Thursday, July 21, 2011
What Is the Biggest Fraud Risk for Nonprofits?
Posted by Josh Nevarez
Did you know that according to a New York Times report, fraud and embezzlement in the nonprofit sector accounts for a loss of approximately $40 billion a year, or roughly 13 percent of all philanthropic giving?
In the world of financial fraud, there are two categories of fraud that all fraudulent activities fall into: misappropriation of assets and fraudulent financial reporting. Albeit fraudulent financial reporting remains a pertinent fraud risk, especially in the for-profit, publicly-traded company world, it is much less prevalent in the not-for-profit industry than risks and instances of misappropriation of assets. This can oftentimes be attributed to less effective internal controls and the overall control environments of most NPO’s that tend to operate with less resources and personnel than other industry organizations.
Although the laundry list of misappropriation of assets risks that NPO’s may be susceptible to is long enough to create an entire website of content, this article is intended to address the most significant of all those fraud risks. If polled, most NPO financial officers, as well as those charged with governance, would say that “cash” is the asset they are most concerned about when it comes to misappropriation of assets and that the most common areas of concern surrounding cash theft would come either from finance office personnel or from fundraising events where typically larger amounts of actual cash is being handled.
For the most part, those assumptions would be incorrect as the most significant fraud risk for all NPO’s resides in the Development/Advancement office and relates to misappropriation of checks made payable to the acronym of the not-for-profit organization. Because of the fact that Development/Advancement offices are tasked with raising millions of dollars a year in most organizations, there is a large amount of fundraising activity that lends itself to misappropriation of assets without the right internal controls in place.
Fundraising activities and the related tracking/accounting is very different than tracking and accounting for the operations of other organizations that sell widgets for provide services in that these revenue streams are derived from actual deliverables from the providing organization. If ABC Company sells a widget or provides a service, they bill the customer and record accounts receivable and revenue related to this reciprocal transaction. Fundraising activities on the other hand, unless tied to promises to give, are often times accomplished through annual solicitations for which no goods or services are being provided and therefore, the transaction is not reciprocal in nature. As a result, there is not a receivable recorded to the organizations books and records that facilitates the future tracking of collection of the receivable. Instead, the not-for-profit organization will only record a transaction for tracking and accounting purposes upon the receipt of cash or checks from donors.
Depending on the internal controls in place at the organization and how frequently checks made payable to the acronym of the organization are received, an organization may already be the unfortunate victim of substantial misappropriation of such donor dollars. Perpetrators within a Development/Advancement office that receive fundraising checks firsthand without restrictive endorsement of the checks and/or a cash receipts log that can be used during the bank reconciliation process to ensure completeness of all deposits of checks received, can easily take a check made payable to the acronym of the organization and cash them at a bank under a fictitious business bank account that carries the same acronym as the not-for-profit organization. By completing the donor acknowledgment and providing the NPO’s federal ID number for tax deduction purposes, the misappropriation often times goes undetected for years if not indefinitely.
This type of fraud is nearly impossible to detect because of the lack of tracking/accounting related to annual fund solicitations that never hit the organizations’ books. The only way to limit a NPO’s exposure to this weighty fraud risk is to ensure that live checks are never handled first by the Development/Advancement office. Organizations should have policies and procedures in place that require all live checks to be restrictively endorsed or tracked via cash receipts log before forwarding to Development/Advancement. Further strengthening of the controls around fundraising cash receipts would be to only forward copies of fundraising checks to Development/Advancement so that live checks can be deposited into the organization’s bank account as quickly as possible.
As you can imagine, the topic of fraud and how it relates to nonprofits extends beyond this post. To provide further insight into this topic, we invite you to attend our webinar,”Fraud – What Every Nonprofit Should Be Thinking About,” on August 11 by registering here: https://www2.gotomeeting.com/register/230360506
Josh graduated from St. Mary’s College in May of 1995 with a Bachelor of Science degree in Accounting. He joined Armanino in September of 1995 and became Partner in 2006. Josh is a CPA and a member of the American Institute of Certified Public Accountants, California Society of Certified Public Accountants and the National Business Officer’s Association (for private schools). Josh is the partner lead of the firm’s private school practice. He has been providing services to the nonprofit industry, and specifically, the private school industry his entire career. Josh is leading the firm’s geographic expansion of its private school practice into Southern California and other parts of the U.S. due in large part to the firm’s many value-added initiatives, including industry leading KPI and peer-to-peer benchmarking as well the development of the industry’s first license-based dashboard for private schools.