3.5 Conclusion 30

Chapter 4 Fund Accounting and Internal Financial Reporting 31

4.1 Fund Accounting Defined 33

4.2 Categories of Funds 34

4.3 Alternative Fund Groupings 37

4.4 Typical ‘‘Fund’’ Financial Statements 38

4.5 Transfers between Funds 40

4.6 Elimination of Funds for Reporting Purposes 41

4.7 Conclusion 43

Chapter 5 Fixed Assets and Depreciation 45

5.1 General Principles—Working Definitions 45

5.2 Property and Equipment—Classes and Kinds of Assets 47

5.3 Fixed Assets Where Title May Revert to Grantors 49

5.4 Collections 50

5.5 Fair Value Measurement 51

5.6 Contributions Restricted for Purchase of Fixed Assets 51

5.7 Impairment or Disposal of Long-Lived Assets 52

5.8 Conclusion and Recommendations 55

Chapter 6 Investment Income, Gains and Losses, and Endowment Funds 57

6.1 Accounting Principles 58

6.2 Total Return Concept 68

Chapter 7 Affiliated Organizations, Pass-Through Transactions, and Mergers 73

7.1 Types of Relationships Often Found 74

7.2 Definition of the Reporting Entity 76

7.3 Mergers of Not-for-Profit Organizations 81

Appendix 7-A Factors to Be Considered in Deciding Whether a Pass-Through Gift 12 Truly Revenue and Expense to a Pass-Through Entity 84

Appendix 7-B Transfers of Assets to a Not-for-Profit Organization or Charitable Trust That Raises or Holds Contributions of Others 87

Appendix 7-C Factors Related to Control That May Indicate That an Affiliated Organization (A) Should Be Combined with the Reporting Organization (R), If Other Criteria for Combination Are Met 91

Chapter 8 Contributions, Pledges, and Noncash Contributions 93

8.1 Expendable Current Support 94

8.2 Gifts-in-Kind 99

8.3 Support Not Currently Expendable 103

Appendix 8-A: Checklist: Factors to Be Considered in Deciding Whether a Particular Gift (for Operating Purposes) Should Be Classified as Purpose-Restricted or Not 114

Appendix 8-B: Checklist: Factors to Be Considered in Distinguishing Contracts for the Purchase of Goods or Services from Restricted Grants 116

Appendix 8-C: Checklist: Factors to Be Considered in Assessing Whether Contributed Services Are Considered to Require Specialized Skills 118

Appendix 8-D: Checklist: Factors to Be Considered in Determining Whether an Organization Would Typically Need to Purchase Services If Not Provided by Donation 120

Appendix 8-E: Checklist: Factors to Be Considered in Assessing Whether a Donor Has Made a Bona Fide Pledge to a Donee 123

Appendix 8-F: Checklist: Factors to Be Considered in Deciding Whether a Gift or Pledge Subject to Donor Stipulations 12 Conditional or Restricted 126

Chapter 9 Accounting Issues Relating to Fundraising 129

9.1 Accounting for Gifts 130

9.2 Accounting for Fundraising Expenses 137

9.3 Other Tax Considerations 141

Part II Financial Statement Presentation 143

Chapter 10 Cash-Basis Financial Statements 145

10.1 Simple Cash-Basis Statement 145

10.2 Simple Statement with Last Year’s Figures and Budget 147

10.3 Combined Cash-Basis Income Statement and Balance Sheet 147

10.4 Separate Statement of Receipts and Disbursements and Statement of Net Assets 150

10.5 Statement of Income with Certain Cash Transactions Omitted 152

10.6 Modified Cash-Basis Statements 154

10.7 Conclusion 155

Chapter 11 Accrual-Basis Financial Statements 157

11.1 Simple Accrual-Basis Statements 157

11.2 Accrual-Basis Statements—Fundraising Organization 160

11.3 Accrual-Basis Statements—International Organization 163

11.4 Conclusion 166

Chapter 12 Multiclass Financial Statements 167

12.1 FASB Accounting Standards Codification 958, Not-for-Profit Entities 168

12.2 Preparation of Statement of Cash Flows 171

12.3 ‘‘Class’’ Financial Statements Explained 182

12.4 Columnar Format Presentation 191

12.5 A Complicated Set of Class Financial Statements 193

12.6 Summary or Condensed Statements 204

12.7 Conclusion 205

Appendix 12-A Financial Statements of Not-for-Profit Organizations—Review Points 206

Part III Accounting and Reporting Guidelines 211

Chapter 13 Voluntary Health and Welfare Entities 213

13.1 Accounting Principles 215

13.2 Accounting for Contributions 215

13.3 Accounting for Other Income 218

13.4 Accounting for Expenses 218

13.5 Accounting for Assets 218

13.6 Net Assets 219

13.7 Financial Statements 220

Appendix 13-A Checklist: Factors to Be Considered in Deciding Whether Allocation of Joint Costs of

Multipurpose Activities (under ASC 958-720-55) 12 Appropriate 235

Appendix 13-B Checklist: Consideration of Whether Items Might Be Reported as Operating or Nonoperating (within the Context of ASC 958-225-45) 238

Chapter 14 Colleges and Universities 241

14.1 Authoritative Pronouncements 242

14.2 The Principal Financial Statements 242

14.3 Accounting Principles 246

Chapter 15 The External Financial Statement Reporting Model for Organizations Reporting under GASB Standards 251

15.1 Introduction 252

15.2 Definition of a Government 252

15.3 Generally Accepted Accounting Principles 253

15.4 External Financial Reporting Model 254

15.5 Basic Financial Statements 255

15.6 The Reporting Entity 262

15.7 Assets, Liabilities, and Deferred Inflows/Outflows 264

15.8 Revenues and Expenses 272

15.9 Other Reporting Matters 277

Chapter 16 Health Care Organizations 281

16.1 Introduction 282

16.2 Accounting Guidance 282

16.3 Financial Statements 285

16.4 Accounting Principles 289

Chapter 17 Accounting Standards for Other Not-for-Profit Organizations 313

17.1 Accounting Principles 313

17.2 Financial Statements 317

17.3 Combined Financial Statements 317

17.4 Appendix 17-A:Checklist: Factors to Be Considered in Deciding Whether a Payment Described as Membership Dues 12 Properly Recorded by the Recipient as Dues or as a Contribution 319

Chapter 18 Special Accounting Issues for Specific Organizations 323

18.1 Associations and Professional Societies 324

18.2 Churches 326

18.3 Clubs 327

18.4 Libraries 329

18.5 Museums 329

18.6 Performing Arts Organizations 330

18.7 Private Foundations 332

18.8 Religious Organizations Other Than Churches 334

18.9 Research and Scientific Organizations 335

18.10 Private Elementary and Secondary Schools 336

18.11 Public Broadcasting Stations 337

Chapter 19 The Financial Accounting Standards Board and Future Trends in Not-for-Profit Accounting 339

19.1 Financial Accounting Standards Board 340

19.2 Trends in Not-for-Profit Accounting 348

19.3 New FASB Statements of Financial Accounting Standards That Affect Not-For-Profit Organizations 353

19.4 Other FASB Pronouncements and Projects 359

19.5 Conclusion 362

Part IV Controlling the Not-For-Profit Organization 363

Chapter 20 The Importance of Budgeting 365

20.1 The Budget: A Plan of Action 365

20.2 Monthly and Quarterly Budgets 370

20.3 Timely Interim Statements 373

20.4 A Five-Year Master Plan 380

20.5 Conclusion 384

Chapter 21 Small Organizations—Obtaining the Right Accountant 385

21.1 Level of Accounting Services Needed 386

21.2 Personality Characteristics 388

21.3 Alternatives to Accountants 388

21.4 Timing in Hiring a Replacement 390

21.5 Conclusion 390

Chapter 22 Small Organizations—Providing Internal Control 391

22.1 Reasons for Internal Control 392

22.2 Fundamentals of Internal Control 393

22.3 Some Basic Controls 394

22.4 Fidelity Insurance 398

22.5 Conclusion 399

Chapter 23 Effective Internal Accounting Control for Not-for-Profit Organizations 401

23.1 Introduction to Internal Accounting Control 402

23.2 Elements of an Effective Internal Accounting Control System 406

23.3 Basic Internal Accounting Control System 411

23.4 Specific Nonprofit Internal Accounting Controls 419

Chapter 24 Independent Audits 427

24.1 Functions and Limitations 427

24.2 Benefits of an Independent Audit 432

24.3 Selecting a Certified Public Accountant 434

24.4 Public Accountants 435

24.5 Audit Committees 436

24.6 Conclusion 438

Appendix 24-A Checklist: Criteria for Selection of a CPA 440

Appendix 24-B Changing Role for the Audit Committee 443

Appendix 24-C Basic Template for an Audit Committee Charter 446

Chapter 25 Investments 453

25.1 Types of Investments 454

25.2 Valuation of Investments 456

25.3 Key Considerations When Investing in Alternative Investment Funds 458

25.4 Pooling versus Individual Investments 460

25.5 Calculating Share Values in Pooled Investments 463

25.6 Allocation of Pooled Income 466

25.7 Conclusion 467

Part V Principal Federal Tax and Compliance Requirements 469

Chapter 26 E-Business for Not-for-Profit Organizations: How Can Not-for-Profits Manage the Risks to Maximize E-Business Opportunities? 471

26.1 Whether You Call It E-Business or Technology-Enabled Business, It Still Matters 472

26.2 Ask Yourself These Questions 474

26.3 Objectives 475

26.4 How Did We Get to the Internet Economy? 475

26.5 Where Are We Today? 477

26.6 What 12 Risk Management? 478

26.7 How Are Not-for-Profit Organizations Using E-Business Today? 490

26.8 How Are Academic Institutions Using E-Business? 491

26.9 What 12 the Path to E-Business Success? 493

26.10 What E-Business Models Exist? 494

26.11 Cloud Computing 496

Chapter 27 Principal Tax Requirements 497

27.1 Organizations Exempt from Tax 499

27.2 Charitable Organizations 500

27.3 Tax Status of Charitable Organizations: Public Charity or Private Foundation 502

27.4 Other Concerns for Charities 505

27.5 Private Foundations 517

27.6 Private Operating Foundations 521

27.7 Noncharitable Exempt Organizations 522

27.8 Recognition of Exemption and Annual Reporting to IRS 527

27.9 Federal Information and Tax Return Filing Requirements 530

27.10 State Information and Tax Reporting Issues 546

27.11 Donor-Advised Funds 548

27.12 Restrictions on Supporting Organizations 550

27.13 Federal Employment Taxes 551

27.14 IRS Audits and Compliance Programs 551

Chapter 28 Audits of Federally Funded Programs 553

28.1 Basic Requirements 553

28.2 Requirements and Definitions 555

28.3 Responsibilities of the Receiving Organization 558

28.4 What to Expect from the Audit 562

28.5 American Recovery and Reinvestment Act of 2009 565

28.6 Conclusion 566

Part VI Setting Up and Keeping the Books 567

Chapter 29 Cash-Basis Bookkeeping 569

29.1 Three Steps in a Bookkeeping System 569

29.2 Checkbook System 570

29.3 Cash-Basis System 575

29.4 Conclusion 584

Chapter 30 Simplified Accrual-Basis Bookkeeping 585

30.1 Books and Records 586

30.2 Chart of Accounts 587

30.3 Monthly Accrual Entries 588

30.4 Payroll Taxes 594

30.5 Fixed-Asset Register and Depreciation Schedule 596

30.6 Investment Ledger 600

30.7 Conclusion 602

Chapter 31 Full Accrual-Basis Bookkeeping 603

31.1 Books and Records 603

31.2 Chart of Accounts and Coding 605

31.3 Sales Register 607

31.4 Accounts Receivable Subsidiary Ledger 610

31.5 Cash Receipts Book 612

31.6 Accounts Payable Register 612

31.7 Cash Disbursements Book 614

31.8 Monthly Accrual Entries 616

31.9 Conclusion 618

Chapter 32 Fund Accounting Bookkeeping 619

32.1 Chart of Accounts 620

32.2 Books and Records 622

32.3 Interfund Transactions 624

32.4 Trial Balance 629

32.5 Conclusion 629

Chapter 33 Automating the Accounting Records 631

33.1 When to Consider Automating or Upgrading 631

33.2 What to Automate 632

33.3 Selecting the Right Software 636

33.4 Implementing the New System 639

33.5 Common Pitfalls to Successful Automation 640

33.6 Conclusion 642

Chapter 34 Tax-Exempt Debt 643

34.1 Characteristics 643

34.2 Accounting and Reporting 644

34.3 The SEC’s Role and Authority 648

34.4 Proposed Municipal Market Reforms 653

Appendix A Code of Conduct 655

Appendix B The Future of U.S. Standard Setting 665

Appendix C Keeping Current 671

Appendix D Alternative Investments—Audit Considerations 688

Index 709

Editorial Reviews

Written chiefly for managers of not-for-profit organizations, this book offers guidance on the management of financial resources and effectively communicating the organization's financial activities to its members and the public. It also provides instruction on the interpretation of annual financial reports, and their uses in making informed decisions. Compliance requirements are detailed for each state, and specific recommendations are provided. Issues related to control and book-keeping are emphasized. Annotation c. Book News, Inc., Portland, OR (booknews.com)

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