How should you account for cash overdrafts (also called negative cash balances) on a balance sheet and in a cash flow statement?
It is year-end and your audit client has three bank accounts at the same bank. Two of the accounts have positive balances (the first with $50,000 and the second with $200,000). The third account has a negative cash balance of $400,000. Since a net overdraft of $150,000 exists, how should we present cash in the financial statements?
Cash Overdraft in Balance Sheet
In the balance sheet, show the negative cash balance as Cash Overdraft in the current liabilities. Or you can also include the amount in accounts payable.
If you are netting the three bank accounts, consider using the Cash Overdraft option. If you bury the overdraft in accounts payable, the financial statement reader may think, “there is a mistake, where is cash?” Using Cash Overdraft communicates more clearly. (The right of offset must exist in order to net bank accounts. The right of offset commonly exists for multiple bank accounts with one bank.)
Some companies have multiple bank accounts with multiple banking institutions. In such cases, the net balance of one bank might be positive and the net balance of the second bank might be negative. Then the company would reflect the positive balance as cash and the negative cash balance (of the second bank) as an overdraft.
Suppose a company has bank accounts with two different banks and the net balance of the first bank is $1,350,000 and the net balance of the second bank is an overdraft of $5,000. Then show cash as one amount on the balance sheet ($1,345,000). The $5,000 is not material.
Cash Overdraft in Cash Flow Statement
Some companies do not include overdrafts in the definition of cash; instead, they include it in accounts payable. Consequently, the company treats the overdraft as an operating activity (change in accounts payable). So, the company includes the negative cash as a change in a liability in the operating section of the cash flow statement. (Some accountants treat overdrafts as a financing activity, but they clear quickly. Therefore, an operating activity classification is more appropriate.)
Alternatively, include the negative cash in the definition of cash (rather than in accounts payable). In doing so, you combine the cash overdraft with other cash (that with positive balances) in the cash flow statement. The beginning and ending cash–in the cash flow statement–should include the negative cash amounts.
FASB ASC 230-10-45-4 requires that the total amounts of cash and cash equivalents in the cash flow statement agree with similarly titled line items or subtotals in the balance sheet. If negative cash is included in the definition of cash, the cash captions in the statement of cash flows should be revised accordingly (e.g., Cash (Cash Overdraft) at end of year).
If the balance sheet contains a positive cash balance in assets and a cash overdraft in liabilities, provide a reconciliation at the bottom of the cash flow statement (or in a disclosure). In the reconciliation, show the composition of the balance–one line titled Cash, one line titled Cash Overdraft, and a total line titled Total Cash (Cash Overdraft).
One Other Consideration
If checks are created but not released by year-end, reverse the payment. Merely printing checks does not relieve payables. Payables are relieved when payment is made (checks are printed and mailed, or electronic payments are processed).
Segregation of duties is key to reducing fraud. But smaller entities may not be able to do so. Today, I tell you how overcome this problem, regardless of the entity’s size.
The Environment of Fraud
Darkness is the environment of wrongdoing.
No one will see us. Or so we think.
Fraud occurs in darkness.
In J.R.R. Tolkien’s Hobbit stories,Sméagol, a young man murders another to possess a golden ring, beautiful in appearance but destructive in nature. The possession of the ring and Sméagol’s hiding of self and his precious (the ring) transforms him into a hideous creature–Gollum. I know of no better or graphic portrayal of how that which is alluring in the beginning, is destructive in the end.
Fraud opportunities have those same properties: they are alluring and harmful. And, yes, darkness is the environment where fraud happens.
What’s the solution? Transparency. It protects businesses, governments, and nonprofits.
But while we desire open and understandable processes, our businesses often have just a few employees that perform the accounting duties. And, many times, no one else understands how the system works.
It is desirable to divide accounting duties among various employees, so no one person controls the whole process. This division of responsibility creates transparency. How? By providing multiple eyes to see what’s going on.
But this segregation of duties is not always possible.
Lacking Segregation of Duties
Some people says here are three key duties that must always be separated under a good system of internal controls: (1) custody of assets, (2) record keeping or bookkeeping, and (3) authorization. I add a fourth: reconciliation. The normal recommendation for lack of segregation of duties is to separate these four accounting duties to different personnel. But many organizations are unable to do so, usually due to a limited number of employees.
Some small organizations believe they can’t overcome this problem. But is this true? I don’t think so.
Here’s two easy steps to create greater transparency and safety when the separation of accounting duties is not possible.
1. Bank Account Transparency
First, consider this simple control: Provide all bank statements to someone other than the bookkeeper. Allow this second person to receive the bank statements before the bookkeeper. While no silver bullet, it has power.
Persons who might receive the bank statementsfirst (before the bookkeeper) include the following:
A nonprofit board member
The mayor of a small city
The owner of a small business
The library director
A church leader
What is the receiver of the bank statements to do? Merely open the bank statements and review the contents for appropriateness (mainly cleared checks).
In many small entities, accounting processes are a mystery to board members or owners. Why? Only one person (the bookkeeper) understands the disbursement process, the recording of journal entries, billing and collections, and payroll.
Fraud decreases when the bookkeeper knows someone is watching. Suppose the bookkeeper desires to write a check to himself but realizes that a board member will see the cleared check. Is this a deterrent? You bet.
Don’t want to send the bank statements to a second person? Request that the bank provide read-only online access to the second person. And let the bookkeeper know.
Even the appearance of transparency creates (at least some) safety. Suppose the second person reviewer opens the bank statements (before providing them to the bookkeeper) and does nothing else. The perception of a review enhances safety. I am not recommending that the review not be performed. Butif the bookkeeper even thinks someone is watching, fraud will lessen.
When you audit cash, see if these types of controls are in place.
Now, let’s look at the second step to overcome a lack of segregation of duties. Surprise audits.
2. Surprise Audits
Another way to create small-entity transparency is to perform surprise audits. These reviews are not opinion audits (such as those issued by CPAs). They involve random inspections of various areas such as viewing all checks clearing the May bank statement. Such a review can be contracted out to a CPA. Or they can be performed by someone in the company. For example, a board member.
Additionally, adopt a written policy stating that the surprise inspections will occur once or twice a year.
The policy could be as simple as:
Twice a year a board member (or designee other than the bookkeeper) will inspect the accounting system and related documents. The scope and details of the inspection will be at the judgment of the board member (or designee). An inspection report will be provided to the board.
Why word the policy this way? You want to make the system general enough that the bookkeeper has no idea what will be examined but distinct enough that a regular review occurs.
Surprise Audit Ideas
Here are some surprise audit ideas:
Inspect all cleared checks that clear a particular month for appropriate payees and signatures and endorsements
Agree all receipts to the deposit slip for three different time periods
Review all journal entries made in a two week period and request an explanation for each
Inspect two bank reconciliations for appropriateness
Review one monthly budget to actual report (look for unusual variances)
Request a report of all new vendors added in the last six months and review for appropriateness
The reviewer may not perform all of the procedures and can perform just one. What is done is not as important as the fact that something is done. In other words, the primary purpose of the surprise audit is to make the bookkeeper think twice about whether he or she can steal and not get caught.
I will say it again. Having multiple people involved reduces the threat of fraud.
Segregation of Duties Summary
In summary, the beauty of these two procedures (bank account transparency and surprise audits) is they are straightforward and cheap to implement. Even so, they are powerful. So shine the light.
Today I provide an overview of how this standard affects nonprofit revenue recognition.
ASU 2018-08: Nonprofit Revenue Recognition
The purpose of the standard is to provide guidance in regard to recognizing revenues in nonprofit organizations. This standard is conceptually consistent with Topic 606, Revenue from Contracts with Customers, which requires revenue to be recognized when performance obligations are satisfied. ASU 2018-08 requires contribution revenue recognition when conditions are met (see below).
Once ASU 2018-08 becomes effective (years ending December 31, 2019 for many nonprofits), nonprofits will recognize revenues in one of three ways:
1. Exchange transaction
If a nonprofit is paid based on commensurate value, then there is an exchange transaction. The nonprofit recognizes revenue as it provides the service or goods. Apply Topic 606, Revenue from Contracts With Customers, for these transactions. An example of an exchange transaction is a nonprofit is paid market rate for painting a local store.
ASU 2018-08 makes it plain that benefits received by the public as a result of the assets transferred is not equivalent to commensurate value received by the resource provider.
2. Conditional Contribution
A conditional contribution is one where:
a barrier is present and
a right of return or right of release for the contributor exists
The following are indicators of a barrier:
Recipient must achieve a measurable, performance-related outcome (e.g., providing a specific level of service, creating an identified number of units of output, holding a specific event)
A stipulation limits the recipient’s discretion on the conduct of the activity (e.g., specific guidelines about incurring qualifying expenses)
A stipulation is related to the primary purpose of the agreement (e.g., must report on funded research)
Recognize revenue when the barrier is overcome.
An example of meeting a measurable outcome would be if the donor requires the serving of meals to 1,000 homeless persons. Another example of the first indicator above is a matching requirement.
An example of limited discretion would be a requirement to hire specific individuals to conduct an activity.
Are budgets an indicator of limited discretion? A line-item budget for a grant is often seen as a guardrail rather than a barrier. A June 2019 FASB Q&A states “Thus, stipulations other than adherence to a budget (for example, the need to incur qualifying expenses) would normally need to be present for a barrier to entitlement to exist.” The Q&A goes on to say, “The unique facts and circumstances of each grant agreement must be analyzed within the context of the indicators to conclude whether a barrier to entitlement exists.”
An example of a stipulation related to the primary purpose of the agreement is a grant that requires the filing of an annual report of funded research. If the grantor requires repayment of the amount received should the report not be filed, then the requirement is a barrier. Judgment is necessary to determine whether a requirement is a barrier. For example, filing routine reports to a resource provider showing progress on a funded activity may be seen as routine and not a barrier. Goals or budgets where no penalty is assessed if the organization fails to achieve them are not considered barriers.
Per ASU 2018-08 “Conditional contributions received are accounted for as a liability or are unrecognized initially, that is, until the barriers to entitlement are overcome, at which point the transaction is recognized as unconditional and classified as either net assets with restrictions or net assets without restrictions.”
3. Unconditional Contribution
If there are no barriers or if barriers have been overcome, the receipt is unconditional. There might still be a purpose or time restriction, resulting in the funds being classified as “With Donor Restrictions” until the restriction is satisfied. Recognize the revenue either as:
Net Assets with Donor Restriction
Net Assets without Donor Restriction
A public company or a not-for-profit organization that has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market would apply the new standard for transactions in which the entity serves as a resource recipient to annual reporting periods beginning after June 15, 2018, including interim periods within that annual period. Other organizations would apply the standard to annual reporting periods beginning after December 15, 2018, and interim periods within annual periods beginning after December 15, 2019.
A public company or a not-for-profit organization that has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the counter market would apply the new standard for transactions in which the entity serves as a resource provider to annual reporting periods beginning after December 15, 2018, including interim periods within that annual period. Other organizations would apply the standard to annual reporting periods beginning after December 15, 2019, and interim periods within annual periods beginning after December 15, 2020.
Early adoption of the amendments in this ASU is permitted.
ASU 2018-08 should be applied on a modified prospective basis. Retrospective application is permitted. Under a modified prospective basis, the amendments should be applied to agreements that are either:
Not completed as of the effective date
Entered into after the effective date
A completed agreement is an agreement for which all the revenue of a recipient or expenses of a resource provider have been recognized before the effective date of ASU 2018-08.
No prior-period results should be restated. There is no cumulative-effect adjustment to the opening balance of net assets at the beginning of the year of adoption.
In the year of adoption, the entity is required to disclose:
The nature of and reason for the accounting change
An explanation of the reasons for significant changes in each financial statement line item in the current annual or interim period resulting from applying the amendments instead of the previous guidance
Per ASU 2018-08, “Accounting for contributions is an issue primarily for not-for-profit (NFP) entities because contributions are a significant source of revenue for many of those entities. However, the amendments in this Update apply to all entities, including business entities, that receive or make contributions of cash and other assets, including promises to give within the scope of Subtopic 958-605 and contributions made within the scope of Subtopic 720-25, Other Expenses—Contributions Made.”
Are you ready to implement FASB’s new nonprofit accounting standard? Back in August 2016, FASB issued ASU 2016-14, Presentation of Financial Statements of Not-for-Profit Entities. In this article, I provide an overview of the standard and implementation tips.
New Nonprofit Accounting – Some Key Impacts
What are a few key impacts of the new standard?
Classes of net assets
Net assets released from “with donor restrictions”
Presentation of expenses
Intermediate measure of operations
Liquidity and availability of resources
Cash flow statement presentation
Classes of Net Assets
Presently nonprofits use three net asset classifications:
The new standard replaces the three classes with two:
Net assets with donor restrictions
Net assets without donor restrictions
These terms are defined as follows:
Net assets with donor restrictions – The part of net assets of a not-for-profit entity that is subject to donor-imposed restrictions (donors include other types of contributors, including makers of certain grants).
Net assets without donor restrictions – The part of net assets of a not-for-profit entity that is not subject to donor-imposed restrictions (donors include other types of contributors, including makers of certain grants).
Presentation and Disclosure
The totals of the two net asset classifications must be presented in the statement of financial position, and the amount of the change in the two classes must be displayed in the statement of activities (along with the change in total net assets). Nonprofits will continue to provide information about the nature and amounts of donor restrictions.
Additionally, the two net asset classes can be further disaggregated. For example, donor-restricted net assets can be broken down into (1) the amount maintained in perpetuity and (2) the amount expected to be spent over time or for a particular purpose.
Net assets without donor restrictions that are designated by the boardfor a specific use should be disclosed either on the face of the financial statements or in a footnote disclosure.
Sample Presentation of Net Assets
Here’s a sample presentation:
Without donor restrictions
Designated by Board for endowment
With donor restrictions
Perpetual in nature
Purchase of equipment
Total Net Assets
Net Assets Released from “With Donor Restrictions”
The nonprofit should disaggregate the net assets released from restrictions:
program restrictions satisfaction
time restrictions satisfaction
satisfaction of equipment acquisition restrictions
appropriation of donor endowment and subsequent satisfaction of any related donor restrictions
satisfaction of board-imposed restriction to fund pension liability
Here’s an example from ASU 2016-14:
Presentation of Expenses
Presently, nonprofits must present expenses by function. So, nonprofits must present the following (either on the face of the statements or in the notes):
The new standard requires the presentation of expenses by function and nature (for all nonprofits). Nonprofits must also provide the analysis of these expenses in one location. Potential locations include:
Face of the statement of activities
A separate statement (preceding the notes; not as a supplementary schedule)
Notes to the financial statements
I plan to add a separate statement (like the format below) titled Statement of Functional Expenses. (Nonprofits should consider whether their accounting system can generate expenses by function and by nature. Making this determination now could save you plenty of headaches at the end of the year.)
External and direct internal investment expenses are netted with investment income and should not be included in the expense analysis. Disclosure of the netted expenses is no longer required.
Example of Expense Analysis
Here’s an example of the analysis, reflecting each natural expense classification as a separate row and each functional expense classification as a separate column.
The nonprofit should also disclose how costs are allocated to the functions. For example:
Certain expenses are attributable to more than one program or supporting function. Depreciation is allocated based on a square-footage basis. Salaries, benefits, professional services, office expenses, information technology and insurance, are allocated based on estimates of time and effort.
Intermediate Measure of Operations
If the nonprofit provides a measure of operations on the face of the financial statements and the use of the term “operations” is not apparent, disclose the nature of the reported measure of operations or the items excluded from operations. For example:
Measure of Operations
Learning Disability’s operating revenue in excess of operating expenses includes all operating revenues and expenses that are an integral part of its programs and supporting activities and the assets released from donor restrictions to support operating expenditures. The measure of operations excludes net investment return in excess of amounts made available for operations.
Alternatively, provide the measure of operations on the face of the financial statements by including lines such as operating revenues and operating expenses in the statement of activities. Then the excess of revenues over expenses could be presented as the measure of operations.
Liquidity and Availability of Resources
FASB is shining the light on the nonprofit’s liquidity. Does the nonprofit have sufficient cash to meet its upcoming responsibilities?
Nonprofits should include disclosures regarding the liquidity and availability of resources. The purpose of the disclosures is to communicate whether the organization’s liquid available resources are sufficient to meet the cash needs for general expenditures for one year beyond the balance sheet date. The disclosure should be qualitative (providing information about how the nonprofit manages its liquid resources) and quantitative (communicating the availability of resources to meet the cash needs).
Sample Liquidity and Availability Disclosure
The FASB Codification provides the following example disclosure in 958-210-55-7:
NFP A has $395,000 of financial assets available within 1 year of the balance sheet date to meet cash needs for general expenditure consisting of cash of $75,000, contributions receivable of $20,000, and short-term investments of $300,000. None of the financial assets are subject to donor or other contractual restrictions that make them unavailable for general expenditure within one year of the balance sheet date. The contributions receivable are subject to implied time restrictions but are expected to be collected within one year.
NFP A has a goal to maintain financial assets, which consist of cash and short-term investments, on hand to meet 60 days of normal operating expenses, which are, on average, approximately $275,000. NFP A has a policy to structure its financial assets to be available as its general expenditures, liabilities, and other obligations come due. In addition, as part of its liquidity management, NFP A invests cash in excess of daily requirements in various short-term investments, including certificate of deposits and short-term treasury instruments. As more fully described in Note XX, NFP A also has committed lines of credit in the amount of $20,000, which it could draw upon in the event of an unanticipated liquidity need.
Alternatively, the nonprofit could present tables (see 958-210-55-8) to communicate the resources available to meet cash needs for general expenditures within one year of the balance sheet date.
Cash Flow Statement Presentation
A nonprofit can use the direct or indirect method to present its cash flow information. The reconciliation of changes in net assets to cash provided by (used in) operating activities is not required if the direct method is used.
You can early implement ASU 2016-18. (The effective date is for fiscal years beginning after December 15, 2018.) Once this standard is effective, you’ll include restricted cash in your definition of cash. The last line of the cash flow statement might read as follows: Cash, Cash Equivalents, and Restricted Cash.
Effective Date of ASU 2016-14
The effective date for 2016-14, Not-for-Profit Entities, is for fiscal periods beginning after December 15, 2017 (2018 calendar year-ends and 2019 fiscal year-ends). The standard can be early adopted.
For comparative statements, apply the standard retrospectively.
If presenting comparative financial statements, the standard does allow the nonprofit to omit the following information for any periods presented before the period of adoption:
Analysis of expenses by both natural classification and functional classification (the separate presentation of expenses by functional classification and expenses by natural classification is still required). Nonprofits that previously were required to present a statement of functional expenses do not have the option to omit this analysis; however, they may present the comparative period information in any of the formats permitted in ASU 2014-16, consistent with the presentation in the period of adoption.
Disclosures related to liquidity and availability of resources.