Newsletter

In the for-profit world (and particularly among SEC-regulated companies), environmental, social and governance (ESG) planning has largely focused on compliance and risk mitigation. Given the mission-based orientation of nonprofits, ESG can be approached as an opportunity to grow their mission and impact in a rapidly changing world. The integration of environmental and social sustainability principles into nonprofits’ operational lifecycles will be key to ensuring donor retention and programmatic success for years to come.

The Rise of ESG Standards and Reporting
Over the past few years, multiple global ESG frameworks and standards have emerged to encourage sustainability strategies and provide guidance on sustainability reporting and disclosure. In the for-profit space, ESG reporting is often used to inform investment decisions, comply with regulations and/or give a company a competitive edge. At present, there is no universally followed standard in place, but there is movement toward consolidation of frameworks and standards. The International Sustainability Standards Board (the ISSB) recently merged with the Sustainability Accounting Standards Board (SASB). In addition, the Global Reporting Initiative (GRI) is a leading framework guiding corporate ESG transparency. Together, they are collaborating in an attempt to establish universal metrics for reporting greenhouse gas emissions, human rights protections, diversity, equity and inclusion (DEI) progress, and linkages to the United Nations Sustainable Development Goals.

In a few short years, the private sector has evolved beyond the early adopters who have expanded their corporate social responsibility efforts into broader ESG reporting. Today, companies understand the risk of being left behind if they do not adopt comprehensive ESG programming. ESG reporting is becoming the new normal, even for entities not beholden to SEC regulations. In the corporate space, ESG adoption is often a reactive response to the demands of investors, customers and other stakeholders. That said, nonprofit organizations will ultimately face demands from their stakeholders; however they are uniquely positioned to leverage ESG to enhance their mission and brand.

The Social License and Increasing Call for Transparency
Nonprofit organizations exist to serve individuals and communities where gaps in the market are unaddressed by the private sector or government. Their social license to operate comes with the benefit of tax exemption in exchange for providing services and transparency (e.g., IRS Form 990). As the nonprofit industry has evolved, so have reporting expectations. In addition to reporting to the IRS, nonprofits self-report an ever-increasing amount of impact and operational data to third-party evaluators such as Charity Navigator, GuideStar and Candid. ESG reporting is the next evolution of transparency reporting for nonprofits.

As nonprofit organizations are adept at reporting financials and an increasing amount of impact data, they must now navigate the evolving expectations related to ESG stakeholders. For stakeholders focused on the bottom line of mission impact, it must not come at the expense of unaddressed (or uncalculated) negative environmental impacts. For example, stakeholders expect nonprofits to understand their environmental footprint and develop strategies to mitigate it. BDO’s Nonprofit Benchmarking Report shows that 18% of nonprofits surveyed report evaluating their vendors, partners and/or funders for their alignment to ESG policies and actions. If that expectation has not been set for an organization today, it is only a matter of time before corporate donors or other stakeholders will expect to see disclosure and alignment. Donors who are accustomed to evaluating their own investments utilizing ESG indexes will be asking questions about the investment portfolios for endowments that fund a nonprofit organization’s programs. Foundations are increasingly aligning their endowments to ESG metrics utilizing the Global Impact Investing Network’s (GIIN) IRIS+ for measuring, managing, and optimizing their impact. Lastly, stakeholders who expect an organization to embody expectations of DEI will also expect reporting on established metrics that demonstrate evidence of progress.

An Opportunity to Grow the Mission
As nonprofit executives examine the industry landscape and their organization’s opportunity to thrive in the future, sustainability must become a key focus in all aspects of management. From attuning to evolving stakeholder priorities to ensuring continued access to donations and capital, and amplifying the impact of their mission, the integration of ESG principles into all facets of the nonprofit lifecycle will contribute to continued success. Indeed, leading industry organizations such as the American Red Cross have exhibited this imperative by incorporating formal ESG programs into their strategic plans.

Establishing ESG expectations at the leadership level can also drive adoption throughout the organization. Program staff can seize the opportunity to further integrate ESG elements and frameworks into program design, delivery and measurement. Development professionals can utilize ESG reporting to articulate insights attractive to individual, corporate and foundation donors. Communication and marketing professionals can tell a truly holistic story of impact. Finance leaders can ensure that their investments reinforce the organization’s mission.

Written by Karen Baum and Corey Eide. © 2023 BDO USA, LLP. All rights reserved. www.bdo.com

An endowment is a pool of funds donated or set aside to be preserved over time in order to support an organization’s mission. Nonprofits establish endowments for a variety of reasons, usually as part of their long-term strategic plan. Donors may contribute assets, such as cash and securities, and make pledges for future contributions to a nonprofit for creating an endowment.

While an endowment is a great idea for long-term planning and may provide continuous funding for charitable activities, it comes with some nuances that must be carefully navigated to ensure it is successfully managed and fulfills the intended purpose for the organization.

The main types of endowments are as follows:

Potential Challenges

Understanding what they are and how to account for endowments
“I received an endowed gift. Now what?” Nonprofits that never had an endowment may not know where to start. Endowments are governed by guiding documents, which may come in various forms such as a trust instrument, other written agreements from the donor or a board resolution. Identifying the right key words in these documents becomes crucial to ensuring that endowments are set up and accounted for correctly. Additionally, recognizing the type of endowment is also important to ensure the appropriate accounting guidance is applied.

Stipulations plus governing laws
Endowment operations are not only governed by the gift instruments but also by state law. Nonprofits may not appropriately prioritize these. The Uniform Prudent Management of Institutional Funds Act (UPMIFA) is a uniform act that provides guidance on investment decisions and endowment expenditures for nonprofit and charitable organizations. Except for Pennsylvania, all states and the District of Columbia have enacted their version of UPMIFA. Pennsylvania has its own endowment law not based on UPMIFA. Nonprofits may not realize that the donor’s stipulations take precedence over UPMIFA, albeit at times the donor stipulations are not explicit enough to override UPMIFA. This can create confusion.

Unclear donor intent
It is not uncommon for donor agreements to be vague when it comes to conveying the intent and purpose of the gift. These documents can be written by various persons who are not accountants, which can create challenges when determining the appropriate financial statement classification and operating mechanics of the endowment.

Managing endowments
Endowment management can be complex and time consuming without proper resources and knowledge. Nonprofits need to track endowment activity in detail, and retain adequate supporting documentation for all gifts and any investment returns. Funds are often commingled in investment pools, which can create allocation challenges for nonprofit accounting teams. Various levels of expertise and strong internal controls are required for effective management.

Donor changes
Over time, donors can submit modifications to their original gift instruments that are not correctly applied on a prospective basis. Nonprofits need to retain support from donors who make modifications to their endowment agreements as a record for any changes made to the accounting and treatment of an endowment from a donor.

Balancing the objectives
Under UPMIFA, applying prudence to the fund to preserve value is the goal, not just retention of the dollar amount of the initial corpus. This is due to the time value of money. A gift of $100 in 1990 is not worth the same today; thus, to preserve the purchasing power of the fund’s principal, prudent investment and spending policies must be applied, while considering the donor’s stipulations for the fund’s use. Funds with deficiencies (where the fund value drops below the corpus) require special considerations related to spending and estimating future recovery. Many of these challenges also apply to a board-designated endowment fund. A board-designated endowment fund is created by a nonprofit organization’s governing board by designating a portion of its net assets without donor restrictions to be invested to provide income for a long but not necessarily specified period. Proper management and investment tracking are also applicable to this type of endowment fund. The board of the organization establishes the purposes for the endowment fund and this should be documented in the board minutes.

Navigating the Challenges
To effectively manage endowments, nonprofits need to be proactive, sophisticated and careful. They must be willing to make the required investment to educate their team and put the right processes and controls in place. Here are some tips to help organizations navigate the challenges discussed above:

• Adopt formal gift acceptance, endowment and investment policies. Policies should clearly address how funds are to be invested, spent and used (purpose).
• Use consistent templates for gift/endowment agreements to standardize the language and avoid misinterpretation. It is important to have personnel from various areas of the organization review and approve these templates including legal, finance, operations and the board.
• When in doubt, clarify intent! Reach out to donors or their representatives, especially for unusual gifts that come into the organization from trusts and bequests.
• Maintain detailed documentation for all gifts. Accurate and detailed recordkeeping is crucial to the success of endowment operations. Documentation should include certain key information on the donor, assets transferred, specified use, spend rate, investment policy and any modifications.
• Monitor endowment assets regularly and compare to donor agreements often.
• At minimum, organizations should analyze investment returns, spending rates and fund balances throughout the year to ensure funds are being managed in accordance with the gift instrument and state law, if applicable.
• Organizations can go back to donors and discuss modifications, if needed. Seek legal advice before any significant changes are considered and obtain written approval from donors.
• Be mindful that the goal is to preserve the overall purchasing power of the endowment over time. Deficient funds should be tracked separately and monitored more frequently. Elevate these to the board or investment committee for review and a plan of action.
• Nonprofits should consider short- and long-term needs when accepting gifts to ensure it is the right strategic decision. Some organizations may need more short-term liquidity to fulfill their mission; thus, it may not be wise to accept endowments that must be maintained in perpetuity and do not generate adequate income for operations. Overly large endowments have been likened to hoarding in the public eye in some cases. Readers of financial statements may not understand how endowments work and see the large balances and question why the entity needs additional resources. Nonprofits may want to consider more flexibility to ensure the immediate needs of the organization are being met. Outside of perpetual endowments, nonprofits can consider term/quasi endowments or include variance power language in their agreements. This will grant the organization some flexibility in redirecting the use of the assets.
• Proper internal controls are imperative to ensure accuracy and completeness of endowment funds. Nonprofit finance personnel should stay abreast of the latest accounting guidance through research and training.
• Before establishing endowments, nonprofits should examine and quantify the costs to manage an endowment, in terms of time and resources. This may be in the form of investment managers, bank charges and other fees, and additional staff time required to reconcile and track activity.

Over the past three years, nonprofits have had to navigate some turbulent times with the disruption of the world’s economic and political environments due to the COVID-19 pandemic, inflation, and political unrest. Endowments and other reserves may be an opportunity for nonprofits to boost liquidity and permanently support their philanthropic goals and survive in an unstable economic climate. Nonprofits should weigh the benefits and costs of establishing and running an endowment. Organizations should also be mindful of the nuances described above and plan how to navigate these. With proper planning and the right resources, nonprofits can avoid improper classification of gifts and financial statement errors when it comes to accounting for endowments. Nonprofits can also lower reputational risk by ensuring compliance with applicable state law and donor stipulations.

Written by Orynthia Wildes. © 2023 BDO USA, LLP. All rights reserved. www.bdo.com

While Accounting Standards Codification (ASC) Topic 842 is applicable to all entities, the adoption of the new leasing standard by nonprofit organizations is bringing into focus some unique considerations that may impact the conclusion of whether a contract actually contains a lease.

What is a Lease?
To set the stage for some of the nonprofit-specific lease considerations to follow, it is important to understand the definition of a lease under Topic 842. A lease is defined as follows: “A contract is or contains a lease if the contract conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration.”[1]

Free or Reduced Rent
A nonprofit organization may be given space, equipment or other assets to use free of charge, or be charged below-market rates for these items. For these types of transactions, a nonprofit organization must consider whether to apply ASC Topic 842, Leases, ASC Topic 958-605, Not-for-Profit Entities Revenue Recognition – Contributions, or a combination of both standards. Let’s illustrate these concepts with some specific examples.

Example 1: Free Rent

Company A provides Nonprofit B with the right to use office space free of charge for five years. Company A retains legal title to the office building but allows Nonprofit B to use the space in furtherance of Nonprofit B’s mission. If Company A had rented the space to another entity, Company A would have charged $1,000 per month for the first year of the lease with a 3% annual escalation of rent for each additional year of the five-year term, which is considered to be the market value.

What’s the accounting for that?
On day one of the arrangement, Nonprofit B would record a contribution receivable, and related contribution revenue, for the full amount of rent payments over the five-year period ($63,710), discounted to present value using an appropriate discount rate.

The revenue is donor-restricted due to time and is released from donor restrictions as the contributed asset (the office space) is used each period. On a straight-line basis each reporting period, Nonprofit B reduces the contribution receivable balance and records rent expense representing its use of the office space.

What is the basis for the accounting?
The transaction in this example falls within the scope of contribution accounting under Topic 958-605 but not lease accounting under Topic 842, because Topic 842 requires an exchange of consideration.

In other words, because Nonprofit B does not pay Company A cash (or other assets) for the use of the office space, the transaction falls outside of Topic 842. If the contributed assets are being provided for a specific number of periods (in this example, the period is five years), the contribution revenue (and related receivable) should be recorded in the period received for the market value of the lease payments discounted to present value.[2]

If the arrangement in this example had not specified the period of use, Nonprofit B would have recorded contribution revenue and the related rent expense each reporting period based on the fair value of the space for that period.

Example 2: Below-Market Rent

Company C provides Nonprofit D with the right to use office space for $250 per month for five years. Company C retains legal title to the office building, but allows Nonprofit D to use the space in furtherance of Nonprofit D’s mission. If Company C had rented the space to another entity instead, Company C would have charged $1,000 per month for the first year of the lease with a 3% annual escalation for each additional year of the five-year term, which is considered to be the market value. For purposes of this example, there is no variable lease cost, no non-lease components, no prepaid rent, no initial direct costs, and no lease incentives. We will assume a 3.5% risk-free rate for the calculation of the lease liability. We will also assume Nonprofit D will use 3.5% as the discount rate for the contribution.

What’s the accounting for that?
On the commencement date of the lease, Nonprofit D would record a lease liability equal to the present value of the lease payments totaling $13,550 (rounded) and a right-of-use asset in the same amount.  For simplicity purposes, the present value calculations in this example are based on annual rather than monthly payment amounts.  The contribution portion of this arrangement is calculated as the difference between the fair market value of rent ($63,710) and lease payments ($15,000) over the lease term totaling $48,710.  Nonprofit D should record contribution revenue and a related contribution receivable[3] at present value of $43,870 on the commencement date of the lease.[4] Similar to the first example, the revenue is donor restricted due to time and would be released from donor restrictions as the contributed asset (the office space) is used each period.  On a straight-line basis each reporting period, Nonprofit D reduces the contribution receivable balance and records rent expense representing its use of the office space.  This example assumes a known fair market value for the rental payments.  When such information is not known, organizations need to obtain such information directly from the lessor or find comparable market data for a similar asset with a similar rental term.

What is the basis for the accounting?
The transaction above falls within the scope of both Topic 842 and Topic 958-605.   Because ASC 842 defines consideration as cash or other assets exchanged, as well as non-cash consideration (subject to certain exceptions), only the portion of the transaction requiring payment is considered to be a lease within the scope of Topic 842.  The fair value of the lease minus the cash payments made represents the contribution revenue and related receivable.[5]

In both of the illustrative examples above, the contribution of free or reduced-rate office space represents a non-financial asset. Nonprofit organizations must consider the revised presentation and disclosure requirements for contributed non-financial assets as outlined in Accounting Standards Update 2020-07, Not-for-Profit Entities (Topic 958): Presentation and Disclosures by Not-for-Profit Entities for Contributed Nonfinancial Assets. This standard is effective for periods beginning after June 15, 2021.

Embedded leases

As nonprofit organizations review their activities and agreements to determine the universe of lease transactions, in both the year of adoption of Topic 842 and in subsequent periods, management should be aware that there may be leases “hiding” within service or other contracts.  These types of contracts are referred to as contracts with embedded leases.  The following chart provides some examples of service or other contracts where embedded leases may be present:

As part of internal policies and procedures related to accounting for leases, management should document, in the year of adoption and annually, how the universe of leases was determined, as well as how management considered the possible existence of embedded leases. While embedded leases may not be material to a nonprofit organization’s financial statements, an analysis to determine the relative value of such transactions should be performed nonetheless.

Use of the risk-free rate
As an accounting policy election, Topic 842 permits nonprofit organizations (specifically entities that are not public business entities) to use a risk-free discount rate for leases instead of an incremental borrowing rate, determined using a period comparable with that of the lease term.[6]  The use of the risk-free rate may be a more expeditious approach for organizations that do not have a readily available incremental borrowing rate.  As a reminder, Topic 842 defines the incremental borrowing rate as “the rate of interest that a lessee would have to pay to borrow on a collateralized basis over a similar term an amount equal to lease payments in a similar economic environment.” If an organization has a real estate lease with lease payments totaling $700,000 over the 10-year lease term, it would not be appropriate for the organization to use its $5 million, one-year, line-of-credit borrowing rate as the incremental borrowing rate because the term and amount of the borrowing is not similar.  Organizations wishing to use an incremental borrowing rate that do not have such a rate readily available may need to use external parties such as banks or other lending institutions or valuation professionals to determine an appropriate collateralized rate for certain lease agreements.

In summary, nonprofit organizations should take the time to examine all their agreements to assess whether they have any embedded leases or other arrangements that are subject to lease accounting.

Written by Amy Duffin. © 2023 BDO USA, LLP. All rights reserved. www.bdo.com

[1] See ASC 842-10-15-3.

[2] See ASC 958-605-25-2 and 958-605-55-24.

[3] See ASC 958-605-55-24.

[4] See ASC 958-605-24 and 958-605-25-2.

[5] See ASC 958-605-55-24.

[6] See ASC 842-20-30-3.

Subrecipient risk assessments and monitoring are critical aspects of federal grants management. These practices ensure that funds are used in accordance with federal regulations, that grant objectives are met and that the risk of fraud, waste and abuse is minimized. The federal government has set forth guidelines in the Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards (Uniform Guidance) found in 2 Code of Federal Regulations (CFR) 200, which outlines the requirements and responsibilities of grant recipients and their subrecipients. This article will delve into common pitfalls around performing subrecipient risk assessments and monitoring, and the best practices for organizations looking to improve their processes in these areas.

Background
The Uniform Guidance addresses the requirements that subrecipients must comply with in section 2 CFR 200.332. This section describes the required procedures for performing monitoring and risk assessments to evaluate the likelihood of noncompliance, fraud or other issues when selecting subrecipients that could impact the performance and success of the grant.

Effective risk assessments and monitoring are crucial for various reasons, including:

• Compliance with federal regulations: Adhering to 2 CFR 200 requirements is essential to avoid penalties, such as disallowed costs or even suspension or termination of the funding.
• Mitigating risks: Timely identification and addressing risks can reduce the potential for mismanagement, waste or fraud, ensuring that federal funds are used effectively and efficiently.
• Performance and outcome achievement: Proper monitoring helps grant recipients track progress, confirm that milestones are met and determine if adjustments are necessary to achieve desired outcomes.

Common Pitfalls
Below are some of the common pitfalls that plague pass-through entities (prime recipients) that work with subrecipients:

• Inadequate risk assessments: Failing to perform a comprehensive risk assessment prior to executing the subaward agreement or relying solely on historical information may result in an incomplete understanding of a subrecipient’s risk profile.
• Insufficient monitoring: Not allocating enough resources to monitor subrecipients or only relying on self-reporting can leave gaps in understanding that can allow certain risks to go unaddressed.
• Lack of documentation: Inadequate documentation of risk assessments, monitoring activities and communications with subrecipients can hinder an organization’s ability to demonstrate compliance with federal regulations and address potential issues effectively.
• Ineffective communication: Poor communication between grant recipients and subrecipients can lead to misunderstandings, missed deadlines and noncompliance with grant requirements.

Best Practices for Subrecipient Risk Assessments
Below are some of the best practices that we recommend:

• Develop a risk assessment framework: Create a structured process that outlines risk categories, scoring criteria, and the frequency of risk assessments. This framework should consider factors such as prior audit findings, debarment, financial stability and the subrecipient’s experience managing federal funds.
• Conduct pre-award evaluations: Before entering into a subaward agreement, assess the subrecipient’s capacity to manage the grant, considering its technical expertise, financial management systems and internal controls. Performing this required risk assessment in the pre-award phase allows for the determination and inclusion of the monitoring procedures as part of the subaward agreement.
• Implement ongoing risk assessments: Regularly reassess subrecipient risk throughout the grant period to identify any changes in circumstances that may affect its ability to meet grant requirements.

Best Practices for Subrecipient Monitoring

• Develop a monitoring plan: Establish a systematic approach to subrecipient monitoring that includes a schedule, tools and documentation requirements. This plan should consider the risk level of each subrecipient and the nature of the grant activities.
• Provide training and technical assistance: Offer support to subrecipients in the form of training, resources and guidance on federal grant requirements, financial management and performance reporting.
• Conduct regular communication and site visits: Maintain open lines of communication with subrecipients and schedule site visits as deemed appropriate to review progress, verify compliance and address any concerns.
• Review financial and performance reports: Regularly analyze subrecipient financial and performance reports and included data to identify potential issues, ensure compliance with grant terms and track progress toward grant objectives.
• Tailor monitoring efforts to risk level: Allocate resources for monitoring based on the risk profile of the subrecipient, with higher-risk subrecipients receiving more oversight and attention.
• As mentioned above, incorporate monitoring procedures directly into subaward agreements.

Conclusion
Effective subrecipient risk assessment and monitoring are essential for federal grant recipients to ensure compliance with 2 CFR 200, mitigate potential risks and achieve desired outcomes. By implementing best practices and avoiding common pitfalls, organizations can strengthen their grant management processes and ensure the responsible stewardship of federal funds.

Written by Dan Durst and Sly Atayee. © 2023 BDO USA, LLP. All rights reserved. www.bdo.com

When asked what is at the top of their finance department “to-do” list, many nonprofits name the need for an updated cost allocation plan. An effective cost allocation strategy is essential to organizations’ understanding of how their resources are being deployed. It is also integral to performing cost analyses, such as evaluating funding requirements and comparing actual versus budgeted costs.

Allocations are an efficient and effective way to distribute costs across activities, including programmatic, administrative and fundraising work. However, many find the practical application of allocation concepts challenging to navigate. While some costs are easily assigned to specific activities and do not need to be allocated at all, there are certain costs that need to be proportionately distributed across activities and the organization, magnifying the potential for complexity and errors.

Allocation Methods
When determining an organization’s allocation strategy, limiting the number of different methods utilized can avoid overcomplication, although most organizations use at least two different allocation methods based on the type of cost.

Payroll and related costs are typically a nonprofit’s most significant expense. Organizations determine employee time worked and how that information is documented and substantiated in different ways. However, the goal is ultimately the same: to report these costs in a way that reflects where employees spend their time—that is, where resources are actually being deployed.

For costs other than payroll, or other than personnel service (OTPS) costs, allocation can be accomplished via various methods, including:

• Full-time equivalent (FTE): The FTE method allocates OTPS in the same proportion as employee time worked in different activities.
• Percent of salary dollars: The salary dollars method allocates OTPS in the same proportion as payroll dollars assigned to different activities.
• Square footage (SF): The SF method, typically applied to occupancy costs, allocates costs proportionate to an activity’s share of facility space.
• Per participant: The participant-based method, typically applied to OTPS across programs, allocates costs proportionate to the ratio of participants in each activity.

Allocating Grant Costs
Grant agreements add a layer of complexity to nonprofit cost allocation. Commonly, grants require related costs to adhere to funder-approved, line-item budgets and conform to defined terms and conditions. That is true regardless of whether the funding is from another nonprofit, an individual or a government entity. Adopting and implementing both a consistent organizational cost allocation methodology and a consistent grant allocation methodology is critical. Special attention to grant allocations helps organizations:

• Understand progress against each grant’s budget
• Avoid the risk of double charging (charging the same cost to two different grants)
• Avoid potential consequences of violating such agreements

To provide an example of how an organizational cost allocation methodology interacts with grant allocations, let’s consider the allocation of program supplies expense for a nonprofit with two different grants supporting a certain program:

The nonprofit has chosen to allocate OTPS using the FTE approach. Under this approach:

1. The program’s share of personnel time and effort is 20%, so the program also is allocated 20% of shared supply costs.
2. The program’s supply expense can be further assigned to the two grants, barring any limitations based on grant budgets and related allowability of those costs per the contracts.

Costs allocated to grants need to be done so with a consistently applied methodology.

From a practical perspective, nonprofit financial systems need to accommodate such multi-dimensional expense tracking. The ability to automate allocation calculations, as opposed to calculating allocations using spreadsheets, is a significant efficiency opportunity. In any case, generating financial reports at different levels of detail, by both activity and grant, directly from the financial system is key.

Once an organization has effectively applied these concepts, the result should be a fair representation of the costs incurred in each program area and in each supportive service. This information is valuable for a variety of reasons. Knowing the cost of programs and the costs covered by grants allows organizations to make more informed choices when evaluating funding opportunities, planning for operational changes and monitoring ongoing activities.

Written by Dan Durst and Gina McDonald. © 2023 BDO USA, LLP. All rights reserved. www.bdo.com

Data quality is a critical factor for organizations of all sizes, and nonprofits are no exception. Poor data quality can lead to inaccurate business decisions, missed opportunities and even financial losses. Further, poor data quality can impact contributions negatively in several ways. It can obfuscate the nonprofit’s achievements year after year, which can erode donors’ trust or describe fewer accomplishments to its contributors. Poor data quality can lead to marketing campaigns that fail to appeal to first-time donors or are insufficient to recapture previous donors.

Why Data Quality is a Challenge
If data quality is a pervasive issue with real consequences, why have most organizations not solved it? This is the case because assessing and remediating data quality is fraught with challenges, such as:

1. Data is an intangible asset and, unlike other assets, does not give detectable signals, such as changing color, giving off smoke or changing smell. In fact, a single erroneous record normally can only be detected when a knowledgeable individual notices the value is not correct in the data.
2. It is not cost effective to confirm the accuracy of every data record. It requires real-world observations or corroboration by another source. These are expensive endeavors.
3. So much data is collected and processed so quickly now that bad records are not perceived as worth the effort to correct, as they will just be replaced soon.
4. Unless the root cause of data quality issues is discovered and resolved, organizations will continue to admit poor data quality into their systems.

Another challenge to data quality is defining what it means for data to be fit for purpose. That definition can change not only across different nonprofits, but within a single nonprofit’s departments as well. In general, high-quality data tends to be defined as:

• A data record presents what is found in reality without distortion (e.g., the ZIP code is the correct ZIP code for a donor).
• The data values follow the correct format (e.g., a U.S.-based ZIP code has five digits with no letters or special characters).
• A data record has no missing values where values are mandatory (e.g., a ZIP code is present for all donor address records).
• There are no duplicate data records for the same entity or event (e.g., the list of valid ZIP codes in a system presents each ZIP code only once per entity).
• There are no contradictions within a data record or across data records (e.g., a ZIP code is the correct ZIP code for the city and state in a donor record).
• The data record represents the most current known information (e.g., the ZIP code in a donor record exists for the donor’s current address, not the prior one).
• The parentage of the record can be traced so that the user knows whence the value was derived (e.g., the donor’s ZIP code was pulled from the contributions database after a donation was made last week).

What Can Be Done
Nonprofits can take one of three stances with regard to data quality:

• Do nothing. Consider poor data quality a cost of doing business and accept the inherent risk.
• Reactive remediation. When data quality problems are discovered—often too late to prevent a damaging business outcome—fix the problem and the class of problems it represents. Over time, data quality will improve.
• Proactive remediation. Pick the data records that are most critical to the nonprofit, usually meaning they are used by more than one department more than once. Define the data quality rules for those data records. Codify those rules into a dashboard that searches for data record violations and aggregates them into a scorecard. When a rule breaks a threshold value —say 15% or more data records have missing values —take action and fix that class of problems.

The proactive remediation approach requires resources and should be taken if the perceived cost of data quality issues is greater than its remediation. In this vein, the approach should not treat all data as equal, but instead consider only the critical data of the entity.

What Questions to Ask
Nonprofits’ leadership should find out what they can about their data quality. Some questions leaders should ask include:

• Is the nonprofit’s data considered trustworthy overall?
• How much time do staff spend cleaning data in preparation for a business analysis exercise?
• No organization has perfect data. Do the managers know where the data quality problems lie? Do they know why the problems occur?
• What steps have the managers taken to detect poor data quality? When found, do the managers fix the data record, fix the problem at the source or both?

The answers to these questions may suggest that leadership devote resources toward not only the assessment and remediation of data quality issues, but in identifying the root cause of those issues and remediating them as well.

Parting Thoughts
Data quality is a critical component of good governance and effective oversight. Nonprofits need accurate and timely information to make informed decisions about their donors and strategy. Poor data quality can distort decision-making, lead to missed opportunities, lower fundraising outcomes and even cause compliance issues. Data quality is also important for risk management, as poor data quality can increase the risk of fraud and cyberattacks and create other business disruptions. Nonprofits should support data quality programs that identify the most critical data records, monitor those records for problems and address problems at the source when they occur.

Written by Jeff Lawton. © 2023 BDO USA, LLP. All rights reserved. www.bdo.com

The Internal Revenue Service finalized regulations on Feb. 23, 2023, significantly expanding mandatory electronic filing of tax and information returns that require almost all returns filed on or after Jan. 1, 2024, to be submitted to the IRS electronically instead of on paper.

Under the new rules, filers of 10 or more returns of any type for a calendar year generally will need to file electronically with the IRS. Previously, electronic filing was required if the filing was more than 250 returns of the same type for a calendar year.

The discussion below focuses primarily on common workplace IRS information forms, such as Form W-2 and 1099 filings and employee benefit plan filings, but the new rules broadly apply to other types of returns.

Insight
Affected employers may need significant lead time to implement new software, policies and procedures to comply with the new rules. Thus, even though electronic filing is not required until 2024 for the 2023 tax year, employers should evaluate what changes may be needed. Simply doing the “same as last year” will not work for many employers.

General Rules
Who is affected? Practically all IRS filers of 10 or more information returns when counting any type, such as Forms W-2, Forms 1099, Affordable Care Act Forms 1094 and 1095 and Form 3921 (for incentive stock options) and other disclosure documents, are impacted by this change this year – that is, for 2023 returns that will be filed in 2024. Even workplace retirement plans may need to file Form 1099-Rs (for benefit payments) and other forms electronically with the IRS starting in 2024 for the 2023 plan or calendar year.

Which returns are affected? In addition to the information returns that are the primary focus of this article, the new rules cover a broad variety of returns, including partnership returns, corporate income tax returns, unrelated business income tax returns, withholding tax returns for U.S.-source income of foreign persons, registration statements, disclosure statements, notifications, actuarial reports and certain excise tax returns.

The rules are not relaxed under these regulations. Thus, returns that are already required to be filed electronically, including partnership returns with more than 100 partners, tax-exempt organization annual returns in the Form 990 series, Form 4720 (for certain excise taxes) and most Forms 5500 (Annual Return/Report of Employee Benefit Plan) continue to be subject to the electronic filing requirement. However, under the new regulations, any taxpayer with 10 or more returns, including income and information returns, must also file its income tax return electronically.

How to count to 10? A significant change introduced by the new regulations is that the 10-return threshold for mandatory electronic filing is determined on the aggregate number of different types of forms and returns. The aggregation rules are confusing because the filings included in the count change depending on which form the determination is made. Also, some filers must be aggregated with all entities within its controlled or affiliated service group to determine if 10 or more returns are being filed for the tax year. For instance, Form 5500 employee benefit plan filers (but not Form 8955-SSA employee benefit plan filers) must count the filings of the employer who is the “plan sponsor” and other entities in the employer’s controlled and affiliated service group.

Example 1: Company A is required to file five Forms 1099-INT (Interest Income) and five Forms 1099-DIV (Dividends and Distributions), for a total of 10 information returns. Because Company A is required to file a total of 10 information returns, Company A must file all of its 2023 Forms 1099-INT and 1099-DIV electronically, as well as any other return(s) that are subject to an electronic filing requirement. The reason for this result is that “specified information returns” such as Forms 1099 and W-2 must be aggregated when counting to determine whether the new 10-or-more threshold for electronic filing is met.

Example 2: Company B is required to file nine Forms W-2 and one Form 8955-SSA. Company B is not required to file the Forms W-2 electronically because the aggregation rules for “specified information returns” take into account only other specified information returns that do not include Form 8955-SSA nor the income tax return. But Company B must file the Form 8955-SSA electronically because the aggregation rules for Form 8955-SSA takes all returns into account.

Example 3: Corporation X, a C corporation with a fiscal year end of Sept. 30, was required to file one Form 1120 (U.S. Corporation Income Tax Return) during the calendar year ending Dec. 31, 2023, six Forms W-2 (for employees), three Forms 1099-DIV (for dividend distributions), one Form 940 (Employer’s Annual FUTA Tax Return) and four Forms 941 (Employer’s Quarterly Federal Tax Return). Because the Form 1120 aggregation rules include returns of any type during the calendar year that ends with or in the taxable year and Corporation X is required to file more than 10 returns of any type during calendar year 2023, Corporation X is required to file its Form 1120 electronically for its taxable year ending Sept. 30, 2024.

Insight
Any payers that currently file any returns on paper should consult with their tax advisor to determine if the new electronic filing requirements apply to them based on the number of returns that they anticipate filing in 2024 for tax year 2023.

Filers must, for the first time, pay particular attention to the total number of returns across all return types, because the new electronic filing threshold is determined based on the aggregate total, not the number of returns per return type. This might require coordination between different departments within an organization and immediate consultation with the IT department and/or software provider to ensure there is adequate time to implement technology solutions or software upgrades before the 2024 filing deadline.

The IRS’s new — and free — online portal for filing these returns electronically, Information Returns Intake System (IRIS), is especially helpful for small filers dealing with electronic filing for the first time. According to the IRS, IRIS is secure, accurate and does not require any special software. This free service is available to filers of any size.

© 2023 BDO USA, LLP. All rights reserved. www.bdo.com

By Marc Berger, CPA, JD, LLM

The recently issued proposed regulations interpreting Internal Revenue Code (IRC) Section 512(a)(6) provide additional guidance and builds on Internal Revenue Service (IRS) Notice 2018-67.

On April 24, 2020, the U.S. Treasury Department and IRS published proposed regulations under IRC Section 512(a)(6) in the Federal Register, which was added to the tax law as part of the 2017 Tax Cuts and Jobs Act (TCJA). The provision requires tax-exempt organizations with more than one unrelated trade or business to calculate unrelated business taxable income (UBTI) separately with respect to each unrelated trade or business. The underlying purpose of the provision is to prevent a net loss from one activity from reducing the net income from a profitable activity. As a result of having to treat each unrelated activity separately, Section 512(a)(6) has become known as the “Silo” provision. The provision has been effective for tax years beginning on Jan. 1, 2018 and thereafter.

Background

The IRS released Notice 2018-67 in August 2018 to provide organizations and their tax advisors some guidance on how to interpret Section 512(a)(6). The proposed regulations generally follow the guidance in the notice, although they make several modifications in response to comments received from the tax-exempt organization community.

The principal issue for organizations seeking to comply with Section 512(a)(6) is determining how many unrelated trade or business activities they have. Congress did not provide explicit criteria for determining whether an exempt organization has “more than one unrelated trade or business” or how to identify “separate” unrelated trades or businesses for purposes of computing UBTI in accordance with Section 512(a)(6). The proposed regulations seek to clarify these issues by establishing a method for determining whether an organization has more than one unrelated trade or business and by identifying separate unrelated trades or businesses. Most business activities will use the North American Industry Classification System (NAICS) business codes, and separate guidance is provided for investment activities. In each of these instances the proposed regulations start with the approach utilized in Notice 2018-67 but make some additional changes to this guidance based on the comments received.

Business Activities Other Than Investment Activities

The proposed regulations would classify most unrelated business activities pursuant to 2-digit NAICS codes, which differ from the more specific 6-digit NAICS codes proposed in Notice 2018-67. The 6-digit codes are described as follows: the first two digits designate the sector, each of which represents a general category of economic sector, e.g., real estate and rental and leasing (53), health care and social assistance (62), accommodation and food services (72); the third digit designates the subsector; the fourth digit designates the industry group; and the fifth digit designates the NAICS industry. When applicable, the sixth digit is used to designate the national industry, to reflect differences between the countries. A zero as the sixth digit generally indicates that the NAICS industry and the U.S. industry are the same.

After considering the comments received from its issuing Notice 2018-67, the Treasury Department and the IRS continue to view an identification method based on NAICS codes as administrable for exempt organizations and the IRS. However, in updating the guidance recommended in the notice, the proposed regulations provide that an exempt organization generally will identify its separate unrelated trades or businesses using the first two digits of the NAICS codes, i.e., by economic sector. While there are more than 1,000 NAICS 6-digit codes, the NAICS divides the economy into only 20 economic sectors. Using the 2-digit codes is expected to result in broader, less subjective identification of trades or businesses that would naturally permit the aggregation of similar activities. In addition, it was noted that the 2-digit codes are less likely to change over time because the codes are revised through notice and comment rulemaking (and OMB has historically not revised the codes at the 2-digit level).

Administratively, the proposed regulations provide that an exempt organization will report each NAICS 2-digit code only once. For example, a hospital organization may operate several hospital facilities in a geographic area (or multiple geographic areas), all of which include pharmacies that sell goods to the general public. Pharmacies are described under the NAICS 2-digit code for retail trade (44). Although each pharmacy potentially could be considered a “separate” trade or business under Section 512(a)(6), particularly if separate books and records exist for each pharmacy, the hospital organization would report all the pharmacies using the 2-digit code for retail trade (44), along with any other retail trades or businesses described by this code, on Form 990-T as one unrelated trade or business.

Finally, the proposed regulations provide that once an exempt organization has identified a separate unrelated trade or business using a particular 2-digit code, the organization may not change the 2-digit code describing that trade or business unless the organization can show that the 2-digit code chosen was due to unintentional error and that another 2-digit code more accurately describes the trade or business. This limitation will apply to codes reported on the first Form 990-T filed after final regulations under Section 512(a)(6) are published in the Federal Register. It is anticipated that the instructions to Form 990-T will be revised to describe how an exempt organization provides notification of such an error. In addition, the Treasury Department and the IRS are requesting comments regarding whether there are other circumstances in which an exempt organization should be permitted to change the selected 2-digit codes.

Investment Activities

The proposed regulations provide that NAICS 2-digit codes are used to identify separate unrelated trades or businesses except to the extent provided in other paragraphs of the proposed regulations. An exempt organization’s investment activities fall under this exception as their rules are provided in other paragraphs of the proposed regulations.

The proposed regulations provide that exempt organizations may aggregate certain investment activities and treat them as one unrelated trade or business for purposes of Section 512(a)(6). For most exempt organizations those activities are limited to: (i) qualifying partnership interests (QPIs); (ii) debt-financed properties; and (iii) qualifying S corporation interests.

For partnership interests, Notice 2018-67 states that the category of “investment activities” should include only partnership interests in which the exempt organization does not significantly participate in any partnership trade or business. As in the notice, the proposed regulations define QPIs as partnership interests that meet one of two tests:

• A de minimis test, which the exempt organization satisfies if it holds directly no more than 2% of the profits interest and no more than 2% of the capital interest of the partnership; or,
• A control test, which the exempt organization satisfies if it directly holds no more than 20% of the capital interest and does not control the partnership, taking into account all facts and circumstances.

In response to comments received on the notice, the percentage interests held by disqualified persons (e.g., directors) do not need to be taken into account under the proposed regulations in applying the percentage thresholds of the de minimis and control tests. In addition, interests held by controlled entities and supporting organizations no longer need to be taken into account for the de minimis test (but do need to be combined for the control test).

With respect to the control test, the notice looked to whether the exempt organization had “control or influence” over the partnership, while the proposed regulations only look to “control.” The proposed regulations provide that control is shown if the exempt organization “by itself” has the ability to require the partnership to perform, or may prevent the partnership from performing, any act that significantly affects the operation of the partnership, or if it has the power to appoint or remove any of the partnership’s officers or employees or a majority of its directors. Like the notice, the proposed regulations also provide that control is shown if any of the exempt organization’s officers, directors, trustees or employees have rights to participate in the management of the partnership or conduct the partnership’s business at any time.

The proposed regulations allow exempt organizations to rely on the information in the annual Schedule K-1s provided to it for purposes of the de minimis and control tests. In addition, once an organization designates a partnership interest as a QPI, it cannot use the NAICS codes to subsequently identify trades or businesses of the partnership unless and until the partnership no longer qualifies as a QPI (in which case it would be required to use the NAICS codes).

Additionally, the proposed regulations temporarily maintain the “transition rule” that was provided in the notice, under which a partnership interest acquired prior to Aug. 21, 2018 may be treated as comprising a single trade or business under Section 512(a)(6). However, the proposed regulations state that an organization’s ability to rely on the transition rule ends at the beginning of the first day of its first taxable year beginning after the final regulations under Section 512(a)(6) are published in the Federal Register.

The proposed regulations provide that income from debt-financed properties includible in unrelated business income (UBI) under Section 512(b)(4) should be included in an organization’s trade or business from ‘investment activities’ for purposes of Section 512(a)(6). This treatment supports the IRS belief that debt-financed properties are generally held for investment purposes. In addition, an S corporation interest that meets either the de mininis or control test for QPIs is considered a “qualified S corporation interest” and would also be included as part of an organization’s ‘investment activities’ unrelated trade or business. An S corporation interest that is not a qualified S corporation interest would be treated as an interest in a separate unrelated trade or business.

Other Activities

The proposed regulations provide that all “specified payments” (i.e., interest, rents, royalties and annuities) received from controlled entities and includible in UBI under Section 512(b)(13) would be treated as a separate trade or business. Moreover, if a controlling organization receives these payments from two different controlled entities, the payment from each controlled entity would be treated as a separate unrelated trade or business.

The proposed regulations also provide that amounts received from controlled foreign corporations which are includible in UBI under Section 512(b)(17) would be treated as income from a separate unrelated trade or business. Finally, the proposed regulations clarify that inclusions of Subpart F income and global intangible low-taxed income (GILTI) are treated in the same manner as dividends for UBI purposes.

Net Operating Loss Deductions (NOLs)

As enacted, Section 512(a)(6) requires organizations with more than one unrelated trade or business to determine any NOL deduction separately for each trade or business. By limiting the reportable unrelated business taxable income from a separate trade or business to zero, the statute supports the underlying purpose of the provision to prevent a loss incurred from one trade or business to offset income generated from another trade or business. To preserve NOLs from tax years prior to the effective date of the TCJA, Congress created a special transition rule for NOLs arising in a taxable year beginning before Jan. 1, 2018 (pre-2018 NOLs). Section 13702(b)(2) of the TCJA provides that Section 512(a)(6)(A) does not apply to pre-2018 NOLs, i.e., that they may be used without regard to the Section 512(a)(6) limitation. For organizations with pre-2018 NOLs, and NOLs arising from years beginning after Dec. 31, 2017 (post-2017 NOLs), a question arose regarding the order in which such losses should be taken. Notice 2018-67 did not affirmatively answer that question, however the proposed regulations do.

The proposed regulations provide that an exempt organization with both pre-2018 NOLs and post-2017 NOLs will deduct its pre-2018 NOLs from its total UBTI before deducting any post-2017 NOLs with regard to a separate unrelated trade or business’s UBTI. Moreover, the proposed regulations state that pre-2018 NOLs are deducted from total UBTI in the manner that results in maximum utilization of the pre-2018 NOLs in a taxable year. This result is organization-friendly in that it allows for the maximum use of these NOLs before their expiration (pre-2018 NOLs expire after 20 years; post-2017 NOLs do not expire).

Charitable Contributions Deduction

For tax-exempt organizations that are corporations, Section 512(b)(10) limits the organization’s charitable contributions deduction to 10% of UBTI. The proposed regulations clarify that Section 512(b)(10)’s reference to ‘UBTI’ refers to UBTI after the application of 512(a)(6). This result is also organization-friendly in that activities with net losses will not lower UBTI for purposes of determining the 10% deduction limit since those loss activities will be limited to zero for purposes of Section 512(a)(6).

Allocation of Expenses

Regarding the issue of allocating expenses between separate unrelated trades or businesses, Notice 2018-67 stated that the Treasury and IRS were considering modifying the “reasonable allocation method” described in Treas. Reg. Sec. 1.512(a)-1(c) and providing specific standards for allocating expenses under Section 512(a)(6). The preamble to the proposed regulations state that Treasury and IRS are still considering the issue and intend to publish separate proposed regulations providing further guidance on this issue. Until these proposed regulations are issued organizations are instructed to allocate deductions in accordance with any reasonable allocation method. Per the IRS, utilizing gross revenues as a method of allocation is not reasonable as it overstates the deduction(s) in determining UBTI.

Proposed Applicability Dates and Approaches

The proposed regulations apply to taxable years beginning on or after the date they are published in the Federal Register as final regulations. For taxable years beginning before that effective date, exempt organizations may (1) rely on the proposed regulations in their entirety; (2) rely on the methods of aggregating or identifying separate trades or businesses provided in Notice 2018-67; or, (3) rely on a reasonable, good-faith interpretation of Sections 511 through 514, considering all of the facts and circumstances, when identifying separate unrelated trades or businesses under Section 512(a)(6).

Summary

While some important questions remain unanswered (e.g., allocation of expenses among various UBI silos), the proposed regulations should provide organizations some comfort in the potential aggregation of activities, which may help the determination of how many unrelated trades or businesses they have. However, this may not ease the inevitable result of increasing their unrelated business income tax liability exposure from a provision that tilts the proverbial “level playing field” towards their taxable entity competitors.

By Michael Conover

The novel coronavirus (COVID-19) crisis has affected all sizes and types of organizations including the nonprofit sector. Regardless of the type of nonprofit, they have been impacted by: forced office closures, dramatic swings (upward or downward) in demand for their services, actual or threatened loss of revenue, budgetary and staff cuts, etc. As the crisis has unfolded, each organization has struggled to respond as new information and guidelines for moving forward have changed. And there is no certainty as to when or how things will begin to change for the better.

Because compensation is generally the largest expense for most nonprofit organizations, it should come as no surprise that many have been forced to reduce or eliminate salaries, and discontinue any bonus and incentive plans. Over time, additional compensation reductions may become necessary if revenues fail to recover to needed levels.

With the struggles to manage day-to-day operational issues a full-time affair, a discussion of compensation would seem to be a pretty low priority in most organizations … particularly since there is likely no good news to report. Like most difficult topics, however, this does need to be raised.

While we cannot make many specific predictions about the future as far as compensation is concerned, I believe there are a few things we can expect as things move forward:

• Staff and salary reductions in response to the crisis will likely result in no or negligible wage growth for the year with possible negative growth in some cases.
• Interest normally devoted to surveys about salary increases for the coming year will likely be focused instead on surveys of trends for addressing the ”no growth” situation which can include plans for restoration of salary cuts, use of one-time bonuses/spot awards, “premium”/ hazard pay for essential personnel, etc.
• Boards will wrestle with decisions about compensation for the executive team managing the organization through the crisis period—pondering a basis for evaluation of performance and an appropriate means for rewarding steps taken for the organization’s survival versus a celebration of growth and profitability.

  Under the best of circumstances, good advice for addressing an organization’s compensation needs is based on an understanding of the facts and circumstances associated with that organization. These uncertain times underscore the need for specific information, but very little is available. With little or no information about when or how things will begin to emerge from the crisis, it might be best to offer some general guidelines for managing compensation in the new normal. A few that come to mind follow:

• Prior to implementing changes in any compensation practices (if not already made), organizations must check with state regulations about required periods of notice before changes can be made. Similarly, plans for eliminating, delaying or changing the terms of payment under any formal plans or employment agreements should be thoroughly researched to avoid any adverse compliance issues.
• Communication about compensation is always important and often not done well. In difficult situations it is more important and must be done better. Information must be shared and provided in advance of change (when possible) by board and management to staff.
• Periodic updates on compensation, particularly in cases where salaries have been reduced, is important. Ideally, plans for restoration can be shared. Until that can occur, communication of assurances that the subject has not been dropped and a plan will be announced as soon as one can be developed should be made. While employees may be reluctant to raise the topic, it is a top-of-mind issue on the home front.
• While board members are likely absorbed in many other issues, the annual compensation discussion may be delayed, but its return to the agenda is a certainty. Management has the same interest in and need for information about compensation as staff members.
• The typical review of actuals in relation to budget, personal objectives met and/or missed, etc. will likely be moot at this point. Similarly, efforts to reset bonus or incentive plans will likely be a pointless effort under current circumstances.
• Rather than delay consideration of management compensation decisions until several days beforehand, board members might do well to devote some time to identifying and discussing some new and/or revised criteria for assessing management’s stewardship of the organization in the crisis. For example:
  • How well were employees treated?
  • How well were the organization’s clients/service recipients treated?
  • How well were the organization’s vendors treated?
  • How did the organization respond to the needs of the community?
• Explore some ideas and/or options for alternative compensation such as non-monetary alternatives for recognition, reward payments (e.g. one-time bonus / spot award, extra paid time off, etc.).
• As circumstances improve and plans for recovery begin to become clearer, communications with all parties about plans for compensation must be a priority. People should not be left in a position to wonder what will happen or be forced to ask. Proactive communication is the best approach.

We expect that in the weeks and months to come, there will be more information to share about trends that will impact compensation later in this year and into next. We will provide updates as they become available.

by Dick Larkin, CPA, MBA

This article is aimed at helping nonprofit organizations plan to cope with the new challenges imposed by the coronavirus pandemic. The first part of the article focuses on matters external to the organization, while the second part focuses on internal matters. The article is intended to raise questions and get people thinking, not to provide pat answers; such would require a book. These challenges are in some ways pervasive among all organizations; in others there will be different effects on different types of organizations, e.g., educational institutions, the performing arts, membership organizations, religious organizations, charitable organizations, healthcare, etc.

The coronavirus has changed our world in ways unimaginable a year ago. The events of Sept. 11, 2001 resulted in permanent changes to air travel. The coronavirus has resulted and will result in permanent changes to a much wider variety of aspects of our personal and business lives. Some of these changes affect both businesses and governments, as well as nonprofits. These articles will focus on those aspects unique to, or that will have a disproportionate effect on, nonprofits.

The most recent events of comparable nature, magnitude, and pervasiveness were the influenza pandemic of 1918-19, which killed tens of millions of people, and the Great Depression of the early 1930s. But, you are thinking: what about 9-11? World War II? 9-11 was over in a few hours; it directly affected only a small number of places and a limited number of people, and was unlikely to happen again. World War II, for most Americans—except those actually in battle and their close families—was not here; it was almost entirely “over there.” Yes there was rationing, and unavailability of some consumer products like new automobiles, but the daily impact of those was relatively small, and not dangerous for most people.

Coronavirus is here, it directly affects everybody everywhere, it is dangerous, and there is as yet no way to predict how long even its direct effects—much less the indirect effects—will last. Even if a preventive vaccine—and a cure for those already sick—were to be discovered tomorrow and made widely available next week, many of these changes still will not ever be completely reversed.

Effect on organizations’ revenue and financial health

Except for healthcare organizations (which of course are working overtime), the nonprofit sector is largely shut down. Educational institutions have closed their facilities and many are conducting classes online, but bookstore sales have largely ceased and athletic department income has completely dried up. Performing arts organizations are silent. Museums are closed, which reduces both admissions income and gift shop sales (some gift shops continue to sell online). Many houses of worship are conducting services online, which has resulted in a drop in “plate” collections. Membership organizations still have their dues income, for now, but meetings are canceled or postponed. Many charitable organizations are seeing increased need for their services, but trying to increase revenue to cover those added costs is challenging because many donors are themselves in financial distress. Many individuals have lost their jobs or seen a reduction in pay. The 2017 income tax act had already reduced the incentive for some to make charitable contributions by doubling the standard deduction for individuals. Now Congress has eliminated the year 2020 required minimum distribution from deferred compensation plans (IRAs and the like), so seniors over age 70½ will have less incentive to make direct charitable rollovers from those plans. On the more incentive side, there is now a $300 charitable deduction available to donors who do not itemize. Foundations have seen their investment portfolios lose value, so they have less available to make grants. State and local governments are seeing declines in sales, gasoline and income tax revenue, so they have less to distribute as support. Only the federal government is pumping money into the economy, some of which is flowing to nonprofits, but this cannot possibly make up for all the other revenue losses.

There are some offsets. It is well known that many performing arts organizations lose money on every performance they put on, so by cancelling performances, they may save more in expenses than they lose in revenue. The real losers there (besides the audiences) are the performers: actors, singers, orchestra musicians, etc., and the supporting staff: stagehands, technicians, ushers, etc. Those organizations that can afford to are doing what they can to keep some of these people on the payroll (there is a limited federal grant program expressly for that purpose), but that does not make everyone whole, and cannot go on indefinitely. Residential educational institutions have lost room and board revenue, but do not have to pay for food and kitchen staff (again a hardship for that staff), or pay for most dormitory current operating costs.

These are short-term effects. But what about the longer term? Will an orchestra or chorus or theater that has had to cancel the rest of its current season be able to attract its audience back when things are able to reopen? Will the performers still be available? (What will a choral concert sound like if all the singers are wearing face masks?) If half of this concert season has been canceled, will donors continue the same level of annual support next season? Will college students re-enroll next semester? Will individuals and companies that have had to cut back on expenditures due to lost income return to their previous levels of charitable giving? Will association members renew their memberships? Will people be willing to resume participating in and attending events in spaces with large numbers of other people, for example, classes, concerts, conferences?

Planning for how to survive these effects is made even more difficult by the current uncertainty about when things will return to anywhere close to normal, if ever. Mounting a museum exhibit or a theater production, or getting all the pieces of a college curriculum in place, or organizing the annual convention of a trade or professional association cannot be done in a week, but at this point no one can be certain when, for example, colleges will be able to fully reopen: This summer session? The coming fall semester? Next year? None of the above? The answer will likely vary by locality. And what if there is a resurgence of the virus during the flu season next fall, as some healthcare experts are predicting is possible?

Internal Effects on Nonprofits

Given the external effects discussed above, how will they affect the internal operations of nonprofits? The governing board and the CEO will take the lead here by first thoroughly understanding the organization’s current situation, then communicating that to the staff (including volunteers), donors, clients (members, students, etc.) and the community. For example, how many months of anticipated expenditures do we now have available in liquid assets?

Some things are obvious. With less income and greater uncertainty, organizations must manage their expenditures even more carefully than they normally do. Expense budgets must be pared; revenue, expense and cash flow budgets must be closely monitored on a timely basis. Difficult choices may have to be planned for and made:

Do we continue this program (academic department, publication, concert series, location) or that one? We no longer may be able to count on the availability of resources to do both.

Should we consider pursuing a merger with [other nearby organization whose programs are similar to ours]?

Do we have access to a line of credit? (If not, why did we not arrange for one before this crisis?)

Would [Major Donor X] be willing to convert a previous restricted gift into an unrestricted gift, or to allow re-purposing of the gift to what is now a more important program?

We are ok for the moment, but what are our Plans B, C, and D if next year’s revenue falls by 20%? 30%? 50%?

Donor and customer relations take on greater importance. Timely and clear communication is vital. Organizations must make every effort to keep the ones they have, motivate donors to increase their giving level, and to attract new donors to make up for the inevitable lost ones. Ditto for educational institutions (students), associations and houses of worship (members), museums (visitors), performing arts organizations (audiences), etc.

Management should become aware of all available governmental resources and take advantage of the ones that may pertain to the organization, such as the Paycheck Protection Program or the SBA Loan Program. Find out what insurance coverage is in place for things like cancelation of events. Would coverage be different depending on whether the cancelation was due to governmental quarantine regulations or the closure of a rented venue versus proactive action by management? Are there foundations which might be willing to help?

Many smaller nonprofits with few staff have always found it challenging to maintain adequate internal controls over their accounting and operational functions. With many staff now working off-site, this challenge is even greater. But the need for these controls is greater, not less. And remember, the responsibility for designing, implementing and monitoring these controls lies squarely with management, not with the auditors. Auditors will (and must under their own professional standards) continue to ask questions of management such as: “How do you satisfy yourself that (for example):

All revenue intended for the organization—especially contributions—has been collected and properly recorded?

All expenditures are for appropriate purposes, consistent with any applicable donor restrictions, in proper amounts, have been properly recorded, and that commensurate benefit has been (will be) received?

All assets that properly belong to the organization are adequately secured, managed, and properly valued and recorded?

All liabilities, and only true liabilities, of the organization are properly recorded and paid?

The organization is in compliance with applicable laws, regulations and funder (private or governmental) restrictions?

All of the organization’s activities are being conducted in an ethical manner? Another way to phrase this is, “Is there anything about the organization, its personnel, or its operations that would cause embarrassment if reported on the front page of tomorrow’s local newspaper?”

Auditors, in turn, are subject to various constraints in performing audit work. They may not have normal access to the client’s personnel, office or other facilities, and thus may be unable to examine hard copies of documents or observe inventory of gift shops or bookstores. Examination of documents and interviews with client staff may have to be conducted electronically, and extra steps taken to verify the authenticity of documents and the proper functioning of internal control procedures.

With the greater risk that staff (including volunteers) may become infected and unable to work at all, and/or infect others, organizations should be sure that every function is backed up by at least one other person or that outsourcing arrangements are in place if needed. Government healthcare privacy regulations probably forbid explanation to the rest of the staff as to why “Mary” is not going to be at work for the next month. But if a virus case is identified in the organization, quarantine regulations may require that that fact (alone—no names) be disclosed to those who may have had contact with the infected person. Legal advice may be needed here.

Some operational areas that may be affected include anything involving travel—especially international, such as students studying abroad, bringing visiting performing artists in from other cities, travel by athletic teams to away games, out-of-town speakers at conferences, members traveling to attend conventions, etc. Technology is already being used in some of these areas, and such use will likely increase. (Ok, technology will not work for team sports: football, soccer, basketball, hockey or racquet sports such as tennis; but maybe it could if golf or a racing-type event such as track and field, swimming or skiing could be contested simultaneously in both home facilities, so the race is effectively against the clock.)

Organizations such as homeless shelters and soup kitchens will need to rearrange their spaces to allow for more social distancing by their clients. Even after the immediate threat of infection has largely passed, would-be users of such facilities may want to feel comfortable that they are adequately separated from their neighbors. An extreme example would be a charity dental clinic, which will have to take extraordinary steps to keep both its patients and staff feeling safe. These and similar organizations should also be certain they have adequate insurance coverage to protect from claims by someone who has accidentally been exposed while in their facility.

Houses of worship have some special challenges: how do they handle group events (apart from regular services) that often involve close personal contact, such as weddings, funerals, baptisms, confirmations, bar/bat mitzvahs, etc.? Even when in-person group services can be safely resumed, should the communion ritual be altered? Should congregants still pass the peace during the service? (There should be an understanding so there will not be embarrassment if one person wants to shake hands or hug a neighbor, but the neighbor does not.)

Some facilities may need to be re-purposed. Convention centers and sports arenas are being used to help meet medical needs of cities. Now-empty college dormitories and dining facilities could be used for helping people in need due to job loss or homelessness.

Now is definitely the time to be thoughtful and creative.

By Barbara Finke, CPA

Most organizations have an established budgeting process. Whether the entity uses a robust performance management tool or a spreadsheet, there is likely a thoughtful process to predict the next year’s revenues and expenses. The budget is usually approved by the board of directors and/or other committee and memorialized in the meeting minutes. Once the budget is final, how an organization utilizes this tool varies. Most organizations utilize the budget as a tool for comparing actuals on a periodic basis while some revisit the budget and make changes based on certain events, and a rare few actually revisit the budget on a rolling schedule and update forecasts routinely.

Based on a survey conducted by KPMG in 2016 with the Economic Intelligence Unit^[1] (consisting of 544 global companies) only two-thirds of organizations surveyed incorporated rolling budgets. Although experts often say reforecasting or rolling budgets are important, many organizations continue to operate with a static budget, citing time or computer system limitations. A static or fixed budget occurs when the organization prepares an annual budget, which remains untouched for the fiscal year. The organization compares actual performance to the budget at periodic reporting intervals. This common type of budgeting is a good tool for keeping spending within a predetermined threshold. A static budget remains useful when spending is generally predictable and consistent. However, it can become cumbersome and unhelpful when the organization sees major changes, and the variances, while explainable, render the static budget meaningless.

Consider the current reality of our unprecedented economic and social times. On Jan. 30, 2020, the World Health Organization (WHO) announced a global health emergency because of a new strain of coronavirus originating in Wuhan, China (COVID-19), and the risks to the international community as the virus spread globally. In March 2020, the WHO classified COVID-19 as a pandemic, based on the rapid increase in global exposure. The world is still determining the ultimate impact of the global pandemic. In the United States, shelter-in-place orders seem to change daily and differ not only by state, but by county or even potentially by neighborhood. Economic stimulus packages were enacted on March 27, 2020, under the Coronavirus Aid, Relief and Economic Security Act, with new grant opportunities, tax changes, and ever evolving lending programs. In addition, we have seen historic stock market changes based on seemingly every announcement from the Centers for Disease Control and Prevention (CDC), the president and/or major corporations. Now, more than ever, organizations need to understand how to reforecast static budgets so that the executive teams can make real-time informed decisions.

Per an article from Kshitjil Dayal, Workday, “…from March 23 to 27, our [Workday] cloud planning platform processed up to 30 times more forecasts and build-out scenarios than in a typical week. Since the emergence of the COVID-19 pandemic, we’ve [Workday] seen an overall average increase of 15 times the amount of modeling and recalibrating as organizations everywhere attempt to make sense of the ripple effects.”^[2] Based on that evidence, organizations seem to be aware of the need to reforecast budgets for fiscal year 2020 and beyond. Was your organization ready?

Historically, the most common reason noted for using reforecasting or a rolling budget was the constantly changing nature of the business environment, whether it be technology innovations, stock market fluctuations or management changes, and the belief that a static budget would not provide organizations with a useful tool when making key decisions. In the past, your organization may have concluded your environment was not constantly changing, or that the headache of the reforecasting process was larger than the benefits. Now every organization is in a state of constant change, and reforecasting is critical.

Budgeting is a bit like road trip directions. In the past, you pulled out the road atlas, plotted your course and headed out. It was a surprise when you hit a major traffic jam or detour, and you were forced to wait patiently. Now, you put the destination into your favorite mapping app and start your route. As you drive, the app periodically notifies you of a shorter available route, or a major road blockage ahead that requires rerouting. Your mapping app provides all of the information you need to quickly make the decision to take a new course or stay on the original one. A budget that can be reforecast quickly gives your organization the same ability. If you want this capability for your organization, the next step is to decide whether you will use a reforecast or a rolling budget.

What is reforecasting?

Reforecasting means updating the entire budget based on new facts and circumstances, taking a holistic look at your original budget and updating any elements as necessary. In the end there is a separate, fully revised budget, not an adjustment to just a line or two. The reforecast allows the operational group to understand the new route to follow and what will be ahead on the new path. It provides a more relevant decision tool than the static budget.

When should an organization reforecast?

As noted above, a reforecast should happen whenever there is a large or unexpected trigger event, such as the COVID-19 pandemic. However, it doesn’t have to be that big of a trigger. It could be a large or unexpected change in one of the organization’s major revenue streams or cost drivers, such as winning (or losing) a major contract. When the main driver of your budget is expected to change as a result of the event, a reforecast should be completed.

Organizations should also consider reforecasting when trends show that the original budget was not accurate, and you start to see recurring, significant variances in line items between actual and budgeted amounts.

The key message is that a reforecast is needed when the main driver of your budget suffers a significant enough impact that it is necessary to consider a holistic change in your original static budget.

How should an organization reforecast?

Before you determine the next steps in reforecasting, consider the budget process in your organization. Do you have a zero-based budget? In a zero-based budget, the organization builds the budget from scratch, considering each expense driving the budget from the expense side and attempting to grow profit by reducing expenses, rather than increasing price per unit or units sold. Or, does the organization look at historical trends and adjust revenues and expenses according to expected growth or shrinkage? Either way, break down the assumptions to the original drivers, whether it is variable costs or variable revenue sources that drive the bottom-line budget. This may require more thought if your organization has not done a zero-based budget recently. If you are struggling to identify your organization’s drivers, consider what key performance indicators you report to the board of directors or what benchmarks you are tracking. These are likely the drivers to consider when you are reforecasting.

Once you have determined which costs or revenues are variable, then reforecast what impact the event will have on your variable drivers. If you budget based on costs, think about what costs are variable, such as operational payroll or supplies. Will these costs increase or decrease? If your costs increase, what will the organization need to do to increase revenues? Another approach is to start with the variable revenue drivers (such as patients served, units sold or students enrolled). Will the visit/unit sales rate increase or decrease? If the unit sales increase or decrease, what is the impact on costs? Will prices need to change? If prices change, what must the organization do in response? Remember as you change the cost driver, consider the impact on revenue, or vice versa.

Next, consider fixed costs and if there are any changes to these based on the trigger event. Typically, fixed costs would not be subject to change; however, in response to an event such as the COVID-19 pandemic, organizations may be renegotiating administrative payroll or rent expenses and, therefore, those fixed costs should be reforecast as well. Perhaps the original fixed-cost assumptions were not accurate in the first place. It is worth looking at all significant line items to ensure the accuracy of the forecast. Take this time to be critical of all original assumptions. Review future debt payments, rental agreements or other recurring charges to ensure that the terms of those contracts have not substantially changed since the budget was originally prepared.

The main drivers of the budget are always program/operational related. Therefore, it is critical that you speak with the managers of each division to understand what their projections entail. Accounting and finance personnel must understand if a change to the budget is realistic and if operations can function with the parameters that have been assigned. For example, if you cut expenses to balance the budget from anticipated revenue losses, make sure operational/program managers agree that there are enough expenses to produce whatever is needed to meet anticipated demands. Finance teams have noted that siloed operations or lack of integrations are main reasons for preparing only a static budget and finding a lack of value in other models.^[3]

While working on reforecasting, time is of the essence. The sooner the data is reforecast, the sooner the organization can use it as a tool for their decision making. It may be difficult the first time the organization works through a reforecast. Take notes on lessons learned and consider how you can set up the next period’s budget in a format that may be easier to reforecast in the future.

How do I predict the unpredictable?

Reforecasting for a trigger event, such as a new contract, is relatively straightforward. Program managers will understand how drivers will be impacted and what considerations should be made. However, what should organizations do with something like the COVID-19 pandemic? How can the future be predicted?

Financial analysts have made a living out of creating models that consider scenarios such as these. Those scenarios are then stress tested to see what happens if certain assumptions change. Using the same thought process can help you “predict” the future.

One way to create a model is to understand your organization’s cash burn. Most CFOs are acutely aware of cash trends. Look back at historical cash flows and calculate what your average spend rate is compared to your average collection rate. With this knowledge you could model a few scenarios.

Consider the worst case scenario first. If the organization is unable to collect cash from any revenue for an entire quarter what reforecast is needed on the budget? What happens if cash from revenue is only reduced a certain percentage over that same quarter? Essentially using this theory, you can start to build steps to respond to a prediction and implement those steps as necessary.

As an example, Organization Y has noted that the current cash position is $1 million, and that fixed costs requiring cash for the next quarter are $200,000. This leaves $800,000 of potential spending. If the organization’s variable expenses are $900,000 a quarter, what steps would need to be taken to cover the shortfall of $100,000 ($1.1 million of variable and fixed costs for the quarter less cash on hand of $1 million)? With a predicted shortfall number, the organization can decide if that means taking on new debt, curbing capital expenses or potentially cutting salaries.

The worst case scenario may not be the most likely. But rather if Organization Y forecasts that instead of the typical cash from revenue of $1 million a quarter, they anticipate $500,000 in cash from revenue this quarter. Now the organization has $1.5 million ($1 million of cash on hand plus the $500,000) to spend over the quarter. If the cash needs are $1.1 million, they know going into the next quarter that they have $400,000 of cash available.

It is easy to establish the worst case scenario. It is harder to picture a realistic scenario, especially during situations like the COVID-19 pandemic. To assist your organization in determining the most realistic scenarios when reforecasting, look at what is happening in your industry in particular. If you are a member of a trade organization, it is likely that they are polling members and publicizing what member organizations are experiencing. You can also look to other sources of benchmarking, such as public companies, to see what the quarterly earnings or filings look like.

Economic sources like IBISworld, Moody’s Analytics, Morgan Stanley Economic Outlook, Morningstar Economic Outlook, or Placer.ai on Retail Foot Traffic provide data and information on economic trends experts are seeing. Organizations often forget to look at external sources to help predict the course of the budget drivers, which can be detrimental when creating an accurate forecast. When preparing any kind of budget, looking at external data sources is critical.

Even if your organization struggles with defining the most realistic scenario, the reforecast is still a helpful tool as it starts to put parameters (Organization Y has somewhere between a shortfall of $100,000 or a surplus of $400,000 to consider) that management can work with to make informed decisions about the best next direction rather than driving blind.

What is a rolling budget?

A rolling budget is similar to a reforecast, except a rolling budget was never intended to remain static and has a set time of when it should be adjusted (rather than waiting for trigger events). A common example of a rolling budget is where an organization would budget four quarters ahead. Each quarter the organization updates the next three quarters and adds a new fourth. Meanwhile monthly comparisons would be made to the monthly budget planned in the rolling budget. The organization would set a time period at which point the budget will be reviewed and updated using the same techniques as noted above for reforecasting. The rolling period could always be adjusted if a trigger event occurred outside of the normal update period. The rolling budget is always anticipating change, so an organization is set up to continuously monitor the trends and update either revenue or cost predictions, or both, to stay nimble.

Which one is better?

The best budget method depends entirely on the attributes of your organization and the industry it operates in.

A static budget is likely the best option for a small organization with relatively small fluctuations year over year. It may also be helpful in organizations that are grant driven where the grant budgets will not change once adopted. While the budgeting process can be long, it only occurs once a year in this environment, which makes it easier for a small staff and limited software capabilities. If your organization utilizes a static budget, to ensure that the budget stays relevant, the organization should routinely compare actual results to budget.

Reforecasting is not always necessary, especially if there is no trigger event and no major variances from the static budget. However, because events like the COVID-19 pandemic are rarely foreseen, the ability to reforecast a static budget is beneficial for any organization. Right now, every organization should prepare a reforecast budget using the steps outlined above based on the impacts of the COVID-19 pandemic. While working on the reforecast, use this time to set up a process and policy of how and when to reforecast your budget in the future. For example, as a policy, an organization could define a trigger event. Try to use thresholds such as an event that would likely change the main budget driver by 20% . When a “roadblock” like the COVID -19 pandemic comes up, the organization needs the tools to create a new fiscal road map. It will likely also lead the organization to identify areas to improve in the static budget process.

If your organization is in a more volatile industry where the drivers are constantly changing and strategy is ever evolving, then the rolling budget is most likely the best method for your organization. Another benefit of a rolling budget is that it inherently pushes the organization to a forward-looking approach, as governance discussions center around how the budget was adjusted and why, versus the historical approach of comparing the static budget to actual and repeating oftentimes the same variances each time. To be successful, a rolling budget requires an ongoing assessment with quick changes to ensure that the periodic budget to actual reporting can be maintained. Reforecasting with a rolling budget also needs to be fairly quick since it is continuous.

If the organization adopts a rolling budget or a reforecasting model moving forward, it is important to make sure careful thought goes into preparing the original budget. Drivers should be clearly identified, and formulas used to show how the variable revenues and costs build from the drivers.

Does my Organization Need Budgeting Software?

A budget could be a simple spreadsheet or prepared using budgeting software. The team should consider how complex the organization’s drivers are when considering whether to utilize a spreadsheet or software. Organizations with multiple streams of revenue with different corresponding variable costs, may find it necessary to utilize software. Software often allows for more complex planning and reforecasting, allowing the organization to create various scenarios to see what an impact such as changing the price of a unit by 5% versus 7% would be. Software can aid collaboration amongst different teams or units, while using a spreadsheet could make maintaining version integrity when sharing with multiple users problematic.

Consider what the likely trend in budgeting will be for your organization to select a tool. In a study done by the Chartered Institute of Management Accountants in 2016, The Reforecasting Report, the authors note that “buying an increasingly complex software platform without full cooperation and negotiation may fail to reduce ‘noise’ in the planning and budgeting process.”^[4] In addition, bad data in, bad data out, no matter what the tool, so an organization should first make sure the budget basics are in place and reliable data can be easily obtained to ensure a software or spreadsheet’s ability to create a proper forecast is enhanced.

^[1]    Kothari, S.P et al. (2007, September) Forecasting With Confidence: Insights from Leading Finance Functions. Retrieved from https://home.kpmg/content/dam/kpmg/pdf/2016/07/forecasting-with-confidence.pdf

^[2]    Dayal, Kshitij (2020, April 15) How to Gain Business Agility in Uncertain Times. Retrieved from: https://blog.workday.com/en-us/2020/how-to-gain-business-agility-in-uncertain-times.html

^[3]    Jelly, Robert (2007, May 1). The Reforecasting Report, 2006 Survey of Current Practices in the UK. Retrieved from https://www.cimaglobal.com/Documents/ImportedDocuments/The_Reforecasting_Survey.pdf

Dayal, Kshitij (2020, April 15) How to Gain Business Agility in Uncertain Times. Retrieved from: https://blog.workday.com/en-us/2020/how-to-gain-business-agility-in-uncertain-times.html

^[4]    Jelly, Robert (2007, May 1). The Reforecasting Report, 2006 Survey of Current Practices in the UK. Retrieved from https://www.cimaglobal.com/Documents/ImportedDocuments/The_Reforecasting_Survey.pdf

By Laurie De Armond, CPA

What is the audit committee self-assessment?

This is a tool designed to assist the audit committee in evaluating how well the audit committee is executing their responsibilities. Please refer to BDO’s Effective Audit Committees for Nonprofit Organizations audit committee self-assessment section to ensure that governance responsibilities are adequately aligned with the charter and are being fulfilled appropriately.

Why should audit committees perform a self‑assessment?

As there is always room for improving quality and performance, we recommend that this document be used in conjunction with your organization’s Audit Committee Charter (or similar document) to ensure that governance responsibilities are adequately aligned with the charter and are being fulfilled appropriately. You may choose to customize this self-assessment further to reflect specific attributes of your organization and develop specific action steps and estimated completion dates to enhance your audit committee’s performance.

Who should use this self-assessment?

This Audit Committee Self-Assessment may be used by those charged with governance (in particular, audit committees) in performing an annual self-assessment. The audit committee chair would generally compile the results, which may be obtained from individual committee members on a confidential basis, but should also contemplate feedback from other key stakeholders such as the board, internal and external audit, and management.

When should the audit committee use this self‑assessment?

The audit committee should perform a self-assessment at least annually with areas identified for improvement to be assessed throughout the year.

How should the audit committee use this self-assessment?

This self-assessment tool is to be used as a guide and in correlation with the responsibilities laid out within the audit committee charter approved by the full board. Thus, organizations may feel the need to tailor the self-assessment to their specific needs. At the discretion of the audit committee chair and members, an additional free-form commentary box could be included to allow for specific recommendations or observations to be captured for further consideration.

Areas of assessment

1. Composition and Character
2. Chairman
3. Independence
4. Continuing Education
5. Setting Tone at the Top
6. Oversight of Internal Control Over Financial Reporting
7. Evaluation of and Communication with Management
8. Evaluation of and Communication with Internal Audit, if applicable
9. Evaluation of and Communication with External Auditors
10. Financial Statements and Other Information
11. Ethics and Code of Conduct
12. Authority and Funding
13. Overall Assessment

Please see the full Effective Audit Committees for Nonprofit Organizations guide here.

For more information from Blackman & Sloop, please contact Deetra B. Watson.

By Tammy Ricciardella, CPA

As calendar-year-end nonprofits have worked through the implementation of Accounting Standards Update (ASU) 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, we have seen quite a bit of diversity in the preparation of the liquidity and availability disclosure required by the ASU.

To improve the ability of financial statement users to assess a nonprofit entity’s available financial resources and the methods by which it manages liquidity and liquidity risk, the ASU requires specific disclosures including:

• Qualitative information that communicates how a nonprofit entity manages its liquid available resources to meet cash needs for general expenditures within one year of the statement of financial position (balance sheet) date
• Quantitative information that communicates the availability of a nonprofit’s financial assets to meet cash needs for general expenditures within one year of the statement of financial position date. Items that should be taken into consideration in this analysis are whether the availability of a financial asset is affected by its (1) nature, (2) external limits imposed by grantors, donors, laws and contracts with others, and (3) internal limits imposed by governing board decisions

The following information can be displayed either on the face of the statement of financial position, or in the notes to the financial statements, unless otherwise required to be on the face of the statement of financial position:

• Relevant information about the nature and amount of limitations on the use of cash and cash equivalents (such as cash held on deposit as a compensating balance)
• Contractual limitations on the use of particular assets. These include, for example, restricted cash or other assets set aside under debt agreements, assets set aside under collateral arrangements or assets set aside to satisfy reserve requirements that states may impose under charitable gift annuity arrangements
• Quantitative information and additional qualitative information in the notes, as necessary, about the availability of a nonprofit’s financial assets at the statement of financial position date

An entity can provide additional information about liquidity in any of the following ways:

• Sequencing assets according to their nearness of conversion to cash and sequencing liabilities according to the nearness of their maturity and resulting use of cash
• Classifying assets and liabilities as current and noncurrent
• Disclosing in the notes to financial statements any additional relevant information about the liquidity or maturity of assets or liabilities, including restrictions on the use of particular assets

Liquidity is defined in the Accounting Standards Codification (ASC) Master Glossary as “an asset’s or liability’s nearness to cash. Donor-imposed restrictions may influence the liquidity or cash flow patterns of certain assets. For example, a donor stipulation that donated cash be used to acquire land and buildings limits an entity’s ability to take effective actions to respond to unexpected opportunities or needs, such as emergency disaster relief. On the other hand, some donor-imposed restrictions have little or no influence on cash flow patterns or an entity’s financial flexibility. For example, a gift of cash with a donor stipulation that it be used for emergency-relief efforts has a negligible impact on an entity if emergency relief is one of its major programs.”

Based on this definition, an entity will have to carefully look at its assets and consider any donor-imposed restrictions that may exist when determining the presentation of liquidity.

A simple measure of liquidity per the ASU is the availability of resources to meet cash needs for general expenditures within one year of the date of the statement of financial position. The ASU does not define general expenditures but does provide some suggestions regarding limitations that would preclude financial assets from being available for general expenditures. Some of these items noted in the ASU include:

• Donor restrictions on the use of assets for particular programs or activities
• Donor restrictions on the time period in which assets are used
• Board designations that commit certain assets to a particular purpose
• Loan covenants that require certain reserves or collateralized assets to be kept on hand
• Compensating deposit balances required by financial institutions

To provide the liquidity and availability disclosure, entities should likely consider combining both a narrative description of their method for managing revenue with donor restrictions and a table that lists the dollar amounts expected to be released from various sources. Entities should develop a liquidity management program that allows them to determine what portions of donor restricted funds will be released from restriction and available for both direct program costs as well as shared expenses that support those programs.

In addition, entities should have a program in place to assess what resources are available. These should only include the portion of funding commitments that are expected to be received in the next year. To assist in this determination, as well as the overall liquidity management, entities should consider utilizing a rolling cash flow projection that covers at least a 12-month period.

Entities should also provide, in the qualitative component of the disclosure, information about other methods they use to manage liquidity and maintain financial flexibility. Examples of these could include:

• The use of lines of credit
• Established operating reserve policies
• Cash management process

It is important to develop this disclosure to present an accurate picture of the liquidity and availability of resources utilizing both financial information and supporting narrative to fully explain the financial health of the organization.

For more information from Blackman & Sloop, please contact Deetra B. Watson.

By Laurie De Armond, CPA, and Adam Cole, CPA

The world needs nonprofits to continue striving for meaningful impact on a wide range of social, economic and human rights issues, and it needs them to remain financially healthy. To do so, organizations need to balance a nonprofit heart with a business mindset.

Your mission is the heartbeat of your nonprofit. Just as the human heart sustains a body, your mission is the driving force of your organization’s work. But the heart can’t do it on its own. One clogged artery puts stress on another element of the system—and while it may go undetected for some time, eventually that stress starts to show. A healthy heart and a strong organization rely on fully functioning support systems.

Like the four chambers of the heart, following are four critical elements for sustainability that can take your mission from idea to impact:

1. People: From the Governing Board to the C-suite team to employees and volunteers, supporting the people behind the nonprofit is vital. While the typical nonprofit professional is highly motivated and engaged, it’s critical for the organization’s leadership team to ensure the skills of its people align with the present and future needs of the organization. If you don’t have the right people or maintain proper engagement and focus on the organization’s mission—or don’t treat your people well—it could ultimately harm your ability to fulfill your mission.

• Retention: Nonprofits who take a business mindset to their recruitment and retention policies will work with their best assets—highly impactful and rewarding work—to promote internally and externally the holistic value of a nonprofit career.
• Succession Planning: Successful organizations have strong leaders at the helm, but they also plan ahead for the inevitable day when a change in leadership must occur. Unfortunately, leadership succession planning can be neglected in the nonprofit world, where devoted leaders often stay for long tenures and can be hesitant to pass the reins to a new leader.
• CFO/Financial Leaders: While the CEO and executive director are critical leaders who set the tone and mission of the organization, nonprofits cannot overlook the importance of their financial leadership.

2. Operational & Financial Management: Nonprofits must look at their operations with a more critical business mindset to find the appropriate balance between programmatic spending and the investments (both capital and programmatic) required for continued growth and stability. Prioritizing programmatic spending is a given, but nonprofits that place equal focus on long-term scalability and sustainability will maximize their impact.

• Tackling the Overhead Myth: Charity rating sites have put additional pressure on organizations to minimize their overhead spending. The unfortunate consequence is that many donors now assume, incorrectly, that low overhead costs are a good measure of a nonprofit’s performance—what is commonly referred to as the “overhead myth.” Low overhead may serve as a nice, short-term talking point for donors, but it’s an unsustainable strategy.
• Avoid the Starvation Cycle: In reality, high ratios of programmatic spending could mean the organization is underfunding critical areas necessary for long-term growth—a phenomenon known as the “starvation cycle,” which creates an unhealthy environment for the organization. Failing to invest in infrastructure, such as new technology, security, employee training and fundraising capabilities, can be detrimental to organizational growth.

3. Transparency & Communication: Prospective donors are increasingly thinking like discerning shoppers—researching organizations as they would a major purchase. They are seeking convenience, and fewer clicks to donate. Meeting these demands requires new skill sets, enhanced training and education, and creates opportunities for automation to improve and streamline processes.

• Digitizing Donor Relations: It’s not enough to create an annual report and share it online, or to send regular email and mail communications on impact and outcomes. Donors expect near real-time reporting, with frequent updates. A large number of nonprofits already use social media to communicate with external stakeholders and that is only likely to increase.
• Communicating Clearly & Often: It’s no secret that budgets have been constrained by economic and donor and funding shifts. To mitigate surprises down the line, start the budgeting process early and make projections to give a realistic picture of how the organization’s financial situation could shake out. By planning ahead and communicating early and often, stakeholders will be better prepared to advise and respond.

4. Governance & Compliance: Lack of compliance with a regulation or insufficient board oversight on a key risk like cybersecurity can erase great mission-driven outcomes, sever trust with stakeholders and put the entire organization in jeopardy. The professionals in and outside of a nonprofit organization who proactively plan for risk, digest and implement new regulations, and prepare for compliance changes are unsung heroes who do behind-the-scenes, labor-intensive work to ensure the broader organization can focus on its mission without the worry of hitting costly roadblocks.

• Staying Cyber Secure: Nonprofits can’t maximize their impact if they are constantly responding to data privacy breaches or cyberattacks. A hack can take down a great organization by erasing trust and diverting resources from the mission. Nonprofits should think of these efforts as their secret weapon, not a financial anchor weighing them down. Even with limited resources, nonprofits must take a proactive approach to regulatory compliance and risk mitigation because the alternative could mean betraying donor and public trust and resulting in financial ruin.
• Managing Your Data Plan: Consider a holistic data privacy strategy as part of your data governance program. A Privacy Operational Life Cycle that helps keep employees apprised of new privacy requirements, embraces recordkeeping and sound data protection practices, and offers enhanced data privacy for stakeholders is crucial with the General Data Protection Regulation in effect and other state and national laws in motion.
• Tax-Exempt, not Tax-Blind: Nonprofits also know that tax-exempt doesn’t mean they can ignore taxes. Tax reform provided another significant shift in rules for nonprofits to address. Major changes to unrelated business income, executive compensation, endowment taxes for higher education institutions and changes to charitable giving deductions, among other items, impacted nonprofits and created significant compliance work for internal and external teams. Assessing guidance and understanding total tax liability is critical to strategic tax planning and maintaining operations. With changes to the tax code still a possibility in the future (including the release of additional guidance), this may be a moving target of sorts for nonprofit leaders, but it’s one that can’t be ignored.

When each of these elements, like the four chambers of the heart, are considered and given priority in setting and executing strategy, nonprofits are poised for greater success and long-term impact.

For more on how to balance a nonprofit heart with a business mindset for optimal, sustainable outcomes, read the first insight in our Nonprofit Heart, Business Mindset series: The Business of Impact.

For more information from Blackman & Sloop, please contact Deetra Watson or Elizabeth Mauch.

By Amy Guerra, CPA

Historically there has been diversity in practice among nonprofits with regard to presentation of restricted cash and cash equivalents in the statement of cash flows.

To address this diversity, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016‑18, Statement of Cash Flows (Topic 230): Restricted Cash. As a result of this ASU, a nonprofit will be required to present the total change in cash, cash equivalents, restricted cash and restricted cash equivalents for the period covered by the statement of cash flows. Thus, cash flows that directly affect restricted cash will be presented in the body of the statement of cash flows regardless of how they are classified in the statement of financial position and the timing of the establishment and release of the restrictions.

The ASU does not define restricted cash and restricted cash equivalents, so how a nonprofit defines these will not be impacted. What will be impacted is how these amounts are presented in the statement of cash flows. Oftentimes, a nonprofit will have these items presented in separate lines throughout its statement of financial position and may not even have them labeled as restricted cash or restricted cash equivalents.

Under the ASU, a nonprofit will show the net cash provided by or used in the operating, investing and financing activities of the nonprofit and the total increase or decrease as a result of these activities on the total of cash, cash equivalents and amounts considered restricted cash and restricted cash equivalents.

Internal transfers between cash and cash equivalents and amounts considered restricted cash and restricted cash equivalents are not deemed to be operating, investing or financing activities and thus the details of any transfers would not be presented in the statement of cash flows.

If a nonprofit identifies cash, cash equivalents, restricted cash and restricted cash equivalents in separate lines in the statement of financial position, these amounts should reconcile to the statement of cash flows. The nonprofit needs to present a reconciliation of the various cash and cash equivalents line items presented in the statement of financial position that shows the total that is presented in the statement of cash flows for each year presented. This reconciliation can be presented either on the face of the statement of cash flows or in the notes to the financial statements. The disclosure may be either in narrative or tabular format. The requirement to provide this reconciliation will allow users of the financial statements to identify where the restricted cash and restricted cash equivalents are included in the statement of financial position and how much is included in these line items.

In addition, a nonprofit must disclose information about the nature of the restrictions on its cash and cash equivalents.

For those nonprofits considered public business entities because they have issued or are a conduit bond obligor for securities that are traded, listed or quoted on an exchange or an over-the-counter market, the ASU is effective for fiscal years beginning after Dec. 15, 2017, and interim periods within those fiscal years. For all other entities, the ASU is effective for financial statements issued for fiscal years beginning after Dec. 15, 2018, and interim periods within fiscal years beginning after Dec. 15, 2019. The adoption of the ASU should be done on a retrospective basis. A nonprofit may opt to adopt the provisions of the ASU early.

For more information from Blackman & Sloop, please contact Deetra Watson.

Author Profile

Amy Guerra is an Assurance Senior Manager in BDO’s Rosemont office and is the Central Region Audit Quality Director for the Nonprofit practice. With more than 15 years in public accounting, she has extensive nonprofit experience in performing financial statement audits of human service organizations, trade associations, private and operating foundations, and other 501(c)(3) entities. She has extensive experience with Single Audits. Amy is experienced in addressing issues unique to nonprofits, ranging from tax-exempt status to endowments, pledge campaigns, and reserve levels. She understands the reporting and compliance requirements of Form 990 and its related complexities having prepared the Form 990 for several years. She has assisted clients with resolving issues related to board governance and fiduciary responsibility as well as the reconciliation of Form 990 to the audited financial statements. Amy approaches each engagement collaboratively with the client’s accounting department and BDO’s assurance and tax teams.  Her responsibilities at BDO include planning, supervising and coordinating audit engagements as well as presenting audit reports and management letters to boards of directors and Finance and Audit Committees. Amy is a CPA in Illinois and a member of the AICPA. She is also a member of Association Forum of Chicagoland. Amy has a B.S. in Accounting from the University of Illinois at Urbana-Champaign.