Last Round of Horseshoes for Summer 2021
Last Round of Horseshoes for Summer 2021
As Labor Day approaches many organizations are returning to the office and schools will be holding in person classes. We can only hope and pray the pandemic will abate as we move through the rest of the year. As summer fades away, it is now time for the last round of NFP horseshoes for the Summer of 2021. For the sake of brevity, I won’t repeat the scoring rules here as I have already done that earlier this Summer.
A Ringer!–RSM LLP, a large accounting and consulting firm, acquires C Systems, a technology services provider to the NFP world. To be sure, RSM is known for its presence in the NFP world, but this acquisition shows their confidence in the rebound of this sector. Perhaps it is a good sign for all those working in the NFP world! PNC Bank also recently spoke about the increased potential of merger and acquisitions in the NFP sector. (Access the article here.) You can read the press release from RSM here. As an aside, RSM offers continuing education courses for NFP personnel that can be accessed here.
A Ringer! Moceans CIL going strong! Moceans CIL is a center for independent living, serving Monmouth and Ocean counties NJ. Despite the pandemic, the staff of Moceans continues to serve their client base. They and all the NFP organizations that have persevered through the pandemic are to be commended for their dedication to their mission. The MOCEANS website can be found here. May they and all NFP organizations continue to have good fortune in their future endeavors.
Missed the Stake. The Trial of Cardinal Becciu adjourned until October. The trial of the former papal chief of staff (or, sostituto as the position is known) started in late July and was adjourned until early October. Yes, Italy tends to shut down for the month of August so that explains some of the delay. However, it seems there has been a certain level of incompetence in the management of the trial. For instance, the defense has not received all of the evidence against Angelo Cardinal Becciu yet. One can only hope the Vatican has the wherewithal to deal with such a complicated trial. That remains to be seen. Pope Francis has made some strides lately to clean up the corruption of the Vatican Curia (including this trial) , but it seems it is too little and way too late in his pontificate. I won’t even get into the petty corruption and graft that exists in all of the dioceses around the world. The Catholic Church is arguably the largest NFP entity in the world and should set the standard for Good Stewardship of the Faithful’s assets for not only the Vatican curia but for all dioceses throughout the world. Sadly, this has not been the case.
Missed the Stake. FASB has not delayed the implementation of ASC 842. For those of you who aren’t aware, ASC 842 is the new lease accounting standards issued by the Financial Accounting Standards Board (FASB). Due to the pandemic, the previous effective date has been delayed for NFP entities that begin their fiscal year after December 21, 2021. While one might think that this gives NFPs the whole year to get the lease accounting under control, that is not correct. ASC 842 is effective for interim financial periods as well. So, if the NFP has to provide financial information to lenders on a quarterly basis it needs to get cracking on this project now. One has to wonder though. Many NFP organizations are having a hard time operating in the pandemic as it is. This is just one more burden for them. Will they be sacrificed on the altar of theoretically correct accounting? Would it have been so traumatic for the FASB to grant one more extension?
Wel, that wraps up our horseshoe games for this summer! The semester at Moravian University has is starting so I will be concentrating on that for a while. I hope you had a great summer. Stay healthy!
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!
ESG and the Disabled
ESG (Environment, Social, and Governance) reporting is an important topic in today’s corporate world. Even the SEC has required increased disclosure in this area. For many years the SEC has required publicly traded companies to disclose the number of employees. That disclosure has now been expanded to include the types of employees and independent contractors the company has. The purpose of this is to give investors a window into how the company regards its workers.
The Value Reporting Foundation (VRF) was recently created by the merger of the Sustainability Accounting Standards Board (SASB) and the International Integrated Reporting Council. Its purpose is to help provide a holistic view of what creates corporate value and advance the development of ESG reporting standards. These include standards for reporting on six capitals, including human capital.
While it is hard to disagree with the fundamental proposition investors would like to know as much as possible about companies they invest in, I somehow can’t shake the feeling that once again disabled are being left behind. For instance, the SASB announced a new project for reporting on the use of plastics in certain industries. By itself, this seems innocuous enough. However, these initiatives have implications. Several years ago I wrote a post on how the banning of plastic straws has impacted the disabled. That post can be accessed here. Perhaps a more humane disclosure would include the impact on the disabled where applicable? Similarly, the expanded human capital disclosures don’t seem to include any disclosure about the number of disabled personnel a company employs. Shouldn’t that be considered by the VRF as well?
As Gandhi said, “The true measure of any society can be found in how it treats its most vulnerable members.” Perhaps this is a lesson the VRF should take to heart as it promulgates reporting standards about what truly creates corporate value.
Supreme Court Allows Larger NFP Donors to Remain Confidential
In a decision delivered on July 1, the United States Supreme Court struck down a California law requiring not for profit entities to disclose larger donors to the State Attorney General. Chief Justice Roberts delivered the opinion for the 6-3 majority, largely split along ideological lines. The more liberal leaning Justices Breyer, Sotomayor, and Kagan dissented. The intent of the California law was to assist in the policing of NFP fraud by requiring these organizations to report all donors of $5,000 or more. A broad coalition of NFP groups banded together to oppose the law.
In his majority opinion, Roberts said such laws had a chilling effect on right of association provided by the First Amendment. In a not so subtle swipe at the State of California, Roberts also wrote the promises of confidentiality the State provided were worthless. He noted donors to the particular charities had received serious threats. The long term implications to this decision are unclear. Many legal pundits are claiming this decision will be the wedge in the door to challenge future campaign finance disclosures. What is for certain now is larger donors to unpopular causes can breathe a sigh of relief as they maintain at least some semblance of anonymity.
The text of the decision can be found here.
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!
Fraud and the Smaller NFP
The Association of Certified Fraud Examiners (ACFE) reported the median loss for any single fraud in a not-for-profit organization (NFP) was approximately $100,000 in 2016. This amount was less than the median losses from frauds committed in governmental entities ( $109,000), public companies ($178,000) and public companies ($180,000) during the same time period. Sadly, NFP fraud constituted approximately 20% of all the reported cases. Putting the median loss number in perspective, a $100,000 loss would have been devastating to the NFP I served as board chair. On top of this, the $100,000 loss was the median loss, meaning one-half of the losses were larger than $100,000 so the pain could even be more acute. Why are the median losses in the NFP sector smaller than in other organizations? My guess is that there is simply less cash available for conversion in the NFP than in the other entities, but more research will be needed to support my supposition. The ACFE also reports the average fraud in an NFP organization will last two years as opposed to eighteen months in public companies.
That is not all the bad news though. In a recent report, ACFE expects the amount of fraud will increase after the pandemic. Many small NFP entities are chronically short staffed so there is often a lack of segregation of duties, a key element of internal control. This is compounded by the pandemic as skilled labor is often in short supply. One executive director I worked with joked she would need to sweep up on the way home because the NFP couldn’t afford janitorial services. Being underfunded as most small NFP organizations are also means a lack of software that supports good internal controls as well.
Is the situation hopeless then? No. There are some cost effective compensating controls the ACFE has found to be effective and they are relatively cost efficient as well. Here are a few suggestions:
- Management review of the financial data and performance indicators. An involved upper management regularly reviewing financial information and performance indicators is often an effective fraud deterrent. No one knows the company better than the senior management. Getting in the habit of reviewing operating data on a regular basis is one cost effective way to combat fraud.
- Fraud training for managers and executives. Training courses are relatively inexpensive, especially compared to the pain an organization will feel from a major fraud. Training heightens management and employees’ awareness of fraud possibilities.
- Fraud assessments. These can be undertaken annually as a joint venture among board members, management, and the external auditors. Knowing the weaknesses in internal controls can often focus management’s attention on them and lead to future mitigation.
- Employee assistance programs (EAPs). Many of you are familiar with the fraud triangle. This relatively simple theoretical construct says fraud is most likely to occur when there is pressure (financial, psychological, etc.) on an employee, the opportunity for the employee to commit fraud (due to a lack of internal control) and rationalization of the action by the employee (“I don’t get paid enough for what I do!”). Organizations can deter fraud by addressing any and all of these root causes. Fraudsters often succumb to psychological pressure because they feel isolated and believe they have to deal with their personal problems themselves. They may be overwhelmed by the situations they find themselve in. An EAP gives employees an opportunity to get counseling help on an anonymous basis. Many benefit plans contain an EAP feature. It is cheap compared to a fraud loss.
- An anti-fraud policy and a code of conduct. The existence of these documents and their annual review also deters fraud. They should contain a clear policy about who whistleblowers should speak to when they suspect fraud and an anti-retaliation policy against whistleblowers. Anonymous tips are still one of the most significant ways frauds are uncovered. Employees and clients should not be afraid of retaliation from making a legitimate whistleblower complaint.
These suggestions are not in and of themselves sufficient as a system of internal controls. General, application, processing and reconciliation internal controls should be used wherever possible. This list is just a few recommendations for compensating internal controls when the organization lacks the time, talent, and treasure to implement a more functional, effective system of internal controls.
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.
Mark Koscinski CPA D.Litt. 