EDWARD McMILLAN, CPA, CAE

• Footnoting the statement of activity• Presenting cash prepared and accrual statements• The executive summary

NOT-FOR-PROFITBUDGETING ANDFINANCIALMANAGEMENTFOURTH ED IT ION

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BUDGETING MADE EASY FOR TODAY’S NONPROFIT

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With more and more nonprofi t employees responsible for the creation and management of the annual budget, it’s clear that

budgets must be well designed and easy to implement in order to accommodate the trend toward decentralizing decision-

making powers in nonprofi t organizations. Continuous budgeting, as explained in Not-for-Profi t Budgeting and Financial

Management, Fourth Edition offers a system that is not only easy to use and monitor, but also ensures true fi scal account-

ability in the complex nonprofi t arena.

This handy guide explains how to separate controllable, semi-controllable, and fixed expenses; take corrective actions

during the year to offset budget shortfalls; define the roles of the CEO, CFO, the staff, and volunteer leaders; establish

expense reduction plans before they are needed; and prepare and present such top-notch budget documents that bud-

gets will be approved the first time.

Written in a nontechnical, understandable, how-to language and format, the Fourth Edition incorporates dozens of relevant

forms and documents and covers:

• All new material on footnoting the statement of activity

• How to present cash prepared and accrual statements on the same page

• The importance of the executive summary

• How nonprofi ts can work toward liberating themselves from the year-to-year scramble

for increasingly scarce resources

Instead of being controlled by outdated, cumbersome, and inaccurate budgeting processes, nonprofi t managers need to be

able to effectively direct and responsibly control their resource allocation. Not-for-Profi t Budgeting and Financial Management,

Fourth Edition helps them get the job done and done right, with its powerful system of continuous budgeting, enabling not-for-

profi t professionals to meet their organization’s needs by creating and managing reasonable fi nancial plans—that work!

EDWARD MCMILLAN is a Certifi ed Public Accountant and Certifi ed Association Executive, and is a nationally recognized speaker

on not-for-profi t fi nancial and management topics since 1992 for the United States Chamber of Commerce, the American Society

of Association Executives, the American Institute of Certifi ed Public Accountants, the American Chamber of Commerce Executives

and the Destination Marketing Association International. He has written six books, including fi ve for Wiley, as well as Guide to Fringe

Benefi ts for Not-for-Profi t Organizations, Complying with SFAS #116 and #117, and The Audit: A Novel. He is also the author of

numerous articles appearing in such publications as Association Management, Leadership, and Dollars and Cents.

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NOT-FOR-PROFIT

BUDGETING FOR

NONPROFIT

ORGANIZATIONS

Fourth Edition

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NOT-FOR-PROFIT

BUDGETING FOR

NONPROFIT

ORGANIZATIONS

Fourth Edition

EDWARD J. MCMILLAN, CPA, CAE

John Wiley & Sons, Inc.

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Copyright © 2010 by John Wiley & Sons, Inc. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in prepar-

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particular purpose. No warranty may be created or extended by sales representatives or written sales materials.

The advice and strategies contained herein may not be suitable for your situation. You should consult with a

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Library of Congress Cataloging-in-Publication Data:

McMillan, Edward J., 1949-

Not-for-profit budgeting and financial management / Edward J. McMillan. — 2nd ed.

p. cm.

Includes index.

ISBN 978-0-470-57541-3 (pbk.)

1. Nonprofit organizations—Finance. 2. Nonprofit organizations—Accounting. 3. Corporations—Finance.

4. Corporations—Accounting. 5. Budget in business. I. Title.

HG4027.65.M364 2010

658.15'4—dc22

2010003131

ISBN-13 978-0-470-57541-3

Printed in the United States of America

10 9 8 7 6 5 4 3 2 1

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To my lovely wife, Nancy

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vii

About the Author

Edward J. McMillan, CPA, CAE, has spent his entire career in not-for-profit financialmanagement. He has served as the controller of the national office of the AssociatedBuilders and Contractors and as the finance and membership director of theAmerican Correctional Association. In 1993, McMillan was appointed faculty chairfor finance for the United States Chamber of Commerce’s Institutes for OrganizationManagement program.

McMillan has written several books on not-for-profit financial management. Hispublishers include the American Society of Association Executives, McGraw-Hill, theU.S. Chamber of Commerce, and the American Chamber of Commerce Executives.

McMillan now concentrates solely on speaking, writing, and consulting on finan-cial management topics for associations and chambers of commerce. He lives nearBaltimore, Maryland. In his free time, he enjoys coaching youth sports and motocrossracing. You may contact McMillan at P.O. Box 771, Forest Hill, MD 21050; phone/fax: (410) 893-2308; e-mail: emcmillan@sprintmail.com. Also see his Web site at www.nonprofitguru.com.

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ix

Contents

Preface xiii

Disclaimer xv

Chapter 1

Budgeting and Financial Operation 1

Chapter 2

Cash vs. Accrual Accounting 13

Chapter 3

Basic Accounting and Financial Operations 45

Chapter 4

Effective Use of Footnotes and Financial Ratio Calculations for the Statement

of Financial Position 51

Chapter 5

Controllable and Uncontrollable Expenses 57

Chapter 6

Controllable, Semi-Controllable, and Fixed Expenses 61

Chapter 7

Noncash Expenses 65

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Chapter 8

Effective Footnotes for the Statement of Activity 69

Chapter 9

Natural and Functional Statements of Activity 77

Chapter 10

Internal Financial Statements 81

Chapter 11

Converting Accrual-Method Financial Statements to Cash-Method

Financial Statements 89

Chapter 12

Budgeting Philosophy 99

Chapter 13

Continuous Budgeting System Overview 101

Chapter 14

The Executive and the Budget Process 105

Chapter 15

Executive Summary 109

Chapter 16

Comparative Financial Statements 113

Chapter 17

Expense Reduction Plans 117

Chapter 18

The Monthly Budgeting Process 121

Chapter 19

The Cash Flow Budget 135

Chapter 20

Getting the Budget Approved 139

x Contents

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Chapter 21

Suggested Format of Budget Documents for an Approving Body 141

Chapter 22

The Role of the Budget Coordinator 157

Chapter 23

Accounting and Budgeting for Fringe Benefits 161

Chapter 24

The Capital Budget and Depreciation 163

Chapter 25

Inventory Purchases and Calculation of Cost of Goods Sold 167

Chapter 26

Accounting and Budgeting for Dues 169

Chapter 27

Capital Assets: Lease-or-Buy Decisions 175

Chapter 28

The Long-Range Plan 177

Chapter 29

Financial Ratios 179

Chapter 30

Zero-Based Budgeting 183

Chapter 31

Putting It All Together 185

Glossary 203

Index 207

Contents xi

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xiii

Preface

Typically, not-for-profit organizations view the budget process as an annual exercisein drudgery, tying up valuable staff time that could be spent on other activities. Itdoesn’t have to be that way!

This handbook provides you with a new concept in budgeting that is easy toimplement and monitor, and that significantly reduces staff time spent on budgeting,while ensuring true fiscal accountability. The method is called continuous budgeting.

You should review this handbook in its entirety before you implement yourfinancial management system. The processes and forms herein are interdependentand must be understood by management before the advantages of this system canbe realized. This handbook is a guide to help managers customize the forms andprocedures described herein for use in their own organizations—it is not a referencemanual on taxes, depreciation, capitalization procedures, and other technical areas.There are other sources for that information. Here you will find a discussion andformat that is both nontechnical and understandable. The program that this hand-book teaches allows management to direct and control the organization, not becontrolled by an outdated, cumbersome, and often inaccurate budget and financialmanagement system.

Edward J. McMillan, CPA, CAE

June 2010

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xv

The contents of this book should not be construed as legal advice, and in that respectthe publisher and author assume no liability or responsibility accordingly.

Before implementation, the internal controls, accounting standards, policies, andforms suggested in this book should be reviewed by a competent attorney and inde-pendent CPA to assure compliance with federal, state, and local laws.

Disclaimer

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1

CHAPTER

Important Terminology and StandardsTO PREPARE A BUDGET THAT IS REASONABLE, accurate, and understandable, a workingknowledge of terminology and accounting standards is vital. The following listbriefly explains this terminology accordingly.

Terminology501(c)(3) Organizations

These kinds of not-for-profit organizations are typically organized for charitable,educational, scientific, or religious purposes.

Advantages:

➢ Charitable contributions are deductible on the tax returns of the donors

➢ Grant eligibility

➢ Favorable postal rates

➢ Exemption from Federal Unemployment Tax

➢ Employees can participate in 403(b) plans

➢ Often benefit from state programs such as exemption from sales taxes

Disadvantages:

➢ Severe restrictions regarding lobbying

➢ Lobbying for legislation must be “unsubstantial,” while lobbying regarding elections is prohibited

Budgeting and Financial Operation

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501(c)(6) Organizations

501(c)(6) organizations are typically organized for business purposes such as cham-bers of commerce and trade associations.

Advantages:

➢ Unlimited lobbying

Disadvantages:

➢ Contributions are not tax deductible

➢ Lack of grant eligibility

➢ Full postage rates

➢ Not exempted from federal unemployment tax

➢ Employees cannot participate in 403(b) plans

➢ Generally don’t benefit from state programs

Accounting Periods

Accounting periods for not-for-profit organizations include:

➢ Calendar year. When a not-for-profit organizations year begins on January 1 andends on December 31.

Fiscal year. Not-for-profit organizations that are not on a calendar year when theiraccounting year does not begin on January 1st and does not end on December 31st.

➢ Short period. A not-for-profit organization uses this accounting period because itstarted later than January 1 and changes its accounting year or terminates.

In the case of an accounting period change, the not-for-profit organizationmust file Form 3115.

Accounts Receivable

Monies owed to the organization are treated as an asset on the Statement of FinancialPosition. Most auditors feel that outstanding dues should not be accorded AccountsReceivable status as the dues outstanding rarely are legally binding. Most auditingCPAs feel that, unless there is a legal obligation to pay, the amounts should not belisted with Accounts Receivable.

Accounts Payable

Monies owed by the organization to other entities should be classified as AccountsPayable; that is, assuming the organization has a legal obligation to pay.

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Accumulated Depreciation

The journal entries crediting Accumulated Depreciation are cumulative, and overtime the cost of the asset less Accumulated Depreciation will result in a book valueequaling scrap value or zero.

American Institute of Certified Public Accountants (AICPA)

The AICPA is a professional association whose members are mainly CPAs.

Amortization

Amortization is similar to depreciation but typically applies to leasehold improve-ments or reduction of value of goodwill expenditures, such as copyrights purchasedand the like.

Typically leasehold improvements are amortized over the remaining time left inthe lease and nonfinancial assets are amortized over the shelf-life of the asset.

Board-Designated Funds

There is a lot of confusion concerning such accounts. While the Board of Directorscan allocate the use of funds for a specific purpose, these funds are subject to creditoraction. However, most accountants agree that properly recorded restricted funds areprotected. A term that should be avoided is a Board restricted fund because it impliesthe asset was contributed. Also, generally stated, the organization is usually power-less to remove the restriction(s) from a restricted transaction.

Building and Land

When an organization purchases real property, a distinction of the value of the build-ing and the land should be computed. The value of the building is capitalized as wellas the value of the land. Only the value of the building will be depreciated (typicallyover 30 years) and the value of the land will not be depreciated, the theory being thatthe land will always exist.

It is also important to note that the building must be presented at its historicalcost (plus improvements) on the Statement of Financial Position, even if it is increas-

ing in value.

Capitalization

Capitalization is treating a cash outlay as creating or increasing the value of an asseton the Statement of Financial Position rather than classifying the cash outlay as anexpense on the Statement of Activity.

Every not-for-profit organization should have a policy whereby purchases ofitems greater than the capitalization cut-off amount are capitalized and depreciated.

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Capitalization Cut-Off Point

This is the dollar amount under which a cash outlay will be treated as an expense andover which it will be treated as creating or enhancing the value of an asset.

Certified Public Accountant (CPA)

A designation granted to individuals who have met the education requirements,passed the CPA examination, and have followed the continuing education creditsrequirements.

Conflict of Interest Policy

A not-for-profit organization filing Form 990 is required to have a Conflict of InterestPolicy. A Conflict of Interest Policy must be imposed on officers, directors, and man-agers who are in a position to benefit financially due to a decision. See also Disquali-

fied Person and Intermediate Sanctions.

Convention Cancellation Insurance

It is very common for not-for-profit organizations to have a substantial financialinterest relating to their convention, festivals, and the like. If this is the case, contactyour insurance agent and request a Convention Cancellation Insurance application.Typically this insurance will make the organization whole in the event that a laborstrike, act of God, and the like affects the organization’s meeting.

Credits

A credit increases liabilities and decreases assets on the Statement of FinancialPosition.

A credit increases revenues and decreases expenses on the Statement of Activity.

Debits

A debit increases the value of assets and decreases liabilities on the Statement ofFinancial Position.

A debit increases expenses and reduces revenues on the Statement of Activity.

Deferred Compensation

Deferred compensation is compensation that has been earned or accrued that isdeferred to a later year.

Deferred Income

Deferred income is a liability account on the Statement of Financial Position. Itincludes monies that the organization receives for which it owes a future service.After the service has been provided, the amount will be taken out of deferred income

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and reclassified as a revenue on the Statement of Activity. Common examplesinclude dues and deposits received for exhibit booth deposits in advance.

Note: On first exposure, it may appear that amounts classified as deferred incomeshould be treated as an asset rather than a liability. However, the future cannot bepredicted and there is no guarantee that the event will take place. For example, whatif a fire resulted in canceling the event? Generally, the deposits from exhibitors wouldhave to be refunded, and that is why it is treated as a liability.

Depreciation

Reducing the value of an asset over time and according to established policy.For example, “an organization might utilize the Straight Line Method over the

following time periods:

Buildings 30 yearsFurniture 10 yearsElectronic Equip. 3 years

Typically depreciation is accounted for by a journal entry as follows:

Debit Depreciation ExpenseCredit Accumulated Depreciation

Please note that this is a hypothetical scenario.

Direct Expenses

Direct expense are expenses that can be allocated to a specific activity or project.For example, the purchase of a single computer that will be specifically used by

one activity or project would be a direct expense.

Disclosure of Information Policies

This is a not-for-profit organization’s policy on what federal and state forms are openfor inspection by the general public, members, or contributors.

Disqualified Person

A disqualified person is any person in a position to exercise substantial influenceover the affairs of the not-for-profit organization. See also Intermediate Sanctions.

Dues

There is a disagreement among accountants whether or not uncollected dues qualifyas accounts receivable, as there is rarely a legal obligation for the member to pay. It hasbeen the author’s experience that recording outstanding dues as accounts receivable

Budgeting and Financial Operation 5

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is the most common reason not-for-profit organizations experience financial difficul-ties. It is the author’s suggestion not to classify outstanding dues among legitimateaccounts receivable but rather detail this amount on the Executive Summary.

Excess Benefit Transactions

See Disqualified Person and Intermediate Sanctions.

Executive Summary

An Executive Summary is a written explanation accompanying the internal financialstatements that explains items in the statements that a reader could not pull out ofthe numbers. For example, consider a dollar amount for rent in the financial state-ments. This may be explained in the Executive Summary as to how much square feetis leased, the current rent per square feet, lease escalation clauses, and maturity date.

Form 990

Form 990 is an information IRS filing. It is open to public inspection.

Form 990-EZ

Form 990-EZ is a shortened version of the Form 990 that is suitable for smaller not-for-profit-organizations. It is also open to public inspection.

Form 990-N

Form 990-N is an electronic information IRS filing for very small not-for-profit orga-nizations that do not regularly have gross receipts over $25,000.

Form 990-PF

Form 990-PF is an information return filed by private foundations.

Form 990 Schedules

There are 16 possible schedules (Schedules A thru O) that may be required to fileForm 990. However, only Schedules A, B, C, E, G, L, and N apply to Form 990-EZ.

Form 990-T

This is required to report an unrelated business income tax (UBIT) that must be filedif the not-for-profit organization has $1,000 or more from an unrelated source, even ifit resulted in a loss.

Form 5500

Form 5500 is an Annual Return/Report of Employee Benefit Plan. An organization’spension, deferred compensation, or profit sharing must be listed.

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