By Shelley Casey, CPA – Manager
As a nonprofit, part of your mission is to bring good to the community and the world at large. One important aspect of running a nonprofit is ensuring that your accounting records are in order to help retain your nonprofit status and to properly report your financial position and the financial results of your organization. Accounting for nonprofits can be complicated. It is important to have a good understanding of accounting concepts unique to nonprofits and to be on the lookout for pitfalls when operating a nonprofit organization. Here are some common mistakes when it comes to nonprofit accounting and tips to help you avoid them.
#1 Not Having Formal Accounting Processes
Each nonprofit organization should have written accounting policies and procedures that provide employees and volunteers with details on how to carry out the accounting function. In addition, you should create internal policies and procedures that help to identify and prevent fraudulent activity. Various fraud indicators should be contemplated when designing internal policies. Below are examples of some fraud indicators:
- Unusual processes or procedures in the accounting system such as allowing certain individuals to circumvent an established process
- Source documents that do not make sense i.e. alterations or photocopies instead of originals
- Unexplained or poorly explained accounting adjustments
One of the best ways to prevent fraud is to also make certain that there is proper segregation of duties. Examples include:
- Accounting staff authorizes and writes checks, and a director signs them.
- The director makes a bank deposit, and the accounting staff records it in the accounting system.
- The director receives and opens bank statements, accounting staff reconciles the bank statement, and the director reviews the bank reconciliation.
Documented accounting policies, procedures, and controls are imperative for board members to carry out their fiduciary responsibility.
#2 Recording Transactions in the Wrong Period
Donor restrictions and an organization’s method of accounting impact the timing of recognizing transactions. When using the cash basis method of accounting, contributions are recognized when received and expenses are recognized when paid. When using the accrual basis method of accounting, contributions are recognized when they are promised and all required conditions have been met, and expenses are recognized in the period incurred. A best practice for nonprofit organizations using the accrual method of accounting is to also use software to track donor contributions and related restrictions.
#3 Lapse in Reviewing Donor Restrictions
It is imperative that accounting personnel have access to donor documents. Donor restrictions impact how funds can be used and how those contributions should be recorded. Contributions should be recorded as advised by the donor and any funds not used within the year should be reported as a net asset with donor restrictions. The contribution would continue to be presented as part of net assets with donor restrictions until the period that an event takes place or transaction occurs that lifts that restriction.
#4 Inaccurate Reporting of In-Kind Contributions
Many nonprofits rely on the services of volunteers and pro bono service providers to assist with its operations. Regulations specify using fair market value for recording the value of services used by nonprofits as a contribution. The fair market value of services provided for specialized skills such as legal, technology, or accounting should be recorded as a contribution to the organization. It is important that the organization document procedures to ensure these services are properly recorded.
#5 Misclassification of Workers
The IRS has been scrutinizing the classification of workers as employees versus independent contractors. Nonprofit organizations should refer to IRS guidelines to assist in identifying the classification of its workers. The IRS emphasizes three “control” factors to help determine a worker’s status:
- Behavioral: Does the organization have the right to direct and control the work performed by the worker?
- Financial: Does the organization have a right to direct or control the financial and business aspects of the worker’s job?
- Relationship: What type of relationship exists between the worker and the organization?
When a worker should be classified as an employee, appropriate taxes must be withheld. Failure to properly withhold taxes can subject your organization to substantial penalties.
#6 Not Understanding Unrelated Business Income (UBI)
The IRS has noted that failure to report the correct amount of unrelated business income is one of the most common mistakes impacting nonprofit organizations. Such failure can have significant consequences for both accounting and tax purposes. Publication 598, Tax on Unrelated Business Income of Exempt Organizations, can help a nonprofit to gain insight on identifying and tracking unrelated business income.
#7 Failure to Invest in the Accounting Function
Nonprofits should ensure that they are:
- Hiring and training qualified accounting personnel
- Investing in proper accounting software
- Ensuring proper backup procedures are in place to avoid loss of information and potential delays in meeting compliance requirements
Accounting for nonprofits can be difficult. Without proper procedures in place, the nonprofit organization can jeopardize its tax-exempt status.
If you have any questions regarding accounting systems, internal controls, or tax reporting for nonprofit organizations, please contact the professionals at MichaelSilver. We are ready to help. Contact us at 847.982.0333.
Shelley Casey, CPA –Manager, has more than 20 years of experience providing personalized, professional accounting services in the public sector. Her experience includes tax, accounting, consulting, and compliance services for closely held businesses, S Corporations and Partnerships, and their owners. Her industry experience includes nonprofits, manufacturers, distributors, furniture wholesalers, professional service providers, hospitality and restaurants, and retailers.