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Accounting 101 for development directors: Five things to know

By:
Leah Pillsbury is a Staff Auditor at BerryDunn. Before joining the firm, Leah spent a decade working at not-for-profits, primarily as a fundraiser, specializing in capital campaigns. Leah’s time spent in the fundraising capacity has given her valuable perspective insight into the not-for-profit audit experience.
Leah Pillsbury
12.11.18

Good fundraising and good accounting do not always seamlessly align. While they all feed the same mission, fundraisers work to meet revenue goals while accountants focus on recording transactions in compliance with accounting standards. We often see development department totals reported to boards that are not in line with annual financial statements, causing confusion and concern. To bridge this information gap, here are five accounting concepts every not-for-profit fundraiser should know:

1.

GAAP Accounting: Generally Accepted Accounting Principles (GAAP) refers to a common set of accounting standards and procedures. There are as many ways for a donor to structure a gift as there are donors?GAAP provides a common foundation for when and how you should record these gifts.

2.

Pledges: Under GAAP, if there is a true, unconditional “promise to give,” you should record the total pledge as revenue in the current year (with a little present value discounting thrown in the mix for payments expected in future periods). A conditional pledge relies on a specific event happening in the future (think matching gift) and is not considered revenue until that condition is met. (See more on pledges and matching gifts here.) 

3.

Intentions: We sometimes see donors indicating they “intend” to donate a certain amount in the future. An intention on its own is not considered a true unconditional promise under GAAP, and isn’t recorded as revenue. This has a big impact with planned giving as we often see bequests recorded as revenue by the development department in the year the organization is named in the will of the donor—while the accounting guidance specifically identifies bequests as intentions to give that would generally not be recorded by the finance team until the will has been declared valid by the probate court.

4.

Restrictions: Donors often impose restrictions on some contributions, limiting the use of that gift to a specific time, program, or purpose. Usually, a gift like this arrives with some explicit communication from donors, noting how they want to apply the gift. A gift can also be considered restricted to a specific project if it is made in direct response to a solicitation for that project. The donor restriction does not generally determine when to record the gift but how to record it, as these contributions are tracked separately.

5. Gifts vs. Exchange: New accounting guidance has been released that provides more clarity on when a gift or grant is truly a contribution and when it might be an exchange transaction. Contact us if you have any questions.


Understanding the differences in how the development department and finance department track these gifts will allow for better reporting to the board throughout the year—and fewer surprises when you present financial statements at the end of the year. Stay tuned for parts two and three of our contribution series. Have questions? Please contact Emily Parker of Sarah Belliveau.

 

Related Services

A capital campaign is a big undertaking. During the planning stage of a capital campaign you need to not only focus on your donor outreach strategy, but also on outreach materials. From an accounting standpoint, the language you use can have a big impact on how the funds will be tracked and ultimately used by the organization. We recommend our clients share their outreach materials with us early in the process so we can measure them against standard accounting practice and regulations. Here are a few things to consider and plan as you get started.

Three components to understand

1.

Pledges. Make sure you understand the difference between a pledge and an intention. From an accounting perspective, only an “unconditional promise to give” is recorded as revenue?an intention to give does not usually meet that criteria. It’s especially important to have this conversation if there is a planned giving element of the campaign, because accounting for bequests can be confusing at times. (You can learn more about intentions here).

2.

Matching Gifts. Matching gift drives can be very successful aspects of your campaign. Be aware that pledges to match gifts from other donors are not considered revenue for accounting purposes until those conditions have been met.

3.

Gift Restriction. For many donors, capital campaigns are particularly appealing, because they fund exciting and tangible projects. Donors who give for a specific building project or scholarship fund are imposing a restriction on how you can use that money. Restrictions can be explicit, as in the case when a gift is accompanied by a note describing the purpose of the gift. However, accounting guidelines also stipulate that restrictions can be implicit?arising from the circumstances surrounding the gift, not necessarily specific instructions from the donor. For example, if a campaign appeal for a new community building focuses just on that project, gifts in response to that appeal may be restricted to building expenses, and can’t be spent on other expenses of the organization. 

Not sure where to start? Here are three helpful tools to get the conversation going.

Three must-haves to build your campaign

1.

Gift Acceptance Policy. Hopefully, your not-for-profit has a written gift acceptance policy. If not, start there. A gift acceptance policy outlines guidelines for pledges, restrictions, and the full range of contribution types?from stocks and bonds to real estate and life insurance policies. A good policy serves as a guide for fundraisers and protects the organization from accepting gifts that may not be beneficial.

2.

Campaign Counting Policy. An essential part of campaign planning is the development of a counting policy, which outlines what gifts are counted toward the overall goal?and how. This is especially important because the campaign counting may differ from how your accounting team records the revenue of the campaign.

3. Pledge Form. Finally, there is the pledge form, where it all comes together. A campaign pledge form should align with the organization’s gift acceptance and counting policies and be written in a way that ensures pledges and gift restrictions are accounted for properly.


In developing each of these tools, be sure to involve your finance department, but also outside experts, such as your legal counsel or your auditing firm, as they can add extra support and knowledge. While launching a capital campaign can seem daunting, proper planning allows the rest of the campaign to run smoothly.  Have questions? Please contact Emily Parker or Sarah Belliveau.

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A CPA's guide to starting a capital campaign

LIBOR is leaving—is your financial institution ready to make the most of it?

In July 2017, the UK’s Financial Conduct Authority announced the phasing out of the London Interbank Offered Rate, commonly known as LIBOR, by the end of 20211. With less than two years to go, US federal regulators are urging financial institutions to start assessing their LIBOR exposure and planning their transition. Here we offer some general impacts of the phasing out, some specific actions your institution can take to prepare, and finally, background on how we got here.

How will the phase out impact financial institutions?

The Federal Reserve estimates roughly $200 trillion in LIBOR-indexed notional value transactions in the cash and derivatives market4. LIBOR is used to help price a variety of financial services products,  including $3.4 trillion in business loans and $1.3 trillion in consumer loans, as well as derivatives, swaps, and other credit instruments. Even excluding loans and financial instruments set to mature before 2021—estimated by the FDIC at 82% of the above $200 trillion—LIBOR exposure is still significant3.

A financial institution’s ability to lend money is largely dependent on the relative stability of its capital position, or lack thereof. For institutions with a significant amount of LIBOR-indexed assets and liabilities, that means less certainty in expected future cash flows and a less-stable capital position, which could prompt institutions to deny loans they might otherwise have approved. A change in expected cash flows could also have several indirect consequences. Criticized assets, assessed for impairment based on their expected future cash flows, could require a specific reserve due to lower present value of expected future cash flows.

The importance of fallback language in loan agreements

Fallback language in loan agreements plays a pivotal role in financial institutions’ ability to manage their LIBOR-related financial results. Most loan agreements include language that provides guidance for determining an alternate reference rate to “fall back” on in the event the loan’s original reference rate is discontinued. However, if this language is non-existent, contains fallbacks that are no longer adequate, or lacks certain key provisions, it can create unexpected issues when it comes time for financial institutions to reprice their LIBOR loans. Here are some examples:

  • Non-existent or inadequate fallbacks
    According to the Alternative Reference Rates Committee, a group of private-market participants convened by the Federal Reserve to help ensure a successful LIBOR transition, …most contracts referencing LIBOR do not appear to have envisioned a permanent or indefinite cessation of LIBOR and have fallbacks that would not be economically appropriate.

    For instance, industry regulators have warned that without updated fallback language, the discontinuation of LIBOR could prompt some variable-rate loans to become fixed-rate4, causing unanticipated changes in interest rate risk for financial institutions. In a declining rate environment, this may prove beneficial as loans at variable rates become fixed. But in a rising rate environment, the resulting shrink in net interest margins would have a direct and adverse impact on the bottom line.
  • No spread adjustment
    Once LIBOR is discontinued, LIBOR-indexed loans will need to be repriced at a new reference rate, which could be well above or below LIBOR. If loan agreements don’t provide for an adjustment of the spread between LIBOR and the new rate, that could prompt unexpected changes in the financial position of both borrowers and lenders3. Take, for instance, a loan made at the Secured Overnight Financing Rate (SOFR), generally considered the likely replacement for USD LIBOR. Since SOFR tends to be lower than three-month LIBOR, a loan agreement using it that does not allow for a spread adjustment would generate lower loan payments for the borrower, which means less interest income for the lender.

    Not allowing for a spread adjustment on reference rates lower than LIBOR could also cause a change in expected prepayments—say, for instance, if borrowers with fixed-rate loans decide to refinance at adjustable rates—which would impact post-CECL allowance calculations like the weighted-average remaining maturity (WARM) method, which uses estimated prepayments as an input.

What can your financial institution do to prepare?

The Federal Reserve and the SEC have urged financial institutions to immediately evaluate their LIBOR exposure and expedite their transition. Though the FDIC has expressed no intent to examine financial institutions for the status of LIBOR planning or critique loans based on use of LIBOR3, Federal Reserve supervisory teams have been including LIBOR transitions in their regular monitoring of large financial institutions5. The SEC has also encouraged companies to provide investors with robust disclosures regarding their LIBOR transition, which may include a notional value of LIBOR exposure4.

Financial institutions should start by analyzing their LIBOR exposure beyond 2021. If you don’t expect significant exposure, further analysis may be unnecessary. However, if you do expect significant future LIBOR exposure, your institution should conduct stress testing using LIBOR as an isolated variable by running hypothetical transition scenarios and assessing the potential financial impact.

Closely examine and assess fallback language in loan agreements. For existing loan agreements, you may need to make amendments, which could require consent from counterparties4. For new loan agreements maturing beyond 2021, lenders should consider selecting an alternate reference rate. New contract language for financial instruments and residential mortgages is currently being drafted by the International Securities Dealers Association and the Federal Housing Finance Authority, respectively3—both of which may prove helpful in updating loan agreements.

Lenders should also consider their underwriting policies. Loan underwriters will need to adjust the spread on new loans to accurately reflect the price of risk, because volatility and market tendencies of alternate loan reference rates may not mirror LIBOR’s. What’s more, SOFR lacks abundant historical data for use in analyzing volatility and market tendencies, making accurate loan pricing more difficult.

Conclusion

The cessation of LIBOR brings challenges and opportunities that will require in-depth analysis and making difficult decisions. Financial institutions and consumers should heed the advice of regulators and start assessing their LIBOR risk now. Those that do will not only be better prepared―but also better positioned―to capitalize on the opportunities it presents.

Need help assessing your LIBOR risk and preparing to transition? Contact BerryDunn’s financial services specialists.

1 https://www.washingtonpost.com/business/2017/07/27/acdd411c-72bc-11e7-8c17-533c52b2f014_story.html?utm_term=.856137e72385
2 https://www.investopedia.com/terms/l/libor.asp
3 https://www.fdic.gov/regulations/examinations/supervisory/insights/siwin18/si-winter-2018.pdf
4 Thomson Reuters Checkpoint Newsstand April 10, 2019
5 https://www.reuters.com/article/us-usa-fed-libor/fed-urges-u-s-financial-industry-to-accelerate-libor-transition-idUSKCN1RM25T

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When one loan rate closes, another opens

In auditing, the concept of professional skepticism is ubiquitous. Just as a Jedi in Star Wars is constantly trying to hone his understanding of the “force”, an auditor is constantly crafting his or her ability to apply professional skepticism. It is professional skepticism that provides the foundation for decision-making when conducting an attestation engagement.

A brief definition

The professional standards define professional skepticism as “an attitude that includes a questioning mind, being alert to conditions that may indicate possible misstatement due to fraud or error, and a critical assessment of audit evidence.” Given this definition, one quickly realizes that professional skepticism can’t be easily measured. Nor is it something that is cultivated overnight. It is a skill developed over time and a skill that auditors should constantly build and refine.

Recently, the extent to which professional skepticism is being employed has gained a lot of criticism. Specifically, regulatory bodies argue that auditors are not skeptical enough in carrying out their duties. However, as noted in the white paper titled Scepticism: The Practitioners’ Take, published by the Institute of Chartered Accountants in England and Wales, simply asking for more skepticism is not a practical solution to this issue, nor is it necessarily always desirable. There is an inevitable tug of war between professional skepticism and audit efficiency. The more skeptical the auditor, typically, the more time it takes to complete the audit.

Why does it matter? Audit quality.

First and foremost, how your auditor applies professional skepticism to your audit directly impacts the quality of their service. Applying an appropriate level of professional skepticism enhances the likelihood the auditor will understand your industry, lines of business, business processes, and any nuances that make your company different from others, as it naturally causes the auditor to ask questions that may otherwise go unasked.

These questions not only help the auditor appropriately apply professional standards, but also help the auditor gain a deeper understanding of your business. This will enable the auditor to provide insights and value-added services an auditor who doesn’t apply the right degree of skepticism may never identify.

Therefore, as the white paper notes, audit committees, management, and investors should be asking “How hard do our auditors get pushed on fees, and what effect does that have on the quality of the audit?” If your auditor is overly concerned with completing the audit within a fixed time budget, professional skepticism and, ultimately, the quality of the audit, may suffer.

Applying skepticism internally

By its definition, professional skepticism is a concept that specifically applies to auditors, and is not on point when it comes to other audit stakeholders. This is because the definition implies that the individual applying professional skepticism is independent from the information he or she is analyzing. Other audit stakeholders, such as members of management or the board of directors, are naturally advocates for the organizations they manage and direct and therefore can’t be considered independent, whereas an auditor is required to remain independent.

However, rather than audit stakeholders applying professional skepticism as such, these other stakeholders should apply an impartial and diligent mindset to their work and the information they review. This allows the audit stakeholder to remain an advocate for his or her organization, while applying critical skills similar to those applied in the exercise of professional skepticism. This nuanced distinction is necessary to maintain the limited scope to which the definition of professional skepticism applies: the auditor.

Specific to the financial statement reporting function, these stakeholders should be assessing the financial statements and ask questions that can help prevent or detect flaws in the financial reporting process. For example, when considering significant estimates, management should ask: are we considering all relevant information? Are our estimates unbiased? Are there alternative accounting treatments we haven’t considered? Can we justify our selected accounting treatment? Essentially, management should start by asking itself: what questions would we expect our auditor to ask us?

It is also important to be critical of your own work, and never become complacent. This may be the most difficult type of skepticism to apply, as most of us do not like to have our work criticized. However, critically reviewing one’s own work, essentially as an informal first level of review, will allow you to take a step back and consider it from a different vantage point, which may in turn help detect errors otherwise left unnoticed. Essentially, you should both consider evidence that supports the initial conclusion and evidence that may be contradictory to that conclusion.

The discussion in auditing circles about professional skepticism and how to appropriately apply it continues. It is a challenging notion that’s difficult to adequately articulate. Although it receives a lot of attention in the audit profession, it is a concept that, slightly altered, can be of value to other audit stakeholders. Doing so will help you create a stronger relationship with your auditor and, ultimately, improve the quality of the financial reporting process—and resulting outcome.

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Professional skepticism and why it matters to audit stakeholders

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