FISCAL ANIMALS

Hidden Accounting & Financial Problems that Not-For-Profit Executives Need to Know Fred M. LaMarca CPA, CFP ® Potter & LaMarca LLP

CHARITIES BUREAU UPDATE

CHARITIES BUREAU UPDATE

 Leadership Committee for Nonprofit Revitalization.

 Body of 32 nonprofit leaders who made recommendations aimed at modernizing New York’s regulatory scheme for nonprofits and improving governance.  Nonprofit Revitalization Act is expected to be submitted to the New York State legislature and voted on in the near future.

RECOMMENDATIONS

 Create a Nonprofit Liaison to the Governor.

 Governor Cuomo in May appointed Fran Barrett to the newly created position of Interagency Coordinator for not-for-profit services. Her role is to bring specific nonprofit issues to relevant government agencies.

RECOMMENDATIONS

 Create an Office of Contracting Reform and Oversight.

 Would streamline contracting process and hold funding agencies accountable?

  Direct state agencies to adjust contract cycle start and stop dates, restructuring contracts to allow for 5 th quarter financing on contracts that the state intends to renew and move to standard and multi-year contracts. Centralize integrity function.

 Allow for submission of electronic filings.  Adopt a single audit approach whereby a single lead agency could conduct fiscal audits for all state agencies.

PROVIDE CASH FLOW RELIEF FOR NONPROFITS

 Provide immediate relief to nonprofits by making cash free loans.  Use the New York City Revolving Grant Fund as its model.  Almost zero default rate as loan payments are recaptured from future payments on delayed contracts.

OTHER KEY PROVISIONS

 Raises audit threshold for small nonprofits.

   California – $2,000,000 threshold.

Massachusetts – $5,000,000 threshold.

Raises current threshold from $250,000 to $500,000.

 Requires a nonprofit board to have an audit committee of at least three independent members.

 Requires audit committee to meet with auditors both before and after the audit process to review audit scope, management letters and regulatory filings.

OTHER KEY PROVISIONS

 Nonprofit boards will be required to form an independent compensation committee that will review executive compensation and determine whether it is fair or reasonable and commensurate with the services provided.

OTHER KEY PROVISIONS

 Requires nonprofit boards with evaluating related party transactions. This includes having independent members with no interest in that transaction determine whether it is in the best interest of the organization, something that New York currently does not require.  Consider alternative transactions and affirmatively determine that the alternative transaction would not be in the nonprofit organizations best interests.

OTHER KEY PROVISIONS

 Eliminate type C nonprofit corporations to reduce confusion.  Change approval process for nonprofits who want to merge or sell off assets.

 Streamline process by obtaining attorney general approval. If attorney general does not approve, NPO can then apply for judicial approval.  Requires conflict of interest and whistle blower policies.

 Allows for E-filing of CHAR 500.

NONPROFIT ACCOUNTING UPDATE

HOW WILL UPCOMING CHANGES IN STANDARD SETTING FOR PUBLIC AND PRIVATE COMPANIES AFFECT NONPROFIT ORGANIZATIONS?

INTERNATIONAL FINANCIAL REPORTING STANDARDS

 SEC trying to determine whether and how to incorporate International Financial Reporting Standards (IFRS) into U.S. financial reporting.  Still no timeline for a decision.

 IFRS do not have standards dealing with not-for-profit issues.

 Even if the SEC decides to adopt IFRS, FASB would need to retain specialized industry guidance.  This would include guidance for NFPs.

STANDARD SETTING FOR NONPUBLIC ENTITIES  Private Company Council (PCC), created by FASB, held its first meeting in December 2012.  PCC will determine whether exceptions or modifications to U.S. GAAP are necessary to address the needs of users of private company financial statements.  PCC will identify, deliberate and vote on any proposed changes, subject to FASB endorsement and public due process.  NFPs are excluded from the activities of the PCC.

IS A NONPROFIT ORGANIZATION A PUBLIC OR PRIVATE ENTITY?

 NFPs have limited resources like private companies.

 Some information that is important to public company investors is irrelevant to users of NFP financial statements.

 NFP stakeholders are interested in the entity’s fiscal sustainability and its ability to repay debt, not the value of the entity for the purpose of trading shares.

FASB NOT-FOR-PROFIT ADVISORY COMMITTEE



Nonpublic Entity Definition Project.

 Substantially all NPF’s have some degree of public accountability (federal & state income taxes, property taxes, tax-exempt debt, etc.)  Distinguishing among NFP’s based solely on whether they are issuers of debt is probably not appropriate.

 FASB should evaluate whether specific standards (public or private) should be extended to NFP’s.

FASB NOT-FOR-PROFIT ADVISORY COMMITTEE

 Key recommendations to FASB      Reexamine the net asset classes and improve how liquidity is depicted in NFP financial statements. Improve reporting of financial performance in the statements of activities and cash flows. Reexamine NFP-specific disclosure notes in order to streamline.

Consider a management’s discussion and analysis (MD&A) to better tell the entity’s financial story.   Management commentary that explains financial information provided in financial statements, including trends over time. Should such information be required or encouraged? If required, for all NFPs or only certain types? MD&A “light” for smaller NFPs?

Estimated completion date is 2 nd half of 2014.

NET ASSET CLASSES

 Current Format  Unrestricted  Temporarily Restricted  Permanently Restricted  Recommended  Other net assets  Donor restricted

SUB CLASSES OF NET ASSETS TO BETTER COMMUNICATE THE LIQUIDITY OF ITS RESOURCES

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Spendable



Designated

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Nonspendable, e.g., PP&E

FINANCIAL PERFORMANCE

 How might the statements of activities and cash flows be improved to better convey financial performance?

  Currently one operating performance measure - Change in Net Assets.

Consider multiple operating performance measures.  Gross measure – reflecting everything that comes into the NPO except capital items.  Intermediate measure – reflecting other activities such as endowment or governing board policies.   Net measure. Should there be one or two statements, e.g., statement of operations, statement of other changes in net assets?

LEASES

 Joint project of FASB and IASB.

 Proposed ASU issued in August 2010.

 Revised proposed ASU expected in 1 st 2013. quarter of  Issuance of final standard to be determined.

 Effective date to be determined.

GAAP DISTINGUISHES BETWEEN TWO TYPES OF LEASES

 Capital Leases  Assets and liabilities are recorded on the balance sheet and depreciation is taken.

 Operating Leases  Lease payments are expensed on a straight-line basis.

 IFRS treats all leases as capital and places them on the balance sheet.

 Employs a “right of use” model for both lessees and lessors.

 Change in the lease reporting standard will have a significant impact on all financial statements, including nonprofits.  Only exception is for leases with term of less than one year.

HOW DOES IT WORK?

 Lessee initially recognizes a liability to make lease payments and a right of-use asset, both measured at the present value of the lease payments.  Forces the recognition of future liabilities for operating lease payments rather than current treatment as a disclosure in the footnotes to the financial statement.  Replaces rent expense reporting with interest and amortization expense for equipment leases.  Although no impact on net assets, could affect financial ratios and metrics, e.g., return on assets and debt-to-equity, which may impact debt covenants.

HOW WILL THIS CHANGE AFFECT NONPROFIT ORGANIZATIONS?

 Could have implications on cost reimbursement for NFPs which have government contracts that allow reimbursement of rent but not reimbursement of interest and/or amortization.

 What about donated space or $1 leases?

 Not covered by the proposed standard, which defines a lease contract as when “the use of an asset…is transferred to the lessee in exchange for consideration.”  NFPs should prepare for this standard.

  Inventory all leases.

Assess capitalization threshold.

THE LATEST ON POTENTIAL CHANGES TO SINGLE AUDIT COVERAGE

 Increase audit threshold to $1 million.

 Entities expending more than $1 million in federal awards would undergo a streamlined single audit (fewer compliance requirements).

 Entities expending more than $3 million in federal awards would undergo a full single audit (with modifications).

 Increase the finding threshold, currently at $10K.

 No indication of effective date.

CHANGES TO AUDIT REPORT

OLD REPORT

For periods ending BEFORE December 15, 2012 INDEPENDENT AUDITOR’S REPORT To the Board of Trustees of ABC Organization We have audited the accompanying statement of financial position of ABC Organization (a nonprofit organization) as of June 30, 20X1, and the related statements of activities, functional expenses, and cash flows for the year then ended. These financial statements are the responsibility of the Organization’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of ABC Organization as of June 30, 20X1, and the changes in its net assets and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.

Firm’s signature City, State August 15, 20X1

NEW REPORT

For periods ending AFTER December 15, 2012 INDEPENDENT AUDITOR’S REPORT To the Board of Trustees of ABC Organization We have audited the accompanying financial statements of ABC Organization (a nonprofit organization), which comprise the statement of financial position as of June 30, 20X1, and the related statements of activities, functional expenses, and cash flows for the year then ended, and the related notes to the financial statements.

Management’s Responsibility for the Financial Statements

Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error.

Auditor’s Responsibility

Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

Opinion

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of ABC Organization as of June 30, 20X1, and the changes in its net assets and its cash flows for the year then ended in accordance with accounting principles generally accepted in the United States of America.

Firm’s signature City, State August 15, 20X1

IRS UPDATE

EXAMINATIONS

 Two Types:   Compliance checks Traditional Examinations  Traditional (Field)  Correspondence  FY 12:   10,473 Field examinations 3,277 Correspondence examinations  < 1% chance of being examined

GOVERNANCE

 IRS undertook a study of the impact of various governance practices of public charities selected for audit.

 Findings based on a sample of 1,300 501 (c) (3) organizations.

 Organizations found to be in compliance had:     Written mission statement.

Always used comparability data when making compensation decisions.

Have controls in place to ensure proper use of charitable assets.

Provide Form 990 to entire Board of Directors before filing.

GOVERNANCE



Organizations found not to be in compliance were those where control of the organization was concentrated in one individual or a select group of individuals.

SIGNIFICANT DIVERSION OF ASSETS

 285 organizations reported a significant diversion of assets on their 2009 Form 990.

 IRS will be auditing these NPO to review their governance practices, both before and after the diversion.

AUTOMATIC REVOCATION AND REINSTATEMENT

 The Pension Protection Act of 2006 (PPA) requires small NPO’s, which had never before been required to file a return, to begin filing an approval notice with the IRS on Form 990-N electronically.  More than 450,000 organizations have lost their tax exempt status, but only 30,000 have applied for reinstatement.

 Can determine a NPO’s current status by reviewing “Select Check” on IRS website.

DETERMINATIONS

 Exempt organization division receives approximately 60,000 new applicants for exemption every year.

 Applications are screened and separated into four categories.

    Substantially Complete – no additional information required (90 days).

Substantially Incomplete – send letter IRS is closing case (60 days).

Applications where minor additional information is needed (120 days).

Application that must be assigned to an agent for further development to determine whether the requirements for tax exempt status were met.

FY 2013 WORK PLAN

Completed Projects  Public Charity Status  Elimination of advanced ruling process.

 Previously received public support status for a 5 year period and then had to file Form 8734, Support Schedule for Advance Ruling Support, to demonstrate it had met the public support test.

 IRS compliance reviews have shown current system is working.

INTERMITTENT NON-FILERS

 Organizations who had filed Form 990 or Form 990-EZ in prior years but were currently delinquent.

 IRS sent out notices to these organizations.

COMMUNITY FOUNDATIONS

 EO Division sent out questionnaires to 3,700 organizations asking for information on their demographics, services, assets, investments, grant making and relationships.  IRS is concerned about situations where donors may appear to exercise significant control over investment and grant making decisions.

FY 2013 WORK PLAN

Ongoing Projects  National Research Program (NRP).

 IRS wide research project on employment tax compliance.

 Agents will examine more than 8,500 returns to ensure proper compliance.

INTERNATIONAL ACTIVITIES OF CHARITIES

 IRS is interested in ensuring that assets and income of domestic charities are not diverted to non-charitable purposes overseas.  Also concerned that U.S. Charities comply with regulations on recordkeeping when they operate abroad.

INTERNATIONAL ACTIVITIES OF CHARITIES

 The results of the exams showed four problem areas:  Failure to file the required report of foreign bank and financial accounts (FBAR’s).  Inadequate recordkeeping.

 Lack of discretion and control over funds sent abroad.

 Failure to file employment tax returns.  In FY 2013, IRS will focus on organizations with high amounts of foreign grant expenditures.

FORM 990-N MISFILERS

 Form 990-N   Organization normally has less than $50,000 of gross receipts.

Form 990-EZ   Gross receipts less than $200,000 and total assets less than $500,000.

Several organizations submitted Form 990-N where other available information indicated they did not meet the Form 990 N criteria.

 Over 1000 organizations “Dual Filed” both Form 990-N and another Form 990 series.

USING FORM 990 INFORMATION IN COMPLIANCE EFFORTS

 Charitable Spending Initiative.

 Focused on the sources and uses of funds.

 Selected for examination NPO’s with high fund raisings costs in relation to overall expenditures.  Will also focus on NPO’s who report substantial income from fundraising, but little or no fundraising expenses.

BETTER BUSINESS BUREAU GUIDELINES

 Spend at least 65% of total expenses on program activities.

 Spend no more than 35% of related contributions on fundraising.

COMPENSATION TRANSPARENCY

 EO Division is focusing on NPO’s who report high gross revenues but very low compensation to all officers, directors, and key employees.

 Circumventing goal of transparency by hiding compensation.