Financial Management Narrative Policy Number and Last Update (01.09.01/03-2015)
All Federal grantee agencies are required to have financial management systems that provide for timely, accurate, current, and complete disclosure of financial information. Grantees will find this resource useful when establishing accounting systems that provide for oversight and protection of Federal funds.
Financial Management Narrative
- Overview of Requirements
- Clarifying Definitions
- Audit Requirements
- Related Links
- Related Program Instructions, Information Memorandums, and Appeals Board Decisions
Overview of Requirements
All Federal grantee agencies are required to have financial management systems that provide for timely, accurate, current, and complete disclosure of financial information while providing for oversight and protection of Federal funds.
Effective and efficient financial management systems are required by Federal regulations (45 CFR 75 and 2 CFR 200). Upon request by the responsible HHS official, each Head Start agency shall submit an accounting system certification prepared by an independent auditor. The certification should state that the accounting system(s) established by the Head Start agency has appropriate internal controls for safeguarding assets, checking the accuracy and reliability of accounting data, and promoting operating efficiency.
Accrual Accounting: An accounting method whereby revenues and expenses are identified with specific periods of time, such as a month, and are recorded when they are earned or incurred without regard to the date of receipt or payment of cash. In accrual basis accounting, income is realized in the accounting period in which it is earned (e.g. once contracted services are provided, grant provisions are met, etc.) regardless of when the cash from these fees and donations is received. Expenses are recorded as they are incurred (e.g. when supplies are ordered, the printer finishes your brochure, employees actually perform the work, etc.), instead of when they are paid.
Budget: A plan for spending money to reach certain goals and provide certain services within a given time frame. The budget serves as the description of how funding will be spent to implement the goals and objectives specified in the grant application.
Budget Period: The interval of time into which a multi-year period of assistance (project period) is divided for budgetary and funding purposes. The budget period is generally 12 months.
Cash Accounting: In cash basis accounting, revenues are recognized when cash is received and deposited. Expenses are recorded in the accounting period when bills are paid.
Cost Allocation: A documented method for equitably assigning costs incurred by multiple funding sources working in a collaborative arrangement.
Disallowance: A determination that funds expended were unallowable based on: the Head Start Act, other applicable regulations or OMB circulars, the terms and conditions of the grant award, or the approved plan.
Internal Controls: A process that helps to ensure efficiency, control over Federal funds, and compliance with Federal regulations.
Obligation: A legally binding agreement between two parties for purchase of services, supplies, or equipment. Examples include purchase orders and contracts.
Title 2 CFR: Regulations 2 CFR 200 and 45 CFR 75 provide guidance to allowability of costs.
Prior Approval: The written permission provided by the authorized granting official before the recipient may undertake certain activities (such as performance modification or expenditure of funds).
Program Income: Gross income received by the grantee/recipient that was directly generated by the supported activity or earned as a result of the grant. The former source includes proceeds from the sale (with prior approval) of a piece of equipment or vehicle that was originally purchased with Head Start funds.
Unliquidated Obligations: Unliquidated obligations for a Head Start grantee are the obligations that remain at the end of an annual budget period, which must then be liquidated within 90 days, prior to closing out the year and reporting via the final SF-425.
Un-obligated Balance: Federal funds available minus all obligations.
All agencies receiving Federal funds are required to have a financial management system that provides timely, current, and complete disclosure of financial information. While the manner in which this requirement is met may be subject to interpretation, certain elements are required. Regulations related to financial management can be found in 2 CFR 200 and 45 CFR 75.
A financial management system is comprised of accounting records (checkbooks, journals, ledgers, etc.) and a series of processes and procedures assigned to staff, volunteers, and/or outside professionals. The goals of the system are to ensure that financial data and economic transactions are properly entered into the accounting records and that financial reports necessary for management are prepared accurately and in a timely fashion.
All agencies have common requirements to fulfill when administering Federal programs. For example:
- Contract and compliance requirements must be fulfilled and grant and contract funds must be expended appropriately;
- Accounting records must be maintained;
- Assets must be safeguarded;
- Internal control systems must be adequate;
- Internal policies and procedures must be developed and implemented;
- Costs must be allocated to the correct program based upon a cost allocation plan in cases where costs are shared by programs; and
- Grantees must have an annual audit.
Often, agencies are administering numerous grants and contracts with differing requirements. Communication between program staff and accounting staff is a key factor to ensuring successful operations. The Head Start Program Performance standards require that each agency have a qualified fiscal officer to oversee the financial management systems operation.
Federally Defined Financial Management System Benchmarks
The benchmarks defined for an acceptable financial management system include the following elements:
- Accurate, current, and complete disclosure of the financial results of each federally sponsored project or program. The grantee may maintain its records on a cash or accrual basis. However, if the agency requires that reports be submitted on an accrual basis, and the agency maintains its records on a cash basis, accrual information must be derived based on documentation at hand;
- Records that document the source and application of Federal funds. These records must include awards, authorizations, obligations, un-obligated balances, assets, outlays, income and interest. The records must permit the tracing of funds to a level of expenditures adequate to establish that such funds have not been used in violation of the restrictions and prohibitions of applicable statutes;
- Effective control over and accountability for all funds and assets;
- Comparison of outlays with budget amounts for each award. Where possible, unit cost data should be maintained;
- Written, cash management procedures which minimize the duration and amount of cash on hand;
- Written procedures for determining reasonableness, allocability, and allowability of costs in accordance with the provisions of the applicable costs principles and terms and conditions of the award; and
- Accounting records that are supported by source documentation.
Accurate, Current, and Complete Disclosure
The financial management system should be designed to ensure accuracy and timeliness of information being reported to agency management and Federal funding agencies. All aspects of the financial management system, such as the internal control system, must be functional to ensure adequate financial disclosure. Consistent treatment of transactions on a cash or accrual basis is necessary to achieve this end.
Timely processing of transactions, such as vendor payments, is necessary to ensure accounting records are current and accurate.
Records that Support the Source and Application of Federal Funds
Accounting records, or documentation, provide a process or trail which must be followed from the point in time where a purchase is requested to the issuance of the check for payment of the purchase. Accounting records or documentation reflect procedures and provide a trail from the point in time. Documentation to be gathered along the way includes:
- Justification for the expenditure that includes an analysis of whether the purchase is necessary;
- Analysis of lease vs. purchase of the item;
- Approval for the expenditure indicated on the purchase requisition and/or purchase order or contract by the appropriately designated individual;
- Appropriately completed forms as determined by agency policy and procedures, such as purchase orders;
- Proof that the purchase has been received as verified on documentation, such as packing slips or receiving reports;
- Proof of payment for the purchase, such as check copies and cancelled checks;
- Posting to the general ledger; and
- Financial statements.
It is important that all documentation be maintained for future reference. Record retention regulations state that records shall be maintained for 3 years from the date of the final expenditure reports. Equipment records must be maintained for 3 years after the date of the disposition. Records that are involved in an audit or other dispute must be maintained for three 3 years after the resolution of the issue.
In order to meet grant and compliance requirements, Head Start grant funds may only be expended on costs that are allowable to the program as defined in regulation and in the Cost Principles. Regulations, Cost Principles, and Policy Statements (e.g., Program Instructions and Information Memoranda) establish the parameters for program operation and establish expenditure guidelines. For example, the Performance Standards define the type of services that may be offered by the grantee using Head Start funding. Regulation and the Cost Principles also define specific criteria for expenditures, such as the administrative cost limitation, which must be adhered to.
Once a payment has been issued, information such as amount, payee, etc. are entered in the general ledger. The general ledger, also called the books of entry, summarizes financial transactions. The general ledger organizes information by account number as defined in the chart of accounts.
The chart of accounts is a list of each item that the accounting system tracks and acts as the table of contents to the general ledger. Accounts are divided into five categories: Assets, Liabilities, Net Assets or Fund Balances, Revenues, and Expenses. Each account is assigned an identifying number for use within the accounting system. The design of the chart of accounts should allow the system to sort and report information by grant, department, location, or subaccount. The design of the chart of accounts should allow for necessary information to be extracted from the system. Head Start funds must be tracked separately from other grants or contract funds. Expenditures for office supplies, for example, must be tracked separately from payroll costs.
In a manual system, summary totals from all of the journals are entered into the general ledger each month, which maintains a year-to-date balance for each account. In a computerized system, data is typically entered into the system only once. After the user has approved an entry, the software includes the information in all reports in which the relevant account number appears. Most software packages allow the user to produce a general ledger that shows each transaction included in the balance of each account, and sorts information by department or grant. For example, a report could be produced that shows all expenditures charged to the Head Start supply account.
The accounting department is responsible for the accounting records. Initial set up of the chart of accounts should be based on communication with program managers, and if necessary, the agency's auditor or other financial consultant, to determine necessary information to be tracked. It also should be based upon the terms, conditions, and regulations applicable to the program. For example, Head Start programs must track administrative cost; see also the narrative discussion on Administrative Costs Limitation). Correct categorization of the chart of accounts will help meet these requirements.
Some of the general ledger accounts that may be required for the Head Start program include:
- Fringe Benefits;
- Office Supplies;
- Computer Supplies;
- Rent; and
- Child Transportation
A chart of accounts coding system may be designed in many ways. For example:
||GENERAL LEDGER ACCOUNT
10 = Federal Grants
03 = Fiscal Year of the Award (e.g. 2003)
15 = Early Childhood Education Department
23 = Head Start Grant
6100 = Salary Expense
Journals, also called books of original entry, are used to systematically record all accounting transactions before they are entered into the general ledger. Journals organize information chronologically and by transaction type (receipts, disbursements, other). There are three primary journals:
- The Cash Disbursement Journal is a chronological record of checks that are written, categorized using the chart of accounts;
- The Cash Receipts Journal is a chronological record of all deposits that are made, categorized using the chart of accounts; and
- The General Journal is a record of all transactions that do not pass through the checkbook, including non-cash transactions (such as accrual entries and depreciation) and corrections to previous journal entries.
There are also "subsidiary journals" which include:
- The Payroll Journal, which records all payroll-related transactions. The Payroll journal can provide excellent information to a program manager to help in review and control of salary-related costs; and
- The Accounts Payable Journal and Accounts Receivable Journal track income and expense accruals. The accounts payable journal can provide a program manager with detailed information related to purchases or other transactions for specific account codes such as supplies or equipment.
The process of transferring information from the journals to the general ledger is called posting. Computerized accounting systems often require users to post all income and expense transactions through the accounts receivable and payable journals. Other automated systems allow users to post to cash disbursements or receipts journals, but cannot produce detailed financial information from these journals.
The end products of the accounting process are the financial statements that summarize all of the financial transactions of the organization for the period. Because each organization faces different financial issues and has different resources to bring to financial functions, each organization will choose a different set of regular financial reports to prepare and analyze. At different times, an organization will need different reports to provide information to support its decision-making.
It is critical that the financial statements meet the needs of the end user. For example, financial statements prepared for the Policy Council may not contain the same level of detail, or be formatted the same way, as those produced for program managers. Regulations state that a Head Start grantee is required to produce a budget-to-actual expenditures report that is timely, current, and complete. Other reports that may be produced include the balance sheet (showing the agency's assets and liabilities) and the cash flow statement (which provides an analysis of cash available for operations).
Internal controls are the systems established by an agency's governing body and/or administrative staff that are designed to provide reasonable assurance regarding the achievement of objectives in the following categories:
- Effectiveness and efficiency of operations;
- Control of assets and records of the organization to protect against loss, theft, or misuse;
- Compliance with applicable laws and regulations;
- Appropriate oversight by the agency's governing body;
- Adherence to the agency's policies and procedures; and
- Reliability of financial reporting.
Internal controls help ensure that financial information is reliable, thereby assuring managers and governing bodies that the information is accurate for making programmatic and other decisions.
To ensure efficiency and maximize limited resources, agency assets must be safeguarded. Agencies are required by regulation to develop and implement inventory control to track the location of equipment and vehicles. The control system should define steps to be taken in case of loss or theft, inventory systems, control over petty cash and other necessary steps (see also the narrative discussion of Equipment Management).
The internal control system should provide for good oversight in reporting, separation of duties, and good record keeping. Internal controls limit the possibility of loss due to theft and error. The first step in developing an effective internal accounting control system is to identify those areas where abuses or errors are likely to occur. Minimally, the following areas should be considered in the design of the internal control system:
- Cash Receipts - To ensure that all cash intended for the organization is received, promptly deposited, properly recorded, reconciled, and kept under adequate security.
- Cash Disbursements - To ensure that all cash is disbursed only upon proper authorization of management, and for valid business purposes, and that all disbursements are properly recorded.
- Petty Cash - To ensure that petty cash and other working funds are disbursed only for proper purposes, are adequately safeguarded, and are properly recorded.
- Payroll - To ensure that payroll disbursements are made only upon proper authorization to bona-fide employees, are properly recorded, and that related legal requirements (such as payroll tax deposits) are met.
- Grants and Donations - To ensure that all grants and donations are received and properly recorded, and that compliance with the terms of any related restrictions are adequately monitored.
- Fixed Assets - To ensure that fixed assets are required and disposed of only upon proper authorization, are adequately safeguarded, and are properly recorded.
Achieving these objectives requires your organization to clearly state procedures for handling each area, including a system of checks and balances in which no financial transaction from beginning to end is handled by only one person. This principle is called segregation of duties and is central to an effective internal control system. Even in a small agency, duties can be divided between paid staff and volunteers, to reduce the opportunity for error and wrongdoing. For example, in a small organization, the director might approve payments and sign checks prepared by the bookkeeper or office manager. The board treasurer, or other individual, might then review disbursements with accompanying documentation each month, prepare the bank reconciliation, and review cancelled checks.
The board and appropriate administrative staff share the responsibility for setting a tone and standard of accountability and conscientiousness regarding the organization's assets and responsibilities. The board or other governing body, usually through the work of the finance committee, fulfills that responsibility in part by approving many aspects of the internal control accounting system. Common areas requiring board approval include:
- Check Issuance - The number of signatures on checks, dollar amounts that require board approval or board signature on the check, who authorizes payments and financial commitments.
- Deposits - How payments made in cash, such as donations, will be handled.
- Approval of Plans and Commitments Before They are Implemented - The annual budget and periodic comparisons of financial statements with budgeted amounts, leases, loan agreements, and other major commitments.
- Personnel Policies - Salary levels, vacation, overtime, compensatory time, benefits, grievance procedures, severance pay, evaluation, and other personnel matters.
Comparison of Outlays with Budget Amounts
A very important component of effective Head Start program financial management is developing and implementing the budget to support the goals and activities outlined in program plans. Many programs are highly competent when developing a sound budget, but often neglect to put in motion processes and procedures to ensure that the budget is understood and utilized by staff to guide the operation of the program. Financial reporting is required to be timely, accurate, and complete. The reports must be used during the planning process required for Head Start program operations.
Once a month, data is summarized from the general ledger and reports are issued. These reports are called financial statements. Regulations require that the program manager receive reports showing expense-to-date and the budget amount with a comparison between the two. For example:
Having this sort of information on a regular basis provides the program manager with information necessary to adjust program operations so resources are efficiently used and deficits do not occur. Financial statements should contain the information necessary to complete any reports required by the grant such as the Standard Form 269, Statement of Financial Transactions.
All staff should have some understanding regarding how the program's financial resources are allocated and tracked, as well as their role in supporting cost effective program implementation. Staff involvement should be targeted at the level of involvement necessary for the individual positions. For example, program managers may need to have a deeper level of knowledge than teachers, cooks, or bus drivers. At a minimum, all staff should have a basic knowledge of:
- The program's annual budget and its link to overall program goals;
- The financial resources allocated to the staff person's area(s) of responsibility within the program; and
- Increasing or decreasing level of effort within specific program area due to funding changes.
A combination of fiscal and program knowledge will produce an optimal approach to the financial management of the program. Although fiscal staff members are "experts" regarding costing and accounting procedures, they do not always have an in-depth knowledge of program operations. With respect to the latter, program staff are the "experts" and should be responsible for ensuring that the program operates within its resources. However, it is critical that fiscal and program staff work together to ensure effective and efficient operations.
The Head Start program also requires the input of the Policy Council in design and application of many aspects of the financial management system. The Policy Council should be involved in all aspects of budget development and receive the monthly statement of revenue and expense for review and input.
The agency's governing body is the fiduciary agent for the program. In other words, the governing body is ultimately liable for the agency's financial operations. Clearly, the governing body's involvement and oversight is critical at all levels.
Procedures for minimizing the time elapsing between the transfer of funds from the U.S. Treasury and disbursement by grantees and sub-grantees must be followed whenever advance payment procedures are used. Grantees must establish reasonable procedures to ensure the receipt of reports on sub-grantees' cash balances and cash disbursements in sufficient time to enable them to prepare complete and accurate cash transaction reports to the awarding agency. When advances are made by letter-of-credit or electronic transfer of funds methods, the grantee must make draw-downs as close as possible to the time of making disbursements. Grantees must monitor cash draw-downs by their sub-grantees to assure that they conform substantially to the same standards of timing and amount as apply to advances to the grantees.
Because of the short timeframe between request of funds and deposit into the agency bank account, many grantee agencies submit a draw-down request to coincide with payroll and accounts payable processing.
The accounting procedures manual is a record of the policies and procedures for handling financial transactions. The manual serves as documentation of the established internal control system that has been approved by the agency's governing body. The manual can be a simple description of how financial functions are handled (e.g., paying bills, depositing cash, and recording revenue) and who has been assigned signatory authority. The accounting procedures manual is useful when there is a changeover in financial management staff. Having a current and complete manual also may reduce audit costs by documenting the internal control system for testing during the required annual audit.
Policies and procedures should clearly define individual responsibility and explain accounting processes. They will help to:
- Provide for clarity and consistency;
- Reduce confusion in job performance;
- Identify training needs during staff turnover; and
- Define internal systems for auditors.
Policies and procedures are necessary for a program to effectively process transactions, such as payroll and purchasing.
Various policies and procedures are required under Federal regulations. For example, the following procedures are required:
- "Written procedures minimizing the time elapsing between the transfer of funds to the recipient from the U.S. Treasury and the issuance or redemption of checks, warrants, or payments by other means for program purposes by the recipient." This procedure is often referred to as a cash management procedure.
- "Written procedures for determining the reasonableness, allocability, and allowability of costs in accordance with the provisions of the applicable Federal costs principles and the terms and conditions of the award."
- "Written cost allocation plans define the methodology for assigning costs to grants and/or contracts where there are shared costs." For example, if a grantee shares space with a Head Start program, costs for occupancy may be shared based upon the square footage used by each program. The cost allocation plan, which must be written, describes the following:
- What the funding sources are (e.g., Head Start, state funds);
- What the expenses being shared are ( e.g., salaries, space, supplies);
- How the expenses are divided (e.g., based upon number of child hours of service); and
- The number of children being served by each funding source.
Accounting Records That are Supported by Source Documentation
Agency accounting policies and procedures define what documentation is required for each unique transaction. For example:
Purchase documentation may include approved and signed purchase orders, purchase requisitions, packing slips, and other agency documents as defined in agency procedures. These documents should be signed and dated to verify approval was given prior to the purchase.
Payroll documentation may include timecards, timesheets, or other means of verifying employee attendance.
Contractual payments require a contract that is signed and agreed to by both parties.
Other documentation includes journal entry forms, bank reconciliations, and other forms supporting or authorizing a transaction.
Agencies that expend more than $750,000 in Federal cash during a fiscal year are required to have an audit completed. An audit of the Head Start program, covering the prior budget period of each Head Start agency shall be made by an independent auditor to determine:
- Whether the agency's financial statements are accurate;
- Whether the agency is complying with the terms and conditions of the grant;
- Whether appropriate financial and administrative procedures and controls have been installed and are operating effectively. Head Start agencies shall either include delegate agency audits as a part of their own audits or provide for separate independent audits of their delegate agencies; and
- Whether the audit is complying with laws, regulations, and the provisions of contracts or grant agreements.
A financial audit is a process for testing the accuracy and completeness of information presented in an organization's financial statements as well as evaluating the financial systems used to gather this information. This testing process enables an independent certified public accountant (CPA) to issue what is referred to as "an opinion" on how fairly the agency's financial statements represent its financial position and whether they comply with Generally Accepted Accounting Principles (GAAP).
The audit team will also develop an opinion regarding the internal control source structure of the agency. The team will test program data to ensure compliance with regulations. During the audit, the auditor may determine that there are "disallowed costs" or costs which were not appropriate under the terms of the grant. For example, fund raising costs are specifically unallowable and may not be charged to the grant. Significant findings will be written up in the audit report. Audit findings are sent to the funding agency and disallowances may result in the grantee having to repay money to the Federal government.
The auditor(s) will:
Perform an audit of the financial statement(s) for the Federal program in accordance with GAGAS (Generally Accepted Government Auditing Standards).
Perform procedures to determine whether the auditee has complied with laws, regulations, and the provisions of contracts or grant agreements that could have a direct and material effect on the Federal program consistent with the requirements for a major program.
Follow-up on prior audit findings, perform procedures to assess the reasonableness of the summary schedule of prior audit findings prepared by the auditee, and report, as a current year audit finding, when the auditor concludes that the summary schedule of prior audit findings materially misrepresents the status of any prior audit finding in accordance with the requirements.
Related Links: 2 CFR 200, 45 CFR 45