Common Audit Issues -Nonprofit CFOs

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    January 13, 2012

    Common Audit Issues for Nonprofit

    CFOs and How to Avoid

    Christian Spencer, CPA

    Director

    (202) 419-5124

    [email protected]

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    Agenda

    Common issues noted

    Other issues noted

    How to avoid audit issues

    Questions/ discussion

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    Roll of the typical CFO..

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    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 dutiesbeing 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 forincompatible functions

    Provide monthly check register and bank statement to Treasurer orfinance committee as they are independent of reconciliation and

    approval process

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    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 besegregated

    Controller should review and approve entries prior to posting

    Compensating control - print out a list of all posted journalentries at months end. This should be reviewed andapproved by the Controller

    Review and approval should be documented and availableduring the audit process to verify the control was in place andproperly executed

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    Common issues noted

    Incomplete Documentation

    Most organizations have an accounting policies and proceduresmanual, but often times no documentation of the executedcontrol exists

    Monthly close process, investigation of significant budget toactual variances, and approval of journal entries are commonareas of this occurrence

    Example- controller may review all reconciliations performed bythe 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 closechecklist is also effective as it summarizes specific close

    procedures and provides trail of controls executed

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    Common issues noted

    Lease Agreements

    Application of FAS 13 (ASC 840) is still in effect until the revisedstandard 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 leasepayments and a corresponding right of use asset will berecorded at the inception of the lease

    Amortization of the asset and reduction of the liability will occuras lease payments are made

    New standard most likely still several years away from beingadopted

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    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 deferredrent 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 impactfinancial covenants

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    Common issues noted

    Contract Reviews Who is authorized to enter into contracts on the Organizations

    behalf

    Organization needs to ensure that contracts are reviewed foroperational and financial implications before they are executed

    Example # 1- Director of fundraising for a museum enters intoan agreement with a beverage company to exclusively offer onlythat companys products in its restaurant

    During the audit the agreement is reviewed and the exclusiveprovider provision is discovered with triggers taxable unrelated

    business income

    Director of fundraising was not familiar with unrelated businessincome provisions and neither the CFO nor legal counsel wereconsulted prior to execution of the agreement

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    Common issues noted

    Example # 2- An organization has a policy that future sites for itsconvention are evaluated and selected by a committee of the boardof directors. The head of the committee enters into a contractobligating the organization to hold its 2014 event at a hotel in LasVegas

    Subsequent to the execution of the agreement, the CFO notes thelarge block of hotel rooms that the organization is required to fill.Based on past experience he knows it will be difficult to fill this largeblock

    As a result the organization has exposed itself to a potential attritionpenalty because the CFO was not consulted to review the contractprior to its execution

    Important that all significant contracts be reviewed by qualifiedindividuals prior to execution

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    Common audit issue noted

    Evaluating significant estimates

    Allowance for doubtful accounts receivable, discounts used invaluation of future promises to give, reserve for nonsalableinventory, and discount rates used in actuarial valuations arecommon estimates

    Common issue is that estimates are not adjusted annually forcurrent events or there is no systematic rationale for the estimate

    There should be a documented process for significant estimatesthat 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 otheritems known to be uncollectible

    Example # 2- inventory is reviewed annually for slow-moving itemsand a reserve for nonsalable inventory is established for any itemsthat are deemed nonsalable based upon recent sales activity

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    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 properlycoded

    Coding was not done timely and followed up by accountingdepartment

    Large suspense account had to be reconciled at year end

    Lack of internal controls over wire transfers

    Policies and procedures manual addresses cash disbursementsbut not wires

    Situations were wires were not required to be confirmed by aseparate individual

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    Other issues noted

    Levels of board designated net assets that create negativeunrestricted net assets.

    Net assets can not be designated by the board so as to createan unrestricted deficit

    You have essentially designated more net assets than you haveavailable

    No documented whistleblower or document destruction policy

    These are the only two provisions of the Sarbanes OxleyAct required to be adopted by all organizations

    Governance section of Form 990 have specific questions aboutthese policies

    Still seeing organizations that dont have these policies

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    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 largedeferred revenue balances

    Many loans require quarterly covenant calculations be submittedto the bank

    Managements responsibility to monitor covenants to ensurecompliance

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    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 auditors 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 ortwo in arrears in terms of the alternative investments

    Consult directly with the fund manager to obtain most recentvalue

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    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 landmarkreport on internal control. Internal ControlIntegratedFramework, which is often referred to as "COSO"provides a sound basis for establishing internalcontrol systems and determining their effectiveness

    The report outlines five essential components of aneffective internal control system

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    How to avoid audit issues

    Control Environment- sets the tone of an organization byinfluencing the control consciousness of its people. The tone isestablished through the actions of management and the governingbody. (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 thatensure management objectives are achieved and risk mitigationstrategies are carried out

    Information and Communication- communicates controlresponsibilities to employees, board members and others byproviding timely, accurate, and relevant information

    Monitoring- are the processes that assess the quality of the

    internal control performance over time

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    How to avoid audit issues

    Proper segregation of duties

    Use of a monthly close checklist to facilitate complete, accurateand timely monthly reconciliations

    Documentation of procedures performed and controls

    executed

    Consult your audit firm as an educational resource throughoutthe 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

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    Speaker Biography

    Christian Spencer, CPA, is a senior audit manager with over16 years of public accounting experience, including 13 yearsworking exclusively with nonprofit organizations. Prior to

    joining Tate & Tryon in September 2011, Mr. Spencer workedas a director in the Vienna, VA offices of McGladrey & Pullen,LLP where he spent 13 years providing audit and taxservices to nonprofit organizations with annual revenues

    ranging from $1 million to over $300 million. Mr. Spencersexperience includes planning and managing the audits of awide range of nonprofit organizations, including associations,charitable and educational organizations including those withfor-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 shelterservices to individuals in need. In addition, he is a member of the Finance andBusiness Operations Section Council of the American Society of AssociationExecutives. He participates in ongoing continuing education courses for not-for-profit accounting and has written articles for various publications.