Executive Perspective on Top Risks for 2014 – Comparison of for-profit concerns with those of tax-exempt organizations

Protiviti reported their survey results from executives in the for-profit sector regarding their Top Ten Risks for 2014:

  • Regulatory changes and scrutiny
  • Economic conditions
  • Uncertainty surrounding political leadership
  • Succession planning for key employees and board
  • Organic growth
  • Cyber threats
  • Organizational resistance to change
  • Privacy and identity security system protection
  • Compliance with healthcare reform legislation
  • Volatility in financial markets

Other concerns include setting appropriate executive compensation and addressing the growing demands of compliance oversight.

Not surprising, the risk concerns stated above are very similar to those experienced by executives in the tax-exempt sector. Why is that? To remain viable within a commercial setting, a for-profit business must remain healthy, relevant and profitable. To compare, a tax-exempt organization must also remain healthy and relevant in order to meet its mission statement into the future.  The similarity is the need for relevance and strong financial health.  The contrast is that the goal of a for-profit enterprise is solely profitability, not the specific product or service it provides. This differs fundamentally from a tax-exempt organization that exists to accomplish its mission. In other words, for the tax-exempt organization, financial health is a means to accomplish its goal, not the goal itself.

Accounting Standards You Should Consider When Closing Your Books for the Fiscal Year

As non-profits with June fiscal year ends start the process of closing their books for the year and begin the financial reporting process, there are new accounting standards that should be considered.  There is one new accounting standard in 2014 financial statements, and some that will affect 2015 financial statements, but should be applied to operations beginning in July of 2014. A summary of these accounting standards follows.

Classification of the Sale Proceeds of Donated Financial Assets in the Statement of Cash Flows
In October 2012, the FASB issued an accounting standard that requires a non-profit to consistently classify, within a statement of cash flows, cash receipts from the sale of donated financial assets with cash donations received for similar purposes. The cash receipts from the sale of donated financial assets must, upon receipt, have been directed without any non-profit imposed limitations for sale and converted nearly immediately into cash. Accordingly, the cash receipts from the sale of those financial assets should be classified as cash inflows from operating activities, unless the donor restricted the use of the contributed resources to long-term purposes, in which case, those cash receipts should be classified as cash flows from financing activities. Otherwise, cash receipts from the sale of donated financial assets should be classified as cash flows from investing activities by the non-profit.

The accounting standard provided a decision tree to illustrate the process that can be used to help determine the appropriate presentation of the cash receipts in the cash flow statement. This accounting guidance is effective prospectively for June 30, 2014 fiscal year ends. Retrospective application to prior periods is permitted but not required in the case where comparative financial statements are presented.

Obligations Resulting from Joint and Several Liability Arrangements
In February 2013, the FASB issued an accounting standard to provide guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of the guidance is fixed at the reporting date. Examples of obligations within the scope of this accounting guidance include debt arrangements, other contractual obligations, and settled litigation and judicial rulings.

This accounting guidance requires an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed at the reporting date, as the sum of the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors, and any additional amount the reporting entity expects to pay on behalf of its co-obligors.

Entities are also required to disclose the nature and amount of the obligation as well as other information about those obligations.

This accounting guidance is effective for December 31, 2014 fiscal year ends. The changes required by this accounting guidance should be applied retrospectively to all prior periods presented if comparative financial statements are presented, so non-profits that present comparative financial statements should determine the applicability of this accounting guidance to determine what effects it may have on the current year financial statements when it is required to be adopted in the upcoming fiscal year.

Recognizing Services Received from Personnel of an Affiliate
In April 2013, the FASB issued accounting guidance which addresses the situation in which employees of a separately governed affiliated entity regularly perform services (in other than an advisory capacity) for, and under the direction of, the recipient entity. This new accounting guidance requires a recipient non-profit to recognize all services received from personnel of an affiliate that directly benefit the recipient non-profit. Generally, those services should be measured at the cost recognized by the affiliate for the personnel providing those services. However, if measuring a service received from personnel of an affiliate at cost will significantly overstate or understate the value of the service received, the recipient non-profit may elect to recognize that service received at either the cost recognized by the affiliate for the personnel providing that service, or the fair value of that service.

This accounting guidance is effective for fiscal years ending June 30, 2015, so non-profits that receive services from personnel of an affiliate will need to consider how the services are being recorded beginning this July.

Service Concession Arrangements
In January 2014, the FASB issued an accounting standard which provides specific accounting guidance related to service concession agreements. This accounting guidance clarifies that an arrangement should not be accounted for as a lease when it contains both of the following conditions:

  • The grantor controls, or has the ability to modify or approve, the services that the operating entity must provide with the infrastructure, to whom it must provide them, and at what price.
  • The grantor controls, through ownership, beneficial entitlement, or otherwise, any residual interest in the infrastructure at the end of the term of the arrangement.

This accounting guidance is effective beginning with December 2015 fiscal year-end entities, so December year-end non-profits will need to begin following this accounting guidance January 1, 2015.

If you have questions about any of these new accounting standards, please contact an Eide Bailly professional. They will be happy to answer your questions.

Addressing Fraud Risks

hand-in-cookie-jarWhile performing audits of nonprofits, we work with management of organizations to identify risks that may cause the financial statements to be materially misstated due to fraud. Sometimes these conversations start with the executive director or other member of the management team claiming they have no risks of fraud, because their employees are all committed to the mission of the organization and would never steal from them. Maybe their bookkeeper has been there for years, and they have complete trust in him/her.

Unfortunately, that is an environment that can be conducive to fraud. When management is unable to look at the situation dispassionately, without putting personalities and personal feelings into it, a fraud can occur. All too often an embezzlement of thousands or hundreds of thousands of dollars is uncovered and it is the trusted bookkeeper or long-time employee who hatched the scheme.

Strong organizations identify the risks of fraud and put controls in place to mitigate those risks. Board members and management evaluate the controls to be certain they are being followed. They ask questions and investigate things that don’t look right. They understand the controls protect their employees as well as the organization. Many nonprofits use outside consultants to perform an internal control examination to address process weaknesses – before the shock of a fraud is uncovered.

Board Responsibilities and Legal Accountability

The members of nonprofit boards have a number of responsibilities. One of those is addressing the legal accountability of the organization. A nonprofit must follow the applicable local, state and federal laws. These encompass issues such as governance, solicitation of funds, service delivery, personnel, and other areas. Each member of the board should be aware of the laws and regulations that govern the organization and be certain that a process is in place to ensure the nonprofit remains in compliance.

Nonprofit organizations can run afoul of legal restrictions in a number of ways. Examples include fraud and embezzlement, telemarketing scams, misappropriation of funds, excessive compensation, using charitable funds inappropriately, participating in prohibited transactions, and others. Penalties vary, depending on the nature and reason for the illegal activity. Consequences could include fines, restitution, revocation of tax-exempt status, or other actions. And of course, there may be irreparable damage to the organization’s reputation.

Nonprofit leadership requires an understanding of legal compliance. This is a complex and extensive area, and legal noncompliance is not always easily detected. Some organizations are lulled by the thought that since they are nonprofit, no one would consider doing anything illegal. Others are simply unaware of the requirements that govern their activities. Creating strong internal controls, communicating clear expectations regarding behavior and legal compliance, and employing the oversight of skilled, involved and informed board members are pieces of an effective program to ensure legal compliance.