Balancing the Mission Checkbook

If you haven’t, you should call them soon and ask about SAS 112, a recent change in auditing standards that will affect audits of nonprofits. Because the new standard was effective in December 2006 we are just beginning to see audit reports using the new standards. SAS 112 establishes new definitions and standards for Communicating Internal Control Related Matters Identified in an Audit. Auditors have always considered the quality and sufficiency of internal controls as a component of the audit. If weaknesses in internal controls are observed, the auditors submit a management letter to the board describing the weaknesses and recommending further attention to these controls. We often joke that the “Segregation of Duties” comment is printed on the letterhead of the audit firms since so many nonprofits receive management letters with this finding. We all understand that it is very difficult to properly segregate all financial duties with a small staff. The new auditing standard could greatly increase the number of internal control weaknesses identified and reported – and cause concern and strong responses by nonprofit boards. The new standards do three things: provide new definitions and terminology for internal control weaknesses; allow the auditors less discretion in identifying weaknesses as significant; and require that auditors apply more complex standards that consider combinations of weaknesses, quantitative and qualitative factors. This article from the AICPA includes links to the SAS 112 document for a thorough review. Enough of the technical – what does this mean for your nonprofits?

The likelihood that control deficiencies will be identified and reported is probably higher. The auditor simply has to consider a much wider range of factors and apply a new and higher standard.

According to accounting firm PricewaterhouseCoopers, “we believe that the new definitions will lower the bar such that more control deficiencies will be considered severe.”

Even for the management letters with the same findings as previous years, the new terminology may cause concern. The term “reportable condition” is replaced with “significant deficiency”. More nonprofits will receive reports of control deficiencies related to their capacity to apply generally accepted accounting principles to financial transactions and financial reports. Think about your internal year-end financial reports. Do you correctly report the following information according to GAAP accounting rules: receipt and release of temporarily restricted funds, in-kind contributions, accrued expenses, and depreciation? If you have relied on your auditors to provide audit adjustments for these items, you should be prepared for a possible finding of a control deficiency. What should you do?

• Talk to your auditor before they come to start fieldwork about SAS 112 and how they will communicate with you during the audit.
• Next, communicate these new standards to your treasurer, finance committee and board of directors. The last thing you want is a surprise when the audit report is presented.
• Last, and most important, do what you can to improve your internal controls and quality of financial accounting. This is the ultimate purpose of the audit standards, and the goal for your nonprofit as a steward of your donor and supporters’ funds.

In the last two months I have heard too many stories of nonprofits who have installed accounting software that was recommended as the “perfect” system for them by a consultant or their accountant. It then turns out that no other software was even considered, and it just happens to be the accountant’s preferred system, which of course is always “perfect” for any nonprofit. Since many of these nonprofits don’t have expertise or even comfort talking about accounting, they trust the professional and plunge in with the purchase. Unfortunately, in many cases the software is far too complex for the organization, requires extensive accounting knowledge, or is simply a bad fit. The software will probably work for them as long as the experienced accountant is in place to manage it, but I can predict, based on experience, that within two years these organizations will either need to spend some money to fix an unwieldy system or change their accounting software again.

We are upgrading our accounting software next month to a newer version of the program we’ve been using for over eight years. We’d hit he point where reports were less efficient and there’s an ongoing technical glitch that can only be solved with the upgrade. Before we took this step I asked for a review of some other accounting packages to make sure that we’re using the “right” software. That begs the question of what is the “right” software for nonprofit organizations. The answer, of course, depends on what you need. The tough part is how to find that answer for an individual organization. Since Nonprofits Assistance Fund is a nonprofit focused on financial management we are fortunate to have a lot of experience and expertise within our staff to complete our own accounting review. For all the nonprofits that don’t have this expertise and rely on other resources to help, the help that’s available is pretty spotty, unfortunately, and complicated with hidden agendas.

Even without accounting expertise, an executive director or board treasurer can complete a basic assessment of accounting needs and insist that this review be used as a selection guide. Here are the basic questions:

• Start with the end in mind – what kind of reporting will be needed? This includes reports for management and the board, for individual programs and grants, and for audit preparation.
• Do you receive restricted grants or donations? It’s important to be able to maintain separate restricted and unrestricted balances, but you may not need a full “fund accounting” system. Many organizations, even large ones, use Excel spreadsheets for some of this detail.
• Do you need extensive program, project, or grant-based income and expense tracking?
• What other financial functions do you need to include in the system – such as billing for services, accounts payable, payroll, and fixed assets and depreciation?
• Are there any external factors (like a significant government contract) that require you to maintain a specific list of accounts, codes, or report formats?
• Who will make regular accounting entries and what training or experience is needed?
• What reports are standard with the software and how easy is it to create new reports
• Does it take a CPA or equivalent accounting knowledge to produce regular monthly financial reports?
• The last question to ask a consultant – what is the simplest system available that will meet these needs? The most frequent error I see is selecting accounting software that’s much more than the organization needs or knows how to manage. Keep it simple.