Financial literacy: A board member’s responsibility to understand GAAP

Posted on Dec 19, 2013 in Not-for-Profit Boards

By Troy Rector, CPA

For some, GAAP may seem like a typo. For others, it may seem like a government group. In fact, GAAP is the abbreviation for generally accepted accounting principles, which are the principles commonly used by Not-for-Profit (NFP) organizations for financial reporting.

What does GAAP mean to you as a board member? Simply put, an understanding of an NFP organization’s financial reporting is a prerequisite for effective oversight of its financial affairs; a key to understanding a NFP’s financial reporting is to understand the accounting policies developed by management and the unique accounting requirements that may be applicable to your NFP.

Though not all NFP’s are required to follow GAAP, many NFPs are required by grant terms, lenders or other regulatory bodies to provide GAAP basis financial statements, with many requiring the GAAP basis financial statements to be subject to annual, independent audits. If compliance with GAAP is not currently required, many NFPs use the standards as a best practice to ensure effective financial reporting.

Management is responsible for generating and presenting the NFPs financial statements, which includes adopting proper accounting policies and procedures. The Board is responsible for providing management oversight. The level of oversight the Board provides and expertise needed largely depends on the complexity of the organization and the knowledge that key finance personnel have of GAAP.

For example, a small organization may have less complex GAAP issues but may be struggling to just keep the books and records up-to-date with little consideration of GAAP. A larger organization may have an existing accounting infrastructure, but the experienced finance manager may be new to the NFP industry and not completely understand the unique NFP GAAP requirements.

In both situations, the Board would be responsible for ensuring that management understands or is seeking outside assistance to ensure that the NFP’s accounting policies and procedures are in accordance with GAAP. The Board member’s responsibility is to provide oversight and not to get into the details and implementation aspects. However, circumstances do arise where the Board member must play the role of a volunteer, providing expertise and guidance to management.

Depending on the size and nature of an NFPs activities, there are a number of areas where a Board member should understand the financial accounting and reporting policies that have been developed by management and that there has been an assessment of whether those policies are sound and in compliance with the regulatory framework used (GAAP, for example).

Key financial reporting areas would include the following:

Key accounting estimates used by management, including assessing the collectability of receivables and methods used to depreciate fixed assets
Recognition of promises to give, including an assessment of whether the promise to give is unconditional or conditional
Planned gifts, including charitable remainder trusts, charitable lead trusts and charitable unitrusts
Endowment accounting, including both donor-restricted and board-designated (quasi) endowments
Revenue recognition criteria used for income sources, such as which period they should be taken into revenue and at what value
Accounting for and tracking of donor-restricted contributions
Agency, fiscal sponsorships and other arrangements where an NFP is performing certain functions for other unrelated entities
Significant or unusual transactions undertaken by the NFP, such as a property purchase or the impact of new program activity on the NFP’s accounting

After some evaluation, it is common for a Board to identify the need for increased internal GAAP expertise on the part of management or the need to increase the Board’s knowledge of financial reporting requirements. There is a wealth of guidance on NFP reporting practices. The most useful source will depend on the level of detailed understanding that you are seeking.

Some useful sources of NFP GAAP guidance are as follows:

Financial Accounting Standards Board (FASB) codification is available for free on-line viewing and includes all existing GAAP standards
American Institute of Certified Public Accountants: Audit & Accounting Guide For Not-For Profit Organizations includes excerpts and references to GAAP standards but also provides practical guidance on how the standards are to be applied
GAAP Guides issued by publishers such as Thompson, PPC or Miller
Publications providing an overview of NFP Board Governance including the AICPA’s “The Best of Boards”
NFP Board Governance training which normally provides a general session on understanding NFP financial statements
NFP Basics Workshops (including Clark Nuber’s 3-day workshop) that provide training on NFP accounting, NFP tax and Federal compliance basics.
Consultation with outside experts (CPA’s, finance professionals, etc.)

When consulting with the NFP’s external auditor, it is important for management and the Board to understand that while the external auditor may provide guidance, the external auditor must maintain its independence. This places the responsibility on management to identify potential accounting issues, ask questions, review any guidance provided by the auditor and make a decision on the appropriate accounting treatment.

Understanding the NFP’s financial reporting practices is a key element of a Board member’s fiduciary responsibilities. If performed correctly, the discussion of a NFP’s accounting treatment and selection of related policies will often lead to enhanced discussions of strategy, plans and financial risks. The key to the process is to understand your responsibility as a Board member, invest the time necessary to become financially literate, and come to the Board prepared to evaluate management’s policies and ask relevant questions.

This article or blog contains general information only and should not be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. Before making any decision or taking any action, you should engage a qualified professional advisor.