Proper internal controls are essential for all organizations. Critical to the implementation of these controls is an appropriate level of segregation of duties. This can be difficult for a small nonprofit to accomplish due to the size of the staff and/or the number of volunteers. The following section provides an outline of the various accounting functions and gives examples of how internal controls can be put into place to make errors or fraud more unlikely, regardless of the size of the staff.
At a minimum, an organization should have two people involved in this process. The process can be broken into several parts with only two people involved:
- The invoice is checked for accuracy by the administrator.
- The invoice should be coded by type of account and department/program/funding source by the person who ordered the service and/or has responsibility for the budget being charged. For example, an invoice for supplies for a conference should have a notation to that effect on the invoice.
- The person who authorized the purchase or service should approve the invoice in writing, preferably on the invoice.
- The check should be written by the administrator if a computerized system is used, and the check writing should be automated. If a manual check is written, an entry should be made into the accounting system (general ledger).
- The unsigned check and the supporting documentation should be given to the check signer. The signer should be someone other than the person writing the checks and should also not have the ability to make changes in the accounting software.
- A copy of the check should be attached to the invoice and filed by the administrator.
When making a wire transfer, all of the documentation and authorization necessary for any disbursement should be obtained prior to making the transfer. Further, a wire transfer form should be developed showing:
- The payee
- The name of the payee’s bank
- The account number for the payee
- The amount of the wire
- The date the transfer takes place
- The initials of the person making the transfer
- The initials of the person(s) authorizing the transfer
There transfers can be requested in person at the bank, by telephone call or online.
Transfers made online appear to provide the highest level of control. The program can be set up in a manner that requires one or more approvals before the transfer will be released. For example, one employee will input the transaction. A second employee will review the transaction. The second employee will have an authorization code that will need to be posted before the transaction will be released. This process ensures that the transaction has been properly authorized prior to its taking place. The second employee who authorizes the transaction should be a check signer.
If possible, have an individual outside of the accounting department open the mail. This individual should make a list of the checks received prior to forwarding the checks to the accounting department. If a large amount of cash (as opposed to checks) is received, or for organizations that receive unexpected funds, such as contributions to a nonprofit organization, two people should always open the mail. Additionally, both people should sign the list of checks as evidence of dual custody of funds during the course of the mail-opening process. In cases where an event is held, two people should always be present at each site where cash is collected. A deposit slip should be prepared listing all checks. Copies of the checks deposited are often kept as support for the deposit. If any correspondence has been received with the check, it should also be kept. Management of the organization should receive regular notification of the amount of the deposits made.
For nonprofit organizations, if a donor has restricted the usage of the contribution to a particular program, it will be necessary to record the amount as in accordance with the organization’s policy related to recording temporarily and permanently restricted donations. All allowable expenses incurred in connection with the donor-restricted grant and program will need to be tracked separately.
If at all possible, an individual other than the person writing checks and making deposits should reconcile the bank account each month. Many organizations hire an outside accountant or bookkeeper to perform this function to increase the internal controls surrounding cash. If the organization cannot afford to hire an outside accountant, the executive director (or the treasurer) should receive the unopened bank statement each month. This individual should review all activity and be confident that all transactions are valid. This individual should also review cancelled check images and compare the payee and amount to the check register to verify such information was not altered subsequent to signing the check. The reviewer should initial the bank statement indicating his or her review. Once the review takes place the appropriate individual should reconcile the account. All bank statements and the related information should then be filed.
There are many payroll services that will process the regular payroll, make direct deposits, prepare quarterly and annual tax filings and remit taxes due for a very reasonable fee. This is generally the most efficient and cost-effective manner for processing payroll and ensuring all tax requirements are met. Once a payroll services has been selected, it is prudent to check with the Internal Revenue Service periodically to verify al taxes owed by the organization are paid currently and in full. This step will serve as a check in the event the payroll service does not remit all taxes when due, no matter what the reason. All withdrawals from employees’ paychecks should be approved in writing by the employees. In addition, any changes in employee compensation should be documented in writing and signed by the executive director or member of the board of directors. The person who is in charge of payroll should notify the payroll service of any changes for the particular payroll period. The payroll summary issued by the payroll service prior to the payment of the payroll should be reviewed by both the payroll processor and a member of management or the board. Support in the form of timesheets should be available to support the allocation of the salaries to the various functions (programs, grants, departments, general and administrative and fundraising). All time records should be retained.
Although the amounts held in petty cash are generally small, the nature of the fund increases the risk of misappropriation. Only one person should have access to the petty cash fund. At all times the cash and the receipts signed for withdrawals should equal the total of the fund in the general ledger. The cash should be in a locked box and kept in a locked drawer of filing cabinet. Every time an individual receives cash from the box, a voucher should be signed and placed in the box. The expense coding should be noted on the voucher. A receipt should be obtained for purchases, and this receipt should be attached to the voucher. When the cash in the box is low, the total of the vouchers should be determined and a check written for that amount to replenish the cash in the fund. The check should be made payable to the individual in charge of the petty cash. A summary of the expenses noted on the vouchers should be prepared and attached to the check copy. This summary will be the basis for recording the activity in the general ledger. Under no circumstances should the petty cash fund be used to advance monies to employees in the form of loans.
The general ledger documents all of the organization’s transactions over the course of the accounting period for all accounts. Access to the general ledger should be limited to a very few individuals. Most transactions are posted automatically through receipts and payables modules. All modifications to the accounts should be made by posting a journal entry. Supporting documentations should be maintained for all journal entries and all journal entries should be reviewed and approved by a second party after they are posted. All accounts in the general ledger should be analyzed and/or reconciled each month to ensure the accuracy of the balances.