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Top 21 Pitfalls for Financial Reports

By Jennifer Coleman, CPA CFE

Financial statements are a vital communication tool for a nonprofit organization. They may not have the emotional pull of a beneficiary’s personal testimony, but a not-for-profit’s financial reports can be scrutinized by grantors, donors, charity watchdogs, and regulatory agencies. These columns of numbers demonstrate not just income and expenses, but an organization’s financial health and spending priorities. The last thing you want your organization’s financial reports to communicate is inconsistent recordkeeping, inaccuracies, or weak internal controls.

Errors in financial reports are most often unintentional. Yet they still harm an organization.  Unfortunately, the error rate for small nonprofits is higher than that of larger organizations, according to a 2015 University of Notre Dame study.

The mistakes can be as simple as incorrectly aligned data or a simple math error in the report itself. However, some are more complicated and require going back to the nonprofit’s records to remedy.  Should the supporting data be inaccurate or unavailable, it’s a sign that there may be an issue with the organization’s operations or internal controls. Below are 21 issues that arise on financial reports that should be addressed in both the report and the organization’s financial management.

Four Financial Statements to Know

First, it’s important to know which financial statements we are addressing. There are four main financial statements every nonprofit should produce.

The Statement of Financial Position is similar to a balance sheet for a for-profit company. It’s divided into assets and liabilities for a specified period. Assets include cash and cash equivalents, receivables such as grants, gift cards, and pledges.  Liabilities include accounts payable and debts. Contributions are reported as either with donor restrictions or without donor restrictions.

The Statement of Activities is similar to an income statement for a for-profit company. It reflects the changes to an organization’s net assets resulting from income and expenses during the period, usually a fiscal year.

The Statement of Functional Expenses lists the nonprofit’s expenses by function, such as program, administrative, and fundraising expenses.

The Statement of Cash Flow provides an overview of cash coming in and going out during a given period. Usually, the cash flow will be demarcated as operating activities, investing activities, or financing activities.

Watch Out for Theses Top Errors

  1. Incorrectly classifying grants. They are reported as either contributions or exchange transactions depending on the conditions of the grant. See my article on classifying grants following the FASB’s 2018-08 update. 
  2. Recording contribution pledges for future donations as without restrictions.
  3. Not accurately reporting as fundraising, the costs of soliciting donations, including in-kind goods and services and recruiting volunteers.
  4. Lack of accuracy in reporting of employees’ time to programs and overhead costs in functional expenses. This often reflects a lack of documentation of time and expenses or a lack of consistency in applying the methodology. 
  5. Not recognizing the inherent contribution of a long-term, below-market lease agreement.
  6. Not recognizing at fair-market-value donated services and gifts-in-kind, including free advertising.
  7. Failing to identify board designated net assets in the financial statement footnotes and classifying them as net assets with donor restrictions.
  8. Failing to report cash, contributions, or other assets that are restricted separately from unrestricted cash and cash equivalents.
  9. Releasing temporarily restricted net assets that are subject to a time and purpose restriction when only one of the restrictions is met.
  10. Recording grant funding received as an exchange transaction for contract cost-reimbursements for which costs have not yet been incurred.
  11. Not correctly identifying reclassifications that are corrections of prior errors as restatements.
  12. Not distinguishing between operating leases and capital leases. A capital lease should be recorded as an asset and a liability on the statement of financial position. The operating lease is not reported on that statement and is expensed as incurred, prior to adoption of ASU 2016-02.
  13. Failure to account for operating lease liability when cash outlay doesn’t match the lease.
  14. Classifying fundraising, advertising, and branding expenses as program costs.
  15. Failing to match financial statements, particularly overhead costs, to what is reported to the IRS in Form 990.
  16. Not renumbering and proofing footnotes. Financial statement footnotes may carry over from year to year, while others are added and deleted, resulting in misnumbered footnotes. 
  17. Unrelated business income incorrectly classified as fundraising income.
  18. Failure to include indebtedness for the acquisition of assets as a noncash activity.
  19. Failing to report as investing activities cash flows from purchases, sales, and insurance recoveries.
  20. Recognizing earnings on perpetual trusts as a component of contribution revenue.
  21. Errors in endowment earning calculations.

It can be tempting for a nonprofit board to focus on the income and expenses on financial statements. However, as the list above demonstrates, there are many details that are worth examining. Errors like those listed above can misrepresent an organization and its activities or, worse, demonstrate weak financial controls.  Don’t let these common mistakes trip up your organization and its reports.

Jennifer Coleman, CPA, CFE is the assurance and quality control partner of Myers, Brettholtz & Company, PA. She is a member of the American Institute of Certified Public Accountants, the Florida Institute of Certified Public Accountants and the Association of Certified Fraud Examiners. 

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