Internal Controls over Cash for Small Nonprofits

Transcription

1 Internal Controls over Cash for Small Nonprofits Internal controls may be a sensitive issue in small nonprofit organizations. These organizations are built on the concepts of honesty, truthfulness, and mutual trust. However, it is essential to realize that internal controls, especially over cash, are of paramount importance to protect these organizations interests. Numerous news stories in 2011 highlighted nonprofits victimized by employee embezzlements. Just a minor sample included Charlotte Mothers of Multiples, Bevill State Community College, Nicolas Valley Elementary School's Parent Teacher Association, Long Beach Pee Wee Football League, Compton Community College, Revere Public Library, Maine Trial Lawyers Association, and Tenderloin Housing Clinic. Unfortunately, the attention afforded to each of these nonprofit organizations was not the attention each likely wanted. Yet, people don't even hear about most of the cases like the aforementioned. In fact, it has been estimated only one case in nine is ever reported in the media. Most embezzlements cases are quietly resolved, avoiding any publicity. There are few enough dollars for nonprofits as it is, and especially for small ones. Considering the state of the economy, decreased federal and state funding, and the expected decline in continued support for nonprofit organizations, it is incumbent on every organization to ensure that every dollar is appropriately collected, deposited, tracked, recorded and used for the organization's programs, and not susceptible to being diverted by an employee for personal purposes Proper internal controls, especially when it comes to cash, are essential for all nonprofit organizations regardless of size. Internal controls can be defined as a set of policies and procedures that have the main objectives of safeguarding assets, promoting accuracy of business information, and ensuring compliance with laws and regulations. Critical to the implementation of these controls is an appropriate level of segregation of duties which simply is the concept of having more than one person to complete a required task. This is particularly difficult for the smaller nonprofit organization to accomplish due to the limited size of the staff and/or the number of volunteers. As cash is the asset most likely to be stolen or used improperly in a nonprofit organization, particular attention must be given to internal controls for cash and cash transactions. The following sections provide an outline of various accounting areas related to cash and give examples of how internal controls can be put into place to make errors or fraud in these areas more unlikely in the smaller nonprofit organization.. Cash Receipts To protect cash from theft and recording discrepancies, the small nonprofit organization must control cash from the time it is received until it is deposited in the bank. The policies and procedures to achieve control over cash receipts should be carefully documented in the organization s accounting procedures manual and should emphasize

2 on the nonprofit achieving the greatest level of segregation of duties possible. A sample outline of procedures to control cash receipts for the small nonprofit would be: 1. An individual outside of the accounting department should open the mail. This individual should make a detailed list of the checks received. This list is to be sent to the accounting department. If a large amount of cash (as opposed to checks) is received, two people should always open the mail. In cases where an event is held, two people should always be present at each site where cash is collected. The nonprofit organization should have a For deposit only stamp which should include the organization s name. Every check received should be stamped by the employee opening the mail. 2. Checks and cash are delivered to a second individual who is neither involved with the accounting department nor the opening of the mail. This individual will prepare a deposit slip listing all checks and cash and make copies of the checks deposited as well as a copy of the deposit slip. These copies are kept as support for the deposit along with any correspondence received with the check. The individual then proceeds to deposit the cash in the bank where a receipt is obtained showing the amount deposited. The bank receipt, copy of deposit slip, copies of checks, and correspondence, are all sent to the accounting department. 3. The accounting department receives the detailed listing of the checks from the individual opening the mail and proceeds to record them in the general ledger. When recording the deposits in the general ledger, care should be given to the type of revenue received. All like items should be coded to the same account. If a donor has restricted the usage of the contribution to a particular program, it will be necessary to record the amount as temporarily restricted. The accounting department should receive from the individual making the deposit, the bank receipt, copy of deposit slip, copies of checks, and correspondence and compares the total amount deposited to the amount based on the list prepared by the person opening the mail. This control helps ensure that all cash is deposited and that no cash is lost or stolen on the way to the bank. Any shortages are thus promptly detected. Separating the duties of the individual handling/depositing the cash and the accounting department, which records the cash, is an essential internal control for nonprofit organizations. If the accounting department were to both handle and record cash, its employee(s) could steal cash and change the accounting records to hide the theft. Many people will opt to charge a contribution or a fee for a service or publication if given the option. With increasing online purchasing, making credit card transactions available may be a necessity. Generally, the nonprofit organization will submit the transaction online to the credit card vendor. Once processed by the vendor, a deposit will be wired into the bank account of the organization. A summary report of the transactions processed will be sent periodically. These summary reports will need to be compared to the organization s records for the transactions submitted. The records from both the credit card vendor and the organization will need to be used to reconcile the bank account each month.

3 Essential to any internal control system but even more so in the case of a small nonprofit is the proper oversight by management and the board of directors of the organization. As such, the management and/or board of directors of the organization should be provided with regular notification of the deposits being made. Cash Disbursements The internal controls of the small nonprofit organization over cash payments should be thoroughly documented in an accounting procedures manual and focus on providing reasonable assurance that payments are made only for authorized transactions and cash is used effectively and efficiently (i.e. controls should ensure that all available purchase discounts are taken.). The more people involved in processing transactions, the less likely it is that a problem will occur. For small nonprofit organizations with limited staffing, this issue is particularly troublesome. Often, the best answer lies in having members of the board of directors get involved in the cash disbursement process. At a minimum, the nonprofit organization should have two people involved in this process. A sample process broken into several parts with only two people involved would resemble the following: 1. All invoices should be forwarded to the accounting department where they would be checked for accuracy (it is important to remember to pay only from invoices and not from vendor statements). Does the invoice add up? Does it match the packing information if the items were delivered? Do the prices match the quotes or contract? 2. The invoice should be coded by type of account and department/program/grant by the person who ordered the service and/or has responsibility for the budget being charged. For example, an invoice for supplies for a conference should have a notation to that effect on the invoice. In addition, the person who authorized the purchase or service should approve the invoice in writing, preferably on the invoice. 3. The check (pre-numbered) should then be written by the accounting department. The use of accounting software to automate the check printing process for the smaller nonprofit is encouraged. If a manual check is written, an entry should be made into the accounting system (general ledger). It is important to remember that all unused checks should be locked in a cabinet or closet and a limited number of people should have access to them. 4. The unsigned check and the supporting documentation should be given to the check signer(s) for review. The signer(s) should be limited to members of the board of directors and management. The organization should set a requirement of two signatures for amounts above a set threshold. When setting the amount, consideration should be based not only on a set dollar amount, but also whether certain checks could be excluded from the requirement. For example, if a set

4 amount is paid for rent each month based upon a signed lease, then as long as the rent is for the amount noted in the lease, a second signature would not required. 5. A copy of the check should be attached to the invoice and filed by the accounting department. As an alternative, the check number could be written on the invoice. In this case, the invoice should be marked as paid. 6. The same procedures should be followed for wire transfers as for checks. Payroll Payroll generally constitutes a substantial portion of a small nonprofit organization s cash disbursements. As such, proper internal controls need to be established and they may differ from those described earlier for other cash disbursements. Many payroll services are available that will process payroll, make direct deposits, prepare quarterly and annual tax filings and remit taxes due. This is generally the most efficient and cost-effective manner for the smaller nonprofit organization to have its payroll processed and ensure that all tax requirements are met. The payroll service is responsible for keeping current with changes to tax and benefit laws in all jurisdictions, and because an outside party is involved in the process, the controls surrounding payroll are enhanced and the risk of errors and/or misappropriation of funds are reduced immeasurably. With few exceptions, the use of a payroll service by a small nonprofit organization is preferable to processing the transactions in-house. It is important to obtain references when selecting a payroll service. Verification should be made that the company is well established, has a reputation for accuracy in the reports it produces, and remits taxes and returns in a timely fashion. Further, the nonprofit should inquire about the ease with which errors are corrected and the responsibility the payroll service assumes when payroll taxes are not calculated and reported properly. As the payroll companies include these services in their fees, the nonprofit should not be held responsible for any penalties or interest resulting from the service s mistakes. Once a payroll service has been selected, it will be prudent to check with the Internal Revenue Service periodically to verify all taxes owed by the organization are paid currently and in full. This step will serve as a check in the event the payroll service does not remit all taxes when due, no matter what the reason. All withholdings from employees paychecks should be approved in writing by the employees. The following are common withholdings that require signed documentation: Federal and State income taxes Pension withholdings Parking/metro Health insurance premiums Loan deductions In addition, the starting salary as well as any raises received by the employee should be also documented in writing and signed off by the executive director or president of the board of directors. The staff in charge of payroll should notify the payroll service of any changes for the particular payroll. The payroll summary issued by the payroll service

5 prior to the payment of the payroll should be reviewed by both the staff in charge of payroll and a member of management or the board of directors. For additional control over cash disbursements related to payroll, the smaller nonprofit organization could use an imprest payroll account to help prevent the payment of unrecorded payroll transactions. An imprest account is a separate checking account in which a small balance is maintained. A check for the exact amount of each payroll is transferred from the general account to the payroll checking account immediately prior to the distribution of the payroll. The advantages of an imprest account are that it limits the organization s exposure to payroll fraud, allows the delegation of payroll-check signing duties, separates routine payroll expenditures from other expenditures, and facilitates cash management. Sufficient cash should be available for automatic withdrawal by the payroll service for both the net salary and all taxes due. Payroll will be either recorded through the check register (QuickBooks) or by journal entry. Timesheets should be available to support the allocation of the salaries to the various functions (programs, grants, departments, general and administrative and fundraising). All time records should be saved. Bank Reconciliations A bank account is a primary internal control that a small nonprofit organization can use over cash. Some of the control advantages of using a bank account are: 1. Bank accounts reduce the amount of cash on hand. 2. Bank accounts provide an independent recording of cash transactions. 3. Use of bank accounts facilitates the transfer of funds using EFT systems. The nonprofit uses the bank s statement as a control by comparing the organization s recording of cash transactions to those recorded by the bank. If at all possible, an individual other than the person writing checks and making deposits should reconcile the bank account each month. Many small nonprofit organizations hire an outside accountant or bookkeeper to perform this function to increase the internal controls surrounding cash. If the organization cannot afford to hire an outside accountant, the executive director (or the treasurer) should receive the unopened bank statement each month, review all activity, and be confident that all transactions are valid. The reviewer should initial the bank statement indicating his or her review. Once the review takes place the appropriate individual should reconcile the account. All bank statements and the related information should then be filed. Petty Cash Depending on need, a small nonprofit organization may establish a petty cash fund to cover incidental office expenses. This fund should be for a minimal amount and should be used sparingly. Although the amount of cash kept in a petty cash fund is minimal, it is amazing how much cash is stolen each year from petty cash funds. In order to control the nonprofit s petty cash, the following should be observed:

6 1. Only one person should have access to the petty cash fund. 2. The cash should be in a locked box and kept in a locked drawer or filing cabinet. 3. Every time an individual receives cash from the box, a voucher should be signed and placed in the box. The expense coding should be noted on the voucher. 4. When a receipt is obtained, such as for taxi fare or the purchase of supplies, this receipt should be attached to the voucher. At all times, the cash and the receipts signed for withdrawals should equal the total of the fund in the general ledger. 5. When the cash in the box is low, the total of the vouchers should be determined and a check written for that amount. The check should be made payable to the individual in charge of the petty cash. 6. A summary of the expenses noted on the vouchers should be prepared and attached to the check copy. This summary will be the basis for recording the activity in the general ledger. 7. Under no circumstances should the petty cash fund be used to advance monies to employees in the form of loans. General Ledger & Journal Entries The general ledger documents all of the nonprofit organization s transactions for all accounts. For example, every time a check is written, the disbursement will reduce cash and every time cash is deposited and recorded, the cash account will be increased. Although most transactions are posted automatically through the accounts payable and accounts receivable modules of the general ledger software used by the nonprofit organization, journal entries should be made for any transaction not automatically produced by the software. These entries often include payroll, reclassification of amounts already posted, bank reconciliation items, and allocations. Existing transactions should never be changed even if the general ledger package allows that flexibility. The use of journal entries to correct prior transactions is necessary to create an audit trail. In this manner, all of the transaction made can be followed and traced to original documentation. All changes and entries should be reviewed by approved by management or a member of Board. All accounts in the general ledger should be analyzed and/or reconciled each month to ensure the accuracy of the balances. Conclusion Due to the inherent difficulty in achieving proper segregation of duties, it is recommended that every small nonprofit organization evaluate its current level of internal controls, especially over cash, and consider having someone independent and outside of the organization provide an objective evaluation of its systems. This will minimize the risk of becoming a victim of embezzlement or of errors in recording transactions affecting cash. If the nonprofit organization has an annual financial audit, the auditor would be the best source of information on how to improve existing controls as well as lessen risks and opportunities. Nonetheless, management and the board of directors needs to acknowledge that there is no substitute for vigilance. Nonprofits are the keepers of the cash that can and do change lives. As such, these

7 organizations have an obligation to use them wisely and protect them for their intended use. It is that the covenant the nonprofit organization has made with its donors and the people they expect the organization to benefit. The Author Fredrick Ho, CPA, MBA is principal of Ho & Associates, Certified Public Accountant. He is also tenured faculty in accounting for the Los Angeles Community College District and an adjunct professor at UWEST.