Archive for March, 2013

„Our donor requires us to use the cash basis of accounting!“

Wednesday, March 27th, 2013

“Our donor requires us to use the cash basis of accounting!” – Ah, we know this outcry very well. Accountants from three continents mourn that these cruel donors force them into a certain not very understandable way of accounting, which makes all complicated.  This outcry is the beginning of a tragedy, an administrative tragedy. I will try to tell you this sad, sad story.

Once upon the time, at the end of the last millennium, a thoughtful Chief Accountant of a well-known donor organization, prepared a standard contract with grantees, and this contract serves up to now as the basic contract between this well-known donor institution and its grantees.  This wise master of accounting wrote in this template, waging well the words to be used: “Grantees have to keep the project funds separately. The project funds have to be registered in the books of the grantee. Generally accepted accounting practices have to be used.”

It is worth to read the lines carefully. Did this honorable person require that a separate bank account has to be opened? No. The anonymous simply wrote that “project funds have to be kept separately” – and he or she did not say how. Funds could be kept separately with a separate account in our books, not necessarily with a separate account in our bank. Did this honorable person require that the cash basis of accounting has to be used? No. Nothing about this is written here. Simply, generally accepted accounting practices (even not principles) have to be used.

Here, we have to mention two things: First, there are many generally accepted accounting principles (GAAPs) around the world: US-GAAP, UK-GAAP, Australian GAAP and many, many other national frameworks. Second, some national accounting frame-works offer different options: We may use the cash basis of accounting, the accrual basis of accounting or a modified accrual basis of accounting. What kind of accounting basis we actually use, is always a question of definition. And this is defined in the accounting policy or elsewhere. All this is, obviously, covered by the above mentioned agreement: “Generally accepted accounting practices”.  And this was very wise. The words of the Chief Accountant in the donor organization did not prescribe how accounts should be organized.

Now, our well known donor organization engages controllers. These people have the task to control. To control in accordance with which framework?  – This is the question here!  Well, in accordance with generally accepted accounting practices! It is understandable, that these controllers ask for further instructions. What is okay, what is not? Typically, over the years, these controllers develop the following tactic:  At the end of the day, it is important to know how much cash is left, and where it is. Consequently, they start to ask more and more about actual payments and cash flows. As a rule of thumb, we can say, that these controllers in donor organisations have no theoretical education in accounting. They hear the word “cash basis of accounting” – it sounds professional. And nobody knows what is exactly means.

Seen from a bird`s eye, the situation looks as follows: In the field, in the  grantee organizations, there are professional accountants who are used to use the accrual basis of accounting – at least to some extent. They register liabilities. They keep track of prepayments and receivables. All these words “liabilities”, “prepayments” or “receivables” create discomfort on the side of the controllers. To be exact: It is not only like this that they feel not very comfortable with these terms. It is also the killing question from the next higher controlling level. The superior controller may ask: “Where is our cash?” So, in order to say something professional, easily the word is said: “You must use the cash basis of accounting”. And cash, we think, is something that we understand?

It was not in the contract, it was not in the mind of the honorable person who wrote the contract. “The cash basis of accounting” is an administrative myth, arising from fears, misunderstandings and self-induced nonage. Please also note here, that the participants of the administrative play that starts now do not exactly know what they mean with “cash basis”. Do they want us, not to report liabilities? Do they think that prepayments are somehow also expenses? Believe it or not, but some controllers even say that prepayments to suppliers or advances to employees  or subgrantees are also project expenses! Consequently, we observe practices, which are clearly not a generally accepted accounting practice. To put it cynically: This nonsense is so popular in the NPO world that it is already a kind of prevailing disease.

And here are the administrative metastases of this disease:  The accountant on side, who keeps the books in accordance with generally accepted accounting principles, registers salaries when they were due (and not when paid). Salaries, taxes, social contributions, payments for health insurance are paid in the month after they are earned. Let us suppose  that the salary of the employees is distributed between different donors. Consequently the following procedures have to be established for one employee:

Salary (gross) as per books in month 1

–          Salary to be paid out for month 1 at the end of the month 1

+     Salary that was to be paid out for month 0 at the beginning of month 1

= Salary paid out in month 1 in local currency

This has to be divided into portions

A: for donor A, times the exchange rate required by donor A

B: for donor B, times the exchange rate required by donor B

and so on.

The same procedure has to be applied for

  • the unemployment insurance,
  • the pension fund,
  • the professional liability insurance,
  • the medical insurance, a
  • and all divided individually by employees!

At the rate required by the donor, this has to be charged to restricted funds.

This means: All processes have to be counted for a second time. It is clear that for this process a second accountant is needed. And so, as a result of this mythology, even in small organisations work two accountants: One for the accrual basis, one to feed the institutional hype of the donor organisations.

In the next step, these two accountants will develop their own style of work. Then, after a while, the two systems are no longer comparable; then contradictions arise, and the helpless directors ask themselves: Is this really a requirement? Was this intended?  Is this rational? Is this efficient usage of funds? Is this in accordance with the contract? Is this a generally accepted accounting practice? And the chorus of professional controllers answers: “You are required to use the cash basis of accounting”. They have no idea what they require. We really should ask ourselves whether this practice is acceptable. In my opinion, it is a generally not acceptable accounting practice.

I know an accountant in a small NGO. She is doing a very good job. In former times, she was a philologue, but political turmoil and social crisis made that she has to earn her living as an accountant. Here counterpart in the donor organization is an anthropologist; and the needs of life made that she has to work as a controller.

My deeply honored accountant cannot see that the problem between donor and donee, between accountant and controller, is a problem of language. It is one of the deep ironies that two persons who are trained for cross border communication, do not understand each other when it comes to figures. It would be so good to say to the controller:

“Look, what we want is to keep our promise. I keep track of what we have promised to you. What I promised is a figure, but this figure is not necessarily cash. It is more. You can see everything in our balance sheet. I am sure that you understand what a balance sheet is. You see the remaining funds of your project separately as a line in restricted net assets, on the right side of the balance sheet, not on the left side. What else do you want?

Why are you so cash-minded? This is no civil society approach: Civil society implies that we may enter into relationships, that we may trust each other, that we keep our promises. All these relationships are figures: What I owe to you, what you owe to me. It is natural to measure them. Not doing so is a kind of state-fixation that we know only from budget organisations. What do you think have we fought for in the last twenty years? I do not believe that you want to force us in this kind of primitivism, isn´t it?

You cannot require that we use the cash basis of accounting. Doing so would reduce everything only on one commercial paper: the one issued by state.  But look: We trust each other much more than we trust in the European Central Bank, for instance. For our needs, this cash perspective is too simplified.  I understand that you need this figure of remaining cash. We will keep track of all resources that we have. And I can break it down to the actual fund balance and, if you want I will draw up also a cash flow statement, using the direct method. What is wrong with this? Do not panic, have no fear that other may say that you are unprofessional. You can understand me, if you want.”

But we do not say this.

Frank Fabel, CPA