CED Financial Management & Oversight 3 — Questions and Answers
Question 1: A nonprofit executive director wants to build a three-month operating reserve. Which funding source is MOST appropriate for establishing this reserve?
- Temporarily restricted grant funds
- Surplus from unrestricted operating revenue (Correct answer)
- Proceeds from a federally funded program
- Endowment principal distributions
Correct answer: Surplus from unrestricted operating revenue
Operating reserves should be built from unrestricted operating surpluses because restricted and federal funds carry usage constraints.
Question 2: Under GAAP for nonprofits (ASC 958), how must organizations classify net assets?
- Restricted and unrestricted
- Without donor restrictions and with donor restrictions (Correct answer)
- Operating, capital, and endowment
- Current and non-current
Correct answer: Without donor restrictions and with donor restrictions
ASC 958 requires nonprofits to present net assets in two classes: without donor restrictions and with donor restrictions.
Question 3: An executive director discovers a staff member has been falsifying expense reports for six months. What is the FIRST step in responding to this internal fraud?
- Terminate the employee immediately before gathering evidence
- Notify the board chair and legal counsel before taking further action (Correct answer)
- Conduct a full forensic audit independently without informing the board
- Reprimand the employee and establish a repayment plan
Correct answer: Notify the board chair and legal counsel before taking further action
Legal counsel and board leadership must be notified first to protect the organization legally and ensure a proper investigation is conducted.
Question 4: Which budgeting approach starts each fiscal year with a zero base and requires every expense to be justified anew?
- Incremental budgeting
- Zero-based budgeting (Correct answer)
- Activity-based budgeting
- Rolling budget
Correct answer: Zero-based budgeting
Zero-based budgeting requires justifying all expenditures from scratch each cycle rather than using the prior year's budget as a baseline.
Question 5: A board member asks why the audited financial statements show a surplus but the organization is struggling to pay bills. What most likely explains this discrepancy?
- The auditor made an error in the financial statements
- Most of the surplus consists of restricted funds that cannot be used for operations (Correct answer)
- The organization owes back taxes that reduce available cash
- The board treasurer miscalculated the operating budget
Correct answer: Most of the surplus consists of restricted funds that cannot be used for operations
A surplus can exist on paper while restricted funds tied to donor intent are unavailable for general operations, creating a cash flow problem.
Question 6: What does the functional expense allocation method require nonprofit organizations to do?
- Report all expenses by natural category (salaries, rent, supplies) only
- Allocate expenses between program services, management/general, and fundraising (Correct answer)
- Separate capital expenses from operating expenses on the income statement
- Report expenses on a cash basis rather than accrual basis
Correct answer: Allocate expenses between program services, management/general, and fundraising
Nonprofits must allocate expenses by function—program, management/general, and fundraising—to demonstrate mission alignment and administrative efficiency.
Question 7: Which document provides the most comprehensive picture of a nonprofit's financial health for a prospective major donor conducting due diligence?
- The current year operating budget
- The most recent IRS Form 990 (Correct answer)
- The monthly bank reconciliation
- The board-approved investment policy statement
Correct answer: The most recent IRS Form 990
The IRS Form 990 provides audited financial data, executive compensation, program descriptions, and governance information in a standardized public format.
CED Financial Management & Oversight 3
A nonprofit executive director wants to build a three-month operating reserve.
Which funding source is MOST appropriate for establishing this reserve?