Does a not-for-profit organization have to include a statement of functional expenses in the financial statements?
What donated items should be recognized as in-kind contributions?
How are Board designated amounts reported in the net assets section of the Statement of Financial Position? How do they differ from donor-restricted net assets?
My organization has never had an audit and we are not required by our funding sources or bylaws to have an audit. However, we are concerned about our internal controls and policies and procedures. Must we have an audit performed to have our internal controls and policies and procedures reviewed? Or could we engage your firm to just look at these areas?
What are some of the differences between an audit and a review?
Does my organization have to have both an Audit Committee and a Finance Committee?
What do granting and watchdog agencies look for?
Do I have to file an IRS Form 990? If so, which form? What is the filing deadline?
How should the Board be involved in the Form 990 preparation and review process?
Is the Form 990 available to the public?
Is a not-for-profit organization ever subject to tax?
What policies listed on the Form 990 are required?
Whose compensation has to be disclosed on the Form 990?
What is the process for setting up a not-for-profit, tax exempt organization?
1. Does a not-for-profit organization have to include a statement of functional expenses in the financial statements?
A statement of functional expenses is currently required for all voluntary health and welfare organizations. Voluntary health and welfare organizations are those supported by the general public and who use this funding to support the health and welfare of people. Not-for-profit organizations that are not considered to be a voluntary health and welfare organizations still must report total expenses by their functional classification on the statement of activities or in the footnotes and may elect to include the statement of functional expenses as a supplementary schedule to the financial statements, however it is not currently required. As part of the upcoming exposure draft regarding not-for-profit financial reporting, the FASB is considering requiring this to be a required statement.
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2. What donated items should be recognized as in-kind contributions?
Not-for-profit organizations receive many types of donated goods and services. What should be recognized as a contribution by the organization varies depending on what is received. The most common non-cash donations received and the proper recognition is as follows:
- Donated goods, except for items donated for an auction at a special event, should be recognized at fair value as an in-kind contribution on the date of donation. Donated auction items should be recognized at the amount ultimately received by the organization when the donated item is sold.
- Donated or discounted use of facilities should be recognized as an in-kind contribution at the difference between the amount of rent paid and the market rent for the facility.
- Donated advertising space (in newspapers, magazines, internet sites, etc.) and commercial air time (on TV or radio) should be recognized as an in-kind contribution at fair value if the organization has input and involvement in the development. Design services, professional talent services, etc. should also be recognized as in-kind contributions at fair value.
- Other donated services should be recognized as in-kind contributions at fair value if they meet the following criteria: create or enhance a non-financial asset (such as land, building, intangible asset, etc.) OR require specialized skills, are provided by individuals possessing those sills and would typically need to be purchased if not donated.
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3. How are Board designated amounts reported in the net assets section of the Statement of Financial Position? How do they differ from donor-restricted net assets?
Board designated net assets represent amounts the Board has designated for specific purposes. These include, but are not limited to, Board designated or quasi endowment funds. Quasi endowment funds are amounts the Board has set aside to “operate” similar to permanently restricted/donor restricted endowment funds; however, there are no donor restrictions on the use of the corpus or earnings. The Board can generally undesignate the funds if they so choose. These funds are reported as unrestricted net assets.
Permanently restricted endowments have been established by donors who have specified, generally, that the principal should be invested in perpetuity and all, or a portion, of the earnings can be spent for operations or a specified purpose. The Board can not re-characterize these funds as unrestricted or temporary restricted unless the donor grants permission.
Boards may also set aside funds for other purposes and report them as Board designated in the unrestricted net assets section of the Statement of Financial Position. Again, because there are no associated donor restrictions, they are considered unrestricted. Should a donor restrict a contribution – for a specific purpose or time period, but not permanently – the contribution would be reported as temporarily restricted.
In summary, an amount that is Board designated is unrestricted. Donor restricted amounts are reported as temporarily restricted or permanently restricted.
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4. My organization has never had an audit and we are not required by our funding sources or bylaws to have an audit. However, we are concerned about our internal controls and policies and procedures. Must we have an audit performed to have our internal controls and policies and procedures reviewed? Or could we engage your firm to just look at these areas?
If your organization determines an audit is not desired at this time, yet is concerned about strengthening internal controls, improving segregation of duties, developing accounting policies and procedures, and/or implementing best practices related to oversight and governance, another type of engagement may be beneficial. An agreed-upon procedures or consulting project could be tailored to focus on the specific issues and concerns identified by your organization.
The engagement could be as extensive or as limited as desired by Board/management. Based upon the findings, recommendations would be provided to enhance your internal controls and policies and procedures. The project could also include assistance in implementing the recommended improvements. Further, if desired, we could help draft and document your organization’s policies and procedures in the form of an accounting manual.
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5.What are some of the differences between an audit and a review?
The objective of a review is to provide “limited assurance” that the financial statements do not have known errors or departures from generally accepted accounting principles. A review requires the CPA to be independent from your organization and to have an understanding of your “business”. Additionally, the CPA must perform inquiry and analytical procedures. Additional procedures may be performed if information obtained is questionable. The accountant’s report states that a review has been performed in accordance with AICPA professional standards, that a review is less in scope than an audit and that the CPA did not become aware of any material modifications that should be made in order for the statements to be in conformity with GAAP. Organizations may choose to engage CPAs to review their financial statements when they have bank loans and the lenders do not require audited financial statements.
The highest level of assurance service is an audit. The objective of an audit is to provide reasonable, but not absolute, assurance that the financial statements are presented in accordance with GAAP. An audit includes all of the procedures conducted in a review but additionally requires the auditor to have an extensive knowledge of the economy, the relevant industry and your “business”. During an audit, verification and substantiation procedures are performed (including, but not limited to, third party verification of cash, investment and debt balances, direct correspondence with donors and creditors, physical inspection of assets, sample testing of transactions, review of board/committee minutes, contracts, etc.).
When performing an audit, the auditor is required to have knowledge and understanding of the system of internal controls in place and must assess the risk the controls may not prevent, or detect and correct, material misstatements of the financial statements on a timely basis. An auditor’s report states that an audit was performed in accordance with generally accepted auditing standards and expresses an opinion that the financial statements present fairly the entity’s financial position and results of operations. While the auditor does not express an opinion on the organization’s internal controls, it may identify material weaknesses or significant deficiencies in internal control, which would be required to be communicated in writing. The auditor may offer suggestions to improve internal controls, as well as opportunities to improve efficiency, and best practices regarding policies, procedures and corporate governance.
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6. Does my organization have to have both an Audit Committee and a Finance Committee?
There is no requirement impacting your tax exempt status that requires an organization to have specific committees. Your organization’s bylaws may specify the establishment of certain committees and their respective responsibilities.
It is a best practice that certain financial responsibilities/functions be performed by members of the Board or a Committee, such as a Finance, Audit or Executive Committee. These responsibilities may include, but are not limited to:
- Overseeing the preparation of and review of the annual budget
- Overseeing the preparation of and review of monthly, quarterly and/or annual financial statements
- Overseeing the administration, collection and disbursement of the organization’s financial resources
- Advising the Board and management with respect to making significant financial decisions
In many organizations, these responsibilities may be performed by a Finance Committee.
In addition, if your organization has an audit performed by an independent CPA, it is important that members of the Board or a Finance, Audit or Executive Committee provide oversight over the audit process. In larger organizations, this oversight may be provided by an Audit Committee. Responsibilities of an Audit Committee may include:
- Engaging auditors, discussing the audit with the auditors, and receiving/reviewing the reports from the auditors
- Overseeing the organization’s system of internal control, management’s compliance with applicable policies and procedures and risk management
- Reviewing and evaluating management letter comments and other recommendations for improvements in internal controls and determining if management has taken appropriate action on these recommendations
Again, there is no requirement that separate Finance and Audit Committees be established. Rather, a single committee could be established to perform all of the functions listed above. Further, for smaller organizations with limited resources in the accounting department, these responsibilities may be significantly expanded to include more hands-on duties to strengthen internal controls.
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7. What do granting and watchdog agencies look for?
Granting and watchdog agencies vary in what they look at when evaluating the finances of a not-for-profit organization. Charity Navigator evaluates organizations based on seven financial performance metrics, with variability in the assessment depending on the type of not-for-profit organization. To achieve the highest rating, general principles include having less than 15% of total expenses devoted to management and general and less than 10% devoted to fundraising activities as well as achieving a working capital ratio (also referred to as an operating reserve ratio) greater than 100%. In contrast, Better Business Bureau looks for program expenses in excess of only 65% while the United Way looks for an operating reserve percentage of between 25% - 75%. Given this diversity, not-for-organizations should carefully evaluate what their donors and grantors are looking for and strategically implement realistic plans that support mission related activities while building financial stability.
1. Do I have to file an IRS Form 990? If so, which form? What is the filing deadline?
Generally, an organization that has filed for and/or received tax exemption with the IRS has to file an annual statement unless the organization is one of the types exempted by the IRS such as certain religious organizations (church, church-affiliated organization, school affiliated with a church or religious order, religious order, etc.), certain governmental organizations, and certain political organizations (committee of a political party, candidate, etc.).
Which version of the organization must file is dependent primarily on the organization’s size. The thresholds are as follows:
- Form 990-N: gross receipts normally < $50,000
- Form 990-EZ: gross receipts < $200,000 and total assets < $500,000
- Form 990: gross receipts > $200,000 or total assets > $500,000
Private foundations file Form 990-PF and if organizations have unrelated business income, they also must file a Form 990-T.
The Form 990 is due the 15th day of the 5th month after the organization’s accounting period ends (May 15th for a calendar-year filer). Up to two additional three month extensions can be requested.
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2. How should the Board be involved in the Form 990 preparation and review process?
The level of Board involvement will vary from organization to organization. In smaller organizations, a Board Member may prepare the return. In larger organizations, the Board may assign a committee (generally the Audit or Finance Committee) to perform a detailed review of the Form 990 prior to filing. In any case, the IRS recommends, as a best practice, that organizations share the Form 990 with their Board prior to filing. This should be the version of the Form 990 filed with the IRS with no modifications.
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3. Is the Form 990 available to the public?
The IRS Forms 990, 990-EZ, 990-N and 990-PF are public documents. The IRS makes copies of these forms available to individuals and organizations that request a copy. Through this process, Forms 990 are available for all to view on the Guidestar website (www.guidestar.org). Many organizations also elect to voluntarily include the Form 990 on their own websites.
The version that is made available to the public by the IRS is referred to as the public disclosure version. This version includes all of the required Form 990 information, except the names and addresses of donors are removed from Schedule B (which discloses significant contributions received by the organization).
Organizations must also make Forms 990-T (related to unrelated business income), Form 1023 (application for exempt status by a Section 501(c)(3) organization) and Form 1024 (application for exemption under Section 501(a) organization) available to the public.
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4. Is a not-for-profit organization ever subject to tax?
Generally, not-for-profit organizations are subject to tax in three situations:
If an organization engages in activities that jeopardize their exempt status and it is revoked by the IRS, the organization is subject to taxation.
If an organization is a private foundation, the foundation’s investment earnings (i.e. interest, dividends, and realized gains) are subject to tax. Private foundations pay an excise tax of either 1% or 2% of their investment earnings. Private foundations can qualify for the lower 1% excise tax rate if they exceed a distribution threshold based on the foundation’s average distributions for the past 5 years.
An organization conducts an unrelated business activity. The IRS defines this as a trade or business, that is regularly carried on, AND is not substantially related to furthering the exempt purpose of the organization. Certain revenue sources such as contributions, investment income from routine investments, etc. are not considered to be unrelated. There are also exemptions for activities performed by volunteer labor, for the convenience of members, selling donated merchandise, etc. The threshold for reporting unrelated business income is gross revenue of $1,000 or more so organizations should be careful to review their activities to see if any might trigger a Form 990-T filing requirement. This requirement is applicable for ALL organizations, even those that are exempt from the other Form 990 filing requirements.
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5. What policies listed on the Form 990 are required?
Part VI of the Form 990 asks organizations if they have certain policies in place such as a conflict of interest policy, record retention policy, whistleblower policy, and executive compensation policy. Publicly traded companies must follow the requirements of the Sarbanes Oxley Act regarding record retention and whistleblower reports; however, not-for-profit organizations are exempt from this Act. Having these policies in place though is a best practice for all organizations and a key element of a strong corporate governance structure.
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6. Whose compensation has to be disclosed on the Form 990?
Any compensation paid to an officer, director or trustee must be reported in Part VII of Form 990. The top management official and the top financial official are considered to be officers of the organization so their compensation must be reported, regardless of the amount. In addition, Part VII should disclose the compensation of “Key Employees” (certain employees other than officers whose compensation is greater than $150,000). Part VII also requires that the five highest paid employees, other than those already listed, with compensation in excess of $100,000 be disclosed. In addition, each of the organization’s current officers, directors, trustees, key employees, and five highest compensated employees whose compensation is greater than $150,000 must report their compensation on Schedule J of the Form 990.
Compensation reflected on Part VII is for the calendar year, regardless of the organization’s fiscal year. Reportable compensation reflected in column D should agree to what was reported on box 1 or 5 (whichever is higher) on Form W-2 or box 7 of Form 1099-Misc. Compensation reflected as officer compensation on Part IX should be based on the organization’s fiscal year; therefore, compensation reported will be different on Part VII and Part IX if an organization’s fiscal year is not the calendar year.
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7. What is the process for setting up a not-for-profit, tax exempt organization?
The first step is to set-up the not-for-profit entity under state law. Most not-for-profit entities are corporations formed under the not-for-profit provisions of state law. Check with your state’s Secretary of State to determine the specific filing requirements that are applicable. Most registration filings include the organization’s articles of incorporation and bylaws. You should consider consulting an attorney to have these documents drafted. Most states also have annual report filing requirements which must be met to maintain legal status.
Once the organization is created under state law, consideration needs to be given to obtaining federal and state income tax exemptions. This process is different depending on the type of not-for-profit corporation. For example if the not-for-profit organization desires federal income tax exemption as a Section 501(c)(3) organization (charity, school, hospital, etc.), it must file Form 1023 with the Internal Revenue Service. Other organizations use Form 1024 to obtain federal income tax exemption. For some types of organizations, filing Form 1024 is required. For example, Section 501(c)(9) Voluntary Employee Benefit Associations and Section 501(c)(17) Supplemental Unemployment Benefit Programs, among others, must file Form 1024 to obtain exempt status. In contrast, other types of organizations merely need to follow the rules related to their type of organization to be tax-exempt. These organizations may file Form 1024 to receive a confirmation that the IRS agrees that they qualify for tax exemption.
Most states accept the IRS determination of income tax exempt status. Others require the organization to make a separate filing to the state’s Department of Revenue to obtain an exemption from state income tax.
Many states also grant certain not-for-profit organizations exemptions from sales tax and/or property taxes. As most states do not grant these exemptions to all not-for-profit corporations, a separate application to the state Department of Revenue is usually needed to obtain sales tax and property tax exemptions when they are available.