Mark Koscinski NFP

Some Modest Accounting Suggestions for the NFP World

As the haze of the Spring semester has sufficiently dissipated, I’ve had a little time to ponder the content  of my Not For Profit Accounting class. Transparency is the watchword of the era, and I think NFP accounting standards are not as helpful as they would be.  As a result I have a few, mostly radical suggestions for the Financial Accounting Standards Board and the regulation of NFP accounting:

  • Allow fund accounting for NFP entities.  Yes, you heard me right, but don’t make it mandatory.  Make it an election if the organization meets certain requirements.  For instance, take a small church congregation.  At the beginning of the year the minister distributes pledge cards.  The members of the congregation complete the cards and in my experience do make the contributions as pledged.  Some don’t but this is easily handled within the framework of the modified accrual basis of accounting. Wouldn’t the use of fund accounting be more meaningful in this context than the current accounting? Additionally, the reconciliation of actual results  to the budget municipalities must do in their Annual Comprehensive Financial Report would be of great interest to many stakeholders of a NFP organization. Wouldn’t it be great to have a management discussion and analysis section of the annual report just like municipalities do? How about the statistical section municipalities are required to report? I know I would find all of this information interesting. 
  • Allow the use of the old classification of net assets. The current classification on the statement of financial position divides net assets into donor restricted net assets and net assets without donor restriction. I liked the previous disclosure that split net assets into unrestricted, temporarily restricted and permanently restricted net assets. Additionally, I like the idea of including assets restricted by board of directors or trustees  in restricted net assets, with the appropriate disclosures of course.  Finally, net assets with a purpose designated by management should be allowed on the face of the statement of financial position.  Yes, this would be a little more complicated but I believe it is much more meaningful than the current schema. The current disclosures hide the intent of management and the board somewhere deep in the footnotes.  Why not be “upfront” about intentions? Wouldn’t stakeholders be interested in that as well? 
  • Use activity based costing and management. Yes, I know this is difficult as well.  However, Gary Cokins, the guru of activity based costing has developed a rapid prototyping model for ABC that even smaller organizations can use.  Why would an NFP organization want to put itself through such a strenuous introspective exercise?  Well, there are a lot of reasons including forming a basis for enterprise performance management.  Also, think about what happens when your organization is applying for a grant.  Donors are loath to fund overhead.  Since ABC traces costs rather than allocating them, your organization would be on a much firmer footing and have a more convincing argument when applying for a grant. 

Yes, these suggestions could complicate the lives of many NFP managers and accountants, but they also would make your organization’s finances much more transparent to stakeholders.  Your organization would become more competitive finding the allusive donation dollar.

Mark Koscinski NFP

Watch Out! The IRS is Just Around the Corner

The IRS issued some interesting rulings lately, denying tax-exempt status to some organizations in several private letter rulings (PLRs). PLRs are not considered to be precedents that can be used in other cases because they are often very fact based. Nevertheless, they can provide some insight into the IRS organizational thinking and provide guidelines for future action. This outstanding article by Cory Halliburton of Freeman Law provides analyses of these PLRs.

At the same time, one has to wonder about how NFP organizations will fare in the future as the IRS plans to add 80,000 new employees. The Treasury Department has estimated the tax gap (tax revenue lost due to noncompliance) is $600 billion per year. One can see how additional IRS resources could have a meaningful impact on closing the federal budget deficit. At the same time, it is only prudent for NFP organizations to review their operations and documentation to ensure they are in fact an NFP organization for tax purposes. Larger donors receive tax deductions for charitable contributions. Losing those tax deductions by losing NFP status would be catastrophic for NFPs.

Mark Koscinski NFP

Managerial Accounting in the NFP World

In its “Trends and Outlook 2022” (I am a little behind on my reading!), the NJ Center for Nonprofits conducted a survey of approximately 225 respondents. They reported funders often do not:  

  • Like to make unrestricted grants;  
  • Understand overhead costs and capacity building to  give the NFP greater impact; 
  • Fund overhead costs and capacity building; 
  • Understand the full cost of of projects; and 
  • Allow overhead costs in grant applications. 

The reluctance of funders to support overhead costs often puts the NFP in an untenable position as these expenditures must be covered if the organization is to stay in business.  The same survey  also reported many of the NFPs tried to do this by:

  • Initiating new fundraising appeals;
  • Seeking funds from alternative sources; and
  • Introducing and/or increasing fees for service.

Their success in accomplishing these efforts can be gauged by the following:

  • 46% of the respondents reported financial uncertainty was the major challenge to viability and effectiveness,  and
  • 55% of respondents reported infrastructure/capacity building was the most important issue NFPs face in 2022. 

How should NFPs deal with this problem?  Perhaps one way is to speak the same language the financial managers of their funders use: accounting.    Specifically, NFPs can:

  • Think about using activity based costing (ABC).  This process does not allocate overhead but traces these costs, in essence converting them to direct costs. It will more effectively tie the indirect costs to each of the programs,  making funders much more willing to include them in grants. ABC also is very useful when supporting capacity planning, one of the main concerns of the respondents.  ABC has the reputation of being difficult to implement, but the number of cost drivers in an NFP organization is generally small, and the system can be built over time. 
  • Do capital expenditure analyses using the traditional tools businesses use. However, make sure to include a discussion of the total welfare gain for the expenditure. In such situations the  qualitative data can outweigh the financial assessment. 
  • Use CVP analysis.  Of course, there is no “P” (profit) in an NFP, so I like to say NFPs should do CVC analysis: Cost, Volume, and Cash. This type of analysis is particularly important when the NFP is attempting to obtain financing for increased volumes or changes to the budget. 
  • Understand the concept of joint costs and their impact on the organization. As we have seen, funders like to see their donations go to programs rather than overhead.  Perhaps proper accounting for joint costs could result in more costs being allocated to programs. 
  • Use responsibility accounting. The most common type of business unit accounting in NFP organizations is the cost center.  If there are different programs and managers, keep the accounting records in such a way that managers can be held accountable for the costs of their program. Also, the use of responsibility accounting will also provide the record-keeping to determine the actual cost of each program. 

Forty-three percent of the respondents said they had to draw against their credit line in 2021.  This is alarming, but it also demonstrates a critical point.  NFPs should try to establish a credit line with their local banks.  Not only is it a source of funding to smooth over the rough patches in the cash flow year, but local banking personnel are great sources of board members and volunteers. When approaching the bank, good managerial accounting as described above and good budgeting practices are critical. 

Where do you get the talent to do all of this? It is a lot to do.  I suggest you contact your local CPA firm.  I am sure they will be able to help you on either a volunteer basis or at a reduced price.  Remember, to secure funding, you need to speak the language of business: accounting!

Mark Koscinski behavioral economics, decision analysis, NFP

Altruism

In a previous blog, I wrote about optimism and its importance in both the business and the NFP world.  Today, I would like to discuss altruism. What makes someone donate to a charity? If only NFP fundraisers knew the answer to this question… Neuroscientists and behavioral economists are trying to provide an answer.  Donors and volunteers have a sense of altruism, gained from  acts reducing their own well-being in order to help others. These acts include  donating or volunteering. The reductions in savings and free time to help out arguably reduces the donors’ well being.  Or, do they? Economists use the term “other regarding preferences” to describe altruistic acts. Giving  time and treasure to a charity comes from internal motivation and a sense of  identity. Donors and volunteers get a “warm glow” feeling or additional utility (to use another economic term) from these actions and neuroscience has developed evidence of this. Dopamine levels rise when altruistic acts are performed. 

Are altruistic acts completely altruistic? Sometimes a seemingly altruistic act isn’t so altruistic. Donating and expecting returns is not really altruistic. For example, political donors may expect  they will receive an appointment or their companies may receive additional business from the government.  Donating significant amounts of money to a charity can send a signal to others of great wealth and conspicuous consumption. These would not be altruistic acts. To a lesser extent,  don’t we expect some return for our donations?  We might get tax deductions for our donations and some recognition for our volunteer efforts.  The economist James Andreoni coined the term “impure altruism”  in 1990 to describe how even the warm glow feeling we get from donating makes our motivation somehow tainted with self-interest. 

While this  discussion is intellectually stimulating, don’t look too deeply into the motivation of donors and volunteers.  They are objectively doing a good thing so I suggest just leave well enough alone.  There are philosophical treatises on mixed motives that are well beyond the scope of this article, but I would suggest human beings are complex creatures who may not be able to articulate their motivations to themselves let alone to anyone else.  As a practical matter judging motivations of a donor or volunteer is at best a very, very tricky endeavor, not worth the time and effort of the NFP management.  There is no moral, ethical, or legal requirement to do so.  Running an NFP is difficult enough.  Why take on the burden of figuring out the motives of donors? 

Mark Koscinski NFP

Behavioral Economics and the NFP Organization

Behavioral economics and finance have become all the rage in academic circles over the last several decades. All you have to do to confirm this is look at the list of behavioral economists who have won the Nobel prize since 2000. They include Daniel Kahneman (2002), Robert Shiller (2013), and Richard Thaler (2018), all of whom have been connected with this school of thought.  

How can behavioral economics help the NFP manager?  Well, here are five specific suggestions:

  • In their book Nudge, Thaler and Cass Sunstein suggest donations to charities can be increased with a Give More Tomorrow program. Donors are asked to give a small amount to their favorite charity beginning in two months and to commit to increasing the amount every year.  A study by Anne Breman in 2006 found this simple nudge increased donations by 32 percent.  Thaler and Sunstein also suggested the use of a charity debit card, but that proposal doesn’t seem to have gathered  a lot of traction.
  • We are all familiar with charities that have donation tiers.  For instance, if you donate $x you will be a Friend of the Charity.  If you donate $y you will be a Patron of the Charity and so forth. Strategically set the tiers, as donors will calibrate their contributions to achieve their desired level of recognition.   This is an example of impure altruism, but more on that in a future blog.
  • Use a silent phase for capital campaigns.  Suppose there are two charities that wish to raise $100,000.  One simply announces the goal and asks for contributions.  Another raises seed money of say $50,000 before announcing the capital campaign. The second charity will receive greater donations than the first.  People want to donate toward an achievable  goal. They can readily see how their contribution will help get the charity to that goal
  • Put a face on your fundraising drive. People are more willing to donate when there is someone like them in need. Donors can identify and empathize with a real person. They can see how their donation will help this one person and will be more likely to donate.. Put another way, the bigger the problem you are trying to solve the less people will donate. For example, suppose you start a fund drive to end global warming. This will be rough sledding as donors simply can’t connect or comprehend the enormity of the issue. They can’t see how their small donation will help end such a huge crisis. 
  • Try to build a sense of community with donors, making them “one of us”. Donors want to belong to something good.  It gives them a “warm glow effect”. More on that in a future blog as well.
Mark Koscinski NFP

Over the Horizon

The phrase “over the horizon” has taken on a whole new and ominous meaning recently. Many associate it with current military doctrine and the deadly drone attacks conducted in the war on terrorism. Not for Profit (NFP) directors and managers think it might be  safe to come out of their bunkers after the COVID pandemic, but they need to be aware of the ominous and scary threats lurking over the horizon. None of these should cause NFP management to hit the panic button yet, but smart managers will always scan the horizon for threats. Some of those looming menaces are: 

  • A shaky economy. Inflation is running over 8% and as of the date this is being written we are waiting for the Second Quarter GDP announcement.  Some economists predict a mild increase to some predicting a mild decrease in GDP. A decrease in GDP over two quarters is the technical definition of a recession. It remains to be seen if charitable giving will continue in these circumstances as some families will tighten their belts. 
  • Higher interest rates. It also remains to be seen how high the Federal Reserve Board will hike interest rates to combat inflation. Rising interest rates could further erode the balance sheets of many NFP organizations with outstanding debt and stress cash flows of these entities.  
  • The weak condition of the stock market. NFP organizations lucky enough to have  endowments will also suffer further  budgetary stress.  The stock market has fallen (it doesn’t matter what index you use. All the major indexes have fallen) this year.  Financial planners will tell you proper financial management will permit the  use of only a small percentage of the endowment  in any year.  As the endowment shrinks because of stock market losses, so does the available funds for operations or projects.
  • Recent Supreme Court decisions could impact certain NFP organizations. Without being political in any way, it is safe to say that a decrease in the abortion rate may stress NFP organizations in those states that move to restrict abortion. Absent an increase in government assistance to new mothers, families and NFP groups will be required to step up to the plate and help out.  On the even more distant horizon, the impact of the West Virginia vs. EPA decision could have some long range and unpredictable consequences.  In this case, the Supreme Court used the “major questions” doctrine to prevent the Environmental Protection Agency from implementing new regulations that could have closed coal fired power plants.  The details of this case are irrelevant here except to say the exact limits of the major questions doctrine have not been explored. Can this doctrine be used to prevent additional regulation issued by, say, the Department of Health and Human Services?  Only time will tell how this plays out.  The only sure thing is there is now some new uncertainty in the regulatory world. 
  • The FASB is looking at new standards for cryptocurrency and Non-fungible tokens. While most NFPs are not big enough to actively deal in such markets, these assets are becoming more and more prevalent. NFP owners will need to keep an eye out for new accounting pronouncements that could result in a swing in asset valuations. 

It is impossible to say which of these possibilities will pan out, if any.  How can  NFP entities deal with this type of uncertainty?  My suggestion is to use  scenario planning.  While it is beyond the scope of this little article, scenario planning assumes managers are not able to provide valid estimates of the likelihood of discrete future events. A scenario is not a forecast of the future but of only one possible future.  Scenario planning considers  a range of plausible contingencies.  In essence good scenario planning will provide the basis for a plan if any one or more of the contingencies discussed come true. For instance if the economy slows down more,  scenario planning might call for a reduction in discretionary spending until the economic situation is clarified. As an added benefit, scenario planning also aids in fighting groupthink, a problem in decision-making that all hierarchical organizations must deal with.  If you are interested in learning more about scenario planning, please contact me for additional information.

Mark Koscinski NFP

Optimism

As Independence Day draws near,  I recall an election night  years ago.  My younger daughter and I were watching the national election returns. When things turned out in a way she didn’t expect, my daughter began to storm off in a huff.  I asked where she was going.  Her response was: “I am going to write an apology to the Queen of England.  Maybe she will take us back.”  

Yes, the Founders of this country got a lot wrong. The three-fifths compromise and the prohibition on stopping the slave trade until 1808 are just two examples.  However, they did get a lot right.  I have been pondering one that many people miss: the ability to fail.  

Daniel Kahneman in his phenomenal book Thinking, Fast and Slow writes optimism is the engine of capitalism. He claims optimists are the “ inventors, the entrepreneurs, the political and military leaders”.  Kahneman notes that small businesses have a 65% chance of failing within five years. Optimists have the confidence to begin the business knowing those odds and  persistence to outlast hard times.  At the same time, Kahneman notes optimism can be a mixed blessing.  Someone can have too much optimism, resulting in failed businesses. 

I want to stretch Kahneman’s thesis in two directions. First, the same general principles of optimism apply to the not-for-profit (NFP) sector as well. We all know even the most optimistic people do not go into the NFP world for a profit motive. They enter this arena for a different purpose: an eleemosynary one.  They often believe the world will rally around their good intentions and they can make a real difference in the world.  We are all thankful for their enthusiasm and optimism. They make the world a better place. Unfortunately, they may also believe they can actually run an organization better than or at least as well as other people.   

Secondly, NFP organizations can and do fail.  Those entering the NFP world often quickly realize the lack of financing and funding can often be crushing. And by crushing I mean not only to the continued existence of the organization, but to the very vision and mission of the organization.  I remember being Board Chair of a long-running NFP organization and worrying not only about  meeting the next payroll but also not having the funding to fulfill our mission. I often thought about what I would do with a spare $100,000 in funding.  The Executive Director was probably tired of me worrying and talking about money.  When I was the CFO of a Catholic Diocese I would often remind the other clergy that “it takes money to do God’s Work.”  I am pretty sure they didn’t appreciate that very much either. As a CPA I knew the consequences of running out of money.  And this doesn’t even take into account Black Swan events such as the recent pandemic that can be devastating to an organization.  

This is where the ability to fail comes into play.  Kahneman and Tversky were the fathers of prospect theory. This fundamental insight into behavioral economics  states individuals feel a loss more than twice as much as they feel an equivalent amount of gain. Consequently, the pain of failure is bad enough such that entrepreneurs or founders of NFP organizations can be dissuaded from their endeavors. How much more difficult would it be to start a business or an NFP organization and risk failure under the debtor prison regime that was in vogue at the time of the American Revolution? The U. S. Constitution provided for the humane way of dealing with organizational failure through its bankruptcy provisions.  Congress has the ability (and has) set up uniform bankruptcy provisions throughout the entire country.  This is an emotionally charged subject but I would propose that removing the fear of debtors’ prison has also primed the pump of capitalism–and of the NFP world as well.  I understand the equity issue many raise to bankruptcy but there is no question it is a humane policy and in the main has been beneficial to capitalism and the NFP world as well.  This is one (among many) the Founders were definitely right about.  

Have a happy Fourth of July!

Mark Koscinski NFP

Volunteering and Giving Back

 I first met Basil about twenty years ago. We attended  deacon training together for the Byzantine Catholic Church.  Basil was already almost sixty years old at the time, past the age limit for acceptance into the program. It can take up to five years or more for someone to complete the course of studies and be ordained and the Church felt the ministry of such an older fellow would be too short.  Fortunately,  the Church wisely waived the age requirement.  Basil completed the training and he was subsequently ordained.  I was proud to serve at that ceremony with the rest of our classmates. 

During our training,  I marveled at Basil’s  energy and willingness to continue to serve his community. This training was the beginning of a “second career” for him.  Basil served as a Byzantine Catholic deacon for many years and was in good standing with the Church until his untimely passing earlier this year at the age of 79.  The feature picture of this post shows him incensing during a church service.  

Events such as this are often times for introspection. To be sure, Basil lived a flourishing life of service to his community. He was married for over 58 years and was a county employee.  Basil was active in the Knights of Columbus, and of course as a deacon in his church.  He lived his calling as a deacon by volunteering his time to causes he felt strongly about. It is this aspect of his life I would like to discuss. 

In 2019, the Johns Hopkins Center for Civil Society Studies noted one out of 10 jobs in the United States was  with  non-profit organizations.  This by itself is a staggering statistic. It becomes all the more impressive when one considers the amount of volunteer hours NOT included in that number.  Candid Learning reports that in 2017 over 25% of all adult Americans volunteered  8.8 billion hours of their time.  Given a full time work year is about 2,000 hours give or take, that is about 4.4 million  full time work years, or about 3.3% of the number of full time employees in the U.S. economy. Not only don’t these volunteers get paid for their time, they don’t get a tax deduction for it either.  It is truly a sacrifice.  When you consider volunteering is part of the  not-for-profit triad of  “Time, Talent, and Treasure”, the impact this has on the economy and our society is considerable. All the volunteer  time and donations shows Americans truly are a generous people.  

Can we do more?  Of course we can.  Some do more.  Some do less. Life circumstances can often dictate the amount of volunteer work we do and the amount we contribute.  Volunteering is the lifeblood of many not-for-profit organizations and churches.  Please do what you can when you can. Basil touched the lives of many people during his time on this Vale of Tears.   Perhaps his example can be an inspiration for all of us. 

Article cited in this post

Mark Koscinski NFP

Form 1099-NEC

his is just a kind reminder to our friends out there in  small NFP organizations getting ready to send out W-2s to employees and 1099s to other individuals who received payments of various types in the past year about the new Form 1099-NEC.  Prior to 2021, your organization was required to provide a Form 1099-MISC to independent contractors who received payments. The IRS now requires Form 1099-NEC  be used instead of Form 1099-MISC when reporting independent contractor income, now labeled “non-employee compensation”  or “NEC”.  NEC is  defined as payments to individuals not on payroll on a contract basis to complete a project or assignment. This is a very common occurrence at small NFP organizations, where independent contractors,  gig workers, or otherwise self-employed individuals receive stipends for services rendered.   

The due date for the 1099-NEC is January 31, which is right around the corner.  The 1099-MISC is due March 1 if filed by paper and March 31 if filed electronically.  The familiar $600 threshold is still in place.  If your organization paid an independent contractor more than $600 in 2021, it must  provide that contractor with a Form 1099-NEC unless the independent contractor is a C corporation or S corporation. You can find this on the Form W-9 you are required to collect from the independent contractor. 

 Copy A of Form 1099-NEC is filed with the IRS and Copy B is sent to the independent contractor. Most states also require all Form 1099s  be filed with them.  You will need to consult your tax advisor to see if your state requires this.  States have been extremely active in auditing independent contractor payments in  recent years.  Many states contend all independent contractors should be classified as employees and applicable payroll taxes be remitted.  For instance, the State of New Jersey wanted information on the royalties I received on my books published through Amazon to see if I was in fact an employee rather than an independent contractor.  Sadly, I am not that great of an author and my royalties were less than $100 for the year.  The implementation of Form 1099-NEC should reduce this confusion in the future. 

There are significant penalties for being late and misclassifying employees as independent contractors so NFPs do need to pay attention to these requirements. Again, it is critical that NFPs consult their tax advisors. 

Mark Koscinski fraud, NFP

Cash in the Plumbing

Cash in the Bathroom Plumbing?

Lest anyone believe I only pick on the Catholic Church, let’s look at the recent revelation a plumber found $600,000 stashed away behind a toilet in  Joel Osteen’s church.  To be clear, the original theft had been reported to the authorities, and no one is claiming Osteen or any of his staff is connected to this theft. Nevertheless, the sheer size of Osteen’s church and the amount at stake has caused a stir. 

I used this situation as a case study in my forensic accounting and auditing class. I showed the class  some of the videos about this sordid affair.  An example of one of these follows. 

The class came back with some interesting  comments.  I have included some of these as well as my thoughts about them. 

  • Another NFP fraud?  It seems NFP organizations do not take internal controls seriously.  Sadly, this is often the case.  Many NFPs are way too trusting.  No reputable person should balk at being subject to internal controls. “Trust but verify” not only works in Strategic Arms Limitations, but also in running an organization.  What donor wants to see their hard earned and generously donated money simply disappear?  Donors have been known to stop giving after such an event. 
  • How could you leave that much money in a safe?  Any bank would be willing to come each Sunday and pick up this deposit.  To be sure, that is certainly a correct comment.  I have participated in NFP fundraising events involving  less than one-tenth of that amount of money.  The local  bank was more than willing to come and pick up the deposit right away as an accommodation to a good customer. 
  • What does the Fraud Triangle tell you about potential persons of interest?  The Fraud Triangle states any fraud is the result of someone feeling financial pressure, having the means and ability to rationalize the theft. Given the fact the safe seems to have been easily opened and the perpetrators knew where to hide the money, we would be looking at an inside job. This perhaps establishes the means.  What was the pressure and the rationalization though?  
  • Why was the loot never retrieved?  The person(s) who hid the funds was not able to retrieve the money.  Why?  Were they fired for other causes? Did someone suspect them of the theft?  An “outsider” to the organization would not count on being able to access the bathroom again, and accordingly, the funds. Could this be a “spite” theft, where the perpetrator(s) were simply doing this to embarrass the church and really didn’t want the money? In any event, any checks became stale long ago (the original theft occurred in 2014!) or the makers have put a stop on them. 

This story just seems so odd my students (and I) believe more will come out. Stay tuned.  

Unfortunately, there can be collateral damage to all NFP organizations from such an event.  Some believe situations such as this are a reason why churches should be taxed.  While this seems like a non sequitur, stranger things have happened.

https://www.foxbusiness.com/politics/osteen-faces-ridicule-of-social-media-after-plumber-claims-to-find-cash-behind-church-toilet

NFP management needs to understand that theft and fraud of such consequence will often result in not only bad press for that organization, but for all NFP organizations.  During this Pandemic any decrease in donations or other revenue resulting from such bad press can have catastrophic consequences to an NFP, even if the organization was not the cause of the bad press.  The major lesson for all NFP management:  Let’s be careful about internal controls.  You don’t want to be on the front page of a local newspaper, sheepishly discussing why the hard earned money of the donors ended up missing because of a fraud or theft.