Greater scrutiny: nonprofit accounting and reporting. (Accounting).

Today's financial press is unfortunately filled with articles on business failures, restatements of financial data, and allegations of management improprieties and even outright fraud. On top of those problems is a downward-spiraling stock market that is said to be reeling from the lack of confidence in corporate financial information and that in turn worsens the doldrums in which the country's economy is currently mired.

Of course, it can be argued that this sour news has been blown out of proportion and that, while there may be some real bad apples to deal with, the health of American business -- and the related accounting and auditing -- is fundamentally sound. And the problems are largely in the commercial sector, after all -- not in the nonprofit arena.

Right?

Well, that may be true, but there are still important considerations for nonprofit organizations arising from the current environment. There are some big changes in the wind, and nonprofits are going to feel the impact.

New rule-making, enforcement?

It seems likely that there will be a federally mandated accounting "oversight" board created in the near future. What is less certain is how it will be structured and its powers.

The U.S. House of Representatives passed a bill in April, 2002 that would create a five-member board (none of whom would be accountants) that would set professional standards, bar certain types of business practices, and have the ability to discipline accountants. The U.S. Senate is working on its own version of a new law, that is generally considered to be a tougher version of the House's effort. And, the U.S. Securities and Exchange Commission has also developed a plan for how a new board should function. President Bush has weighed in with his thoughts as well, and the marketplace must bide its time until the lawmakers work out the necessary compromises.

Even though the various plans are clearly directed at publicly held, commercial enterprises, most observers believe that there will eventually be an overflow into the private-business and nonprofit worlds.

It is not expected that there will be a change in the basic nonprofit accounting and reporting set forth in the Financial Accounting Standards Board's (FASB) landmark pronouncements of the 1990s. But no one knows for certain what is in store for the FASB at this point, and it might not take too many highly publicized scandals among large nonprofits -- such as the problems at the Baptist Foundation of Arizona and the Foundation for New Era Philanthropy -- for the sights of a new oversight board to be fixed on any type of organization.

Certainly there isn't anything in the way the new board is being envisioned that excludes nonprofits from current or future consideration.

So what is a nonprofit to do? It seems that we are entering an era in which providing more meaningful financial information is going to be the watchword. Nonprofit entities should be looking at their current financial statements and asking themselves the question, "Are these statements telling the whole financial and accounting story of our organization, or are we just 'getting by'?"

For example, many nonprofits have business relationships with other entities, both for-profit and nonprofit. Many have circumstances that need to be closely evaluated as to whether their financial statements -- and those of other enterprises -- need to be consolidated. An undisclosed related party does not have to be "off-shore," a la Enron, to have significance.

Effect on auditing

Although accounting principles have been developed in recent years by the FASB (and, for governmental entities, by its sibling organization, the Governmental Accounting Standards Board), U.S. auditing standards have always been produced by the American Institute of Certified Public Accountants' internal Auditing Standards Board. There are also international bodies that produce accounting and auditing rules, and there is the expectation that at some point in the future accounting, auditing and financial reporting will be governed by a worldwide set of standards.

Once again, it in not entirely clear at this point whether a new oversight board would take over audit standard-setting entirely or would simply establish more rigid audit guidelines in certain areas while leaving the current promulgation framework in place.

Fraud, independence

Fraud. Concerns about financial fraud, regardless of whether it is the misappropriation of assets or the material misstatement of financial data, is obviously a driving force behind the plans for change.

Of course, nonprofit organizations do not have stockholders or, some might argue, the need to reach earnings projections at any cost. But a few nonprofits have nonetheless succumbed to the temptation to put a better (or worse) face on their financial information than has actually been the case.

Sometimes that has been the result of a misguided effort to devote more resources to a mission; sometimes it has been to mislead a donor or grantor as to how its funds are being used; and sometimes it has been for the personal enrichment of an officer or employee. Unhappily, commercial enterprises do not have the monopoly on greed or fiscal dishonesty.

Current generally accepted auditing standards (GAAS) that relate to fraud continue to make clear the decades-long position of the accounting profession that GAAS, as currently constituted, provide no guarantees that a material fraud in an organization will be discovered by the auditors. The marketplace has never really understood that concept, and we may be on the brink of what will amount to little less than a federal requirement that audits find fraud. However, it is one thing to demand that GAAS be constructed to find fraud, and it is quite another to formulate the in-depth examination procedures that will fulfill that mandate.

Thus, an enhanced auditors' responsibility to find fraud will most certainly mean a more in-depth analysis of financial statements and the underlying records, and with that will come a higher price-tag for audits. In the commercial world, some of that additional cost can be passed on to consumers through higher prices for goods and services. But for nonprofits, higher audit costs will simply mean higher non-program expenses and a very difficult argument to be made to funding sources that additional money is now needed to maintain the costs of their missions.

Independence. Auditors' independence from their clients is a fundamental element of the auditing process, although it has always been understood that independence in a GAAS sense includes the free-market concept that auditors negotiate their fees with, and are ultimately paid by, their clients.

In recent years, concern has also arisen, particularly among the Securities And Exchange Commission (SEC) and other regulators, that independence might be compromised if the auditing firms also performed non-audit, consulting services for their clients. Indeed, today's accounting firms are frequently capable of meeting a wide range of client needs, and it has not been unusual for one arm of a firm to provide outsourced accounting and/or internal-audit services for a client, while another arm conducted an audit of the client's financial statements.

It seems likely that in the near future a number of consulting arrangements previously constructed between accounting firms and their publicly held commercial clients will be prohibited, if the firms are also to be the auditors of those clients' financial statements. Again, it is not clear what that will mean for nonprofits, but it is likely that the governing boards of nonprofit entities -- many of whom come the for-profit marketplace will feel more comfortable extending the "no-consulting" rule to nonprofits.

In addition, for those nonprofits that receive federal funding, the General Accounting Office (GAO) has recently amended the independence rules of governmental auditing standards, as set forth in the well-known "Yellow Book," by establishing a comprehensive set of proscriptions for a variety of consulting tasks by the auditors of recipients of federal monies.

Those "non-audit" services that were completed prior to January 25, 2002, are not covered by the new rules. Also exempt are non-audit services that were performed under a contract between a nonprofit and an accounting firm that was entered into, or that were initiated by a government auditing entity, by June 30, 2002, so long as the work is completed by June 30, 2003. Persons with an interest in the specifics of these new rules should obtain the GAO's "Answers to Independence Standard Questions," published in July 2002.

Two of the best steps that a non profit can take to be certain that it is up-to-date with the changes in store, and what they will mean for the organization, is to be sure that its audit committee remains fully informed of the government's anticipated changes in the production and enforcement of accounting and auditing rules.

They must also know the interpretations that are sure to come and maintain an ongoing dialogue with its accounting/auditing firm.

If an organization does not have a fully functioning audit committee, it certainly should form one.

The changes ahead are going to require that nonprofits and their accounting firms be flexible, but it must be assumed that, in the end, the accounting, auditing and financial-reporting processes will be improved and the public's confidence in the resulting financial information will be enhanced.

D. Edward Martin, MBA, CPA, is the partner-in-charge of the Not-for-Profit Industry Group at the accounting and advisory firm of Eisner LLP in New York City. Julie L. Floch, CPA, is a partner and the director of Not-for-Profit Services at Eisner. Martin is an adjunct professor at Pace University and Baruch College/CUNY. Floch is an adjunct faculty member at Baruch College and the New School University and Is a former member of the now disbanded Not-for-Profit Committee of the American Institute of CPAs.