Financial Process Recommendations to obtain GAAP and other Regulatory Compliance

December 2018 | Laura Nakoneczny, CAE, IOM

This project has been undertaken in response to observed deficiencies in the current financial operations of IEA. The proposals here outline what is needed to create essential policies and procedures, tidy up financial reporting, and provide a strong and auditable financial framework that facilitates proper organizational transparency, provides substantive financial reporting, and assists the Council in its decision-making processes. 

The recommendations here are based on a lengthy examination of IEA’s financial processes in comparison to guidelines published in its Handbook, Internal Revenue Service (IRS) requirements, GAAP standards, and association best practices.  

It has become clear over the course of this examination that IEA traditions and cultural norms probably contribute to some of the practices that have been observed. Consequently, resolving these challenges will take more than mere approvals of new processes. Retraining, and educating volunteers on the new financial processes will be required. 

Why Develop Organizational Financial Policies based on Association Management Best Practices and What is GAAP? 

All nonprofits must practice sound financial management and comply with a diverse array of legal and regulatory requirements.  In the case of a global organization, like IEA, the challenges are further compounded by regional regulations and cultural differences.  

Transparency and accountability are the primary goals of any organization’s financial practices. At minimum, accurate financial records with appropriate documentation should be kept as evidence that the organization's financial resources are used in furtherance of the organization's purposes.

A review of IEA’s financial procedures conducted in 2015 by Joyce and Company, CPA, and conducted in accordance with attestation standards established by the America Institute of Certified Public Accountants (AICPA), determined several deficiencies in IEA’s financial processes.

A further review of IEA financial processes by staff at FirstPoint Management Resources, first in 2015/2016 and again in early 2018, determined additional deficiencies, and little correction of the previously identified challenges. Collectively, these deficits place IEA outside the bounds of proper financial accounting; consequently, an audit cannot be completed until corrections are made.

FirstPoint offered IEA several suggestions for GAAP compliance in 2015/2016 and added them to the recommendations from the external auditor; there’s no evidence that any of the recommendations were ever implemented. 

I would like to explore any reason that these recommendations would not have been carried out. Some reasons could have been internal opposition or lack of board consensus, a cultural barrier that may have been created as a result of policy changes, or a sudden change in priorities. Please make me aware of any of these conditions that may still exist and cause delays in the implementation of these recommended best practices. 

Naturally, there will be some short-term frustrations for volunteers as IEA moves into full GAAP compliance. The bulk of these unfortunately, will happen at the regional level which is the organization’s front line. 

However, in my experience the implementation of full GAAP compliance is very important. Beyond the knowledge that you’re operating IEA as it should be and are compliant with organizational best practices, it opens doors for grant funding and other opportunities that can certainly benefit the organization. These recommendations are structured to position IEA for more “wins” ahead, despite the temporary set-backs that may ensue. 

Consequently, I encourage the IEA Executive Committee to devote time and attention as necessary to develop GAAP compliant financial policies and practices. Although FirstPoint can aid in the recommendation and administration of these policies, ultimately, the decisions must be “owned” by the IEA Council which is ultimately responsible for the financial state of the organization. 

As trustees of the organization’s assets and stewards of IEA members’ trust, Council best practices would include: 

  • Exercising good decision‐making, without exposing IEA to unnecessary risk;
  • Understanding financial basics and terminology;
  • Reading financial statements, judging soundness, recognizing warning signs;
  • Establishing and monitoring key financial indicators;
  • Agreeing on general guidelines and standards to measure effectiveness and ensure consistency in decisions;
  • Ensuring adequate control mechanisms are in place (this could be via delegation to a management firm or others with suitable skills, knowledge or experience to oversee the programmatic, financial and tax needs of the organization);
  • Managing potential conflicts of interest; and
  • Developing and approving budgets and comparing actual figures to projected ones. 

It is my goal always to ensure that IEA has a healthy and stable financial grounding for its work; one that will ensure growth and programmatic successes in the future.  However, as always, I work at your behest, so your approvals are required.

A Little More Information About GAAP

GAAP is a collection of commonly-followed accounting rules and standards for financial reporting. The acronym is pronounced "gap."  The Financial Accounting Standards Board in the US recognizes GAAP accounting as the most appropriate tool for communication nonprofit financial information.

GAAP specifications include definitions of concepts and principles, as well as industry-specific rules. The purpose of GAAP is to ensure that financial reporting is transparent and consistent from one organization to another.  In the United States, the Securities and Exchange Commission (SEC) mandates that financial reports for nonprofits adhere to GAAP requirements. The Financial Accounting Standards Board (FASB) stipulates GAAP overall.

The decisions and recommendations in this report, once finalized and adopted, will help ensure IEA is on the correct path to GAAP-compliant financial processes and is following best practices concerning governance and management.


Decision One: Determination of an Appropriate Tax Exempt Charitable Status

IEA is a nonprofit 501(c) 3 organization. Organizations described in section 501(c) 3 are commonly referred to as charitable organizations by the US Internal Revenue Service. Organizations operating as 501(c) 3 nonprofits must derive one third of their revenue from “public support” (e.g. membership dues).

Since 2013, the IEA’s Form 990 Schedule A indicates that the public support test for IEA’s 501(c) 3 status is not being met. Charitable organizations that do not meet the public support test are deemed to be private foundations.  

Unlike public charities, private foundations typically receive the bulk of their income from investments and endowments and there are strict restrictions on the use of those funds to benefit contributors. For instance, as a private foundation, IEA would be barred from supporting regional member activities as it does now; instead, it would be mandated to contribute its investment income to other 501(c) 3 charities that further its purposes.  As private foundations are not tax exempt, IEA would also pay taxes. There are also different, more rigid protocols for recognizing donors (e.g. members) that would need to be followed. 

Although some of the revenue derived from the International Journal of Epidemiology can be reallocated to demonstrate “public support” toward maintaining IEA’s 501(c) 3 tax status, the bottom line is that the subscription revenue derived from non-member readers of IJE combined with membership dues revenue will still fall short of where the organization needs to be in demonstrating “public support” for quite some time. There are two recommendations. 

  1. Seek qualification of IEA as a 501(c) 6 trade association. This would require formal board approval, a modification of your bylaws, constitution and Handbook, and submission of Form 1024 Application of Recognition of Exemption Under Section 501 (a) for Determination Under Section 120 of the Internal Revenue Code. There would also be some necessary user fees for this filing.

  2. On a more strategic level, the organization needs to commit to strengthening its membership levels. Membership has clearly been declining in recent years, and the revenue associated with memberships has been impacted with recent, lower pricing models. This would be a more long-range plan than immediate correction, but it should be undertaken regardless of the tax status decision.  

This discussion was closed February 28, 2019. We do not need to change IEA’s tax status.  After consultation with a tax attorney it was determined that the “public support” calculation for 501c(3) organizations is now based on a 5-year test rather than annualized data. The numerator in this calculation is dues + contributions. The denominator is the sum of the numerator + investment gains. Program revenue is irrelevant to the calculation. Applying the 5-year test to IEA puts the organization at +/- 64 percent in terms of public support.; safely above the 33.3 percent “threshold” needed to remain a 501c(3).

IEA will need to monitor 2020 revenue as that will be the first year in the “5 year lookback” that the large amount of revenue generated in 2015 from contributions + membership fees will drop off the calculation. Should IEA drop under the 33.3 percent threshold in 2020 we have the option of filing an explanatory document detailing reasons why contributions were lower than the norm. However, as we plan a membership growth campaign in 2019, I’m confident we won’t need to do that. We only need to look at a change if we fall below 10 percent for a few years in a row at which point we’ll surely fail the 5-year lookback test. 

Beyond that there remains a question on the taxability of the journal. Any revenues from conferences or the journal – even royalties – can be defended as non-taxable because the sale of registrations and the journal are open to the public, and because they are academic in nature.


Decision Two: Approval of Changes to IEA’s Regional Financial Processes 

By far, the most significant changes that need to be made to IEA’s financial processes to gain GAAP compliance will happen at the regional level. 

Current regional practices do not align with those stated within the IEA Handbook (2015), recommendations made by auditors in 2015, GAAP processes in general, and the U.S. Internal Revenue Service as described below.  Although I’m guessing these practices are based on organizational tradition, they don’t render the organization as transparent as it should be in terms of its financial reporting. 

The following few paragraphs contain some of the reasoning for the recommended changes 

The Handbook. The IEA Handbook offers guidance and provisions that include the submission of work plans by regional Councilors for review and approval by the Executive Committee. It also offers travel guidelines, and expense reimbursement guidelines. These provisions are often not met or followed.  

Auditors and GAAP. As it appears that regional activities are conducted for the benefit of association members, regions are not separate from the Association and any funding provided or received from these activities – including regional meetings – should be accounted for using GAAP principles.  In other words, each region is part of IEA, and not a separate legal entity.

Proper recording of transactions related to regional activities would include assets owned (e.g. property) and liabilities owed at fiscal year-end, as well as proper recording of associated revenues and expenses. However, asking each region to undertake this would create an undue burden, and I suspect great confusion and unease. 

As an alternative, policies and practice decisions need to be made by Council regarding what are allowable and unallowable regional expenses. General recommendations are provided here that would allow the regions to function appropriately, but within a more compliant financial framework. Still, it is Council’s decision what the actual practice should be. 

IRS. As noted earlier, IEA was granted a charitable status 501(c) (3) in 1967, which imposes strict rules by the Internal Revenue Service (IRS).  By the IRS definition, to be tax-exempt under section 501(c)(3) of the Internal Revenue Code, an organization must be organized and operated exclusively for exempt purposes set forth in section 501(c)(3), and none of its earnings may inure to any private shareholder or individual.  

As a penalty, if the organization engages in an excess benefit transaction with a person having substantial influence over the organization (e.g. a regional councilor), an excise tax may be imposed on the person and any organization managers agreeing to the transaction

Noncompliance can lead to the IRS imposing monetary penalties, excise taxes, and even revoking the nonprofit's tax exemption, in extreme cases. Excise taxes may also be imposed on directors, officers, employees, and others who participated in improper activity through the nonprofit organization.  

In testing whether or not IEA earnings are benefitting individuals, IEA fails at the regional level.  The recommendations here meet the test of what constitutes appropriate reimbursement to regional officers in manner that avoids the current questions of whether IEA funds are benefiting individual members. 

With the Handbook, previous recommendations, GAAP compliance and IRS regulations in mind, FPMR makes the following recommendations for IEA’s consideration. 

Regional Reimbursement Requests. The following policy recommendations apply to requests for the USD $5,000 funded annually to support each region. 

  1. The values of universality, decentralization and volunteerism should be applied to all decisions regarding requests for IEA reimbursement; most especially, volunteerism. As these values are stated in the Handbook and elsewhere, it is reasonable for the Executive Committee to question the need to pay for services that can be handled voluntarily. Ideally, Council will approve a statement to this effect, and provide examples of what activities should/could be done by volunteers. 
      
  2. Expenses eligible and ineligible for reimbursement will be established and agreed to by the IEA Executive Committee. Expenses that are eligible for reimbursement may include: website hosting and design fees; pre-approved regional travel; entertainment expenses (when the parties involved are named); printing of notecards, copies or other routine business items; and secretarial services (see more on this below). This list is not complete as these are examples and not an exhaustive list. A final determination of what is reimbursable will be based on Executive Committee guidelines and IRS rules and be made available to members.
      

    Expenses that are not eligible for reimbursement might include: office equipment or other assets that would require recording as physical assets; services that can be interpreted as personal in nature (e.g. cell phone service, internet services or other subscriptions); and travel that exceeds the guidelines set forth in this document. (These are examples not an exhaustive list). A final determination of what is not eligible for reimbursement will be based on Executive Committee guidelines and IRS rules and be made available to members.

  3. Financial support for annual budget allocations related to regional operations (e.g.$5,000) must be disbursed in the appropriate period; they cannot be obtained in advance, or in anticipation of future expenses. They also cannot be obtained in arrears.  

    Under GAAP, funding allocations must be limited to the year in which they have been budgeted to protect the overall programmatic health of the association during each fiscal year. They also need to be attached to an annual program of work per the IEA Handbook.

  4. Bundling of annual allocations, or multiple years of allocations, to accommodate large expenses is disallowed. For instance, increasing budgeted conference allocations with funds reserved for regional support or workshops. This process is often suggested and used by regional councilors experiencing financial challenges. It is not considered a viable solution under GAAP.That said, with sufficient notice, budgets can always be reworked and reapproved to accommodate the unforeseen needs of a region. This policy would therefore not prevent the association from addressing the challenges of a region in need, merely specific a better means for doing it. 

  5. All expenses requiring reimbursement must be submitted to IEA Headquarters within 30 days of receipt to allow for proper recording of revenues and expenses each month. All reimbursements must be recorded in the appropriate year. (For instance, 2017 expenses will not be reimbursed in 2018, with the notable exception of January requests.)  The ability of FirstPoint to provide IEA with accurate financial statements is dependent on the timely receipt of information regarding expenses. If expenses are not attached to the month and year in which they occurred, there are unknown liabilities that exists for IEA that may impact service capabilities.


    For instance, let's assume a regional councilor requested reimbursement for two full years of expenses; these expenses are not tied to the appropriate budget or tax year and consequently represent a challenge to IEA’s current financial position and ability to support other activities.

  6. Reimbursements for regional expenses will only be approved following the Executive Committee’s approval of a detailed annual workplan for each region that includes budget details. All requests for reimbursement must be connected to the completion of the plan, and updates on the plan are required at the time reimbursement request is filed. Taken from the Handbook, this requirement will help provide the needed documentation that IEA funds are being correctly used to support the organization’s mission. By tying the receipt and invoices to the work plans, the Executive Committee will gain a better understanding of what progress is being made in each region, and a better sense of what funding may be required to advance the organization’s mission. It will also meet IRS requirements.

  7. Reimbursement for secretarial support will be paid based on invoices for services already performed per each regional plan. A job description for each secretary must be filed with the Headquarters office in order to make a determination regarding the reasonableness of the rates paid for these services (this is an audit requirement).  Because secretarial services are considered taxable compensation, a 1099 must be completed for any US citizens receiving more than $600; this amount will be reported to the IRS as taxable income. For residents outside the US, a W-8Ben will be required. Monies paid under a W-8Ben form are taxable by the US at a 30 percent rate.
      

    There is little in terms of regulation that suggests a cap on these expenses, however, regional councilors should consider the impact these costs have on their annual $5,000 budget and the principle of volunteerism should be applied. This is also a question the Executive Committee should consider in terms of their desire for these costs to be incurred. (Note: In September 2020 the Executive Committee determined a cap of $1,000 on administrative support.)

  8. Out of pocket airfare and other pre-approved travel expenses will be reimbursed for economy class travel only. In those cases where a personal vehicle is used for travel, mileage records shall be submitted and will be reimbursed according to the current rate published by the IRS. Out of pocket housing expenses for Council meetings and Congresses will be paid only at the group rate in the host hotel.
      

    IEA has long accepted petrol station receipts as a reimbursable expense. This practice falls outside acceptable guidelines, however, as it cannot be determined that the entire charge isn’t simply a “benefit” to the recipient.  The housing clause enables application of “fair to all” policy; this has not been enforced, so some individuals receive more in terms of “compensation” than others.

  9. All requests for reimbursement must be uploaded on the form located on the IEA website. 

  10. Reimbursement funds will only be sent to requestors or to the bank account of a regional office. Payments will not be sent to intermediary parties, such as family. Use of a bank that accepts payment in USD can help facilitate prompt payments of reimbursement requests. There have been instances where funds were transferred to family members or friends of members prior to 2018. This practice can be construed as money laundering by regulatory agencies.

 

Regional Requests for Advance Funding. These recommendations apply to regional requests for congress support or regional workshops: 

  1. Requests for funding in advance of an event/activity must be supported by an itemized budget for that event/activity with estimated costs for accommodation, travel, salaries, and all other expenses. This will need to be submitted to the office for review and approval by the IEA Executive Committee at least 4 months before the planned activity. 
      

    A template for requesting advance funds and providing a detailed budget will be made available on the IEA website to meet this need. 

  2. Whenever possible, funds for a congress or regional workshop should be sent to an organizing partner (e.g. another association, a university, a bank account established for the event) and not directly to the regional councilor. An invoice for these expenses on a partner’s letterhead is the most effective means of requesting these funds.

  3. In cases where funding is requested in advance, a report detailing the activities/events and how IEA funding was used to support this activity/event must be submitted to the IEA office within 60 days of its completion. Whenever possible, receipts for expenditures supported by IEA, or invoices for good received should be sent to the IEA office with this report.

Decision Three: Recommendations Regarding General Processes, Budgets and Financial Statements 

  1. Currently, staff requests approval from the Treasurer for every expense, and involves the President when the request has an issue or question involved. I would recommend that practice be documented as policy.

  2. Any expense request exceeding USD $2,500 currently requires the approval of the Executive Committee. I would recommend that the Handbook be changed to allow for approvals from the President and Treasurer if the assembly of the Executive Committee is not feasible, with concurrence to follow during the next regularly scheduled meeting.

  3. A three-year budget will be created following each World Congress of Epidemiology for the following three fiscal years. Preparation of the budget shall be done by the Treasurer with delegation/assistance of staff. The final budget will require the approval of CouncilTo the extent feasible at the time of budgeting, expenses will be allocated in the fiscal year in which they are expected to occur.   
  4. The budget shall be a “living” document so that changes in the timing of events, or expected activities, can be accommodated. In these events, the Treasurer will propose a modified budget for the approval of Council.
  5. Staff will review the budget with the IEA Treasurer annually to ensure understanding and accuracy on both sides.
  6. Following approval of the budget by the Executive Committee, staff will develop an appropriate chart of accounts for the triennium and provide the Treasurer and other Executive Committee members with monthly financial statements detailing expenses against current year’s budget and gains/losses on the investment accounts.
  7. New councilors will receive training on the mechanics of the reimbursement/budgetary processes and other aspects of IEA financial policies and processes relevant to their position in the organization. This training will be provided by FirstPoint Management Resources in conjunction with full Council meetings.

 


Decision Four: Recommendations Regarding World Congress of Epidemiology Funding

  1. The draft contract for Melbourne shall be standardized and incorporated into the Handbook as the model for financial responsibilities between parties.

  2. Requests for loan funding will be made by the organizing committee following the processes used for advance funding requests and will be tied to a detailed program of work that substantiates detail.

  3. Should the loan be repaid by the organizing committee, documentation will be drawn up to support the deposit from the organizing committee. This documentation can take the form of letters, emails, invoices or other items that accompany the deposit.

  4. Should the loan be forgiven by the Council, documentation supporting the decision will be drawn up by staff. This can include copies of meeting minutes, emails, or other items in support of forgiving the loan.

Decision Five: Recommendations Regarding IEA Cash Reserves, Investments.

  1. IEA’s cash reserves/investment balance has fallen by USD $300,000 in the past few years. You currently have slightly under USD $500,000 in these accounts. A policy regarding what can and cannot be accessed to address routine operational items is not in place. Such a policy, if approved, can help support the growth and continuation of these assets, while continuing the organization’s work in times of need.

    While the Council can use the organization’s reserves and investment income as it desires, a general recommendation followed by our more conservative clients is to allow no more than 4 percent of the association’s investment income from the previous year to be used during any one fiscal period. This, or an alternate amount, should be decided by Council and approved as a policy. 

    The rationale behind this is that your portfolio should gain more than 4 percent each year. As a result, if you only access 4 percent of your investment gains the remaining amount can be reinvested to strengthen your overall position. 

  2. Based on year-end financial statements for 2017, the amount accessible under this policy for 2018 would have been USD $206.00.

  3. It may behoove IEA to consider budgeting with the goal of breaking even, or even budgeting for a small profit that can be then be added to the investment portfolio.

In World Congress years, IEA tends to drain its finances to the point where investment income is potentially needed to support the organization; the organization exhausts its income until IJE royalties arrive in late April.  

Because FirstPoint understands the nature of IEA’s cash flow each year, we “carry” IEA on credit as a courtesy for the months following a World Congress and pay your essential bills with the knowledge that magazine royalties will reimburse our expenses each spring. However, your cash flow challenge every triennium is something that should be considered; especially as magazine revenues seem to be declining rather than increasing. 


Next Steps

The next steps should be determined by IEA. This has been a large project and contains many recommendations categorized under 5 “decision” headings.  Although each one has been made with the health of IEA in mind, I understand that there may be further questions, a need for debate, and even cultural differences that I haven’t considered. To that end, the timing regarding decision-making is up to you and should be sufficiently long to incorporate understanding and agreement by all. 

Should you all lean toward approving these recommendations, I would love to conclude this project between now at the Council meeting in Maputo so that we could obtain a vote of support from the Council. Deliverables at that time would include: 

  • Draft revisions to governing documents concerning the tax status change;
  • Completed tax status change forms for signature;
  • Written policies and forms for inclusion in the Handbook;
  • A budget draft and revised chart of accounts for the current triennium; and
  • Instruction packages and forms and guidance for regional councilors.