Trap #8 Violating basic accounting rules and practices (Part 4)

Another practice of many churches plays right into one of a fraudster’s strengths, the ability to withhold information.  Perhaps in an attempt to avoid interminably long finance committee meetings brought on by micro-managing members, or more likely, fearful that the messenger is going be killed, some church administrators tend to hold back on the financial facts. Failure to present full-disclosure financial statements is the most common way of holding back information. 

Instead of traditional financial statements, a church may elect to present summary information in an attempt to control the facts.  Making matters worse, they may also use electronic spreadsheets to do the work.  Although spreadsheets are very powerful and useful, they have one major flaw: the preparer is in total control over what goes into the report.  There are no balancing requirements as with a normal set of financial statements based on a double-entry accounting system.  Some crooks have one word to describe this situation. Disneyland!

Financial statements are simply another form of communication used to convey the financial situation of the church.  Their goal, in the church environment, is to answer a few basic questions.  How much cash do we have on hand?  Is any of it restricted?  What kind of assets do we own?  Who and how much do we owe?  How did we do this year?  Did we stay within budget?

To answer all of these questions adequately, a church must present a full set of financial statements.  This includes at a minimum, both a balance sheet and an income statement.  (These are business terms; the corresponding non-profit titles are statement of financial position and statement of activities, respectively.)  In addition, if a church has a high volume of restricted activity, a separate schedule of restricted gift activity should also be presented. 

Not only does “summary reporting” result in an uninformed church.  It can also result in a victimized church.  A church with a history of being satisfied with summary reports combined with poor personnel decision-making may end up with an embezzler having the best of both worlds; being able to take what he wants from the church and covering up the evidence with his own reporting system.

Volunteer Training – Fraud Awareness in the Church – part 4

Part 4 of our ongoing Fraud Awareness in the Church series will address Volunteer TrainingPSK in cooperation with the National Association of Church Business Administration (NACBA) conducted a survey to determine the extent of fraud awareness in the church environment. We asked churches to respond to this statement:

Our church conducts formal volunteer orientation or training.

Over 60% of the respondents reported having formal volunteer orientation and training. The Church (universal) is arguably the greatest volunteer organization in world history. Without volunteers, there would be no church, or at least not an effective one.

But unfortunately, many churches take their volunteers for granted. One way I’ve seen this played out is the lack of volunteer TRAINING. Many churches send their financial volunteers into action with little, if any, formal preparation. Often, these individuals are pressed into service and simply try to do the best they can with little knowledge of the church’s policies and procedures.

There is a negative byproduct of not training volunteers: While the church’s policies may not change (after all, they should be in writing), procedures certainly will change. With the normal flux of volunteers coming and going procedures will be constantly changing as well.

In short, operational baselines will become blurred. And remember, fraudsters HATE baselines!

KEY: Volunteer training helps ensure a thorough knowledge of church policies and procedures, and thwarts potential fraud.

Trap #8 Violating basic accounting rules and practices (Part 3)

Aug 3, 12 • NewsNo Comments

The larger a church grows the more ministries it will enter into. (Examples include day care services, private schools and family life centers.)  Following their parent church’s lead, these satellite ministries often launch into a significant growth arc placing additional pressures on church administrative staff. Due to the “tyranny of the urgent”, an already time-strapped admin staff cannot handle the accounting and management of another activity. To alleviate this pressure, many churches will allow the subsidiary activity to establish a separate management structure and maintain a separate set of books.

A separate set of accounting records is not necessarily a bad thing and in fact may be preferable.  This is due primarily to differences in the accounting needs between a church and its related entity.  For example, a church’s primary source of revenue is free-will gifts and offerings. But, a private school’s revenue stream is made up mostly of tuition and fees billed to students requiring a much more sophisticated accounting. (Accounts receivables, receivable write-offs, deferred tuition, etc.)

However, where churches tend to make a mistake is allowing a ministry to operate independently with LITTLE OR NO ACCOUNTABILITY TO THE CHURCH THAT BIRTHED IT.  All churches with satellite ministries need to understand that even though these ministries operate independently with little or no oversight, if no separate corporate structure has been created, the church is responsible for all of their subsidiary’s actions! 

Key: Best practices dictate that all satellite ministries should be included in the church’s regular financial reporting system.

Key: Some of the things we have seen go wrong when this doesn’t happen:

A ministry could be undergoing significant financial difficulties and the parent church has no knowledge of it.

Payroll deposits become delinquent; the church doesn’t find out about for several quarters and ends up having to fund the ministry to make up the shortfall.

An executive director, not accountable to the parent church, perpetrated fraud by creating “phantom employees” and cashing the phony paychecks.

A private school entered into transactions prohibited by the IRS Code endangering the church’s tax exempt status.

Conflict of Interest – Fraud Awareness in the Church – part 3

Part 3 of our ongoing Fraud Awareness in the Church series will look at Conflicts of InterestPSK in cooperation with the National Association of Church Business Administration (NACBA) conducted a survey to determine the extent of fraud awareness in the church environment. We asked churches to respond to this statement:

Our church has adopted a formal conflict of interest policy.

Approximately 30% of the churches responding do not have a written conflict of interest policy.

It is important to point out that a conflict of interest policy is not a fraud preventative in and of itself.  The primary purpose of such a policy is to insure that a church or other exempt organization does not transact business with board members and executive level employees to such an extent that private benefit or inurement occurs.  When this happens, the parties involved can face some pretty serious repercussions with the IRS.  But a conflict of interest policy does play a key role in fraud prevention.

Creating a fraud-free environment involves much more than policies, procedures and internal controls.  It also involves setting the proper organizational tone, or atmosphere of financial accountability.  One element in the proper tone at the top is the implementation of a conflict of interest policy which limits transactions between the church and its employees, directors and significant contributors.

KEY: A conflict of interest policy is a strong ADVERTISEMENT to potential thieves that the church takes stewardship and accountability seriously.

Trap #8 Violating basic accounting rules and practices (Part 2)

Attitudes about budgets vary greatly among churches.  Some churches operate without one, a practice I definitely do not recommend.  Many others swing to the other extreme expending great amounts of time (and blood, sweat and tears…) creating a budget plan.  But that is only the start.  After all of the effort is expended, they then protect their “sacrosanct” budget with all of the additional energy they can muster.  More times than I can count, I have seen this attitude cause a church to slip into our next trap.

Trouble comes when a church that considers its budget as carved in stone is faced with an unexpected (unbudgeted) expense.  These churches find themselves on the horns of a dilemma…

The first reaction is to not pay the bill or postpone the services simply because “it’s not in the budget…”  I cannot tell you how many times, churches in dire need of our services postponed the work until the next budget year even though they were flush with cash.

But often, the expense simply cannot be postponed.  (For example, an air-conditioner malfunction, in mid-August, in Texas with 100+ degree temperature.)   What do they do???

Once again, because the budget is written in stone, they dare not charge the expense to a budget line item.  So they “dump” this expenditure in the next best thing, one of their equity accounts.  The technical title according to accounting principles is “Net Assets” but we have seen equity accounts called by many names including “Fund Balance” and “Retained Earnings”.  We even had one church set up a special fund for unexpected expenses and called it the “Dump Fund”! 

Too much of this “dumping” will render a church’s financial statements meaningless.  The purpose of the Statement of Activities (Income Statement) of a church is to reflect how much money was received and how much money was expended, regardless of what our budget planning had hoped for…  I haven’t checked the Bible closely about this but I don’t think having a negative budget variance is an automatic sin.

Church Governance – Fraud Awareness in the Church – part 2

Part 2 of our ongoing Fraud Awareness in the Church series will deal with Church GovernancePSK in cooperation with the National Association of Church Business Administration (NACBA) conducted a survey to determine the extent of fraud awareness in the church environment.

Where Fraud Prevention Begins

Typically, when a CPA is asked about fraud prevention, he/she will launch into a long dissertation about the importance of internal controls.  To most accountants and administrators this is where fraud prevention begins.

I disagree.

Fraud prevention, in my opinion, begins with a strong organizational structure.  Internal controls are great, and necessary.  But, it is the organizational strength that sees to it that the internal controls are actually followed.  Without an adequate church governance program in place, the controls will not be consistent.

I can attest to this personally.  The WORST (by far) fraud investigation I have been involved with totaled in excess of $1.25 million dollars.  And, the theft did not start until AFTER the perpetrator had convinced the church to adopt a leadership team approach and abandon the more traditional committee approach the church had historically followed.

The leadership team consisted solely of church employees who answered to the culprit.  Once this system of NON-ACCOUNTABILITY was put in place, it was a simple proposition to dismantle what little controls the church had once had.

KEY – A strong church governance, which is characterized with good stewardship, accountability and transparency, is the first line of defense against fraud attacks. 

Next post we will begin taking an in-depth look at some of the questions we asked our participants to respond to, starting with Conflicts of Interest.

Trap #8 Violating basic accounting rules and practices (Part 1)

Jul 20, 12 • NewsNo Comments

In order to make good and timely financial decisions a church must have a strong financial REPORTING system.  This system will also provide the transparency and accountability in financial activity that all churches should strive for.  The end-product of a strong system is a complete set of financial statements that give a clear picture of where the church is (balance sheet) and where it has been (income statement)

Now, what I am NOT saying is you must prepare statements just like your CPA does at the conclusion of your audit.  Those statements have a different purpose than your internally generated statements. (Audits are for the public, internal f/s are for management)  In fact very few, (if any) of our church clients produce monthly financial statements that are strictly in accordance with generally accepted accounting principles (GAAP).

Instead, they produce budget reports, that help them monitor and manage cash flows on a month by month, or even a day by day basis.  And we are OK with that.  We can convert this to GAAP at year end.  Let me modify; we are ok with that as long as the church sticks to basic accounting/bookkeeping rules and practices. 

During the next few posts, we are going to be describing some of the “violations” we have spotted that have led to problems within a few churches.  And I am not referring to trouble from their auditors. It’s much worse than that. Their “violations” led to trouble with their members!

In the meantime, if you have a few good stories about unorthodox church practices, why don’t you share them with us…

PS – Unorthodox when it comes to accounting/bookkeeping.  No theology please….

The Fraud Survey Numbers Are In

Last week I conducted two break-out sessions at the NACBA National Conference in Houston. During these sessions I reported the final results of the PSK/NACBA fraud survey conducted earlier this year. In the coming posts I will be sharing some of the information we gleaned from our survey.

Goal of the Fraud Survey

Before launching into this discussion however, it must be pointed out that this was not a scientific poll. Rather, it is simply a questionnaire answered by a little over 100 participants who were invited to participate. The goal was not to obtain specific answers to specific questions, but simply to gain a general understanding of the extent of fraud awareness in the church environment.

In fact, because the sample size was small and most of the participants (I assume) were NACBA members or churches with a high degree of management sophistication, I expected the results to be skewed to the high side.  *My opinion – If a scientific poll had been conducted, compliance indicators would have been MUCH lower.

As we go through the results of our fraud survey, you will notice that we (PSK) have grouped the questions asked of participants according to several “key” areas in church operations that are fundamental to fraud prevention. The first of these key areas – Church Governance.

The full list of topics are below. Stay tuned in the coming weeks for more of the same great fraud prevention tips you have learned to trust from Weeds in the Garden!

Results of the PSK/NACBA Fraud Survey – Upcoming Blog Topics:

  • Church Governance
  • Conflicts of Interest
  • Volunteer Training
  • Policies & Procedures Manual
  • Credit Checks
  • Segregation of Duties
  • Cash Disbursements
  • Payroll Fraud
  • Information Technology
  • Payments to Individuals
  • Fraud Prevention Programs

Trap #7 Failing to develop a Fraud Prevention Program

Jul 13, 12 • NewsNo Comments

When discussing fraud, churches continue to believe in the myth that “it can’t happen here”. In their annual report to the nations, the Association of Certified Fraud Examiners released statistics that debunk this myth.  According to the ACFE, more than 14% of reported fraud cases involved nonprofit organizations with churches and religious groups accounting for almost a third of these cases.

There are two facts that need to be pointed out about fraud in the church. 

  •  First, as the statistics illustrate, it can happen here.  And the Bible, in John 12:6, tells us that this behavior has been going on for a long, long time.
  • One of the reasons that churches hang on to this myth is that they do not have a sufficient understanding of what fraud examiners call the “Fraud Triangle”.  The Fraud Triangle consists of the three elements normally present to create an environment conducive to conduct fraud.

The first leg of the triangle is – PRESSURE

Although it does happen, the normal pattern for economic abuse of a church is not that of a “crook” seeking out a vulnerable church.  The most frequent situation involves a trusted long-term church employee or volunteer.  Usually these individuals are facing some type of pressure that makes them consider taking things that are not theirs to take.  Examples are unexpected medical costs, business reversals of a spouse and more and more frequently, addictions.

The second leg of the triangle is – RATIONALIZATION

Rationalization is the “self-talk” a potential thief engages within his mind that convinces him that what he is doing is ok.  The most frequent rationalization is, “I’m not stealing.  I am borrowing.  I’m going to pay it all back.”  Unfortunately (for the thief) unauthorized borrowing will get you in just as much trouble with the law as actual stealing.

What these first two legs tell me is this; it is often not BAD people who steal from church, but rather good people who find themselves in difficult circumstances.  Another thing these first two legs tell me is that the church has little control over them. 

However, the church has total control over the last leg –OPPORTUNITY

Opportunity refers to the presence of weaknesses in the church’s management, accounting and cash control systems. If little thought is given to the strength (or weakness) of your church’s business operations, the church is creating a significant OPPORTUNITY for a fraud event to take place.  In other words, by ignoring this vital area, you may be adding the final ingredient to a “perfect storm” of financial calamity.

A fraud assessment and prevention program is a must. 

Planning tip – It is really not that difficult to at least get started.  One idea is to have a brain storming session for a couple of hours with key staff and volunteers.  During this session a simple flow chart of the church’s various cash flows could be developed.  From this simple process you might be surprised how many loopholes in your system exist…

Trap #6 Exercising Poor Credit Card Management

Jul 6, 12 • NewsNo Comments

Many churches issue credit cards (In the name of the church) to ministers and other employees.While credit cards provide the benefit of efficiency, they also present quite a few problems to a church.  For example:

  • Credit cards can be used to circumvent the budget. 
  • Poor judgment can result in a tarnished reputation for the church when credit cards are used in inappropriate establishments or used for improper purposes
  • Credit limits may be exceeded
  • Poor purchasing decisions are made in order to generate bonus miles/points
  • Personal expenses may “slip into” the church’s operations

In our opinion there are only two methods of credit card management.

  • Don’t do it! It is not the norm in the business community to issue credit cards in the business’s name to employees.  When cards are issued, the business wants their employee to have some “skin in the game” so the employee’s name is on the account too.  That way, if personal or other non-business expenses are charged, the employee will be required to pay, not the employer.
  • But if you insist on issuing credit cards be sure to adopt a clear, concise and written credit card use policy.  Also, it is a good idea to use a uniform plan through your bank or other financial institution.  (This way the bonus points accrue to the church, not employee…

Overlooked danger zone – Accountable reimbursement plan rules apply to credit card expenditures

Occasionally we notice that churches are using the monthly credit card statement as documentation for their accountable reimbursements.  Not a good idea – One of the requirements of establishing the business purpose of an expenditure is the documentation must be “contemporaneous”.  Waiting until the end of the month and reconstructing what happened will not get the job done.  You need to obtain the receipts…

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