Common Audit Issues for Nonprofit CFOs and How to Avoid January 13, 2012 Christian Spencer, CPA Director (202) 419-5124 Cspencer@tatetryon.com Agenda Common issues noted Other issues noted How to avoid audit issues Questions/ discussion Roll of the typical CFO…….. Common issues noted Inadequate Segregation of Duties Recordkeeping, reconciliation, and authorization of transactions should be performed by separate individuals Staffing cuts and vacant positions result in incompatible duties being performed Example # 1: Bank reconciliation procedures Bank reconciliation is performed by staff accountant Bank reconciliation reviewed by Controller Checks are signed by CFO Controller position becomes vacant Staff accountant prepares reconciliation and is reviewed by CFO Use of compensating controls becomes necessary to account for incompatible functions Provide monthly check register and bank statement to Treasurer or finance committee as they are independent of reconciliation and approval process Common issues noted Example # 2: Journal entries Non-standard entries are prepared and posted by staff accountant with no documented authorization by Controller Recording and approving of journal entries should be segregated Controller should review and approve entries prior to posting Compensating control - print out a list of all posted journal entries at month’s end. This should be reviewed and approved by the Controller Review and approval should be documented and available during the audit process to verify the control was in place and properly executed Common issues noted Incomplete Documentation Most organizations have an accounting policies and procedures manual, but often times no documentation of the executed control exists Monthly close process, investigation of significant budget to actual variances, and approval of journal entries are common areas of this occurrence Example- controller may review all reconciliations performed by the accounting staff; however, no documentation exists of this review Solution- preparer and reviewer should sign and date manual reconciliations For less paper intensive environments- use of a monthly close checklist is also effective as it summarizes specific close procedures and provides trail of controls executed Common issues noted Lease Agreements Application of FAS 13 (ASC 840) is still in effect until the revised standard on lease accounting is adopted The revised standard will require nearly all operating leases to be accounting for as capital leases. A liability for future lease payments and a corresponding right of use asset will be recorded at the inception of the lease Amortization of the asset and reduction of the liability will occur as lease payments are made New standard most likely still several years away from being adopted Common issues noted Lease agreements Current standards require rent expense be recognized straight- line over the life of the lease agreement Most leases include annual rent escalation clauses and many include periods of free or discounted rent As a result the rent paid does not equal the amount of rent recognized on a straight-line basis- the difference is the deferred rent liability Allowance for tenant improvements needs to be recorded as well as an asset and deferred tenant liability Tenant allowances are often missed because these are transactions handled by the landlord Gross-up of assets and liabilities can be material and can impact financial covenants Common issues noted Contract Reviews Who is authorized to enter into contracts on the Organization’s behalf Organization needs to ensure that contracts are reviewed for operational and financial implications before they are executed Example # 1- Director of fundraising for a museum enters into an agreement with a beverage company to exclusively offer only that company’s products in its restaurant During the audit the agreement is reviewed and the exclusive provider provision is discovered with triggers taxable unrelated business income Director of fundraising was not familiar with unrelated business income provisions and neither the CFO nor legal counsel were consulted prior to execution of the agreement Common issues noted Example # 2- An organization has a policy that future sites for its convention are evaluated and selected by a committee of the board of directors. The head of the committee enters into a contract obligating the organization to hold its 2014 event at a hotel in Las Vegas Subsequent to the execution of the agreement, the CFO notes the large block of hotel rooms that the organization is required to fill. Based on past experience he knows it will be difficult to fill this large block As a result the organization has exposed itself to a potential attrition penalty because the CFO was not consulted to review the contract prior to its execution Important that all significant contracts be reviewed by qualified individuals prior to execution Common audit issue noted Evaluating significant estimates Allowance for doubtful accounts receivable, discounts used in valuation of future promises to give, reserve for nonsalable inventory, and discount rates used in actuarial valuations are common estimates Common issue is that estimates are not adjusted annually for current events or there is no systematic rationale for the estimate There should be a documented process for significant estimates that is reasonable and consistently applied Example # 1- allowance for doubtful accounts receivable includes 50% of amounts past 90 days due plus an amount for any other items known to be uncollectible Example # 2- inventory is reviewed annually for slow-moving items and a reserve for nonsalable inventory is established for any items that are deemed nonsalable based upon recent sales activity Other issues noted Lack of sufficient controls over corporate credit cards Payment of the credit card was done prior to coding of expenses Amounts were recorded in suspense account until properly coded Coding was not done timely and followed up by accounting department Large suspense account had to be reconciled at year end Lack of internal controls over wire transfers Policies and procedures manual addresses cash disbursements but not wires Situations were wires were not required to be confirmed by a separate individual Other issues noted Levels of board designated net assets that create negative unrestricted net assets. Net assets can not be designated by the board so as to create an unrestricted deficit You have essentially designated more net assets than you have available No documented whistleblower or document destruction policy These are the only two provisions of the Sarbanes Oxley Act required to be adopted by all organizations Governance section of Form 990 have specific questions about these policies Still seeing organizations that don’t have these policies Other issues noted Monitoring debt covenants Discuss nature of covenants with financial institution at time of loan agreement to ensure they are feasible to maintain Working capital or liquidity ratios may be skewed due to large deferred revenue balances Many loans require quarterly covenant calculations be submitted to the bank Management’s responsibility to monitor covenants to ensure compliance Other issues noted Internal controls and monitoring of alternative investments Investment in partnerships, hedge funds, and funds of funds Documenting your evaluation process is a key control Meeting with general partner or fund managers to understand controls in place over valuation and risk assessment Review funds’ financial statements and auditor’s opinion Be aware of gates and restrictions on ability to obtain funds Monitor performance Compare performance to benchmarks Review portfolio holdings on a regular basis Amounts reported by the investment advisor may be a month or two in arrears in terms of the alternative investments Consult directly with the fund manager to obtain most recent value How to avoid audit issues Establishment of solid internal control structure Consider using the COSO framework as a basis The committee of sponsoring organizations of the Treadway Commission (COSO) issued a landmark report on internal control. Internal Control—Integrated Framework, which is often referred to as "COSO" provides a sound basis for establishing internal control systems and determining their effectiveness The report outlines five essential components of an effective internal control system How to avoid audit issues Control Environment- sets the tone of an organization by influencing the control consciousness of its people. The tone is established through the actions of management and the governing body. (remember actions speak louder than words!) Risk Assessment- involves the identification and analysis by management of relevant risks at the organization (financial, operational, political, public relations, competition) Control Activities- are the policies, procedures, and practices that ensure management objectives are achieved and risk mitigation strategies are carried out Information and Communication- communicates control responsibilities to employees, board members and others by providing timely, accurate, and relevant information Monitoring- are the processes that assess the quality of the internal control performance over time How to avoid audit issues Proper segregation of duties Use of a monthly close checklist to facilitate complete, accurate and timely monthly reconciliations Documentation of procedures performed and controls executed Consult your audit firm as an educational resource throughout the year, not just at year end Remaining abreast of developments in the non profit sector through CPE, roundtables, and groups like ASAE. Appropriately address unusual transactions during the year, not at year end Communication- internally and externally Speaker Biography Christian Spencer, CPA, is a senior audit manager with over 16 years of public accounting experience, including 13 years working exclusively with nonprofit organizations. Prior to joining Tate & Tryon in September 2011, Mr. Spencer worked as a director in the Vienna, VA offices of McGladrey & Pullen, LLP where he spent 13 years providing audit and tax services to nonprofit organizations with annual revenues ranging from $1 million to over $300 million. Mr. Spencer’s experience includes planning and managing the audits of a wide range of nonprofit organizations, including associations, charitable and educational organizations including those with for-profit subsidiaries and political action committees. Mr. Spencer sits on the audit committee of a large 501(c)(3) Washington, D.C.- based not-for-profit organization that focuses on providing food and shelter services to individuals in need. In addition, he is a member of the Finance and Business Operations Section Council of the American Society of Association Executives. He participates in ongoing continuing education courses for not-for- profit accounting and has written articles for various publications.
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