Archive for March, 2011

Why is there no international accounting standard for non-profit accounting?

Monday, March 21st, 2011

The standard cucumber

European standard setters had a problem: cucumbers are sometimes not straight; they are sometimes curly and crooked. This is not very efficient. A curly cucumber, packed into a standard box, requires as much space as two or three straight cucumbers. You can imagine how much can be saved on transport facilities, if cucumbers are standardized! Thus, the European Union decided to standardize cucumbers. Only straight cucumbers would meet the requirements of directive No 1677/88 as of a16 June 1988 (published in the Record of Directives L 150 (p. 21–25). All other cucumbers had to be sorted out and juiced. And so, Europeans only received straight cucumbers. This is not the end of the story, as you will see later. European readers already know how it will end…

The trend for standardization

There is one force in the world that drives for standardization. This is – not surprisingly – the profit motive. It is the profit motive that was also the driving force in the development of international accounting standards. Those amongst you who are a little older probably remember the heroic times when H&P or IBM went around the globe, earning money in different economies: these were the Seventies. And this was also the rise of the big international accounting firms, who travelled the world together with the international players. Thus, it was not by chance that the IASC was founded in 1973. The main driving force has always been that the standards should be beneficial to markets, users and preparers.

“IFRS are designed for use by profit-oriented entities. Unlike, IFRS, US GAAP is designed for use by both profit –orientated and not-for-profit entities, with additional accounting standards that are specifically applicable to not-for-profits” (J. Russel Madray, “IFRS Essentials with GAAP comparison” AICPA, Lewisville 2010, p. 1-15). I think it is worth thinking a little bit about this phenomenon. Many national standards have a rule, how we should count in the NPO sector. IFRS is silent on this.

Is IAS 20 a NPO standard?

Okay, I just heard this interjection: “Hey, we have IAS 20 Accounting of Government Grants and Disclosure of Government Assistance: this could also serve as a standard for non-profits! How you can say that the IFRS is silent on this issue? There is something about grants! Why not use this for donations?”. Mmh! This is an argument, and it will take some time to consider it. We will then return to the main point of this article.

Look: IAS 20 deals with the treatment of a special kind of inflows to an entity. You agree that it is not a standard for NPOs, right? It is more a standard on how to account for a special inflow, correct? So, this standard is obviously not focused on NPOs. It does not help NPOs to make their accounts more understandable or decision useful.

However, I must admit that IAS 20 gives a hint, how grants should be accounted for. Thus, it would be interesting to discuss the question: does IAS 20 prevent the accounting of restricted and unrestricted funds, like it is required by many national standards?

I am not ready to answer this question. However, whatever the answer may be, it will be not so favorable for the IFRS. If the answer is YES (i.e. IAS 20 prevents NPOs from using the concept of restricted and unrestricted net assets), than the IFRS is not the best choice for NPOs – the statement of activities will be very poor (please see also the November blog of the NOPA forum). If the answer is NO (i.e. the IFRS does not prevent NPOs from using the concept), the result would be that we have two different approaches in our system: donations would be recognized as revenue when promised or received, while government grants would be recognized when spent – this does not look very consistent, does it? Okay, I am not in this blog to make jokes about the IFRS. All I want to say is that, obviously, the IFRS is silent on NPO accounting. Thus, I think, we can return to the main point of this article.

Why do national standards take NPO accounting into account?

The interesting point here is that some national standards do take NPO accounting into account, while the IFRS is silent on it. Astonishing, isn’t it? Well, I must admit that it is a bit difficult for readers to feel surprised by something that is missing. Usually, you feel surprised by something that is there that you did not expect. I probably have to dig a little bit deeper into history to justify my surprise.

In many Anglo-Saxon accounting frameworks or in frameworks that are built on the basis of Anglo-Saxon traditions, NPO accounting standards are highly developed. Why? I personally think that it is NOT or NOT ONLY the profit system that makes us count. The profit motive is more a surface phenomenon of a deeper concept of accountability.

The Domesday Book as a primary inventory

Those of you who are familiar with the history of the British Isles have probably heard of the “Domesday Book”. After the end of the Roman Empire, there were hardly any written documents in Western Europe for a long time. These were the dark ages of Western Europe, and literacy survived only in monasteries at the periphery of a continent. The continent suffered a total cultural blackout that lasted for more than two centuries. The periphery: these were the British Isles. How to get things started? William the Conqueror started with taking inventory of his newly conquered empire (in the year 1066) – it was a process of stock-taking. Every household was entered into a list, specifying the quantity of cattle and crop.

“Then he sent his men all over England into every shire and had them find out how many hundred hides there were, or what land and cattle the king himself had, or what dues he ought to have in twelve months”

This list, later called in all religious seriousness “the Domesday Book”, served as basis for taxes. What do we see here? We see that accounting is done not because of profit reasons, but in order to create some justice in taxes. I think you agree that there is a difference between robbing and taxing? In my opinion, the difference is that in the latter case you have some basis of accounting, while in the first this is not a necessary condition.

Foundations in the Islamic World

Probably, there are other examples in other regions of the world. I have read a bit about the tax system of the Osman empire; and I understood that the ability to have a sufficiently proper tax base was “key” to this empire (here it would be necessary to know more about the Diwan of Umar; maybe some of the readers of this blog could recommend a good book to me…). I was deeply impressed by the techniques and regulations for foundations (“vakif”) that were established in Turkey and also to some extent in Egypt. Why are there such sophisticated regulations in these countries on non-profit accounting issues? I mean, you cannot say that Egypt or Turkey were capitalist power-houses in the 19th and early 20th century, correct? You see, that non-profit accounting is not a side effect of profit accounting. It is something else.

A Social Foundation in the City of Lübeck

An auditor in the German city of Lübeck showed me an example of the rich traditions in non-profit accounting of this “Hansa” city . The city has an old welfare foundation, the “Schiffergesellschaft” or “St. Annen-Gesellschaft”, documented since the year 1401. Lübeck is a port city, and the purpose of the foundation was, among others, to take care of widows and orphans of sailors who did not return from the sea. 609 years is a quite a long time. Why is this foundation so stable? I can identify two reasons: firstly, the persons who take care of the foundation were obviously able to protect the net assets from vanishing – and this means that they were clever enough to count. And secondly, there is no public understanding of the needs of the organisation, and that is why there should be some kind of public control in this area – the statutes of the “Schiffergesellschaft” can only be changed with the consent of the municipality. In other words, from experience we can see that net assets were not lost over a very long time period, neither by embezzlement nor by stupidity. You can see here that this kind of entities is much more stable than ENRON or the USSR or other entities that claimed to be capable of accounting.

The excess amount over the span of a human lifetime

If we talk about non-profit accounting, it is worth talking about religious or social foundations. Why? Because these entities serve aims that exceed the span of a human lifetime. The tool, how they do this, is simply an accounting algorithm. In foundations, there is – by definition – this element that ignores the “here and now” profit approach. And it is this excess over the short-term calculation for personal benefits that force foundations to calculate. In short, this means that the figure that we call capital comes into the world not via short term profit accounting, but through the wish to keep a certain mission alive. From these examples you can see that non-profit accounting is older than profit accounting. You can also say: accountability is first a concept of social responsibility, and then, on top, it could also serve as a concept for a business. If you read chapter 4 of  the “Summa de Arithmetica” of Fra Pacioli, the founding father of modern double entry bookkeeping (1494), you will see that he would agree with this. “Before all other things, put always the needs of your neighbor… Nec caritas opes, nec missa minuit iter – Neither does charity decrease your wealth, nor does the mass shorten your way.” In other words, for Fra Pacioli – of course – charity was the purpose of all profit accounting.

In the context of this article, it sounds funny that Seyffert in his book on Pacioli (Seyffert, Luca Pacioli, Stuttgart 1933, p. 61) determines that Pacioli´s rigid moral requirement has nothing to do with modern bookkeeping, and “we would eliminate such a chapter”. This is more or less what has happened in IFRS. IFRS is intended to be beneficial to markets, users and preparers, nothing else.

Agents of Globalized NPO accounting

Why should we wait for a non-profit standard from an institution that is the “dernier cri” of the globalized profit principle? This does not sound so logical. One of the main aims of the IFRS was to make figures comparable around the world. You can immediately see the benefit of this standard: it is beneficiary to capital markets. You can compare the performance of Microsoft with Apple, for instance, and make your decision which stock you will buy. But is this necessary in the non-profit world?

Comparability of NPOs?

There is one very serious attempt to make NPOs comparable. This is my beloved website of the charity navigator in the USA ( Here you have a serious financial rating with different ratios. It is a wonderful approach to put pressure on these “as-if non-profits” that serve more or less the purpose of fattening their management. However, once again, the Charity-Navigator comparison is so far only a national one. Why? Because US GAAP provides an excellent tool to measure administrative costs in a standardized way.

In other words: It is not that it is impossible to compare the “Salvation Army” with “Save the Children”, for instance. However, if we make comparisons, we will certainly not do this on the basis of the increases in net assets. There are many other parameters that we will take into account: modesty of management, results in the field, quantitative output and quality of the results, commitment and solidarity, true grit! And of course, we can expect that funds will not be embezzled and will be protected, and that there will not be a hole in the balance sheet.

The Cucumbers

Ah, the cucumbers! The story ends like this: the cucumbers were a public relation disaster for the European Union. I mean, you buy cucumbers frequently at your grocery store and “eurocrat bashing” is a nice topic to start a talk with your grocer or with your neighbor, isn’t it? So what has happened is that whenever we buy cucumbers, almost inevitably and with a smile we remember directive No 1677/88. It was this public joking that finally killed the standard. The EU was forced to withdraw the directive. Why is there no standard on cucumbers? –  Because we want other qualities from cucumbers than that they are straight. They can be curly, but they have to be healthy and tasty. This attempt of standardization was simply ridiculous.