Tag Archives: Audits

Functional Accounting

The Secrets of Cost AllocationA few years back I co-wrote an article about getting accurate numbers from your financial system for the California Association of Nonprofits that was based on a workshop I developed. This blog post and the last post excerpt some of the material from that piece. For folks who would like the whole article you can click the above link. The other post is on cost allocation, this one is on setting up a functional accounting system.

Functional accounting is a method of accounting that is based on the organization’s major types of activities, primarily (a) program or mission-based services and (b) supporting services such as administration, governance and fund development.

Functional accounting allows you to identify three key characteristics of every dollar coming into and going out of the organization:

Dollars coming in (income) Dollars going out (expense)
Who Who is providing the dollar (i.e., the specific funder) Who is paying for an expense (i.e., the specific funder)
What What type of income it is (e.g., grant, contract, earned, etc.) What the dollar will be spent on (e.g., payroll, supplies, etc.)
Why Why they are providing the dollar (i.e., for which program or purpose) Why the dollar is being spent (i.e., for which program or purpose) Administrative and Fundraising would be a Why as well.

Breaking down expenses by what and why reflects the broad outlines of major nonprofit reporting requirements. For example, the IRS Form 990 asks nonprofits to divide expenses by program, management/general and fundraising. A statement of functional expenses is required as part of the audit for voluntary health and welfare organizations.

But a statement of functional expenses is also recommended for every organization for three reasons. First, unless your organization is very small (less than $25,000 in revenue annually), you probably have to file a 990 or 990-EZ already. Second, even if you are very small now, you might someday be large enough to need an audit – so you might as well get in the habit of creating a statement of functional expenses right now.

Third, and perhaps more importantly, a statement of functional expenses is an ideal method for tracking the real costs of program and supporting activities, making it an invaluable tool for decision-making. It allows you to see exactly what Program X is costing, what Program Y is costing, whether your fundraising is proportionate to the areas that need it, whether you want to build, maintain or scale back a program and so forth.

The information found in a statement of functional expenses can most easily be organized, streamlined and accessed through the meeting of two basic functional accounting tools: your chart of accounts and your functional areas.

Chart of Accounts

A chart of accounts consists of numbered account names that describe the types of income and expenses that your organization experiences over time. It is the list of categories that tracks the what of each dollar coming into and going out of your organization.

Your chart of accounts should be flexible enough to change as your organization changes. For example, you want to be able to insert new income and expense categories as they arise. But you want to be able to insert them within the broader categories of the existing chart instead of simply appending them to the end of it, which is why it is numbered by the tens, hundreds and thousands instead of 1, 2, 3 and so on.

Functional Areas

Functional areas place the who and the what of each dollar into the why – the program or service for which that dollar is designated. Many organizations that I have worked with tend to track the why by funder or contract rather than by mission-based purpose. But if you use Functional Accounting, you can use functional areas to cross-cut funder information with programs/services and income or expense line items so you can accurately track any given dollar in its journey through your organization. If you haven’t already developed functional areas, start with your mission. Read your goals and values statements, and take a look at how your nonprofit is divided programmatically. Identify each larger purpose, within the overall organization, on which you spend time and money.

Each transaction coming into or going out of the organization should be identified with a code corresponding to the who, the what and the why of that transaction. The more you can integrate these three pieces, the higher-quality, more accurate reports you will produce. And you will produce them more quickly. If your accounting system cannot slice and dice your numbers these three ways, you might consider an upgrade of your financial software.  Don’t forget also to integrate those three questions – who, what and why – into all your relevant processes such as payment requisition forms and record-keeping for bills that come in. It can take some time to set up, but once it is set up, tracking and reporting runs very smoothly. And it will make your auditor happy, too.

If you would like to learn about creating a functional accounting system and policies for your nonprofit please click on the image below.

My Financial Management Plan

Human Resources for Nonprofits Update

News StandThis post is focused on some of the latest developments and issues in human resources, issues that can affect all nonprofit organizations that have employees.

Let’s start with the I-9 form. All employers are required to have these filled out by their employees.  Federal agencies are stepping up their compliance audits of companies in an effort to crack down on illegal immigrants by going after employers. It is best to make sure you have these from all of your employees.

Does your nonprofit use interns? Do you use those interns as a pool of potential employees?  Then this article might be of interest to you.

In any issue involving human resources your documentation is key. From setting performance expectations to defending yourself in court, a solid paper trail can only help. This article list seven major mistakes to avoid.

Hiring employees can be an expensive and time consuming process. As much as we strive to make the best matches not every new-hire works out. This piece has some great advice for those doing the hiring and includes questions to ask potential employees that may help us make better hiring decisions.

Your nonprofit has a policy to only pay overtime pay if approved in advance but an employee is claiming overtime hours worked that were not approved in advance. What do you do?

A disaster waiting to happen or a boon to employers? This article talks about this service from CareerBuilder.com where employers can search for information regarding potential, and current, employee’s online life. Searches of people  can be done without this service but I think this straddles the issue of work-life vs. private-life a little too much.

“That type of behavior goes on here all the time.” is not a sufficient defense against a harassment claim. All managers need to take harassment claims seriously to protect both employees and employers.

Finally, sometimes it is the little things, things that you might think will have no repercussions that get us into trouble. Here is an example of an employee who didn’t like being refereed to by his nickname on the job.

Questions and Answers

I’m either asked these questions or I come across them in my work.  Here are three somewhat common ones.Questions?

Our nonprofit is getting ready for our first audit.  What are we supposed to do, and what does the auditor do?

You should receive a letter of engagement from the auditors that helps spell out the relationship.  You’ll also get a lists of things to do and get ready before the auditors come to your offices for the field work.  This article also talks about the process.  But if you have any questions you should ask your auditors before things get going to avoid any confusion and additional cost.

Should board members be allowed to contact staff directly?  Or should all contact go through the Executive Director?

This was a question on an email listserv and the answer that I liked was posted here.

I would like to have “Gross Receipts” defined. Would this include the value of our volunteer labor? Or is it strictly cash value of donations received?

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