Most common accounting errors in nonprofit organizations

October 4, 2015

How does the quality of financial information of nonprofit organizations compare to that of for-profit entities? What are some typical accounting errors of nonprofit organizations? This article provides answers to these and other questions.

1. Accounting errors in nonprofit organizations

Accounting researchers study for-profit entities a lot while nonprofit organizations are not devoted so much attention.  At the same time, nonprofit organizations represent an important sector in the U.S. economy.

Error-free financial information of nonprofit organizations will allow a better decision making by involved stakeholders (e.g., donors, institutions, federal or state governments).  How does the quality of financial information of nonprofit organizations compare to that of for-profit entities?  What are some typical accounting errors of nonprofit organizations?

A study performed by Jeffrey J. Burks and reported in article “Accounting Errors in Nonprofit Organizations” Accounting Horizons 2015, provides some answers.

Based on the analysis of financial reports of 501(c)(3) nonprofit organizations over a number of years, the author of the article determined that the error rate is about 6.1%.  This is higher than the average error rate for for-profit entities (i.e., 3.8%).

It is also interesting to note that the error rate is negatively correlated with the audit firm size.  Specifically, nonprofit organizations audited by Big Four and second-tier firms had a lower error rate compared to the organizations audited by other (smaller) firms.

So, what are the most common accounting errors identified in the study?

There is no single dominant accounting error type.  They are spread over different financial statement elements.  There is also no apparent tendency towards overstating net assets; which is not the same for for-profit entities which tend to overstate assets and/or revenues.

The following most common financial item errors were identified (percent of total errors):

  • Errors related to revenue and accounts receivable = 26.0%
  • Errors related to net asset restrictions = 20.2%
  • Errors related to expenses and associated accounts payable and prepaid assets = 17.8%
  • Errors related to non-current assets (e.g., fixed assets, loans) = 14.8%
  • Errors related to long-term liabilities = 8.8%

What were the actual error types observed the most in the study?

  • Recognition errors – failed to recognize = 35.0%
  • Line item is understated = 22.1%
  • Line item is overstated = 20.8%
  • Recognition errors – early revenue recognition = 6.6%
  • Recognition errors – late revenue recognition = 6.0%
  • Recognition errors – should not have recognized = 5.7%

The most common type is inability to recognize transactions.  This signals that accounting or finance departments of nonprofit organizations should emphasize the importance of recognizing and recording transactions.  Organizations may need to provide more training for their accounting personnel and perform reviews by managers and supervisors.

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