I just bought a computer. Why doesn’t it show up as an expense?

Of course, major purchases such as equipment most definitely are major costs to your organization! The short story is that it does show up as an expense. The longer story involves explaining how that happens.

Accounting makes a distinction between day-to-day operational costs – treated as expenses – and major purchases – treated as capital assets.

Anything treated as an expense is of minor value, and is generally consumed within a year. By contrast, capital assets (also known as fixed assets) cost a significant amount of money, last longer than a year, and are instrumental in carrying out your daily operations.

Buildings and equipment are the most typical examples. Major renovations (as opposed to maintenance work) are also treated as capital assets. Computer software and websites may also be capitalized, depending on their scope.

When an item is capitalized, the purchase cost is recorded in the assets section of the balance sheet. It moves gradually into the expense stream over a period of years, through the mechanism of depreciation (also known as amortization).

A key aspect of managing capital assets is estimating their useful life. Computers and other office equipment are often estimated to last five years. Vehicles are often depreciated over five years, office furniture and fixtures over seven years, and buildings over 40 years. These may be common periods, but you and your accountant need to discuss what makes sense for your organization and its belongings.

Once you’ve estimated useful life, you and your accountant need to select a method of depreciation. The simplest – and one that is commonly used in the not-for-profit sector – is straight-line depreciation.

If you estimate that you’re going to get five years out of your computer before you need to replace it, you divide the purchase cost by five. This year, you will see one-fifth of the cost of the computer in your expenses – and the same over the next four years.

Why is it done this way? An intuitive way to grab hold of the accounting theory might be to imagine it as a question of fairness. It wouldn’t be fair to charge this year’s bottom line with the full burden of a five-year purchase. Nor would it be fair to give the next four years a “free ride” in terms of computer cost. Depreciation allows the price of the computer to be spread fairly over the years of ownership.

I bought my capital asset part-way through the year. Should I take a full year of depreciation?

Policy around managing capital assets is a good topic for discussion with your accountant. You need to make sure that your processes are designed to work for your organization and its belongings.

The short answer on this one is that, no, for the sake of accuracy, you probably should not charge a full year of depreciation when you owned the asset for only part of the year.

A good question is, how accurate should you be?

To be right on the nose, of course you would count how many days you used the asset in the year of purchase, and allocate depreciation expense accordingly. Thus, if my organization uses a calendar year for its fiscal year (i.e. January to December), and I bought a new computer on May 22, I owned the computer for 223 days out of 365.

Now, remember, useful life is an estimate: you don’t know how long you will actually own your new purchase. So, it’s generally not considered necessary to be quite that particular about measuring depreciation expense.

One common method would be to go by the month of purchase. So, if I bought the computer during May, I would take 8 months of depreciation expense – that is, 8/12 of the full year’s depreciation cost.

Another common method is the “half-year rule.” Under this method, for every asset you buy, you take 6 months of depreciation in the year of purchase. The thinking is that if you do this consistently over a period of years, your total depreciation cost will more or less even itself out. You may under-depreciate some purchases, but you’ll over-depreciate others, and at the end of the day your depreciation expense for any given year will be within the zone of reasonable – plus there’s less finicky bookkeeping to do.

Remember, the last year of depreciation must make up the compensating time period. So, if I’m depreciating a computer over five years and I take eight months of depreciation expense in the year of purchase, I need a four-month period at the tail-end to make a full five years. Thus, six fiscal years would be affected:

• Year 1 – 8 months’ depreciation expense
• Year 2 – a full year of depreciation expense
• Year 3 – ditto
• Year 4 – ditto
• Year 5 – ditto
• Year 6 – 4 months’ depreciation expense

How do I estimate the useful life of a capital asset?

There are norms around estimating useful life, which may vary by sector. These are often set by, or influenced by, tax authorities.

In the commercial world, where companies pay income tax on their profit, depreciation policies are important for taxation, because by shortening or extending the amortization period, a company can affect its bottom line. The Canada Revenue Agency’s term for depreciation is “capital cost allowance,” and you can find information on its rules here.

Capital cost allowance (CCA) works on the “declining balance” method of depreciation, where you expense a percentage of the asset’s remaining undepreciated value each year. Nonprofits often use the simpler “straightline” method, where you divide the cost by the estimated years of useful life, and expense an equal amount each year.

Not-for-profit organizations generally do not pay income tax, and so do not have to deal with capital cost allowance rules. However, it’s interesting to know how things work in the commercial sector, because we often follow similar patterns.

As with the CCA rules, nonprofits typically group their assets together in a way that makes sense. Thus, computers and office equipment are commonly depreciated over five years. Within that group, you might have a laptop computer that you don’t expect will last more than three or four years, and a photocopier that you think will probably last something over five years. However, on the whole, five years is considered to be a reasonable estimate for purchases of this sort.

Grouping saves you from having to estimate useful life for each item, and track every capital purchase separately.

Vehicles are often depreciated over five years, office furniture and fixtures over seven years, and buildings over 40 years. These may be common periods, but you and your accountant need to discuss what makes sense for your organization and its belongings.

This process of grouping streamlines bookkeeping duties. From time to time, you will need to make special calculations when you dispose of an asset earlier than your accounting estimate.

Ten Tips for Reporting Financials to the Board

Ever had a moment of dread when preparing for a board meeting? Board meetings do not always have to be the event we wished we could skip. By establishing expectations for clear communication between board and staff and creating a common base of understanding of the company’s finances, your board of directors can become a foundational resource for your organization.

To uncover some of the best tips for financial reporting to your board, Young Associates interviewed senior managers and collated their views on handling financial reporting to the board of directors. We would like to thank Soundstreams Canada, Prologue to the Performing Arts, Toronto Dance Theatre, Crow’s Theatre, Playwrights Guild of Canada, and Dance Ontario for their support and assistance in creating these tips for financial reporting to boards of directors.

Now, for some tips on best practices:

1. Don’t give up; the right Treasurer is out there! Just like dating…you don’t always meet the right one for you first time out. Seek a Treasurer with a strong financial background who can help you prepare and present board reports, address the Annual General Meeting, and support the development of the annual operating budget. It’s often a balancing act between accounting training or business skill, and an understanding of the not for profit world. Having the right credentials is great, but may ultimately be less important than finding a compatible person. So, finding a CA or Bank Manager may not be essential. If you’ve found somebody who has great technical skills, but is new to the sector, it’s up to you to help them deliver their best by cultivating their engagement with your organization and the sector.
2. Gauge the financial comprehension level of your board. It’s not necessary for everyone on your board to be financially literate, but according to our interviewees, it’s extremely helpful to have multiple board members with at least a basic grasp of financial management. How much they understand the financial stuff will influence how often and how in depth financial reports are presented at each board meeting. With a board comprised solely of artists, you risk a lack of financial comprehension and understanding, making presenting financial data difficult, timely, and at times, ineffective. At the same time, if your board is comprised only of those with strong financial backgrounds but with little understanding of the organization’s mandate, then you risk focusing solely on financial matters and at the expense of other mission related topics that need to be addressed.
3. Sometimes the ideal is not the realistic. While it would be nice to have a healthy balance of individuals with practical financial management experience and arts people (or people from whichever sector your charity occupies) on a board, most of the time, this is not the case. Ideally, it would be great if all board members read reports prior to the meeting, and attended all the organization’s events accompanied by some of their friends and colleagues. The reality is that some board members will not do that on their own accord. Learning from our interviewees, the best approach is to promote the engagement of all members, creating policies for them that ensure that their participation on the board will benefit the organization and its bottom line. Examples include attending 75% of the performances in a fiscal year, contributing an annual donation to the organization, and recommending colleagues with sought-after attributes. Although you may not reach the ideal, you can still reach a realistic goal with your board that benefits the organization, and communicate how the actions of board members impact the financial reality of the organization.
4. People are always changing. Be prepared for that moment when your beloved Chair or Treasurer has reached their maximum time as a board member, and you have to go about finding a new one, (one you are worried will not be as compatible!) But that’s okay… and normal! Outlining the qualities and attributes that your previous member had, or ones that are missing from your current board will help narrow your focus in recruiting a new candidate. All of our interviewees have been in that position, and said they were open to recommendations and referrals from other board members, colleagues, and confidants. Remember, the point in the recruitment cycle when you need to pay attention is when the new VP is being sought. Start setting standards and building relationships then; thus, when they arrive as your new President, you have been grooming them for up to two years!
5. Send out materials ahead of time. Sending out materials (board report, balance sheet, income statement) to your board members prior to the meeting gives them time to prepare questions and concerns in advance. It can save you time at the board meeting because it is anticipated that everyone will have reviewed the material. A board with members who possess strong financial comprehension skills may not need to see copies of the reports prior to the meeting – unless there is a specific issue at hand that needs to be addressed. For most of our interviewees, sending out the material ahead of time allowed some of their directors time to process the information, and save valuable meeting time.
6. Not all board meetings need a balance sheet and income statement. If an organization has a Treasurer who possesses a background in chartered accounting, then that individual tends to keep such a close eye on the finances that regular viewing of the balance sheet and income statement would become redundant and unnecessary for both the Treasurer and the other members. This is not the case for most of our interviewees, who include a balance sheet and income statement in the board reports that are sent out at least a week in advance to the meeting, allowing them some time to review the month’s finances and keep up to date. Most of our interviewees use the balance sheet and income statement to continue engaging their board on financial matters, allowing for complete transparency of the numbers.
7. Consider if your board meetings need to include a standard financial agenda. A common principle for financial reporting to the board is to schedule financial reporting at every single board meeting. For our interviewees, this varies based on the level of financial comprehension of their treasurer and board. For organizations with a strong Treasurer, financial matters would only be discussed if absolutely necessary. For other organizations, it becomes necessary to include a financial agenda at every meeting in order for everyone to be on the same page. Creating a standard agenda focusing on addressing any issues with the financial data is one way to encourage board members with limited financial knowledge to ask questions and become more engaged with the financial operations of an organization.
8. Plan to connect with your treasurer before each board meeting. Most managers do not have a lot of time in a board meeting to talk at great lengths about the financial matters at hand; therefore, preparing beforehand with your treasurer can ensure that both of you are on the same page and more importantly, that they are able to understand your perspective on the finances. If your treasurer has a strong financial background, then he or she can help you determine the reality of your financial position, and work together to map out how to present the information effectively to the rest of the board.
9. Board meetings do not have to occur every month. While common principles call for board meetings to run every month, most of our interviewees push it to every 6-8 weeks. Timelines can be affected by physical distance between members, and scheduling. While it is good practice to plan out each meeting date at the AGM, in reality many organizations decide on the date at the prior meeting. The most important thing to take away is that board meetings should be consistent and require all members to be present and prepared.
10. Make sure your board is “on board”. Remember: your board members are the legal representatives of your organization. It is their responsibility to be committed to your organization by reading the board reports, engaging in the organization’s activities, and helping with fundraising initiatives. You shouldn’t have to parent your board members to make sure they do all their readings. Make it clear to the board what is expected of their position, and how beneficial their efforts are to the organization. It doesn’t matter if they come from a business, finance, or arts background: all of them are expected to be engaged with and updated on the events and happenings of the organization, as well as the financials. Make sure your board members are aware of their duties and do not get caught up in using their position as a resume booster, but rather they prioritize the mandate of the organization.

This tip sheet was created by Caroline Bendiner, Centennial College Intern from the Cultural Heritage & Site Management Program. Founded in 1993, Young Associates provides bookkeeping and financial management services in the charitable sector, focused on arts and culture. Young Associates also provides consulting services in the areas of data management, business planning and strategic planning. Heather Young published Finance for the Arts in Canada (2005), a textbook and self-study guide on accounting and financial management for not-for-profit arts organizations.

Disclaimer

If I have a surplus, why don’t I have any money?

It’s probably a timing issue.

You might be strapped for cash if you are paying off bills from past year losses. In the same way, if you’re doing some early spending on future projects, this year’s money might be flying out the door to get ready for next year.

You could also be tight if you haven’t collected all the money people owe you. For instance, maybe you’ve rented a lot of studio time or gathered a lot of event registrations. If those people have booked but not yet paid you could be in trouble. In the same way, you could have solid fundraising pledges, or a confirmed grant, but still be awaiting the funds.

If I have a deficit, how come I’m not broke?

It’s probably a timing issue.

This year’s losses might be floated by money that you made in the past.

Or perhaps next year’s money has started to arrive. This is common for performing arts companies that sell seasons on subscription: in the spring, when next year’s tickets go on sale, money arrives that might make you feel flush, but that actually should be carefully stewarded so it can be used to pay for the next season. In the same way, grant instalments might arrive early.

Perhaps the bank is in good shape despite your losses because you haven’t paid the bills yet. You may know that you’ve lost money, but still be awaiting invoices from suppliers.