Discussion of "Towards a framework fornot-for-profit accounting"

COLIN GRAHAM Ernst & Young

Although I disagree with the two conclusions of this paper that (1) not-for-profit organizations (NFPs) are clustered on two dimensions: resource providers/beneficiaries utility interdependent, cind type of products or services provided:collective or private, each requiring different accounting treatments; and (2) itis the nature of the organization and its products, not the type of transaction,that governs the accounting and control system, clearly the line of research andthe arguments made in this paper are important in the struggle of accountantsand managers towards assisting society to produce relevant, understandable in-formation for decision making by those reading the infonnation.

Haim Falk's objectives are to:

1 Analyse theoretical explanations for the NFP phenomenom.2 Distinguish between those organizations and profit entities.3 Suggest an accounting framework that is consistent with both the economicnature of NFPs and the nature of the giving decision.He does achieve his objectives of analysing theoretical explanations for the NFPphenomenom and distinguishing between those organizations and profit entities,but I believe the accounting framework he proposes is not consistent with boththe economic nature of NFPs and the nature of the giving decision.

Those NFPs that are interdependent (i.e., clubs), are regarded as being similarto businesses because payment is made for services or a product with the idea ofmatching all costs, short- and long-term, with all revenues and, presumably, asin any cooperative venture, having no profit or loss for the participants. "Bottomline" accounting is appropriate, with a bottom line target of zero. I agree withthis, as do the standard setters in Canada and the United States.

I do not agree that such "club" enterprises arise only in response to marketfailure, govennnent failure, or contract failure. These enterprises usually arisebecause a group of people wish to have a cooperative venttire for somethingthat is not currently available in the form they, a small group, are preparedto pay for. That "something" may be absent from the market or govemment

Contemporary Accounting Research Vol. 8 No. 2 pp. 500—503

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activity,' ti'iroiigh failure or through lack of interest or understanding by thesebodies, whicn 1 woiild not always call failure. It is unreasonable to expect thataf :-iny point in time the market and the govemment between them will provideeverything thai each one of us wants to have. Often, of course, such not-for-pTofil activities are eventually taken over in whole or in part by the market or gov-orirnerii when their utility to a broad group has been demonstrated by the NFP.

With respect to those NFPs that are regarded as noninterdependent—nonclub—-Haim Falk concludes (p. 489), because of no formal membership,ao excLusiofis for benefits, no reciprocal contributions, no formal control byac.nors, no economic return expected by patrons, and oo sharing of assets, lia-bi'(:Eie>., !;urpjus or deficit, that accrual accounting is not useful in this contextan.? a cash accounting system will suffice. Although I agree generally with theuc/iCriptive preamble, 1 fail to see how the conclusion follows. It fails to recog-.ni/.e tliat donors do not just give and then forget but that they are interested ina.rider«ta.ndir.g the results of the use of their funds and the funds of others, in"he viabifiiy of ihe organization they support, and usually in contributing yeariiftw year In support.

ii seems ro me that Haim Falk has left out a significant feature of nonclub or-£ar.ii:atiof!s. Certainly, many exist because of market failure, government failure,or contract failure. Eavironmental groups are an example; there is perceived to?";£ i soclelal need not being answered by the market or govemment. But oftentne,' exi&i not lo fill (lie need but rather to press the market and govemment to'eciignac ihe unniled market and the govemment obligation to the quality of!:.ie as .'ieen by the members. The significant feature I see is charitable purposes.K v\ ir.cHviduais, groups, associations, or corporations that do things that areciiSiiVdO'.e, Charity is an attitude and an aspiration, not an organization. Charityha:-; two key attribuies: altruism, which means the benefit must be for others, notfor dlrecuy seif-interested purposes, and community, which means the benefit::i3si be avasiabie on some general basis. Supporters of a particular NFP supportihe orgaiiizalio.n year after year because of its purpose and are interested in acontinuing understanding of how its purpose is being carried out, including anandi^rstundsng of liuanciaf information.

i .-ubscribe to the vievi', most recently expressed by Peter Dmcker, that non-ci'jb organizations are in grave danger of being mired in mismanagement andburcduacracy if they do not look critically at their expenses, revenues, assets andTiabjiitieK, .ajid tangible and intangible accomplishments just as other enterprisessbouid. Cash accounting is insufficient for this kind of monitoring. That is notlo sa.' vl'iat casii fiow information is not very important for operating people ton"anif.or.. for h is essentiai.

.in my view, the extent to which financial reporting provides useful perfor-z'Lmii c inforraatioi} depends on the primary characteristics of relevance and re-.Uitbiiity and on the qualities of comparability and consistency. As the Englishinstitute's SQRF 2 of 1988, "Accounting by Charities," states in its introduction.

502 C. Graham

The purpose of a charity's annual report is to provide timely and regular infonnationon the charity, enabling the user of the report to gain an understanding of the charity's op-erations and achievements and a full and proper appreciation of the charity's transactionsduring the period and of its position at the period end.

I believe that Haim Falk's conclusions would result in highly subjective andpotentially misleading financial statements for nonclub organizations. Failure toaccrue revenues and costs at a point in time, and failure to allocate long-termcosts, such as the cost for capital assets, to the periods benefited, introduceshighly subjective judgments as opposed to externally verifiable evidence as thebasis for important accounting classifications. As a result, his model for noncluborganizations allows wide latitude for managing the "operating" bottom line andsmoothing the results of operations—far more latitude than that provided by thejudgments required by allocation accounting.

I would have liked to have seen this paper Unk its analysis of NFPs to thenature of the balance sheet, and the nature of period results. I believe in thisregard there are two views:1 The asset-liability view, which sees results as a measure of the increase innet resources of an organization during a period. The proponents define resultsprimarily in terms of increases and decreases in assets and liabilities. Changesin them is the fundamental measurement process in financial accounting.2 The revenue-expense view, which sees results primarily in terms of the dif-ferences between revenues and expenses for a period, measuring revenues andexpenses and tying their recognition to related effort (expenses) and accom-plishment (revenues) for a period. The proponents see this as the fundamentalmeasurement process in financial accounting.

The CICA and the FASB have expressed a preference for the primacy ofassets and liabilities. In particular, both have concluded that assets and liabilitiesare essentially the same for both business and NFP enterprises. I subscribeto this view. To foUow cash accounting for nonclub organizations and leaveout significant assets and liabilities of an enterprise to me produces misleadingresults and can lead the reader to misunderstand the results of the operationsand the current position of the organization.

A number of NFPs are similar to conglomerates—churches, the United Way,large universities, and hospitals—-and the trend is for them to become morecomplex, rather than narrow and limited. Rather than being in "mutually exclu-sive" categories, I believe the characteristics of all but the simplest NFPs putthem, at any point in time, in several spots on the continuums discussed, whichis acknowledged but not treated as sufficiently significant.

I believe that the CICA and the FASB did address, and are continuing toaddress, the differences in observed practices noted. There is, of course, a belief,to which I subscribe, that similar transactions should receive similar accountingtreatment in all enterprises. Accounting differences have grown up between avariety of profit, and not-for-profit, industry groupings for similar items, such as

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short- and long-term investments and capital assets, but such differences shouldaot be enshrined as accounting standards advance, unless reality dictates thatthere should be a difference reflected by the accounting.

Money is "spent" when a liability is incurred, whether or not the cheque hasbeen written and cashed because that money is not available to meet anotheroperating cost. This is why all organizations need accrual accounting—so theyknow where they stand at a point in time. Depreciation is a proxy for the veryreal cost of using up a long-lived asset over time. It is not particularly accuratein a single year, but it is a reminder to the financial statement user of the wastingnature of the equipment and facilities being operated by the organization, capitalassets that need to be maintained, refurbished, and replaced.

I tried to contemplate Haim Falk's nonclub conclusions applied to one nonclubnot-for-profit area, education. A review is underway by the Ontario Council onUniversity Affairs on the likely consequences of maintaining the current policiesof university base funding. On the basic financial side, ignoring the aspects ofquality, research, and faculty workload, cash accounting is certainly inadequate.For that matter, current accrual accounting is inadequate, and depreciation ac-counting would be inadequate, if we had it, unless it took into account deferredcapital maintenance and technological updating, and the current value of excessland holdings. It is hoped that Haim Falk's paper will stimulate further work onthese ideas.