Topics: accounting methods fund accounting sample financial statements budgeting financial audits accounting software giving records records retention employee records & reporting tax exemption issues internal controls
The accrual basis of accounting must be followed if a church or Christian applies Generally Accepted Accounting Principles to its financial reporting practices. GAAP is rarely required of smaller churches. Most Christian organizations that have gained tax-exempt status under Internal Revenue Code section 501(c)(3) are required to file an annual report (Form 990) with the IRS that will likely require reporting following GAAP. The Cash Basis is the simplest to understand, especially to lay people and ministers in local churches. Receipts into organization cash accounts are reported as “in” and disbursements from these accounts are reported as “out.” The excess (or deficiency) of cash receipts over cash disbursements during the reporting period must equal the change in cash balances from the beginning to the end of that period of time. For ministries not required to follow GAAP but with a desire for more accurate reporting, I generally recommend a Modified form of Cash Basis. The method can be applied in several different forms based on the preferences of the ministry. However, as long as it is followed consistently from year to year, I believe it produces a good balance of accuracy and simplicity. Over the next few slides I will illustrate the differences using a Sample Local Church set of financial statements and supplemental reporting.
The accrual basis of accounting requires that revenues be recorded at the time they are earned regardless when the cash is eventually received from those paying for the products or services of an organization. Contributions received by churches and Christians ministries are generally recorded as revenues only once a cash or property gift is received. Typically, when revenues are recognized before cash receipts are collected Balance Sheet accounts called receivables reflect the amount of revenues earned but not yet received. The accrual basis requires that expenses be recorded at the time they are incurred as obligations even if payment is not made until a later time. Typically, when expenses are recorded before cash disbursements are made Balance Sheet accounts called accounts payable or accrued liabilities reflect the amount of expenses incurred but not yet paid. While not reflected in the balance sheet presented on this slide, technically, the portion of long-term debt that is due within the next year is classified as a current liability. Accrual (GAAP) balance sheets report all assets, liabilities and fund balances of the organization. Fund balances represent the excess of assets owned by the ministry over the liabilities owed . Churches and Christian ministries must also observe principles of Fund accounting which require the maintenances of separate fund balances depending on the nature of donor stipulations, either 1) with no restrictions or 2) with restrictions as to the use of the gifts. Fund Balances are segregated into following three categories. Unrestricted (also called the “General Fund”)—this portion of the Net Assets (Assets minus liabilities) is available for use by the organization as it sees fit Temporarily Restricted (also called the “Designated Fund”)—this portion of the Net Assets can only be spent as directed by donor designations Permanently Restricted (also called the “Endowment Fund”)—this portion of the Net Assets cannot be spent. (The example above reports that $48,000 of the $559,000 excess of assets over liabilities was Permanently Restricted.) Only earnings on these monies (presumably the $45,000 in marketable securities, plus $3,000 of the cash balance reported under “Assets.” can be spent and then only spent as originally directed by the donor(s)
Revenues and Expenditures are reported (in columns) based on their presence or absence of donor restrictions. As temporarily restricted funds are used in accordance with donor designations, they are “reclassified” as unrestricted donations (note the row for “released from restrictions”) and an identical amount of expenditures from these funds are combined with expenditures from the unrestricted fund. Unrestricted fund budget amounts (slide 10 discusses budgeting in greater detail) should be compared with amounts reported here only after eliminating the affect of this combination.
Supplemental information often accompanies GAAP financial statements, including a report of the total expenses per the Statement of Activities classified based on the functions fulfilled by various expenditures rather than the activities for which they were incurred. Independent auditors generally report on GAAP financial statements expecting additional detailed disclosures to accompany the financial statements.
Organizations using the cash basis record 1) revenues at the time they are received in cash form and 2) expenses at the time they are paid. On the Balance Sheet, only cash and highly liquid investments are recorded as assets. No liabilities are reported. Small ministries that find the cash basis suitable will rarely have received endowment gifts. Even extremely small ministries must maintain accounting of Designated Funds.
The Statement of Activities is replaced by a Report of Receipts & Disbursements. Disbursements are often classified based on their nature of use.
Additional disclosures of designated fund activity, mortgage status, and accounts payable are important supplementary information items.
The Modified Cash Basis adds current assets and current liabilities to the balance sheet reporting. But long-lived assets and long-term liabilities are not included. Budgeting on the strict cash basis can be complicated simply because a current year invoice could be unpaid before the accounting period expired and, thus, not be recorded as a disbursement in the current year. The modified cash basis permits inclusion of any unpaid, but incurred expenses to be reported along with all other amounts related to the reporting period.
While the report here is prepared for one year, interim reports should be prepared often to compare actual results to budget. I recommend the following columns be presented in partial-year reports: actual year-to-date receipts & disbursements, annual budget amounts, percent of actual to budget received or disbursed year-to-date. When GAAP is not used, some church congregations budget to “disburse” a portion of their funds from the unrestricted (General Fund) budget into Designated Fund accounts in order to set aside funds for future use for specific projects (e.g., a vehicle replacement fund). The supplementary information often provided by organizations using the modified cash basis is not significantly different than that which is appropriate for ministries using the cash basis.
Every church or Christian ministry will have a unique chart of accounts. This is one example for a local church using the Modified Cash Basis. Both revenues and expenditures related to Designated Funds are posted directly to fund balance accounts. Posting these transactions to General Fund revenue and expenditure accounts both distorts General Fund budget comparisons and fails to carryover unexpended designated gift balances from one year to the next.
Audits by CPAs are often appropriate for churches and Christian ministries, particularly larger ministries that desire to encourage contributions from a wide-range of sources (not just from the local members of a small church). Some organizations are required to engage independent auditors in order to comply with terms stipulated in loan agreements. Annual fees for these services range from perhaps as little as $2,000 to $25,000 and more. An internal “audit” may help to partially fill a need for accountability when the costs of annual audits are prohibitive. An internal inspection conducted by members of a local church is not an examination in accordance with Generally Accepted Auditing Standards used by Certified Public Accountants. The purpose of a church internal audit policy is three-fold.
Organization of the “audit” committee. The church [or designated group] appoints a minimum of two or more individuals to conduct an annual inspection of church financial records and reports. Each committee member should have a background that indicates God-given gifts in understanding financial concepts. The members should not be related to the church treasurer, financial secretary, pastoral staff, or anyone else with direct financial responsibilities at the church. The committee should conduct its inspection after the close of the church's fiscal year but before the time when the financial reports are to be presented in their final form to the church membership. The committee should elect its own Chair, who is responsible to lead the inspection, oversee preparation of the committee's report, resolve any conflicts, and retain custody of the committee's work papers, including annual inspection checklists. When a committee of internal “auditors” presents its report of its inspection, the following principles should be applied. Accompanying the financial reports to the church, the committee should report its findings. The report should not borrow language from audit opinion letters written by CPAs. Rather, the committee should list the procedures which it followed. The report should conclude with committee recommendations and comments, if any. If it is ever suspected that gross errors, intentional or not, have been made, church leaders not connected with the discovery should be advised and professional assistance should be sought.
The above list is illustrative only. Committee members must use their judgment to determine the most appropriate procedures to complete. Other inspection procedures: Determine compliance with offering count and expenditure authorization and disbursement procedures. Review prior years’ audit committees’ recommendations to the church leadership; compare with current practices. Reconcile payroll expenses reported on IRS filings to those reported in the financial statements. Test interest and principal payments on long-term debt for reasonableness given the unpaid balance and interest rate. Inquire regarding off-Balance Sheet liabilities. Inspect insurance policies to assure that assets are adequately protected. Reconcile investment income with summary reports from securities companies.
Peachtree Complete is only slightly more expensive than QuickBooks. It offers significantly better accounting controls. However, it is definitely less well-known among typical church members who may be asked to serve in volunteer accounting roles.
Other pertinent IRS Forms and Publications include: Form 8283, Noncash Charitable Contributions Publication 78, Cumulative List of Organizations (lists most organizations qualified to receive tax-deductible gifts) Publication 561, Determining the Value of Donated Property Software alternatives – Ministries use software to record and report contributions. There are many options including products offered at the following websites. http://www.fundraisersoftware.com/ (“Starting at less than $200 a month for a single user, with minimal startup fees, FundRaiser Online is affordable and scalable for any budget.”) http://www.memplushome.com/ (Membership PLUS Standard v11 MSRP $249.95 --one time purchase) Some online versions may be available for significantly less cost. Quid Pro Quo (f rom the Latin meaning "something for something") – donations for which donors receive a tangible benefit in return are not 100% deductible.
At the end of each year, many ministries store and label boxes of financial records with “Destroy” dates seven years later. This is a very basic presentation. More detailed disclosures can be found at sites such as the following. http://www.ecouncil.org/records&time.htm
The US Military has no superiority over the IRS when it comes to the volume of forms it requires. W-2 / W-3 Annual Wage and Tax Statement and transmittal form (W-3) due Jan 31 of following year W-4 / I-9 Forms required at time of employment (W-4 Employee's Withholding Allowance Certificate) (I-9 Employment Eligibility Verification) 1099-MISC Report of Miscellaneous Income. Most often required for non-employee compensation > $600 per year paid to evangelists and other speakers to whom checks are personally written (checks to missions agencies do not require issuance of Form 1099-MISC) 941 / 944 Quarterly Form 941 (or, for certainly small employers notified by the IRS, annual Form 944) is used to report and pay federal withholding taxes. State withholding forms may also be required. FUTA / SUTA Churches and most 501 (c)(3) organizations are exempt from federal unemployment tax act (FUTA) payments and similar state (SUTA) taxes.
According to IRS Publication 557, “an organization may qualify for exemption from federal income tax if it is organized and operated exclusively for one or more of the following purposes.” Of the eight purposes listed, the first is religious . The Publication continues: “To qualify, the organization must be a corporation, community chest, fund, or foundation. However, an individual or a partnership will not qualify.” It must file the 26-page Form 1023, pay a user fee (typically $850), submit copies of its Articles of Incorporation and Bylaws, and provide several additional documents listed on two pages following page 26 of the Form 1023. As required by the “Paperwork Reduction Act,” the IRS has estimated the average time to complete the application process; it is in excess of 15.4 hours. An estimated 174 hours are needed to complete “recordkeeping” and for “learning about the law and the form.” Fortunately, churches are not required to file Form 1023 to qualify for tax exemption (Publication 557). The definition of a church is a challenge for the IRS. It states in Publication 557, “because beliefs and practices vary so widely, there is no single definition of the word church for tax purposes. The IRS considers the facts and circumstances of each organization applying for church status.” Most non-church tax-exempt organizations are also required to file each year a laborious Form 990.
The leadership of a church or Christian organization is required to safeguard its assets. This includes securing adequate insurance against unreasonable risks of loss. Maintaining appropriate controls over the internal functions of the ministry also must be addressed. For churches, the primary cash receipt measure relates to the collection, counting, recording and depositing of offerings. Various procedures are followed by local churches, but one overriding principle must be observed: “At no time is uncounted money to be in the possession of only one person.” There are at least three purposes for church policies and procedures governing offering collections and counts. 1 st —sensibly designed procedures protect the integrity of all custodians of cash from unwarranted suspicion. 2 nd —these same procedures assure donors of the careful security, secrecy, and stewardship maintained relative to contributions. 3 rd —offering collection and count procedures are established to observe God’s instructions regarding accountability for church collections. The apostle Paul was very careful with money (I Corinthians 16:3,4). He was adamant that someone would go with him if he would deliver the offering from the church to the saints in Jerusalem. Again in chapter 8, verse 4 of his second letter to the Corinthians, Paul, speaking regarding the churches of Macedonia and their gift, says “praying us with much entreaty that we would receive the gift and take upon us the fellowship of the ministering to the saints.” Verses 16-24 of the same chapter reiterate Paul’s extreme care to “provide for the honest things, not only in the sight of the Lord, but also in the sight of men.” Other internal controls over cash receipts may also be necessary for many Christian organizations. These ministries should apply common business practices in these situations. Similar to internal controls over cash receipts, cash disbursement controls used by businesses are commonly application in ministry settings. Other controls should be established related to: bank accounts and reconciliations, compensation and benefit authorization, property, plant, and equipment inventories, corporate resolutions for authority to borrow, and many other categories
Church Christian Ministry Financial Management
Church and Christian Ministry Financial Management By Corey A. Pfaffe, CPA, PhD; Spring 2010
Sample Local ChurchDecember 31, 20xx Accrual (GAAP)AssetsCurrent Assets Cash $17,000 Marketable Securities, at market value Receivables 45,000 2,000 $64,000 Balance SheetProperty, Plant & Equipment Land & Buildings, at cost 1,250,000 Assets Furniture, Fixtures & Equipment, at cost 200,000 Less Accumulated Depreciation -350,000 1,100,000 Liabilities, current & long-Total Assets $1,164,000 termLiabilities & Fund Balances Fund Balances, unrestrictedCurrent Liabilities Accounts Payable Accrued Liabilities $12,000 8,000 & restricted Notes Payable 15,000 $35,000Long-term Debt Mortgage Payable 570,000Total Liabilities 605,000Fund Balances Unrestricted 476,000 Temporarily Restricted 35,000 Permanently Restricted 48,000 559,000Total Liabilitites & Fund Balances $1,164,000
Sample Local Church Accrued (GAAP)Year Ended December 31, 20xx Temporarily Permanently Unrestricted Restricted Restricted TotalRevenues Contributions $780,000 $70,000 $5,000 $855,000 Statement of Investment Gains and Losses Investment Income 6,000 4,000 6,000 4,000 Activity Auxiliary--Camp 32,000 32,000 Miscellaneous 4,000 4,000 Revenues & Released from Restrictions 55,000 -55,000 0 Expenditures areTotal Revenues 881,000 15,000 5,000 901,000 categorized inExpenditures Ministry columns based on Teaching & Preaching Music 456,000 52,000 456,000 52,000 donor restrictions. Youth 62,000 62,000 Ending Fund Occupancy 190,000 190,000 Auxiliary--Camp 35,000 35,000 Balances reported Interest 28,000 28,000 Miscellaneous 12,000 12,000 here must equalTotal Expenditures 835,000 0 0 835,000 Balance SheetIncrease (decrease) in Fund amounts.Balances 46,000 15,000 5,000 66,000 Expenditures areFund Balances, January 1, 20xx 430,000 20,000 43,000 493,000 reported by Activity.Fund Balances, December 31,20xx $476,000 $35,000 $48,000 $559,000
GAAP Supplementary Information: Functional ExpensesSample Local Church Expenditures that were reported byYear Ended December 31, 20xx Management Fund- Program & General Raising Total activity on theCompensationOffice Expenses $434,000 19,000 $89,000 22,000 $523,000 41,000 Statement ofDepreciation 12,000 39,000 51,000 Activities areUtilities 5,000 73,000 78,000 recategorizedRepairs & Maintenance 2,000 31,000 33,000 based on functionInterest 28,000 28,000Miscellaneous 13,000 68,000 81,000 (program, management &Total Expenditures $485,000 $350,000 $0 $835,000 general, or fund- raising) and nature.
Cash Basis Balance Sheet A portion of the cash andSample Local ChurchDecember 31, 20xx equivalent-to-cash resources was received from donors whoAssets designated the purposes for whichCurrent Assets Cash $17,000 they could be spent. At the end of Marketable Securities, at market value 45,000 December, $11,000 of these giftsTotal Assets $62,000 were yet to be disbursed for their restricted purposes.Fund Balances $51,000 could be spent for any General Fund $51,000 Designated Funds 11,000 purpose authorized by the church Endowment Funds 0 itself since the original donationsTotal Fund Balances $62,000 were unrestricted.
Cash Basis Report of Receipts & Disbursements (General Fund)Sample Local ChurchYear Ended December 31, 20xx Unrestricted contributions andReceipts other receipts exceeded Contributions $160,000 disbursements of these funds by Investment Income, Gains & Losses 4,000 Miscellaneous 2,000 $8,000 during the year endedTotal Revenues 166,000 December 31. Payments on long-term debt andDisbursements Compensation 68,000 expenditures for long-lived assets Occupancy 34,000 Mortgage Payments 22,000 (“Capital Expenditures”) are Capital Expenditures Office 12,000 19,000 reported as disbursements. Miscellaneous 3,000 This reporting format (and theTotal Expenditures 158,000 cash basis) is perhaps the easiestIncrease (decrease) in Fund Balance 8,000 to understand among the threeGeneral Fund Balance, January 1, 20xx 43,000 choices.General Fund Balance, December 31, 20xx $51,000
Cash Basis Supplementary InformationSample Local Church While cash basisSupplementary Information--Designated FundsYear Ended December 31, 20xx reports are easy to Missions Other Total understand, supplementaryDesignated Fund Balances, January 1, 20xx $4,000 $3,000 $7,000Receipts 18,000 3,000 21,000Disbursements -16,000 -1,000 -17,000 information shouldDesignated Fund Balances, December 31, 20xx $6,000 $5,000 $11,000 be provided.Sample Local ChurchSupplementary Information--Mortgage ActivityYear Ended December 31, 20xxMortgage Balance, January 1, 20xx $100,000Principal Payments $7,000 -7,000Interest Payments $5,000 n/aMortgage Balance, December 31, 20xx $93,000Accounts Payable Balance, December 31, 20xx $1,000
Modified Cash Basis Balance SheetSample Local ChurchDecember 31, 20xx The modified cash basis omits long-lived assets and long-termAssetsCurrent Assets debt from the balance sheet, Cash $17,000 but includes short-term Marketable Securities, at market value $45,000 Accounts Receivable 2,000 receivables and payables.Total Assets $64,000 This approach avoids budgeting challenges and otherLiabilities & Fund Balances Accounts Payable $1,000 shortcomings sometimes experienced when a strict cashFund Balances General Fund $51,000 basis is used. Designated Funds 11,000 Endowment Funds 1,000 63,000Total Fund Balances $64,000
Modified Cash Basis Report of Receipts & Disbursements (General Fund)Sample Local ChurchYear Ended December 31, 20xx Budgeted Favorable (Unfavorable) revenues are Actual Budget VariancesReceipts Contributions $160,000 $155,000 $5,000 “projected” while Investment Income Miscellaneous 4,000 2,000 5,000 1,000 -1,000 1,000 most budgetedTotal Revenues 166,000 161,000 5,000 disbursementsDisbursements are “authorized.” Compensation 68,000 67,000 -1,000 Occupancy 34,000 36,000 2,000 Variance analysis Mortgage Payments 22,000 22,000 0 Capital Expenditures Office 12,000 19,000 12,000 20,000 0 1,000 can also be made Miscellaneous 3,000 2,000 -1,000 based onTotal Expenditures 158,000 159,000 1,000 percentage ofIncrease (decrease) in Fund Balance 8,000 $2,000 $6,000 actual to budget.General Fund Balance, January 1, 20xx 43,000General Fund Balance, December 31, 20xx $51,000
Financial Audits Independent Certified Public Accountant audit Internal inspection—purposes: To provide accountability for church leaders and staff as stewards of the resources God has committed to the church To secure the confidence of the members in the reliability of the church financial reports To maintain credibility of the church as a self-policing organization
The “Audit” Committee Organization ReportingReport of Audit Committee Report of Audit CommitteeFor Year Ended December 31, 20xx For Year Ended December 31, 20xx We have inspected the financial reports and related supporting We have inspected the financial reports and related supportingrecords of the church for the year ended December 31, 20xx. The records of the church for the year ended December 31, 20xx. Thefollowing procedures were completed: following procedures were completed:……In the course of our inspection we identified severalIn the course of our inspection we identified severalrecommendations that have been communicated to the churchrecommendations that have been communicated to the churchleadership.leadership.
Inspection Procedures—Illustrated Compared budget amounts adopted by the church to actual receipts and disbursements for the year. Investigated major discrepancies and received satisfactory explanations. Traced all significant Balance Sheet amounts to appropriate supporting documents. Reconciled Fund Balances reported on the previous year’s Balance Sheet with current year increases and decreases in Fund Balances and current end-of-year Fund Balances. Traced a sample of receipts and disbursements reported on the Statement of Receipts and Disbursements to bookkeeping records. Evaluated adequacy of documentation.
Accounting Software for Churches and Christian Ministries QuickBooks—Online or Pro (or Peachtree Complete) Advantages: well-known (likely to find members who are familiar with its use); easy to use; relatively inexpensive Disadvantages: not a substitute for formal accounting training; poor internal controls; Not-for-profit version adds little value Shelby (or other church-specific softwares) (http://www.shelbyinc.com/) Advantages: specifically designed for church and ministry applications; valuable supplementary products available in donor and church management, etc. Disadvantages: more expensive & complex
Giving Records Ministries must carefully follow IRS guidelines when receiving cash and property gifts. IRS Publication 526 can be helpful. Software can be very helpful in recording and reporting donor activity. Annual reports to donors $250+ contributions must be specifically acknowledged (date and amount); otherwise, total contributions can be reported on annual statements to donors. Quid Pro Quo Disclosure: “The only benefit provided to the donor in return for his or her donation was an intangible religious benefit.”
Records Retention Most financial and employment records should be retained for up to seven years. A copy of each year’s annual report should be kept indefinitely. Minutes of official meetings should be kept indefinitely.
Tax-exempt Status The most recognized Internal Revenue Code section in the not-for-profit organization world: IRC 501 (c)(3) Benefits of tax-exempt status Ability to receive contributions that are tax-deductible to donors Elimination of taxes 1) on profits, 2) on real estate, 3) on purchases normally subject to sales taxes, and 4) on salaries and wages that normally require employer-paid unemployment taxes Application Form 1023 Annual information return Form 990
Internal Controls Cash receipts—“At no time is uncounted money to be in the possession of only one person.” Cash disbursements—Before a payment is made, a ministry must assure that the product or service was 1. purchased by an authorized individual following an authorized procedure, 2. received in a useable condition, 3. priced as previously agreed. Other controls
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