To some, this question is equivalent to “Why would I stick a red-hot poker in my eye?” Going through an audit doesn’t have to be the worst experience in your life, but that isn’t the topic of today’s posting. I frequently get the question “Why do non-profit organizations need an audit?” There are many reasons why your financial statements should be subjected to the scrutiny of independent certified public accountants. Here are the most common ones:

• The by-laws of the organization require an annual audit of the financial statements.
• Affiliated fund raising organizations, such as United Way, may require recipient organizations to have an audit as a condition of receiving allocations.
• Lending institutions may require audited financial statements before making a loan and in each year that the loan has an outstanding balance.
• Potential donors, especially foundations, may ask for a copy of the most recent audited financial statements. Although it may not be a prerequisite to receiving funding from them, it is a tool that the foundation can use in its decision-making.
• The federal or state agency from which you are seeking funding requires an audit.
• Management and/or the Board of Directors believe that it is a “best practice” to have an annual audit.

This last reason is the one that I like the most because there is no outside interest that is forcing an audit. I have a friend who recently became a controller at a local church that had never been audited. He requested that his Board of Trustees hire a CPA firm to conduct an audit because he wanted to start his tenure with a clean slate and to have full accountability. What better way to demonstrate to your Board that you are above board, capable, and fiscally responsible than to open your books and records to professionals trained in auditing that will provide an opinion on whether the financial statements are free of material misstatements.

If you’ve never had an annual audit (or it has been a long time since your last audit), some may ask when you should start. Following are a few ideas:

• A year or two before launching a capital campaign
• If there is an expectation that you may be involved in a merger or acquisition
• Before starting a new program that may require some creative funding
• Construction of new facilities that may require interim or permanent bank financing

If you are wondering if the organization you are involved in should have an audit of your financial statements, give us a call.

FIN 48 is an accounting standard that publicly traded companies have been complying with since 2007. Due to many comments and concerns about the standard, the implementation was delayed for nonpublic entities. FIN48 is an interpretation that clarifies accounting for uncertainties in income taxes, but more importantly, it changes the way that resulting liabilities are recognized, measured, presented and disclosed in the financial statements. When a tax return is completed, every answer or number is really a tax position. FIN48 asks the theoretical question, “would that tax position (either taken on a return or expected to be taken on a future return) stand up to examination by the IRS if they have full knowledge of the facts?”. 

Ok that is a bunch of tax talk. How can this standard affect tax-exempt organizations? The Financial Accounting Standards Board actually addressed that issue specifically, in a staff position paper issued last year. There are several FIN48 issues that can affect tax exempt agencies, but the most common are (1) performing services that are not consistent with the organization’s tax exempt purpose and (2) unrelated business income.

The first assessment of any tax position is whether or not the position is more likely than not to be upheld during an IRS examination. If the position would be upheld, then it is NOT an uncertain tax position and there is NO liability.  If the position cannot be upheld, then FIN48 requires a liability to be recorded and disclosed. The calculation of the liability is prescribed but allows some judgement. The recorded liability is the difference between the benefit recorded (full amount) and the amount that would be 50% or more likely to be allowed after the examination. The disclosure will identify this as an uncertain tax position, and will raise red flags for an IRS audit. As reported in the Journal of Accountancy, the IRS is currently proposing companies with more than $10 million of assets to disclose uncertain tax positions on their annual returns. 

Need help in determining what is considered an “uncertain tax position”? See our next post.

In my previous post we discussed external financial statement audits. Now we will discuss the audit process.

To begin the audit, the accountant (or equivalent) will present the auditor with a listing of all accounts and the related balances that are used to compile the financial statements. Basically, the accountant is saying this is what I believe to be the balances of these accounts. Then the auditor goes through various steps, such as confirming information with third parties, reviewing invoices, contracts, receipts, bank statements, and analytical procedures to prove that the balances are not “materially misstated” and that the statements conform to generally accepted accounting principles.

An audit does not look at every transaction that occurred during the year. Normally this would be cost prohibitive. So the auditor will look at various accounts and take a sample of transactions from those accounts. Because we “test” the account balances and not review 100%, our report is not saying that the financial statements are necessarily 100% accurate, but our report tells the users of the financial statements that we believe there is not a material misstatement that would cause you to alter a decision.

For example, your organization may report to us that they have a balance of accounts receivable of $2 million. Through various means of testing this balance, we have reviewed $1.9 million of this balance and believe it to be accurate. But we have not audited the remaining $100,000. We believe that the users of the financial statements would make the same decision if the actual balance were $2 million or $1.9 million. When errors are found during the audit, the auditors will discuss the issues with management and propose adjustments to the financial statements.

Understanding what an audit of financial statements entails helps management, Board of Directors and others to know what they are paying for and that the statements fairly represent the financial status of the organization. If the accountant uses the same generally accepted accounting principles to compile the monthly financial statements, this will help management and the Board of Directors make consistent, well-informed decisions.

FAS 164 issued in April 2009, sets out the principles and requirements for how a not-for-profit entity should determine whether a combination is in fact a merger or an acquisition. Prior to the issuance of this standard FAS 141 provided guidance on combinations for Business entities (for-profit organizations). There are different motivators for acquiring or merging with another organizations. For-profit entities tend to be motivated by market share, generating revenues and maximizing net income. Nonprofit organizations may merge for different reasons, other than the effect on the bottom line. Enhanced program services and missional outreach while reducing overhead, play important factors in negotiating a combination.

Non-profit organizations exempt status requires continued operational compliance with its exemption. Whether the organization fulfills a religious, educational, scientific, cultural service to the community, any organizational changes have to be focused on continuing or expanding the operational exemption. Many non-profit combinations involve an inherent contribution between the organizations.

When two non-profit organizations are combined – is it a merger or an acquisition? After the combination, who controls the combined entity? Who is in control? A new governance team – the combination is recorded as a merger. If one entity cedes control to another entity – the combination is recorded as an acquisition.

How is the combination recorded? Read the rest of this entry »

When I tell folks that I am an auditor, I immediately get that defensive look as they assume that I am a dreaded IRS auditor (which I am not). When I further explain that I audit financial statements, I usually receive a weak smile and a slight head nod, as if to signal that they are glad I am not with the IRS, but they really don’t have an idea what I do and are a little too embarrassed to ask or don’t really care. For those of you employed at non-profit organizations or serve on their Board of Directors, I thought I would take a few moments and explain what an audit of financial statements really entails. In a later post I will address who may need to have an audit.

So what is an audit of financial statements? Usually on a monthly basis, the controller, CFO, or accountant at your organization prepares financial statements, usually consisting of a balance sheet and income statement. These statements are used by staff, management and the Board of Directors to make decisions about the organization. But all of the information is gathered by and reported by people INTERNAL to the organization. A financial statement audit involves someone EXTERNAL to the organization, an independent certified public accountant.

Audits of financial statements are done according to a set of standards that all CPA’s must adhere to, which are referred to as Generally Accepted Auditing Standards (GAAS). These standards have been developed by the American Institute of Certified Public Accountants and are monitored and revised based on financial circumstances, including failures related to fraud.

So how do we perform an audit? See my post, next month.

Whether your annual audit is approaching or this will be your business’ first audit ever, an audit can seem like a daunting event. But there are ways to make this potentially painful event pass with minimal frustration:

10. Begin working on your schedules weeks before the audit occurs, you might have questions and your auditor is just a phone call or email away.
9. Keep track of issues you struggled with during the year. It will help the auditor key in on important areas at the beginning of the audit.
8. Get the confirmations back to the auditors quickly! The more time there is to send these out the better chance the auditor receives the accurate information. Not getting them back causes more work for all parties involved.
7. Communicate your schedule to the auditors. This helps the auditor work around your normal responsibilities.
6. Make all your adjustments to your trial balance before you provide it to the auditor.
5. Those schedules we talked about earlier make sure they tie to that final trial balance.
4. Make needed documentation easy to access and provide it to the auditors as soon as possible.
3. Be available! Here’s a tip, set aside time on your calendar devoted to auditor questions and audit prepwork.
2. Implement good segregation of duties among your staff. The more checks & balances you have the less likely you are to have errors or issues.
1. Don’t do anything fraudulent or misleading during the year. (Always a plus). Tell the truth.

The key to success is communication and preparedness. If you apply these steps you should see a reduction in the amount of friction an audit can cause.

Preparers of financial statements for nongovernmental entities are rquired to follow the accounting guidance contained in FASB Accounting Standards Codification 855, Subsequent Events (FASB ASC 855) and the accounting guidance contained in AU section 560 would no longer be applicable to audits of nongovernmental or state and local governmental entities. 

FASB ASC 855 requires that the auditor’s report date should not be earlier than the date on which the auditor obtained sufficient appropriate audit evidence to support their opinion (i.e. the date to which subsequent events were evaluated). Therefore, the auditor’s report date cannot be earlier than management’s subsequent event footnote date.

In summation: the specific management representations relating to information concerning subsequent events should be made as of the date of the auditor’s report.

It’s year-end and tax-exempt (T-E) organizations are preparing budgets for next year. In fact the budget process relating to expenses has probably been completed, however trying to estimate the revenue stream can be difficult. A number of churches utilize a pledge card to estimate contributions.

During the budget process expenses are reviewed and operations are monitored/analyzed, determining the effectiveness to the mission. Remember, all T-E organizations must continue to be organized and operate in accordance with it’s stated exempt purpose, as approved by the IRS (Form 1023).

Before the end of the fiscal year, department managers are usually asked to submit their budget for next year. Reviewing the current year disbursements, estimated costs for significant capital/program projects, revisions for personnel and related costs are just several of the key factors that must be considered.

To help the finance department and ultimately those charged with governance, churches may ask their congregants to complete a pledge card, indicating their intention to give. During this weekend, First United Methodist Church of Mansfield, accepted the annual “estimates of giving”. An estimate or an “intention to give” allows the church to collect and assess the level of contributions for the next year, without recording an unconditional promise to give. Remember conditional promises to give are recorded when collected (or when the condition has been met). Unconditional promises to give as recorded with the promise has been made by the donor.

So as your church prepares it’s annual budget, it’s o.k. to ask congregants for a giving estimate. This estimate allows management to prioritize capital expenditures and program services.

The IRS recognized the need for transition relief related to information included in Form 5500 by some 403(b) plans. It was noted that some of the filings would be rejected under ERISA because the filing would be incomplete due to the administrator’s inability to identify all participant contracts and accounts that should be included in plan assets. The filing would also be rejected if the audited financial statements contained an adverse, qualified or disclaimed opinion (other than disclaimers related to limited scope audit provisions in 29 C.F.R. 2520.103-8 or 103-12).

Administrators of 403(b) plans do not need to treat annuity contracts and custodial accounts as part of the employer’s plan assets for purposes of ERISA’s annual reporting requirements (further, the employer is not required to count the individual as a participant under the plan for Form 5500 reporting purposes) provided that:

1. The contract/account was issued to a current or former employee before 1/1/09
2. The employer ceased to have any obligation to make contributions and has ceased making contributions to the contract/account before 1/1/09
3. All of the rights and benefits under the contract/account are legally enforceable against the insurer or custodian by the individual owner without any involvement by the employer
4. The individual owner of the contract account is fully vested

The Department will not reject a Form 5500 on the basis of qualified, adverse or disclaimed opinion if the accountant expressly states that the sole reason for such an opinion was because such pre-2009 contracts/accounts were not covered by the audit or included in the plan’s financial statements.

The above information obtained from Field Assistance Bulletin 2009-02.

Has your company considered using IFRS?  The IASB has now issued IFRS for Small and Medium Sized Entities (“IFRS for SMEs”) which is a modification and simplification of full IFRS and private companies now have the option of preparing their financial statements in accordance with US GAAP, OCBOA, full IFRS or IFRS for SMEs.  IFRS and IFRS for SMEs are not OCBOA; rather, they are GAAP.  The final version of IFRS for SMEs, in total, is a mere 230 pages in length!

IFRS for SMEs applies to private companies or those that do have public accountability (i.e. companies that file, or are in the process of filing, with a securities commission or other regulatory organization for the purpose of issuing any class of instruments in a public market; or it holds assets in a fiduciary capacity for a broad group of outsiders such as banks, insurance companies, brokers and dealers in securities, pension and mutual funds).

For private companies that are owned by a foreign parent, have a significant foreign investor, supplier or venture partner, IFRS for SMEs is an alternative to the more complicated and voluminous US GAAP.  For such companies using a consistent global financial accounting and reporting standard will increase comparability and improve efficiencies of conducting business with their foreign counterpart.

The key differences in IFRS versus US GAAP:

• Disclosures are simplified in a number of areas including pensions, leases and financial instruments
• LIFO is prohibited
• Goodwill and indefinite life intangible assets are amortized over a period not exceeding ten years
• Depreciation is based on a components approach
• A simplified temporary difference approach to income tax accounting
• Reversal of impairment charges, if certain criteria are met, is allowed
• Accounting for financial assets and liabilities makes greater use of cost

 Key challenges if your company decides to use IFRS for SMEs:

• Understanding the differences between IFRS for SMEs and US GAAP
• The willingness of financial statement users to accept financial statements prepared under IFRS for SMEs
• Working with and accepting a more principles-based set of accounting standards compared to the more rules-based US GAAP
• The impact on taxes and tax planning strategies
• The impact on financial reporting metrics

 The final IFRS for SMEs can be obtained free, after registering, from the IASB website: http://www.iasb.org/IFRS+for+SMEs/IFRS+for+SMEs.htm

 Additional information about IFRS for SMEs and about activities of IASB can be found at www.ifrs.com