Expert: Consuelo Herrera, International Accountant and Fraud Examiner - 2/26/2009

Question
I was recently appointed to the Board of a 501(c)3. However, I now have some concerns about past and ongoing financial activity and I want to have an audit. While there is an accountant that has been in charge for the past several years, this is part of my concern and I would want to know how to call for and set-up an external audit. Suggestions?

Answer

Dear Timothy,

Congratulations for being proactive and taking your responsibility as a Board member that way.

Having an audit may or may not be a requirement for your organization. If your organization is required to have an audit because of the level of revenue, it would take care of your concern. Make sure that your accounant takes vacation and someone else takes over his or her responsibilities. This is a strong internal control that each organization should implement.

Below I am including a helpful document issued by geocities.com which I believe will help you out with your concerns and role as well.


FINANCIAL SYSTEMS THAT PROTECT NOT-FOR-PROFIT ORGANIZATIONS:
·   Management is responsible for making sure the organization implements and maintains appropriate checks and balances systems.
·   The Board should assure itself that management is following board policies.
·   The most difficult internal problems are those that occur gradually, over time, as the organization grows.
·   The job of a diligent board member is to make sure not only that management reviews established accounting procedures, but that the Board also regularly takes a fresh look at ongoing routines.
I.   INTERNAL CONTROLS
o   Processes and procedures that protect the assets and promote efficient operations.
o   Protection of assets is fundamental to the well being of a not-for-profit organization.
o   One key to good internal controls is segregation of duties.
o   Board members of not-for-profit organizations should insist on effective internal controls.
o   Appropriate checks and balances are necessary to prevent errors, fraud, and abuse.
o   Leaders must be alert to the possibility of fraud.
o   An up-to-date accounting manual is needed that details correct procedures.
o   When there is any doubt about internal controls, the organization's auditor should be consulted.
II.   ACCOUNTING POLICIES AND PROCEDURES
Every not-for-profit should have written policies and procedures governing how it does business. Two specific documents are most important to have in place:
1.   Accounting Manual
2.   Investment Policies
QUESTIONS BOARD SHOULD ASK:
o   Have we adequately documented our policies and procedures with respect to all of our financial activity?
o   Do we have an investment policy? Are we following it?
III.   EXTERNAL AUDITS
o   The key role of the external auditor is to attest to the accuracy of the organization's financial statements.
o   External auditors may also provide consultation.
o   The principal purpose of an external audit is to keep the Board and other key constituent groups apprised of the organization's financial position.
o   Auditors must be absolutely independent.
o   There is no need to replace an existing audit firm if the Board is satisfied with the firm's competence, independence, etc.
o   A small organization may need to have an audit every two years, rely on a "review" by an external audit firm, or, with financially astute members, do a careful "member audit."
QUESTIONS THE BOARD SHOULD ASK:
o   Do we have an annual external audit?
o   If we do not, what are we doing instead?
o   What are the key characteristics of a good audit firm?

Detecting Financial Problems that Can Derail your YWCA
·   Understanding the Full Cost of Operating Each Program (including the correct allocation of indirect costs)
·   Understanding how costs and revenues are changing over time
·   Understanding YWCA Fund Accounting Structure
·   Understanding how YWCA Resources and fund Balances are changing over time
·   Recognizing early warning signs
·   Recurring deficits and "cash crunches"
·   No cost study within the last 3 years
·   Bills not paid within 45 days
·   Ignoring depreciation as a cost of operation
·   Monthly financial reports not ready within 30 days
·   Audits are late and difficult, or "qualified"
·   National dues are not current
·   Other payables are overdue
·   All payables are not reported
·   IRS form 990 is late (or not filed!)
·   No Board policy on programs to be subsidized or self-supported
·   No advance budgeting of fund-raising and United Way revenues to programs
·   No written strategies or financial plans

Six Key Warning Signs of YWCA Financial Problems
On the Operating Statement (P&L):
o   Operating deficits three years in a row, or three out of 5 years
o   Consolidated deficits three years in a row, or three out of five years
On the Balance Sheet:
o   Operating fund balance or combined fund balance is negative
o   Year-end accounts payable over 60 days old two years in a row
o   Consolidated fund balance declines three years in a row, or three out of five years
If ANY one of these is true, immediate and major action is necessary!!
But your auditors probably won't point it out to you.
Determining the Full Cost of Programs
Allocating Indirect (Shared) Income and Expense among Programs
o   Administrative costs (net of Income) are allocated among direct programs in proportion to each program's share of total program expenses
o   Building and Occupancy costs (net of income) are allocated among direct programs and administration in proportion to each program's space utilization (see space utilization form)
o   Fund-raising income (net of expenses) is assigned to specific programs based on Board policy or Executive action (avoids after-the-fact "depends on where we need it" approach)
Unless you include their proper share of indirect costs, you really don't know the REAL cost of your programs.

Finance and Administrative Functions
Accounting Functions
·   Cash Receipts & Accts. Receivable
·   Disbursements & Accounts Payable
·   Payroll and Timekeeping
·   General Ledger
Each of these functions should be segregated to maintain internal controls. Need one person specifically for each task. GL often handled by a supervisory person in smaller organization. Represents 30-40% of total finance and administration line.
Budgets, Reporting & Analysis
·   Report Preparation
·   Budget Preparation
·   Cashflow analysis & planning
·   Financial Planning
·   Special analysis
Typically requires 20-25% of staff and supervisor's time. Often handled by a supervisor in smaller organization. Requires one or more full time person with special skills in larger organization.
Contractual Functions
·   Taxes
·   Investments
·   Info. Systems
·   Purchasing
·   Real Estate
·   Contracts and Grants
These tasks often account for 30-40% of staff time but are less conspicuous than accountings. Some tasks may be combined with accounting tasks in smaller organizations, handles by a supervisor or outside contractor (e.g., investment manager, real estate manager, insurance broker, consultants, etc.)
Audit & Control
·   External Audits
·   Internal Controls
·   Operations & Procedures
These tasks typically account for 10-15% of supervisory and senior staff time. Internal controls and operating procedures may get short shrift in situations where staff has adequate time for duties assigned.
Personnel Administration
Typically assigned to a separate specialized department.

Questions for Self Evaluating the Financial Health of your Association
Are financial operating statements reviewed monthly? Are they available for review by staff and the Finance Committee within 30 days after the end of each month? Is a comparison of actual income and expenses made to the amounts budgeted? To prior year? By Program or unit? Is a written explanation given for each line item?
Are balance sheets prepared monthly and reviewed at least quarterly by the Finance Committee?
Is an independent financial audit collected annually and reported promptly tot he Finance Committee? Is your accountant experienced in not-for-profit accounting?
Is there an annual operating budget? Is this budget detailed into a monthly budget for each program or unit? Is there a monthly cash flow budget for the year based on the monthly operating budget?
Are overhead costs for facilities and for administration segregated from direct program costs? Are these overhead costs promptly allocated to the various programs to determine total program costs? Are the total program costs reviewed regularly by the Finance Committee and used in planning budgets and program changes?
Are income and expense regularly compared with service measures such as participant hours, day-care days, etc. to evaluate changes in cost effectiveness and productivity in and among various programs?
Are programs which are expected to be self-supporting documented? Are programs which are subsidized also documented and by how much? Is action taken to restructure or reduce programs that consistently fall short?
Is there a written plan identifying programs and facilities targeted for growth, reduction, replacement, or restructuring?

Biggest Mistakes People Make in Their Financial Projection are:
1.   Not taking into consideration all costs.
2.   Not Pricing products and services adequately (the problem in doing this results in under funding.)
3.   Starting a new program without sufficient cash reserves.
4.   Not planning for glitches or Murphy's Law.
5.   Not understanding or knowing where your break even point is (i.e. the true cost of a unit of service or applying planning goals accordingly.)
6.   Not allowing a realistic number of days for account receivables.
7.   Not creating a cash flow analysis or not reviewing that analysis monthly. AN ANNUAL REVIEW IS NOT ENOUGH.
8.   Not verifying the numbers in the statement of activities, cash flow analysis and the statement of financial position.
9.   Not realistically making financial projections. Such as financial projections that do not support the stated goals of the Association.

In addition, I am including the link to Circular 133

http://www.whitehouse.gov/omb/circulars/a133/a133.html Audits of States, Local Governments, and Non-Profit Organizations

Finally, just to reinforce what you already know, here is the link to the IRS site where you will find a wealth of information on Governnace matters that will walk you through your obligations.

http://www.irs.gov/pub/irs-tege/stm_loyolagovernance_112008.pdf