Appendix 17

Accounting

 

A FEW SIMPLE ACCOUNTING TRANSACTIONS 

            With the Balance Sheet (or Statement of Financial Position) and an Income Statement (or Statement of Current Activity) described in the section entitled "Right Brain Accounting”, we established the general structure within which we can keep track of our financial affairs.  Now let's look at a few transactions to get a clear picture of how it happens. 

            To begin, we'll imagine that the congregational members launch a campaign to raise $100,000 for a remodel in the religious education building.  The church borrows money from its membership.  The money all comes in during one generous weekend.  On Monday morning, the church bookkeeper makes the following entries on the books: 

 

INCOME STATEMENT

budget                   actual Revenues     Expenses         Net Surplus                                             unchanged

                                                                                                            Illustration 17/ 1

 

BALANCE SHEET

Assets     cash                                                                               +100,000           Total, Assets                                               Liabilities     building notes                                                               +100,000 Reserves Accumulated Surpluses     prior     current net                                                                    unchanged             Total, Liabilities, Reserves, & Surpluses

 

     On Monday afternoon, a crew comes and erects a pre-fab building addition.  The contractor is paid that evening.  On Tuesday morning the bookkeeper makes the following entries.                                                          

 

BALANCE SHEET

Assets     cash                                                                             -100,000     building                                                                      +100,000         Total, Assets                                                          unchanged                              Liabilities Reserves Accumulated Surpluses     prior     current net                                                                           Total, Liabilities, Reserves, & Surpluses              unchanged

                                                                                                                        Illustration 17/ 2

 Notice that nothing that has happened in these transactions has yet affected the Income Statement of the church.  You will recall that all the operational activities of the congregation show up as changes on the Income Statement; that is, they show up as affecting the budgeted operations and are thus translated to the Current Surplus.  Since we entered these transactions without changing the Current Surplus, we know we did nothing to affect the budget.  Some people loaned the church money; it was borrowed and is not income.  Then, the cash was changed into a building addition; the character of a church asset has changed but no money has been spent.  These two transactions took place entirely on the balance sheet – no income, no spending.[1] 

            During the next year there are three items related to this building remodel however which are included in the budget: interest expense on the mortgage, principal reduction on the mortgage, and an expense for the building.   

            First, the notes used to finance the building will be paid in a lump sum in eight years, both principle and interest.  The budget includes an annual interest expense of $6,500 (or $1,625 per quarter).  Each quarter money is set aside in a reserve account as shown below.  Notice that the expense is offset by an increase in reserves.  The amount of cash available in the checking account is unchanged by this transaction; however some of that cash is now reserved. 

 

INCOME STATEMENT

budget                 actual Revenues   Expenses     interest on notes                                                       1,625           Net Surplus                                                         -1,625

                                                                                                            Illustration 17/ 3 

BALANCE SHEET

Assets         Total, Assets                                                       unchanged                                                            Liabilities Reserves     building note savings                                                 +1,625 Accumulated Surpluses     prior     current net                                                                   -1,625         Total, Liabilities, Reserves, & Surpluses             unchanged

  

The amount set aside for principal repayment ($9,500 annually or $2,375 quarterly) is not an expense however.  It was included in the  budget because the congregation must come up with the cash to pay off the loan.  But just as the original borrowing of funds was not "revenue" to the church, so too when we pay back principal on the mortgage notes this transaction is not an "expense" either.  (When you make a payment on your own mortgage, you are reducing your mortgage balance somewhat.  Many people do not think of that as ‘”spending” but as “forced saving”. 

The principal payments are handled as follows:

                                                                                                           

BALANCE SHEET

Assets         Total, Assets                                                             unchanged                 Liabilities        mortgage                                      100,000         less principal in reserve                 -2,375 Reserves         mortgage reserve                          +2,375 Accumulated Surpluses     prior     current net                                                                           Total, Liabilities, Reserves, & Surpluses                 unchanged

                                                                                                                        Illustration 17/ 4 

In these transactions, we borrowed money and paid the contractor.  We paid interest on the loans into the reserve escrow account, and we set aside additional money in reserve to pay off the principal of the loans.  What about the building itself?   

            The purpose of “depreciation” is to recognize the actual cost of a building as an expense to the organization that built it.  A depreciation schedule spreads that cost, appropriately, over a number of years as the building is used, matching the cost of the building to the income stream occurring during “useful life” of the building.  Because churches are not concerned with calculating "net profits" from that income stream however nor with determining annual tax liabilities, "depreciation” is a cost concept easily set aside by church leadership.  It is forgotten in the press of immediate uses for cash.  After years of neglect, the concept becomes distrusted. 

            The Finance Committee at The Community Church decided to use the general notion of depreciation, but to refer to it instead as "repair & replacement reserves.”  They will set aside 4% of the value of the building addition ($4,000) each year in reserves.  During the first quarter the bookkeeper makes the following entry.             

INCOME STATEMENT

budget           actual Revenues     Expenses     Repair and Replacement transfer                           1,000           Net Surplus                                                       -1,000

                                                                                                            Illustration 17/ 5 

BALANCE SHEET

Assets           Total, Assets                                                      unchanged              Liabilities Reserves     Repair & Replacement Reserve                                +1,000 Accumulated Surpluses     prior     current net                                                                   -1,000         Total, Liabilities, Reserves, & Surpluses          unchanged

 Over time cash accumulates in the reserve accounts because of this expense.^[2]  Annual giving supports all the expenses, including the "repair & replacement reserves"  item.  When this expense is entered on the books, no money leaves the checking account.  After 25 years, the congregation has not only an old, used but remodeled, building, but also $100,000 in savings in reserve with which to make the major repairs which will be required.   

 

Gifts for Special Purposes 

            Another common problem is the handling of income and gifts intended for a specific purpose, particularly when no one is certain when the spending for that purpose will occur.   Examples of such gifts might be the proceeds from a special Sunday offering earmarked for assistance to the partner church in Transylvania, or a car wash put on by the youth group.  The question we face at such times is how do we prevent such funds from getting "lost" in the general accounts of the church while holding them for (perhaps) an extended period of time? 

            My preference is to treat such an item as a special reserved amount until it is used, and the purpose of the gift has been accomplished.  Such gifts are "revenue" but are immediately expensed to a reserve account until such time as they will actually be used.   

            Let's use the car wash example to see how this is done.  The youth group conducts a hugely successful car wash and raises $1,000.  The money will be partially used ($600) to support three members of the group in attending Leadership School next summer.  The rest will be split between buying books for the youth library and supporting a local runaway teen shelter.  Initially the entire $1,000 is put into reserves.  This involves two transactions. 

 

INCOME STATEMENT

budget             actual Revenues      YRUU Car Wash                                                             1,000   Expenses         Net Surplus                                                                 +1,000

                                                                                                            Illustration 17/ 6 

BALANCE SHEET

Assets     cash                                                                          +1,000         Total, Assets                                                                   Liabilities Reserves Accumulated Surpluses     prior     current net                                                                 +1,000                                                                            Total, Liabilities, Reserves, & Surpluses

                                                                                                           

  

INCOME STATEMENT

budget             actual Revenues     Expenses     Unbudgeted xfer to Reserves                                           1,000          Net Surplus                                                                   - 1,000

                                                                                               Illustration 17/ 7                                                                                                                                    

BALANCE SHEET

Assets         Total, Assets                                                          unchanged   Liabilities Reserves     YRUU Reserve                                                            +1,000 Accumulated Surpluses     prior     current net                                                                   - 1,000                                                                                Total, Liabilities, Reserves, & Surpluses            unchanged

  

First the revenue comes in and increases the church income.  On the Balance Sheet cash increases.  Then, an expense is entered as the money is credited to the reserve account.  The income and expense have been offset so there is no budget impact.  Cash has increased; and the reserve account is increased. 

            The needed books are purchased the following weekend.  The bookkeeper reimburses the group leader for them.  Two transactions are entered.  First, an amount equal to the expense is brought out of the reserve account and recognized as revenue to the church.  Second, the expense is entered and a check is issued, reducing the checkbook balance. 

 

INCOME STATEMENT

budget         actual Revenues     Unbudgeted xfer from Reserves                         119.50   Expenses         Net Surplus                                                     +119.50

                                                                                                            Illustration 17/ 8 

BALANCE SHEET

Assets         Total, Assets                                                   unchanged               Liabilities Reserves     Unbudgeted Use of Reserves                               -119.50 Accumulated Surpluses     prior    current net                                                                 +119.50                                                                             Total, Liabilities, Reserves, & Surpluses     unchanged

                                                                                   

 

 

 

INCOME STATEMENT

budget         actual Revenues      Expenses    Library Books                                                       119.50           Net Surplus                                                    - 119.50

                                                                                    Illustration 17/ 9

                       

BALANCE SHEET

Assets     checking account                                                          -119.50         Total, Assets                                                                  Liabilities Reserves Accumulated Surpluses     prior     current net                                                                     - 119.50                                                                                                                                    Total, Liabilities, Reserves, & Surpluses

                                               

            The reserves cover the expense, so after both entries are completed on the books, the church income statement is again unaffected; neither the reserves nor the expense require any particular explanation to the Board.  The remainder of the youth group car wash money is still reserved for later use. The bookkeeper is then asked to send off the money to Leadership School to secure a reservation.  A similar set of transactions are entered. 

 

INCOME STATEMENT

budget              actual Revenues     Unbudgeted xfer from reserves                          150.00   Expenses            Net Surplus                                                    +150.00

                                                                                                            Illustration 17/ 10

BALANCE SHEET

Assets            Total, Assets                                                        unchanged         Liabilities Reserves     Unbudgeted Use of Reserves                  -150.00 Accumulated Surpluses     prior     current net                                                   +150.00                                                                                                                  Total, Liabilities, Reserves, & Surpluses               unchanged

  

INCOME STATEMENT

budget              actual Revenues    Expenses        Deposit for Youth Training                                  150.00           Net Surplus                                                      - 150.00

 

 

                                                                                                            Illustration 17/ 11

 

BALANCE SHEET

Assets     checking account                                                          -150.00         Total, Assets                                                                   Liabilities Reserves Accumulated Surpluses     prior     current net                                                                    - 150.00                                                                                                                      Total, Liabilities, Reserves, & Surpluses

            

            The important point to notice here is that it is possible to keep a clear record of special reserve amounts, and to retrace precisely what they have been spent on.  This is true even though the reserve funds are intermingled with the accounts of the church.  If anyone wants to know specifically how the $1,000 has been used, they can look at the entries in the reserve account and see when the $1,000 came in, and when and why each withdrawal was made from that account.  

            On the other hand, they also know the total amount spent on training by the church since both the youth group training expense and all other training expenses are included in the church books as part of total training costs for the church for that year.  This method of accounting for special reserves tells the Board the true annual cost of running the church, including the use of specially raised gifts.   

            By the way, if you use this method for your congregation you will also need to be clear with the Board and the membership that the "adopted budget" gets routinely increased by spending of reserve amounts.  This is because the use of reserves is often not budgeted — for example, the use of youth car wash funds we just saw.  We did, however, increase both the revenue and expenses of the church with these funds.  Such adjustments to the adopted budget should not require review and approval by the Board.  The approval occurred when the Board said at some point that the youth group could have a car wash and raise money to support their program.  Ostensibly the Board would also have said at the same time what the general parameters were for use of the money, or would have outlined purposes it in creating the reserve account as well as indicating who could approve specific uses.