Lesson 6 in the course Intro to Nonprofit Accounting
In this lesson, we’re going to learn what internal controls are and how you can use them to protect your nonprofit. In previous lessons, we have covered how to create and use an accounting system. Now, we will learn how to protect it. If you work for a nonprofit, this lesson is for you!
What is an Internal Control?
An internal control is a process put in place that protects both the assets and people of a nonprofit.
A nonprofit doesn’t simply have one internal control, but rather a system of them. Think of a chain that holds the entire system together. Together, the links are strong and achieve their purpose. However, when one is broken, the integrity of the entire chain is compromised. As they say, “a chain is only as strong as its weakest link.”
Let’s say your nonprofit throws a fundraiser that uses donation buckets to collect money. At the end of the fundraiser, this money is gathered, counted, and deposited into the bank. This income also makes its way into your accounting records. It is then reported on an income statement report showing the profit from this fundraiser.
With me so far? Here are the questions you may ask when trying to create internal controls for this fundraiser:
Each of these questions needs an answer, and each answer represents an internal control that can (and should) be put in place.
Say the person who counted the money took some. Without internal controls for that process there would be no way of knowing. Your nonprofit’s assets (the cash donated) have been compromised, as has the reputation and integrity of the person counting the money.
An internal control activity for this step would be to require two people to count the money together. This would protect the individuals counting from being accused of stealing, as well as ensure that the money counted is accurate.
The above internal control activity would help make sure the money counted is accurate, but what happens next? The money still needs to be deposited into the bank, recorded in the accounting system, and reported.
Say the person that deposited the money was the same person who recorded the deposit into the accounting system. If this person decided to take some money out before depositing the money, they would be the one to record the deposit, so it would be very difficult to catch.
An internal control activity for this step would be to have the two volunteers who counted the money, place it in a secure bank deposit bag that the person depositing does not have access to. This way, the money counted by the two individuals is secured and then deposited by a third person. This third volunteer doesn’t have access to the money in the bag, nor the ability to withdraw money from the bank. This protects the individual depositing the funds, and guarantees the money deposited is the same as was counted.
The examples go on and on, but remember, internal controls protect your assets and people. With a complete internal controls system in place you can rest easy knowing that the chain is strong.
Many nonprofits avoid creating and implementing internal controls because they trust the people involved and worry that the internal control may make others feel like they are not trusted.
On the contrary, internal controls help protect your trusted employees or volunteers should you be audited or detect fraud. If money does go missing and internal control activities have been followed, you can be confident there is no need to suspect them because there is no way they could have taken money without someone else knowing about it. Thus, you have protected your people from false accusations and mistrust.
Having internal controls is an extremely important thing for your nonprofit and will be vital to your success. In this lesson, we have provided a taste of what an internal control system looks like. Stay tuned for our full course covering internal controls that will dive further into this topic. We will provide plenty of examples of how to structure an internal controls system for your nonprofit.
In lesson 7, we will learn more about the rules and standards that go along with an accounting system for nonprofits.