Not-for-profit Financial Statements and Financial Audit: “Friends of . . .” Organizations

Not-for-profit organizations may be registered in America and operate here in Eretz Yisrael. Sometimes these are referred to as “Friends of . . .” organizations. Not-for-profits registered in America traditionally include Shuls, Yeshivas, Jewish outreach organizations, and companies that assist individuals with the process of making Aliyah, among other organizations. Oftentimes, these types of organizations are required to file information returns both federally and in-state. These returns typically require an audit by a registered certified public accounting firm. The definition of a not-for-profit organization in America is a company that operates solely using donations rather than by selling goods or services. Another distinguishing quality of not-for-profits is that they don’t have individual owners like for-profit companies do.

When American not-for-profit organizations operating here in Israel are required to file with American tax authorities and to be audited by a registered CPA, the audit will be provided by a licensed CPA authorized to perform American audits. This financial audit assures that the
financial statements have been prepared by the client in accordance with the principles of accounting that are generally accepted in the United States. Here are some non-profit financial statement preparation guidelines from the standard-setting board, the Financial Standards Accounting Board. Understanding these rules will help you ensure that your financial statements are prepared correctly. That way, if you need a financial audit from us or any other firm, you can be confident that it will be a smooth and simple process, and that the auditor will be satisfied.

Financial statements for not-for-profit organizations can be presented in ways that are generally pleasing to the organization; however, certain governing rules must be honored and adhered to. Some of these are presented here. Sometimes “Friends of . . .” not-for-profits receive funds intended and designated to be paid out to some final individual or other not-for-profit organization. This is common with American organizations that have counterparts here in Eretz Yisrael. These “Friends of. . . “ organizations are deemed to have received agent, trustee, or intermediary contributions. These donations are not recorded as revenues but are offset only to show revenue as any administrative fee held by the receiving organization for transacting the donation. The “Friends of . . .” organization may either show just its administrative fee, or it may show the entire donated amount and offset it by “Less: amounts received to be distributed to specific organizations.” Either way, donations to “Friends of. . .” organizations intended for the final destination are not reported as revenues to the “Friends. . . of” organization but are reported as revenues by the organization that ultimately receives those funds.

In a more general sense, assets and liabilities must be grouped together in a logical manner that distinguishes their level of liquidity, and the ease with which they could be converted to cash and used to fulfill current financial obligations. One way to do this is through the provision of a classified statement of financial position. This is one that creates a separate, subtotaled portion for current versus fixed or long-term assets, also separating current and long-term liabilities with subtotals. The financial statements must also clearly distinguish between net assets that are restricted – where donors have put requirements on the cash or other assets they donated – and net assets
that are unrestricted, where donors gifted cash or any other valuable assets to the non-profit for the non-profit to use at their discretion. Any restriction must be clearly disclosed and adequately identified in the notes to the financial statements.

Some donations of valuables or cash may be designated by the donor not to be sold or that the asset is to be used in a certain way. For example, a Van Gogh painting or Steinway piano may be donated to a non-profit and designated by the donor never to be sold. Similarly, endowments are investment accounts that are donated so that the principal can never be used, only the interest and dividends from the endowment may be used by the non-profit. Therefore, these are restricted donations. There are also “term endowments” and “quasi-endowments” that a high-quality CPA will help you to deal with. Your financial statements must be prepared so that   all of these designated donations are clearly identified.

The income and expenses of the non-profit must also be logically classified and the statement of activities must show how they flow to the restricted or unrestricted net assets on the face of the statement of activities. It must be clearly shown to which class of net assets they flow: restricted or unrestricted. The financial statements should also include a separate statement of functional expenses, classifying expenses by nature and once again by function. For example, salaries expense is the expense’s classification by nature but may be a program cost by function. And travel expense is classified by its nature, but may also be a fundraising cost by function. This two-dimensional classification differentiates not-for-profit financial statements from the financial statements of for-profit businesses that many people prepare.

Some of your reported income items should not be included in this separate statement of functional expenses, and so these items are not classified by their function. Examples of items that are usually considered “comprehensive income”, include:

• Currency exchange adjustments,
• Certain currency exchange gains and losses,
• Gains and losses on hedges,
• Unrealized gains and adjustments on holding securities, and
• Certain impairment losses on debt.

These items do not show on the statement of activities as income with the organization’s
donations and program revenues.

A separate statement of activities for changes in net assets without any restrictions may be helpful. An expert accountant will prepare the statement of activities to clearly show all users of the information how the money is being received and then show that its uses are consistent with the organization’s purpose statement. Ultimately, the financial statements should support the
organization’s purpose by providing financial evidence certified by an auditor that the company is receiving money and spending it in accordance with its registered mission.

If segments of the organization are discontinued during the course of the year, the statement of activities must subtotal the change in net assets before the effects of the discontinued operations – and the bottom line should show the grand total after the effects of the
discontinued operations on the organization. This is true whether the net effect of discontinuing segments provides an overall net gain or an overall net loss to the organization for the period.

Fundraising expenses are carefully regulated and must be classified and disclosed separately from program expenses, management expenses, and general expenses. Some not-for-profits hire external organizations to market and raise funds, however, this spending must be carefully monitored and recorded. Special events may generate costs that are spent on potential or current donors attending the events or expenditures with the purpose of soliciting donations from the attendees at the event. These costs are properly netted from the revenues at the event, reducing income rather than being separately identified as an expense.

The level of detail with which a not-for-profit reports to the IRS and the figures on its financial statements for operating revenues is a matter of preference for the organization. The financial auditor will make a final determination in their opinion letter to declare whether or not the reports are a fair representation of the results of the organization’s operations in a manner that is consistent and in accordance with accounting principles generally accepted in the United States. Even though the not-for-profit does not pay taxes, it is liable for reporting to federal and state regulators in order to ensure compliance with all laws and regulations that it is subject to.
The IRS may not require a financial audit in all cases. The rules of financial reporting and audits of nonprofits are altered every few years so make sure to check in with us regarding your particular situation. You won’t regret it!