Three areas where accountants could help with analyzing charities

Image courtesy of DollarPhotoClub.com

Image courtesy of DollarPhotoClub.com

Professor Brian Mittendorf has outlined his ideas on how the accounting community could pitch in on industry-wide efforts to assess the effectiveness of charities.

1/25 – Counting on Charity – Three Pressing Issues in the Nonprofit Sector that Need Accounting Input – He  introduced three areas of nonprofit accounting where accountants could help:

  • Accounting for impact investments
  • Follow the money trail through multiple organizations
  • The development of alternative metrics of performance

Expanded discussions:

2/1 – Counting on Charity – Accounting for impact investments – A charity can make an investment with the goal of furthering its mission knowing there will be returns lower that could be realized from an investment intended only to make money.

What to do about that opportunity cost? That would be the difference between a market return and the expected lower return on an impact investment.

Article points out under current accounting rules the entire investment return is categorized as investment income which produces what looks like a poor performing portfolio of market investments. Also leaves out of the program expense category an implicit expense moving forward the NFP’s mission.

A conceptual alternative would be to recognize investment return at what would otherwise be realized at a market return with the difference between a market return and actual return offset as a programmatic expense. This would better reflect the cost of programs.

Some will say the accounting and disclosures would be difficult. Subjective estimates would be required. Prof. Mittendorf correctly points out FASB has taken on more difficult, more complex, and more subjective issues.

Difficulties of measuring impact investments are simplistic compared to stock-option expensing, pension accounting, and derivatives. (Bifurcated derivatives anyone? FMV of interest rate swaps? Assumed rate of return on pension investments?)

This would be stunningly simple. Pick a market index that approximates what the charity is trying to do in its portfolio. Or use just about any index published in the WSJ. Calculate average balance of investments and average actual return. Calculate difference between market index and actual return, multiply that by average investment, take the difference and debit program expense and credit investment income. Disclose all of the above.

Easy to do. Easier to audit.

2/8- Counting on Charity – Following the Money Trail through Multiple Organizations – When an organization spends a significant portion of its funds in the form of grants, the question arises how were those funds spent. A related question (given the general infatuation with “overhead ratios”) is how much of those funds were in turn used for administrative costs. What shows in the granting entity is that 100% of the grant is a program expense.

The current reporting model makes it difficult, if not impossible, to track the funds downstream. At the moment, the pressure to hold down administrative costs overrides the desire for improved reporting and transparency.

(If you really need a concrete example of how this could be valuable, consider valuation of medical GIKs that was in the headlines recently and the related widespread ‘daisy chain’ accounting that was oh so popular of late. Journalists working on the issue had to spend a lot of time tracking meds that had been passed around from one organization to another. Average donors have zero chance of understanding the economic reality.)

This would be very easy to do. Merely drill down on a few general ledger accounts, aggregate disbursements by grantee, list the amounts in the notes. Simple. Do the same for the largest donors to the charity.

Easy to do. Easy to audit.

2/15 – Counting on Charity – Developing Alternative Metrics of Performance – Ongoing and increasing pressure exists to find some way to measure effectiveness . The current accounting model does not provide any tools to measure effectiveness.

Prof. Mittendorf suggests three steps:

First, provide more detail on expenses. Breaking out grants from hands-on programming from awareness & public education would be a great start.

I really like that idea. It would allow identification of what some donors consider to be of vague and questionable value: general education of the public. If donors discount sending out educational flyers through bulk mail as something that changes the world, they could back out that entire portion of expenses in any assessment of effectiveness.

On the other hand, if the goal of an organization is advocacy, the vast majority of dollars should be in education. That would be good for donors to see. A further breakout of lobbying, media campaigns, publishing, direct mail, and community based door-to-door education would be invaluable for donors.

Splitting out impact achieved by others through grants versus the direct effort of the organization would be helpful for other donors. Perhaps having others accomplish your impact through grants is a good thing, or perhaps donors would discount that. If helping those in need or distress is the charity’s purpose, the amount of direct grants is important.

This would be very easy to do. Any charity that prepares the functional info for the audited financials and functional data for 990 already has the numbers. Might need to break out a few accounts into more detail, but not many. Re-aggregate general ledger accounts into new categories. Type info into the notes.

Easy to do. Easy to audit.

Break out the information along those lines and let donors sort out what is important to them.

Second, develop new methodologies for measuring outcomes. This is a huge step that many are struggling with. There are a few, though infrequent, signs of progress.

 

This will be difficult. I have not read of anyone that has any great ideas that can be replicated. There are several people trying to work something through.

All of us, including accountants, need to put on our thinking caps to figure out what would actually help donors.

Third, develop methodologies to identify “value-added”. This would

entail a comparison of outcomes achieved by an organization to the counterfactual of what would have been achieved absent the organization’s involvement.

That is a very intriguing idea. What did your organization accomplish compared to what would have happened if your organization didn’t exist?

I have no clue on how to develop such tools. Epidemiologists and research scientists do have the tools to do such measurement. Finance staff could learn to use the simple tools and hire experts to do the complex research.

This would be quite difficult but extremely useful. Would require new methodologies in general and new skills for NFP accountants and CPAs.

This info would be hard to audit. Not impossible, just difficult. If we, as a profession, know how to audit goodwill impairment and FMV determinations, we could figure this out.

Such info would allow assessments of opportunity cost and what approaches of other organizations would have worked better.

Check out the full articles linked above. I do hope the professor’s ideas gain some traction.

Update:  Auditors’ are in their busy season. You can wait to tell me how hard it would be to audit counterfactuals of charity impact until after you have finished the annual evaluation of each goodwill component of each subsidiary (recurring goodwill testing), recalculating the disposal costs of a nuclear reactor 30 years from now (asset retirement obligation), what the cost will be to fully remediate your client’s waste site using technology yet to be perfected (environmental liabilities), and determine a point estimate for settling their dozen class action suits on three continents, all of which are to-do tasks on your current audit. I know you only have until Monday to resolve all those issues. Then get back to me!

(For those who aren’t CPAs, that comment is pointing out how testing counterfactuals would compare to many of the other tests auditors perform as a matter of course.)

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