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Internal Controls & Fraud Prevention in a Not-for-Profit Organization

April 26, 2012

Nobody’s perfect- How human nature plays into the rules and assumptions of many non-profits.

One of the greatest challenges in managing a successful not-for-profit organization is understanding their similarities and differences from other organizations. This blog, and most not-for-profit articles, devote a great deal of time describing how these organizations are different. But today, I will key in on one critical way in which the not-for-profit is the same as everything else in this world.

Not-for-profit organizations are all run by human beings. Regardless of their mission, people make them run. Failure to recognize that individual people are the foundation of all actions in the not-for-profit organization is a potential recipe for disaster. Yet I frequently see management acting as if those employed or volunteering for a not-for-profit organization possess attributes that are substantially different from the rest of mankind.

Internal controls that should be designed to safeguard assets and provide assurance that activities are conducted in accordance with established policies and procedures are frequently overlooked in the not-for-profit organization and considered too costly. This is a convenient conclusion when mission related activities are never adequately funded. The reality, however, is that mission related spending can always be increased – seldom will an organization ever have enough financial resources to do all that it could in trying to achieve its mission.

However, if the board recognizes that human beings work in the organization and are not perfect – as we all are – then internal controls will no longer appear to be a costly luxury. Fraud and embezzlement occur in not-for-profit organizations just as they do in every other sector of the economy. They result from the actions of imperfect human beings. Internal controls should be viewed as a necessity, critical to the long-term sustainability of the organization.

Here’s another example. The Governor of Massachusetts will likely sign House Bill No. 03516 (co-sponsored by 21 legislators) which will outlaw compensation for not-for-profit boards of directors. This legislation was introduced at the request of Attorney General Martha Coakley who believes that “compensation of board members creates unavoidable conflicts of interest and diverts resources otherwise focused on achieving the mission of the charity.”

The reality is that board members assume a significant responsibility to the public when they agree to serve on a not-for-profit board. Every citizen is providing resources to these organizations either directly, via personal donations, or indirectly via tax-exemptions or grants funded by tax dollars. The failure of boards to take their job seriously or to not devote a sufficient effort to the job is a frequent complaint of resource providers. Yet, Ms. Coakley and the Massachusetts Legislature believe that this job must be performed for free.

I wonder, isn’t it human nature for someone who has a busy life to let slide that which he or she is doing for no compensation? No employer adds an important additional responsibility onto the job description of an employee without a commensurate adjustment in compensation. Why do the Attorney General and the not-for-profit world think differently?

Occasionally I have not-for-profit organizations ask if we (KLR) perform any work on a pro-bono basis. The answer is no, and there are two very good reasons for this. First, it is unfair to our clients who are paying for services rendered. If I am working somewhere for free, I must be overcharging those who are paying because there is a cost involved in every piece of work performed. Second, it is unfair to the organization that is not paying for the services. The reality is that each day my staff and I will naturally work first and foremost for those clients who are paying customers – it is only human nature to do so. No organization should be provided less, but human nature being what it is, will likely negatively impact the pro-bono work.

One of the central structural features of the U.S. Constitution is the separation of powers. The division of power among the three branches – legislative, executive and judicial – is necessitated because human beings are imperfect. The imperfection of human nature means that well-structured government is necessary to prevent tyranny. Separation of powers is the means by which power is divided and its accumulation in the hands of any single entity denied. If our country is founded on the realization of the weakness of human nature, shouldn’t the not-for-profit organization follow suit?

As one of the largest CPA firms in Boston, KLR is unique because they service over 220 not-for-profit organizations with compliance and consulting services. We have extensive experience helping Nonprofit organizations regarding boards, and board responsibilities, charitable contributions, taxes and 990 filing requirements.

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