Nonprofit Accounting Basics

Minimizing Fraud Opportunities at Your Nonprofit Organization

Note: Articles published before January 1, 2017 may be out of date. We are in the process of updating this content.


Terri McKnight, CPA

Gelman, Rosenberg & Freedman, CPAs

Nonprofits, like every other type of institution, have been forced to weather a variety of challenges—some dire—during the economic downturn. Many have cut back on programming, reduced staff, streamlined operations, or been forced to rely on rainy-day reserves to break even or just survive. These unfortunate events, however, do not mean nonprofits can relax their efforts to protect against more routine risks that can occur anytime. One of the most serious is fraud.

Organizational environments must operate efficiently and effectively. Part of overall effectiveness must include having sufficient safeguards so nonprofits have the right internal controls to protect against fraud. Management and those charged with governance must be aware of where potential vulnerabilities exist so decisions can be made to fill those gaps. Staff should also be educated about the threat (and management’s awareness) of fraud including such issues as whistle blower policies, conflicts of interest, and appropriate ethical behavior. Regularly communicating about the topic heightens awareness of abuse or fraudulent activity throughout the nonprofit and even can discourage potential perpetrators from acting.

During economic downturns such as the current one, staff reductions can compromise internal controls that once were sufficiently in place, leading to greater vulnerabilities to fraud. Even without reductions though, many nonprofits have capped salaries or reduced benefits, both potential motivators for fraudulent activity. Nonprofits should be particularly wary during such large-scale changes in organizational environments to protect valuable assets.

It goes without saying that one area where personnel fluctuations poses an especially heightened risk is in the finance department. Reductions or changes in key finance staff bear close scrutiny. The appropriate segregation of duties can be difficult for management to keep intact during such situations, and the executive director, treasurer, controller, or other key members of management may need to participate to strengthen controls.

Regular “check-ups” of processes and documents at the nonprofit must be performed as well, such as the routine reconciliation of asset and liability accounts and their review and approval by management or supervisors. Employees must be familiar with and comply with organizational policies about document submissions such as requirements to submit cash receipts and disbursements for review by management. Credit cards are another source of concern. Charging personal expenses to a nonprofit’s credit card should, as a policy, be restricted with penalties for transgressions such as revoking use of cards. Chain of command warrants that supervisors regularly review employees’ credit card statements with board members responsible for reviewing the charges submitted by executive leadership.

Externally, vendors that work with nonprofits should be vetted and approved entities. Expenses they accrue when contracted for services should be clearly stated in invoices submitted to management. Vague line items should be researched further.

Finally, it is important not to forget back-end vulnerabilities such as information technology. IT department controls should include ensuring computer and network security. Nonprofits should not conduct banking transactions using computers that are socially networked. Regular password changes and dual controls to initiate electronic banking transactions should be a routine part of oversight. An experienced IT professional or consultant can ensure these and other appropriate safeguards are in place.

Identifying all the potential vulnerabilities to fraud should be a part of nonprofit management’s risk assessment function. Fraud is not just a matter of lost finances (which certainly is the most damaging aspect of fraud), but the damage to reputation can result in a public relations disaster that can last for years, even long after the economic impact of fraud has subsided. Misappropriated assets are publicly disclosed on IRS Form 990, creating easy access to embarrassment if irregularities are discovered. Management should fully understand the protection available under the nonprofit’s insurance policies so that in the event of fraud, the full extent of the financial damage may be mitigated.

Although contemplating fraud at your nonprofit is not especially appealing, it is a necessary and critical task. When there is a breach of integrity in your nonprofit’s finances or when fraud is discovered, management should move immediately for prosecution. It is only through the consistent pursuit of justice from those responsible for organizational oversight that the seriousness of combating fraud is demonstrated. Knowing the vulnerabilities of your nonprofit’s structure, especially during economically uncertain times when personnel and internal structures can be exposed to quick and significant changes, makes it important to understand everything you can do to keep your nonprofit fit. When better times return, your nonprofit then will have suffered only the strains it absolutely had to.