Audit committee members have many aspects to consider when reviewing their nonprofit organizations’ financial statements. For some, this may be the first time they have had to closely review a set of financials, or possibly the first time they have had to navigate the nonprofit financial statement format.
While all aspects of the financial statements and related reports are important, there are five key areas that should not be overlooked in assessing the current financial state of an organization.
NEW LEASE STANDARD
The new lease standard is now effective. If a nonprofit organization has material leasing arrangements, it is recommended to review the lease footnote (which will look different given new disclosure requirements) for key details such as the rate at which the present value was discounted (organizations have the option to choose a risk-free rate at the implementation date or analyze their current debt for a standard borrowing rate to use).
Be careful to closely scrutinize this rate, as a common mistake is using the rates at the end of the fiscal year or not considering the period to which the rate applies. For example, if an organization adopted the ASC 842 as of July 1, 2022 for a 3-year lease, it will need to use the 3-year risk free rate as of July 1, 2022 for the calculations, not the rate as of June 30, 2023 (its fiscal year end).
Organizations using the risk-free rate are choosing a higher gross statement of financial position adjustment in the current year. While organizations using the implicit debt rate are choosing a lower dollar value impact on the statement of financial position.
ASU 2020-07 PRESENTATION AND DISCLOSURES BY NOT-FOR-PROFIT ENTITIES FOR CONTRIBUTED NONFINANCIAL ASSETS
ASU 2020-07 went into effect last year for June 30 year-ends and expanded existing disclosures related to contributed non-financial assets, or “gifts in-kind” as they are commonly referred to in financial statements. This standard update increased disclosures about how such contributions are valued and presented, which caused many organizations to more closely scrutinize how they were valuing these assets.
As a committee member, it is important to gain an understanding of how a nonprofit is valuing and calculating these items and evaluate the method and inputs for reasonableness. For physical item donations, are they using readily available market prices? For food and gently used clothing, are they using the publicized estimate per pound? If they have a donated facilities arrangement, are they calculating based on what they would otherwise be paying for that space using comparable rates in a similar leasing market? These are all questions worth looking into in regards to ASU 2020-07.
LIQUID ASSETS
Another important factor to consider is an organization’s liquid assets and how many months of expenses those assets will cover. If a nonprofit is looking at one to three months, perhaps it is time to consider what the anticipated cash flows over the next few months will be and whether additional fundraising options need to be explored.
Does the nonprofit have assets to cover the next 12 to 18 months? This might be a good time to explore higher-dollar or long-term projects that improve infrastructure or maximize internal efficiencies.
STATEMENT OF FUNCTIONAL EXPENSES
Be sure to consider the percentage of expenses attributed to the costs of running the program when reviewing the Statement of Functional Expenses. Is an organization spending at least 70 to 75 percent running its programmatic activities?
While there is no “right” percentage, an impact is often seen on funding and contributions if an organization’s programmatic ratio dips below this threshold. If a nonprofit is in this situation, it might be time to discuss how to reduce general and administrative or fundraising costs and focus more funds on the program.
MANAGEMENT LETTER
Finally, and perhaps most important of all, the management letter should be reviewed for any noted opportunities to strengthen internal controls. In some cases, there might also be significant deficiencies or material weaknesses that need to be addressed promptly to ensure the organization’s internal control procedures are operating appropriately to prevent and detect fraud or incorrect reporting within the organization.
If you have any questions on this anything else related to nonprofit audits, please reach GHJ’s Nonprofit Practice.
