Archive for June, 2013

Donor-driven accounting systems vs. mission-driven accounting systems

Tuesday, June 4th, 2013

By earmarking project and overhead costs, documents in an organisation can be linked to one donor. That is why we call these systems donor-driven. With this technique, donors and donees try to guarantee that expenses are not double-charged to different donors. However, this technique is only a default version. There are better systems available.

These other systems could be described as mission-driven accounting systems: First, the NPO draws up its programme, then donors are invited to take part. Different donors may take part in one programme. Every donor is required to pay a fee for the administrative overhead. Consequently, expenses are allocated to programmes and to the administrative overhead. In this system, it is not possible to say, which document is linked to which donor. It is also not possible to say, which donor paid for which liter of water, which kilowatt hour and which telephone call. However, the organisation and also the donor gain an overview on the whole programme. It would be possible to say: “Our admin costs amount to 10 percent of our programme expenses, and every donor contributes evenly to this percentage”. Measurement is usually done “in accordance to our accounting policy”, which should be known to the donor.

A. Donor-driven systems

In donor-driven systems, everything is separated. There are separate bank accounts, separate petty cash, separate documentations, separate reports, separate audits. As a rule of thumb, these separations come with negative side effects:
• Documents are kept according to project and not how it would be expedient for streamlined administrative procedures
• Cash is kept strictly separated, but typically, in times of low liquidity, cash is borrowed from one project cash to the other.
• Sometimes even separate accountants or finance managers are engaged who exclusively work for the individual project.
• The usage of the project funds are reported in a separate format; and these reports are sometimes not derived from accounting.
• Finally, these projects are audited separately.
In extreme cases, donors may even have their own employees in the organisation to whom they give direct work orders. It goes without saying that this approach does not lead to self-sustainability. The borders of an organization are weakened.

B. Mission-driven systems

An accounting system in the self-interest of the grant-receiving organisation would look different: there would be one basis of accounting, and this would be probably full accrual. There would be one way of documentation. There would be one cash and one operative bank account. There would be one financial manager, supported by assistants. All administrative procedures would be organised according to the needs of the organisation. Capital (or let´s say “net assets” or “accumulated funds”) would be divided into restricted and unrestricted net assets. Project reports would be derived from general accounting. In such a system, everything is unified. There are no separate procedures for one donor. Donors would receive (maybe even audited) overall financial statements, with a segment report included.

Of course, it would also be possible to realize in parallel the ideal solution, mission-driven accounting, and the default version – and some organisations even do so. However, in such a coexistence of systems, the administrative costs are high. Moreover, the evolving categories are too specific. For instance, the system would “claim” that a certain electricity bill belongs to the administrative overhead category and is somehow linked to UNDP funds or the like. However, the statement “The UNDP paid for this electricity” is – strictly spoken – not verifiable.

Advantages and disadvantages of both systems

• If executed completely, with a 100 percent segregation per project, the donor-driven systems give a high assurance that the project cash resources are still available. Although these systems cannot prevent fraud or abuse, at least they give “some assurance” that the cash was indeed not allocated to other purposes by error or liquidity needs.

• Donor-driven systems have a negative impact on the administrative capacities of organisations. As everything is separated, the administrative unity of the organisation is threatened.

• The mission-driven approach gives an overview on administrative expenses. This overview is not generated in the donor-driven approach. The donor-driven approach creates the illusion of an overview. Frequently, we see the phenomenon that in the micro-perspective of a project, everything is okay: A separate report, a separate cash, a separate audit. However, if we put all project reports of the organisation together and draw up a balance sheet, it turns out that funds were used for other than the intended purposes. As long as you do not see the balance sheet, you do not see this effect.

• Mission-driven systems require a higher initial investment of the NPO. First budgets have to be drawn up, and, at this point, it is not clear for the organisation leaders, whether there will be financing for these programmes or not. A donor-driven solution is – in the beginning – easier: Projects are executed on demand. Budget forms are already prepared by the “ordering party”. These are, however, only short-term advantages. A general approach with unified procedures is by far more efficient.

• Many budget organisations love a hundred percent segregation of cash, because it allows them to apply FIFO for the evaluation of expenses in a foreign currency. In FIFO, no evaluation gains and losses occur. However, the price for this technique is high. In most cases, national accounting in the country of performance will differ from this approach – the work has to be done twice.

• As it is evident, mission-driven systems serve more the mission, donor-driven systems more the short-term administrative needs of donors.

Why is donor-driven accounting so popular? I fear that the deeper reasons lie in some shortcomings of the human nature. In the interaction between donor and donee, servility might be more honoured than an open word. Both sides might agree on a relationship in which one has power and the other appeals to his or her grace – a pattern which is supported in many cultures. Middle management on both sides might develop a work style that is dominated by the fear of wrongdoing. The intuitive desire of the clerk in the donor organisation may appear like a “must” to the donee, and so on.

But why is this general tendency not stopped, as it is so clearly counterproductive? There are two reasons for this: first, management might feel (sometimes half-consciously) that there is a personal advantage, if administrative costs are not measured as a whole. If every donor pays a portion of the salary of the director, who will ever find out how much he earns? If directors defend the donor-dominated status quo furiously (against the interests of their own organisation), the conclusion that there might be a portion of self-interest in this argumentation is not so far away.
Second, there is a self-enforcing mechanism in donor-driven accounting. Would the organisation measure the real administrative costs, it would be evident that donor-driven accounting is no good option. If admin-costs are not measured, there is no reason to cut them. The donor pays for the administrative burden. Why should an accountant protest against this?

Overview on the General Practice

It is actually a myth that donors explicitly require a strict earmarking, as you will see in the following table. We have added here a list of bigger charities and donor organisations, with a classification of their reporting requirements:

(see attachment)DDD list

As is demonstrated by this, naturally incomplete, list: not one of the listed donors requires an explicit and exclusive earmarking. Co-financing is in most cases possible. The problem is more in the second column. Many grantors do not explicitly allow an admin charge (In some cases, you simply have to ask, and then it is allowed). The EU grants a 7 percent charge in most contracts. USAID requires that admin costs are first measured; then, they can be charged. SOS KDI agrees on administrative budgets with the local associations. UN structures use the admin charge widely.

Other smaller grantors do not allow the admin charge; however, they allow the programme approach (for instance in a co-financing of programmes). This is a “funny” combination! How should a receiving NPO react to this? One answer would be to allocate the individual documents for administrative expenses also to the programmes. This evidently does not add to transparency – the difference between administrative overhead and programme expenses is blurred. To allow co-financing agreements and to require an earmarking of administrative expenses is, in essence, a contradiction in itself. This logical contradiction does not prevent the widespread application of this technique.

In many cases, the reason behind this contradictory behavior is that the donors are themselves agents or middlemen. Their back donor is frequently a state or government, and this means that they fear the auditor general. Fear from superiors is always the strongest trigger for donor-driven accounting, I would dare say.

As a rule of thumb you can say: the bigger the donor, the more frequent is the programme approach. On the other hand, the Global Fund discussed recently whether the general admin approach is not too liberal. The reason is that the GF programmes are so big that even a modest admin charge gives local management many possibilities for uncontrolled allocation. As a result, a combined system may evolve: admin costs are measured in a holistic way, but certain positions (for instance the salary of the director) are nevertheless limited in bilateral agreements. In small organisations, with a functioning board, this problem is not so virulent.

One more remark: Sometimes, co-financing agreements appear as donor requirements. For instance, the EU might require that “we will give support only if you find other support”. In a sense this is an echo of the original mission-driven concept, which comes back as a donor requirement. Many directors do not understand the original intention; they understand it as “one more bureaucratic requirement”. It would be more healthy if a director reacted with the words: “Great, finally a donor understands the nature of our work!” However, the first reaction is the usual one.


The donor-driven approach is only useful if the recipient is not able or not willing to keep a sophisticated accounting system. In all other cases, we should encourage controllers and management that they dare make the step into a holistic accounting approach. Switching to a mission-driven accounting system is better for both donors and donees, because it provides a clear overview.

Frank Fabel, CPA