The top 4 categories of common financial reporting and disclosures errors include the following:
- Revenue recognition (ASU 2018-08) as more government grants will be treated as conditional contributions rather than previously recognized as an exchange transaction. This is based on the fact that both parties must receive value for it to be an exchange transaction under the new revenue recognition standards.
- Net asset classifications for the new accounting standards
- Financial Statement presentation as listed for each financial statement
- Disclosure errors as listed in the notes to the financial statements
The following series is a listing of some of the financial statement errors found in Not-for-Profit organizations. I have broken it down by the different financial reports.
The Statement of Financial Position which is commonly referred to as a Balance Sheet may have the following financial statement errors:
- Display of current/noncurrent assets without displaying current/noncurrent liabilities when a classified statement is used.
- Improperly including items in cash and cash equivalents, such as cash held or other assets that are restricted or not available for current use.
- Failure to report cash, contributions receivable, and other assets that are restricted for a long-term purpose separately from unrestricted cash and cash equivalents, contributions receivable or other assets.
- Recording deferred revenue for amounts received under a “grant” instead of recording temporarily restricted revenue in circumstances where the “grant” is, in substance, a temporarily restricted contribution and not a true cost-reimbursement arrangement.
- Improper reporting of beneficial interests in assets or net assets held by others, such as in the instance of an entity transferring assets to a community foundation and naming itself beneficiary.
- Failure to distinguish between operating leases and capital leases and apply the proper accounting under the circumstances. A capital lease is recorded as both an asset and a liability on the statement of financial position. An operating lease is not reported on the statement of financial position and is expensed as incurred.
- Missing one or more of the required totals: total assets, total liabilities, total net assets, permanently restricted net assets, temporarily restricted net assets, and unrestricted net assets.
- Include Cash and Cash equivalents items that are board designated or donor designated and not available for current use.
- Failure to capitalize certain costs of internal use software: ASC 350-40.
- Failure to account for operating lease liability when cash outlay doesn’t match up with lease.
The Statement of Activities which is commonly referred to as an income statement or statement of revenues and expenses may have the following financial statement errors:
- Improperly releasing temporarily restricted net assets that are subject to both a time and purpose restriction when one, but not the other, restriction is met.
- Reporting revenues from exchange transactions as increases in restricted net assets. Only those revenues related to contributions with donor-imposed restrictions can result in restricted net assets.
- Reporting amounts receivable under a cost-reimbursement contract/grant as temporarily restricted (may be legally limited as to use, but it is an unrestricted activity for which unrestricted costs have been incurred).
- Recording amounts as a receivable under cost-reimbursement contract/grant for which costs have not been incurred.
- Failing to properly classify revenue transactions (or portions thereof) as contribution or exchange transactions. Improperly including expenses in temporarily or permanently restricted net assets. Expenses should decrease unrestricted net assets.
- Erroneously reporting just one program service function when the NFP has more than one major class of program services. For example, an NFP may have programs for health or family services, research, disaster relief, and public education, among others. One program service activity could be fine for private foundations, supporting organizations, or potentially a smaller organization.
- Failure to recognize contributions of services that meet the recognition criteria or recognizing
contributed services that do not meet the criteria as discussed in paragraphs 16-17 of FASB ASC 958- 605-25.
- Not reporting contribution revenue for gifts-in-kind (free or below-market rent, services provided by another organization, donated supplies, donated media, food, facilities, entertainment and so on.) Would nonprofit purchase this service if it was not donated?
- Not reporting costs of soliciting contributions, including costs of soliciting contributed services that do not meet the recognition criteria, as fundraising costs. Generally, an organization that reports contributions will have fundraising expenses. Remember, the costs of recruiting volunteers is fundraising
- Management and general expenses include Business management, General recordkeeping, Payroll, and Human resources, and administering grant and contract financial reporting, annual report, and all other management and administration except for the direct conduct or direct supervision of program services or fundraising activities.
The Statement of Cash Flows may have the following financial statement errors:
- Failing to display donor restricted capital-type contributions (permanently restricted gifts, gifts restricted for acquisition of property) as a financing activity.
- Failing to display information about noncash gifts for endowment or property, plant and equipment purposes.
- Failing to disclose indebtedness incurred for the acquisition of assets as a noncash activity.
- Netting amounts for purchases and sales of property, plant and equipment. This should be reported at gross.
- Improperly reporting unrestricted contributions that were subsequently designated by the governing board for long-term purposes as a financing activity rather than an operating activity.
- Failure to report as investing activities the cash flows from purchases, sales, and insurance recoveries of unrecognized, noncapitalized collection items.
- Reporting net cash flows for purchasing and sales of investments, purchases and sales of property and equipment, and borrowings and repayments on long term debt.
The Statement of Functional Expenses may have the following financial statement errors:
- Failing to include certain expenses in the statement (for example, expenses netted against revenues or non-operating expenses).
- Failing to include the statement when one is required (voluntary health and welfare entities).
- Management and general expenses are inappropriately or completely reallocated to other functional categories. For example, costs associated with soliciting funds other than contributions, including applications for and administering certain grants and contracts, are allocated to program services or fundraising activities.
- Within the listing of natural expenses in a Statement of Functional Expenses, including a function or program line item. For example, within the listing of natural expenses listing the line item “grant expenses” which might have already been allocated such items as payroll, occupancy and supplies.
- Commonly excluded items include expenses netted against the revenues:
- Special event expenses
- Costs of Goods Sold
- Costs of Rental Activities
The Notes to the Financial Statements may have the financial statement errors:
- Failing to include the required disclosure for summarized financial information.
- Failing to disclose an adequate description of the organization’s activities, including each major class of programs
- Failing to disclose the capitalization policy for property, plant and equipment.
- Failing to disclose discount rates used in present value measurements, such as in measuring unconditional promises to give or split-interest agreements.
- Failing to disclose information about the nature of permanent restrictions include the following:
- Donations to be invested in perpetuity
- Collections items or other assets to be held in perpetuity
- Endowment disclosures
- Failing to disclose information about the nature of temporary restrictions include the following:
- Support for specific programs
- Use in future periods
- Acquisition of long term assets
- Unappropriated endowment earnings
- Failing to disclose information about the programs or activities for which contributed services were used.
- Failing to present reclassifications which are in effect corrections of errors as restatements. However when reclassifications are not corrections or errors, failing to describe the nature of reclassifications made to prior-year amounts to conform to current year presentation when such reclassifications are significant, even if such reclassifications had no effect on the prior year’s change in net assets.
- Failing to disclose total fundraising costs. When a statement of functional expenses is presented and certain fundraising costs have been netted against revenue, such netted costs need to be included in total fundraising costs.
- Failing to disclose total program expenses if the components of total program expenses are not evident from the details provided on the face of the statement of activities (for example, if cost of sales is not identified as either program or supporting services).
- Consider whether information disclosed is consistent with or compliments: annual report, website, Form 990, or strategic plan.
- Failure to disclose material related party transactions as set forth in FASB ASC 850-10. Related parties include, but are not limited to, the following: officers, board members, founders, substantial contributors, and their immediate family members; members of any related party’s immediate family; parties providing concentrations in revenues and receivables; supporting organizations; financially interrelated entities; or other entities whose officers, governing board members, owners, or employees are members of the NFP’s governing board or senior management, if those individuals have significant influence to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests.
We hope you find this list helpful as your review and evaluate your current financial statements. The notes to the financial statements are typically only included in the audited financial statements which means the organization is typically unaware of these disclosures. We work with our clients on a daily basis to review and update the financial statements on a regular basis so let us know if you would like us to review and update your financial reports.
We have found the following types of errors in the Net Asset Classifications:
- Errors in endowment calculations and related reporting (beware of large spreadsheets)
- Debit balances in net assets with donor restrictions (except for underwater endowment funds) and released net assets without donor restrictions
- Recording board designated net assets in net assets with donor restrictions instead of net assets without donor restrictions
- Reporting pledges receivable without donor restrictions due in future years as without restrictions
- Reporting reclassifications of amounts between net asset categories when the reason is other than changes in donor designation
- Improperly presenting expenses as net assets with donor restrictions
- Not releasing restrictions with first dollar spent
We can help you to present your net asset classification properly so please contact us to help you review your reports and make suggestions for improvements and proper reporting.