Happy New Year! A gift from one of my students!
Who is the New Grinch This Christmas?
The Financial Accounting Standards Board (FASB) recently delivered an unwelcome holiday season body blow to the NFP world (and privately owned companies as well).
Working hard to earn the title of Grinch, the FASB decided on November 10 not to defer the new lease accounting standard for a third time. The previous justifiable deferrals of the original implementation date were caused by the Pandemic, as many organizations were shut down or forced to adapt to their new reality.
The new lease accounting will take effect for fiscal years beginning after December 15, 2021, and for interim fiscal periods beginning one year later. This standard requires all lease obligations to be recognized on the balance sheet of the organization, with only minor exceptions. Management could be in for some surprises as bank loan covenants might be impacted because of the new debt on the balance sheet. Additionally, an NFP organization will need to not only implement the lease accounting for future years but also to retroactively recalculate the impact of the new accounting for prior years. This is required even if the NFP decides to adopt a “cumulative change” approach to implementation. In short, NFPs shouldn’t underestimate the amount of work involved in this effort. Many organizations have already found the implementation more difficult than they originally anticipated.
To say I disagree with the Grinch’s action is to put it mildly. Many NFP organizations have been operating on a shoestring budget for extended periods of time, not to mention the fact the job market for accountants is extremely tight. This means just finding the bodies to do the work is a difficult proposition. Mercifully, many NFP organizations have fiscal years such as June 30, giving them some more time to complete the required work. Nevertheless, it is imperative to begin working on this project as soon as possible so the delivery of financial statements to donors and other stakeholders is not delayed.
Perhaps the FASB should adopt green as its new official color?
The Birthday Problem
Hello Everyone! I hope you all had a wonderful, long and restful Thanksgiving Weekend! There was some excitement in my family as my fifth grandchild was born on Thanksgiving Day. Interestingly enough, this was the third grandchild out of the five born on Thanksgiving Day itself. They were all born in different years but all on Thanksgiving Day of that year. I have told my children the individual birthdays are now irrelevant. All three now have an official birthday, like the Queen of England does.
How unlikely is this scenario? I teach Decision Analysis at Moravian University and have acquainted my students with the mathematics of combinatorics. Check out this amusing little video made by David Knuftke for Ted-Ed called the Birthday Problem. it describes the use of combinatorics in calculating a similar but somewhat different problem.
PS. You can calculate the odds of three people being born on the same day by watching this video. Enjoy!
The Delegation Heuristic
Heuristics have been called “fast and frugal” decision-making rules. There are many types of decision-making heuristics, some notably better than others. For instance, I am not a particular fan of the concept of satisficing, a term coined by Herbert Simon. Simon won the Nobel Prize in Economics in 1978, but I have always believed his theory of satisficing short-changes the process decision makers actually employ. Daniel Kahneman (another Nobel Prize winner) and his partner Ivan Tversky (who sadly passed away before he could be awarded the Nobel Prize) developed or discussed many other heuristics. For a more complete discussion of these, I suggest you take a look at Kahneman’s outstanding book Thinking Fast and Slow. Some of my graduate students have called this the best book they have ever read.
I would modestly like to propose another heuristic I will call the delegation heuristic. Many of us have seen organizations grind to a halt because the decision maker was often overwhelmed with many small decisions or with subdividing a major project into many smaller tasks. A prime example of this is history is how Robert E. Lee controlled the Confederate Army of Northern Virginia during the Civil War. Lee made very little use of his staff, who jokingly referred to him as “the Tycoon”. Lee insisted on coordinating every aspect of a potential engagement. This constant exertion wore Lee out and may have contributed to the final defeat of his army after years of combat. Contrast this with Union General U. S. Grant, who maintained a large military staff for the time and used them effectively. Even while he campaigned with the Union Army of the Potomac, Grant left General Gordon Meade in command of this army while Grant concentrated on strategic issues. In short, one of the reasons why Grant could effectively manage multiple armies was because he could delegate effectively and knew the rules of delegating. He maintained final responsibility but he gave authority to his subordinates to issue orders and coordinate the campaign in detail.
Delegating is perhaps the most fast and frugal of all heuristics. A leader understands heuristics conserves critical time and energy and brings more mental firepower to solving the problem at hand. This type of leader will often delegate smaller less consequential decisions to staff members or subordinates. In other words such a leader will make a decision by appointing someone else to make a decision. The decision is always made in the name of the leader, who may not even know sometimes the decision has been made.
The decision heuristic can be executed in several different ways. For instance, i would divide decisions I faced into the following categories: (a) delegate the decision entirely to someone else; (b) delegate the decision to someone else but provide the decision rule or decision methodology for the delegatee; (c ) delegate the decision but ask the person to inform me or discuss the potential decision before it was issued; and (d) major decisions I would reserve to myself. In this way I would be able to provide strategic leadership and deal with complex tactical problems without being encumbered by many smaller decisions, all of which needed to be made but would distract from my dealing with the “tougher decisions”.
Delivering Bad News
Robert Stack, portraying Eliot Ness in the TV show and movie The Untouchables was asked if he heard about Al Capone’s death. Stack responded, “Good news travels fast.” That is so true. Not only that, but good news also has many parents. I once overheard the CEO of my company being asked if he heard about the collection of a long overdue accounts receivable He said, “Yes, from about a dozen people.”
On the other hand, bad news travels much more slowly than good news, if at all, throughout an organization. Unfortunate information about a problem is an orphan as people are often reluctant to pass it along. This can be a problem as sometimes as an immediate response may mitigate the effects of the problem.
How do you deliver bad news? Well, let’s start with some ways you should NOT deliver bad news:
- Email. When I was a busy CFO I would receive a massive number of emails per day. It was hard to keep up with them, and sometimes a whole day would pass before I worked through my entire email queue. Like most people, I would respond to the most recent email first and work backwards. If the bad news or the problem was buried in my email, I often could not respond to it on a timely basis. It was even worse if I accidentally deleted the email before reading it. I eventually turned the tables by sending out an email to my colleagues prohibiting the communication of bad news to me via email. I did not want to play email roulette with bad news. I thought it was ironic when some of my colleagues said that email was lost in their email.
- The “desk document dump”. This sneaky method consists of waiting until your manager leaves his office and then throwing a document with the bad news on her desk. The person doing this prays it won’t be found until the next day, or even better, it will be buried by other documents thrown on top of it. I truly hated this, and I eventually learned to close my office door when I left it, even for a short while.
- The casual conversation in the hallway. As you are rushing off to an appointment, your colleague tries to quickly deliver bad news, often requiring an immediate answer. You can’t focus on it, and even worse, feel forced to give a quick, off the cuff response. As Daniel Kahneman writes in his best-selling book, Thinking Fast and Slow, these initial reactions are often wrong, potentially compounding the problem.
- Delivering bad news at 4 pm on a Friday. You wait until the very end of the workweek to lower the boom on your manager, depriving her of the ability to react appropriately to the situation. Companies and government agencies have raised this to an artform. They rely on the fact their audience may already be focusing on the weekend. What’s worse, the manager on the receiving end thinks about the bad news over the weekend, feeling frustrated at her inability to respond to the problem.
- Not delivering the bad news at all. People simply do not like confrontation. They hope the situation will turn around or the crisis will blow over before anything needs to be done about it. Obviously, this can be disastrous if the bad news needs to be addressed right away.
How should someone deliver bad news? Here are a few suggestions:
- It is okay to think about the problem for a little bit before going to your manager with it. Please note this does not mean sitting on a problem for an extended period of time. It means quickly ascertaining all of the facts about a situation, organizing them in a logical manner so they are easily communicated and coming up with potential solutions. Managers hate having a problem dumped on their desk without a proposed solution. A good manager values colleagues who work harder in adversity and having a proposed solution shows this.
- Make sure the recipient of the bad news has engaged their System 2. Kahneman writes that we make decisions and eventually take action in two different ways. System 1 responses are fast and intuitive and often wrong. That is one of the problems with the casual hallway conversation. System 2 is the application of our full conscious attention to a problem. Make sure the person receiving the bad news has engaged System 2 or they otherwise might not even remember receiving the information at all! How do you do this? Each person has their own preferred decision-making process. I liked it when someone made an appointment with me so I could focus all of my attention on a problem. I would engage my System 2 and work on the problem with minimal distraction. You will need to find your colleagues’ preferred method of focusing on bad news or a problem. They will also appreciate the honesty.
- If you are forced to communicate problems via email, follow up. If circumstances require communicating bad news via email and you did not hear anything back from your manager, wait an appropriate amount of time and then follow up with a phone call or a visit to their office. Who knows? The email might have been accidentally deleted or your manager’s attention is diverted elsewhere. Not everyone is glued to their cell phone or their computers. They may not even know a problem has occurred.
Besides the sneaky methods of delivering bad news I listed in this article, what other ways have you received bad news? I would certainly be interested in hearing from you!
Horseshoes, Round 2–Summer 2021
As things return to normal after the pandemic, it is time for a second round of summer horseshoes. Perhaps by the Fourth of July we might have some real picnics again and play a real round of horseshoes. As a refresher for those of you who don’t play horseshoes or haven’t played in a long time, here are the scoring rules. A “ringer” is worth two points. A “double ringer” is worth four. A “leaner” or “closest to the stake” is worth one point. Since Independence Day is fast coming upon us, this is a special edition of Government Horseshoes. Here we go!
Completely missing the horseshoe pit—The SEC fires the PCAOB Chair. For those of you who don’t work in the accounting field, the Public Company Accounting Oversight Board (PCAOB) was created by the Sarbanes-Oxley Act in 2002 as a watchdog over the financial reporting of publicly traded companies. The board members have staggered five year terms and could only be removed for cause under the original law. The latter provision was struck down as unconstitutional by the U. S. Supreme Court in 2009. Since then, the PCAOB has become a partisan battlefield. In early June of this year the SEC fired the Chairman of the PCAOB and began soliciting resumes for the other four board positions. This also opened a political rift at the SEC, where the two Republican members voted against the termination of the board chair and labeled it as “hasty”. To be fair, this is not the first time such events have happened so both political parties are guilty of turning a watchdog agency into one that has an agenda. The accounting principle of neutrality requires information contained in financial statements be free from bias. Perhaps a modern rendition of the neutrality principle should require accounting regulators and standard setters to also be free from political bias. I know. This is a lofty goal…
Closest to the stake– Governors opening up their states in response to the COVID vaccinations. As vaccination levels are increasing on a daily level, Governors continue to open up their states for normal business operations. My home State of New Jersey has achieved over a 50% vaccination rate at the date this article is being prepared and there are minimal mask requirements such as in health care facilities, public transportation etc. currently in place. Perhaps by Labor Day these too will be gone. Why not a higher score? There was a lot of controversy over how the COVID crisis was managed by the various states. I point you to New York State as one example of this.
A double ringer–The New Jersey Society of CPAs pushes for plain language CAFR summaries. Governmental entities keep two sets of accounting records (No, not the cooked books and the real books, you cynics!). The first set is the fund accounting statements, designed to provide accountability for the expenditures and revenues of government entities (okay, NOW you can be cynical.) The second set uses more traditional accounting principles to produce the Comprehensive Annual Financial Report (CAFR). This set of financial statements is much more useful for other stakeholders such as bondholders of the entity. The NJSCPA is working to provide a “plain language” CAFR for the State of New Jersey. To be sure various entities such as the SEC and the GASB (Government Accounting Standards Board) already require financial information to be written in plain language but much work needs to be done there. The last NJ CAFR is over 400 pages long and obscures (not intentionally) some key information such as the State’s pension debt. The NJSCPA also recommends comparative statistics be included in the CAFR. This is certainly a breath of fresh air in the financial reporting for government entities.
The horseshoe is still in the air–Defense Department report on UAP. Come on now, did you really think they would disclose everything they know about them?
Have a great Fourth of July weekend!
Budgets and the Smaller NFP Organization (Part 2)
Budgets and the Smaller NFP Organization (Part 2)
In a previous blog, we reviewed how important mindset was to the budgeting process of smaller NFP organizations. If the budget is viewed as a chore, the end product will often not be worth the paper it is written on. (Did I just give away my age with that reference?) We saw how even the categorization of expenditures ( capex, opex, riskex and stratex) influences how the budgeting process is perceived. Ultimately, effective budgeting ties into the vision and mission of the organization.
Here are some additional tips about making the budgeting process more effective:
- Avoid cost allocations as much as possible when budgeting. Yes, all fixed costs must be covered. There is no question about that. However, allocations of those costs often lead to incorrect decisions. Look for “cost drivers” rather than allocating expenses across a client base. Cost drivers in the NFP industry will be the subject of a future blog.
- Look towards developing client cost computations in addition to program costing. A typical NFP program will measure the cost of a program being provided rather than looking at the total cost of a particular client. Some clients are more cost intensive than others. Should particular clients be directed to other agencies or NFP entities for service? It is difficult to be all things to all people. More on this when we examine cost drivers in the future.
- Don’t forget to tie the budget into the strategic plan. The budget should be prepared with one eye on daily operations and one eye on the strategic plan. Many strategic plans are completed and then simply forgotten about. They often contain operating projections for three to five years. Each annual budget is an integral part of the strategic plan, and the current year budget should be the first year of financial projections in the operating budget. By doing this the organization is forced to revisit its strategic plan at least annually..
- Get into the habit of forecasting frequently. First let’s differentiate between budgeting and forecasting. For our purposes, budgeting is the process of planning activities and expenditures for the year. Forecasting is the periodic updating of the budget. One criticism of budgeting is it becomes outdated quickly. Frequent forecasting alleviates this problem. Again, we are talking about a mindset. Forecasting can be done quickly if one only deals with the major items in the budget. Timely and more accurate forecasting produces information management can use to run the organization,
- The budgeting system should produce and measure key performance indicators (KPIs). At the end of the day, the budgeting system should produce a small number of KPIs. These KPI’s will be part of the balanced scorecard management will be judged on. Additional information about balanced scorecards is available on this website.
I know this and the previous discussion have been a just a survey of budgeting issues. If you want to discuss how to improve and automate your budgeting process, please don’t hesitate to contact me!
Budgets and Smaller NFP Organizations (Part 1)
With many Not-For-Profit entities (“NFPs”) using a June 30 year end, the budget cycle for the new fiscal year has already begun. The budgeting process can be a very painful ordeal for many smaller NFPs, causing much groaning, complaining, and the gnashing of teeth. The most common complaints are budget preparation takes too long and the budget is quickly out of date shortly after it has been published.
There are many reasons why an organization needs to budget. I won’t address them here as you can pick up any accounting or management textbook and get those answers. Nevertheless, budgeting can be a significant contributor to the success of the organization. In this and a future blog, I want to make some suggestions that might make the budgeting process more informative and potentially less difficult.
Let’s begin with the mindset management needs when it begins budgeting. There are generally three ways an annual budget can be built:
- Incremental budgeting. This is the lazy method of budgeting. You start with last year’s actual results and adjust for anticipated changes such as the inflation rate, the addition of personnel, etc. While this can be the quickest way to get a budget, it is also the most ineffective. Incremental budgeting has many problems, including the potential omission of expenditures and necessary additions of new line items simply because they did not occur in the prior year. As such, they can be easily missed. Secondly, incremental budgeting can build in inefficiencies since it uses the prior year actual data as its starting point. Inefficient or even unnecessary expenditures made in the year just closed are simply carried forward to the current year’s budget, sometimes with insufficient analysis being done to see if the expenditures were required.
- Zero based budgeting (“ZBB”). This method of budgeting is the polar opposite of incremental budgeting. Incremental budgeting begins with last year’s actual expenditures and makes adjustments for the current year. It accepts last year’s actual results as the base for the current year’s budget. ZBB assumes NO expenditures as the starting point for the budget. The department or person proposing an expenditure must support the request for it with good reasons since the budget for that item is presumed to be zero in the upcoming year. While ZBB is a theoretically correct way to budget, it can be extremely time consuming as all expenditures need to be supported.
- Value proposition budgeting. My favorite style of budgeting, as it is a Golden Mean between incremental budgeting and ZBB. In value proposition budgeting, each expenditure from the prior year and any new expenditures are scrutinized to see if it and the amount are necessary to achieve the vision and mission of the organization. Any expenditure not necessary to attain the entity’s objectives is eliminated. This method keeps everyone’s eyes on the vision and mission of the organization and reminds everyone why the doors are opened every morning. It aligns the budgeting process and its results with the organization’s vision and mission.
In line with the use of value proposition budgeting, the categorization of budgeted expenditures can also achieve the same purpose. One common way to classify expenditures is this:
- Capex. I am sure we have all heard of Capex, or capital expenditures. These are expenditures for items such as equipment that will last over a period of years.
- Opex. These are operational expenditures required to keep the organization running on a day to day basis. These include personnel expenses, rent, utilities, etc.
- Riskex. Expenditures reducing risks to the employees, clients, and operations of the organization. Examples of these include insurance expenditures and alterations to the working environment to eliminate potentially hazardous working conditions.
- Stratex. Expenditures required to achieve the mission of the organization. These could be ongoing, annual expenditures or expenditures for new programs.
Thinking of expenditures in this manner also focuses management on the vision and the mission of the organization, particularly when riskex and stratex expenditures are being evaluated. Management is forced to ask what expenditures are needed to achieve the organization’s objectives. In the next instalment of this blog, I will continue to explore how good budgeting is truly mission-critical.
AI and NFPs
Artificial Intelligence (“AI”) has made amazing progress in recent years and has had an incredible impact on the business world. Scanning resumes and making credit decisions are two examples of common AI utilizations that come immediately to mind. Even NFL teams are using it to evaluate players. As time goes on, it will become more and more ubiquitous. Small NFP organizations often lack the funds to deploy this technology, but as its cost comes down NFP entities will need to utilize AI to efficiently achieve their missions. However, before they do, management will need to understand that AI is not the panacea for all of its problems. The sad truth is that AIs often do make mistakes. How can I prove this bold statement? Let’s look at the world of chess.
The internet is ablaze with the story of AlphaZero, currently the best chess player in the world. AlphaZero is an AI owned by Google that trained itself to play chess. It was given the rules of the game and then played 44 million games against itself to become the best player in the world. AlphaZero played two historic matches against Stockfish, a brute force chess engine that calculates millions and upon millions of moves a second. The first match was 100 games. AlphaZero won 28 games and 72 games were drawn. This would be a staggering achievement for a human player. For technical reasons we don’t have to get into here, many discounted this smashing victory. The technical deficiencies were corrected in the second, longer match of 1,000 games. AlphaZero won 155 games, drew 839, and lost 6. This was another very lopsided match, but AlphaZero did make mistakes since it lost games.
AI can make mistakes. They are not infallible. (Of course, those of us from the Baby Boomer generation do remember Terminator and HAL 9000…) Granted, AlphaZero had a very limited number of losses but these were only the discernible mistakes. There is a second type of mistake. AlphaZero may have made inferior moves earlier in drawn games it was able to compensate for later in the game. Put another way, AlphaZero could have won the game but it only ended up with a draw. A third type of mistake could occur when AlphaZero played an inferior move and then had to fight for a draw. The latter two types of mistakes are often overlooked because we tend to focus on the games won and lost. Drawn games are often insufficiently analyzed.
What lessons can NFP management learn when they begin installing AI? NFP organizations need to understand their tolerance for errors and omissions mistakes and put appropriate internal controls in place to insure against them. After all, many NFP organizations deal with human services. Six mistakes out of 1,000 can still be devastating when dealing with human lives.
In short, AIs are very efficient assistants, but they can make mistakes. Sometimes these mistakes can be hard to find. An organization employing AI needs to make sure it has sufficient safeguards and internal controls in place to make sure these errors are not dangerous to the organization’s mission.
NFP Horseshoes–Summer 2021
With Memorial Day right around the corner, it is time for Not For Profit (NFP) Horseshoes. Well, actually we are not going to physically play horseshoes, nor are we going to use Zoom to watch a horseshoes game. I use the horseshoe scoring system to rate various developments in the NFP world. As a refresher for those of you who don’t play horseshoes or haven’t played in a long time (not only has it been a year since the last Memorial Day, but who knows how many of you actually played horseshoes last year during the pandemic?), here are the scoring rules. A “ringer” is worth two points. A “double ringer” is worth four. A “leaner” or “closest to the stake” is worth one point. So, here we go!
Completely missing the horseshoe pit—The impending divorce of Bill and Melinda Gates. A divorce is a sad event for any couple. I have often been a critic of Bill Gates’ business practices and some of the gossip about the marriage becoming public is less than flattering to him. Nevertheless, I have often said that what goes on in a marriage (or civil union) is the private business of those in the marriage and one can’t listen to gossip about the sad situation. This divorce could have repercussions throughout the NFP world. I have also said Gates has done a tremendous job in this arena. The Bill and Melinda Gates Foundation has reportedly donated $50 billion to charities since 1994. Both parties have said they will continue to cooperate after the divorce so their foundation can continue its good work. I think it is appropriate at this time to simply thank each of them for their past generosity and wish them the best of luck.
Closest to the stake– Pope Francis’ financial reforms at the Vatican. I have also been critical of the Pope in the past for the way he has handled the financial scandals in the Vatican. His actions (and inactions) included terminating Price Waterhouse before it completed the audit of the Vatican and allowing the Vatican Secretariat of State to invest Peter’s Pence (the annual collection taken up by dioceses throughout the world in support of the Vatican) in a real estate scheme in the United Kingdom. Francis has now reversed course and implemented a string of reforms at the Vatican. Cardinal Becciu, a close assistant to Francis and who used Vatican funds for the real estate scheme and was allegedly involved in other financial scandals, was stripped of his authority and his ability to function in future papal conclaves in September 2020. Other reforms were instituted. Clergy involved in fraudulent activity in the Vatican will now be subject to the Vatican court system and not just to ecclesiastical punishment. Contract authorization and approval has now been centralized in the Vatican. Why then only a “leaner”? It is too soon to see if these and other reforms will go far enough, be enforced or even survive. The Vatican has the reputation for being notoriously corrupt (sadly) so many of these reforms may not outlast the Pontificate of Francis. Only time will tell.
Update: It was announced on July 2, 2021 Cardinal Becciu would face a trail at the Vatican for various crimes ranging from embezzlement to extortion. Eight others were included in the indictment. The trial is due to begin on July 27, 2021.
A double ringer–All the NFP organizations that labored through the COVID pandemic. The last year has been incredibly tough for all NFP organizations. The enforced shutdown, loss of revenue and employees have taken a toll on these organizations. The fact that so many are left standing is a testament to the goodwill and charitable nature of their management and employees. Hats off to them and our gratitude! Please find a way to show your gratitude and support to an NFP by donating, volunteering, or both!
Mark Koscinski CPA D.Litt. 