If you run a nonprofit, the last thing you want is to issue financials to your board or funding sources that are materially misstated.
Stakeholders using unreliable information to make important decisions affecting your organization is highly undesirable.
But preparing nonprofit financial statements is complex and errors are common.
Even an annual independent audit isn’t guaranteed to find every material error; and, besides, auditors will propose corrections to your books for errors found, but your funders may have already made decisions based on the bad data.
The saying “an ounce of prevention is worth a pound of cure” applies here.
As auditors ourselves, we find all sorts of errors in nonprofit financial statements. Most are unintentional and often occur because something (or things) slipped through the cracks.
Here are six of the most common mistakes and tips on how to prevent making them yourself.
Nonprofit financial statements: The 6 most common mistakes…
1. Missing pledges
Donors frequently make a commitment (or promise) to donate to a nonprofit before they actually transfer the money. Nonprofits are supposed to record these pledges as assets and contributions.
To ensure that they’re properly recorded, build clear channels of communication between your development and accounting staff. Also, run a periodic scheduled reconciliation between the donor database and general ledger to identify differences that may be indicative of errors.
2. Unrecorded in kind
If you receive donated goods or professional services, you may be required to record these as contributions and expenses in your nonprofit financial statements.
The idea behind this requirement is that you can either solicit cash to buy the goods and services you require as an organization, or you can solicit the goods and services directly from the donor.
Either way, the value should be reflected as both a source of support and a cost of doing business.
Ensure you have a mechanism to track these contemporaneously. Don’t wait until year-end to compile a list. This will serve you well in properly accounting for your in-kind.
3. Unrecorded interests in estates and trusts
If you have an irrevocable interest in a donor’s estate, the value might need to be shown as an asset on your balance sheet.
It’s not enough for a donor to simply name you in their will. Your interest needs to be irrevocable in order to record it as an asset.
This usually means that the donor has either died after naming you in their will or has included your organization as a beneficiary on a charitable remainder trust, charitable gift annuity or some similar gift instrument.
Similar to pledges, these tend to fall through the cracks because the donor (or their representatives) inform development staff or the executive director but the news doesn’t trickle down to the accounting department. Ensure you have a mechanism in place to prevent this.
4. Revenue recognition and classification errors
GAAP and the IRS require that you segregate earned income from contributed support in your nonprofit financial statements and tax returns.
In addition, contributed support must be further divided into conditional, unconditional, unrestricted and restricted categories.
The execution of these concepts can get complicated, especially with the new accounting pronouncements ASU 2014-09 and ASU 2018-08. To learn more about this, please see our previous blog post.
The best way to mitigate potential problems in this area is through a well-designed revenue recognition policy.
5. Expenses recorded in the wrong period
Organizations are required to recognize expenses when they are incurred, which is often before payment takes place. This affects everything from travel to service fees to supplies.
Unfortunately, expenses incurred late in one year are frequently recorded in the subsequent year when payment occurs, which doesn’t conform to proper accrual-basis accounting. This can lead to an overstatement of net income and an understatement of liabilities.
However, there are some easy ways to avoid making this mistake.
When year-end approaches, reach out to regular vendors and contractors and make sure they are current on their invoicing. In the new year, review significant expenses paid in the first couple of months and make sure that expenses pertaining to the previous year were properly accrued.
6. Functional expense allocation errors
As part of ASU 2016-14, FASB has issued clarifying guidance on which expenses should be classified under program services, management and general, and fundraising.
This is an area of accounting that was already prone to bias and error; and the new guidance has resulted in changes that have caught some nonprofits off guard.
Certain expenses that you may have allocated to program services in the past may need to be moved to management & general going forward.
To avoid making errors with the allocation of functional expenses, please see our previous blog post on this topic.
You’re now across the most common errors made with nonprofit financial statements but the above six areas are by no means exhaustive.
The best way to prevent material misstatements is to work with your accounting team to develop a comprehensive monthly and year-end checklist.
Feel free to contact us if you have any questions.
