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

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

Civil Society and Accountability

April 23rd, 2013

“Civil Society means accountability”. Sounds good. Good election slogan. What is accountability? What is civil society? Is this interrelated? Is here something wrong?
Civil society is an amoeba, that came into literature in the late 18th century. Some people say that it is the leftover of ALL minus FAMILY, minus BUSINESS, minus STATE. Other people do not say what it is, but make themselves and others belief that that they know what it is by repeating the term all the time. Again others use it as a description of an Elysium, as something what has to be achieved. Some people use the term as an analytical category, others as an aim; and this makes it so difficult to agree on what it is.
When I first heard the word civil society, I thought: “What would be the opposite? Probably a martial society!” Civilians and warriors are usually considered to be antagonists, isn´t it? Here are the good guys, there are the bad guys – everything is clear. But is the world like this? No. Things are usually mixed. Thus, I looked out for warriors of civil society. I had not to search for a long time; I understood that politics is a kind of permanent fight in an arena, which we usually call civil society. I personally “liked” most of all this idea of civil society as a kind of arena, in which, we – actors, protagonists or gladiators, sponsored by different interest groups – fight for our lives by amusing the audience.
And accountability? Probably, accountability is the ability to account. Hence, there is this call for duty in the word: somebody has to account to somebody. Or, in order to stay in the metaphor used above: Accountability is one of the standard weapons that is used in the arena of civil society. To make this clear: Accountability is not a standard weapon in aristocracies, in tribes, in armies. Hard to imagine, how the entourage of Louis XIV would require that the sun king should report to the yard on his last travel expenses. Impossible to think that clansmen would require from the chief that he should draw up an inventory list. And an officer, who would answer on a command from his general with the sentence “Of course, we can take height 211 – we make you a special price” would either face military trial or psychiatric treatment. In martial societies, there is no deal, there is no choice, there is no freedom of contract – and consequently, there is no debit and credit. There are only budget decisions, and measures to enforce budget execution. The standard weapons in these “older” societies are draggers, sables or pistols on forty steps. As a rule of thumb, we can say that societies of non-accountability regulate their affairs not through accounting but through duels or bloodshed. Heroism is part of these societies. Heroism is not part of the civil calculation, as Hegel mentioned.
In our days, the request for accountability challenges authorities, without risking much. We can require accountability to the public from each and everybody, and in requiring so, there is no disadvantage for us. The risk is on the side of those who have to account. In a civil society, who has to account to whom? The citizens have to report their income to the state. State officials have to report to its citizens. Greenpeace requires Shell to report to the public. Members require Greenpeace management to report on the usage of funds. Directors require their employees to report on their work time. Trade unionists require employers to report on their financial position. Donors require donees to report on the usage of funds. Who is, in this arena, not accountable to nobody?
It is, in democracies, the people who is not accountable to nobody. This is probably the deeper reason why democracies have this ugly attitude to live on the account of future generations. Nobody can hold citizens accountable for their irresponsible decisions. Nobody? Ah, future generations can hold previous generations accountable for their sins. It is this time lap of 30 or 60 years that causes so much problems in our systems of accountability at the moment, I believe.
Accountability makes the arena of civil society bigger, by drawing spectators into the ring. Yesterday, Mr. Bill Gates thought, that he is only accountable to the tax inspection. Today, the public believes that Mr. Gates is accountable for the deeds of good, which he is doing. This means that not the donee is accountable to the donor, but the donor to the public. The same will happen to other institutions who thought to be only spectators of the fights, down there, in the sand of the arena. There is no place to hide even for the Churches. The Vatikan is subject to requirements of financial transparency – have we ever heard of this in the last two thousand years? The public even requires transparency in the secret service. And even Swiss banks are leaking. The hunger for accountability is breathtaking. It is accelerating.
The last extension of the civil audience was to give all internet users the possibility to raise their thumb – did somebody mention the coliseum like metaphor behind the “thumb up”-button of Facebook? The like-button makes that civil society is everywhere. Everybody could be drawn into the arena, at every moment.
But there is one tricky thing in this: You cannot expect from these gladiators that they respect the border line between arena and audience. At one day, the gladiators might jump over the wall and a handful would be enough to change the rules of the game. The interrelation of accountability and civil society is, it seems, not a stable one. On the long run, unlimited accountability may undermine civil society. The consequence is that a civil society which is interested in its stability should probably limit accountability. Is there a majority for this?

For reference we recommend C. Schmitt, Legality and Legitamcy , Duncker & Humboldt, 1st issue Berlin, 1932.
Frank Fabel, CPA

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

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

Non-Profit Tax Status and Usage of Funds in Other Countries

February 21st, 2013

A non-profit organisation collects funds in country A (let’s say: in Germany) and transfers it to an organisation in country B. Under which condition is this transfer compatible with the non-profit tax status of the donor organisation in country A? Under which circumstances is the non-profit status endangered? International literature on non-profit accountability provides a lot of information on values, but the tax perspective is often forgotten. The non-profit status is, after all, also a tax status.

In general terms, the non-profit tax status of an NPO has three possible financial implications, depending on the respective legislation:

a) Donors who give resources to the NPO receive an acknowledgement of receipt for the donation, which the donors may use in order to reduce their personal income tax.

b) The NPO is exempted from corporative profit tax. The excess amount of inflows over expenses will not be considered as profit.

c) In some legislations, NPOs are allowed to run enterprises. Even more, in some cases, the profit of these enterprises is tax free, as long it is used for the purpose of the entity, and/or VAT privileges are granted.

Evidently, these tax advantages are desirable for an entity. It is understandable that national tax authorities make these privileges subject to certain conditions. As a rule of thumb, many legislations link these privileges to a public benefit (with the exception of those legislations that are very restrictive towards the freedom of assembly). If the NPO creates a public benefit, so the common sense, the tax incentives are justified.

 In Germany, our interpretation of this overall principal is very broad. Our legislators decided that even building tiny aircraft models and testing them in public parks is – no kidding – a public benefit. And this results in associations of aircraft model makers being public benefit organisations in accordance with German law. As a result, our public parks are crowded with model planes, model hovercrafts, model racing cars. Model speedboats scare swimmers in the lakes. Model helicopters circle around people taking a walk. This example shows that the criteria of what is a public benefit are rather inclusive than exclusive in Germany.

Now, let’s move on to cross border accounting. If an NPO is testing small model aircrafts in other countries, is this also a public benefit activity in Germany? Does it matter whether the activity is a public benefit activity in accordance to the standards of the country in which the performance takes place? Would it endanger the public benefit status, if this activity was forbidden in this country? Okay, we must admit that our example is a bit absurd. (Only armies use small model aircrafts abroad, and armies do not need a public benefit status, as far as I know).

 Let’s take a look at another example: human rights. An NPO collects funds for defending human rights in country A and spends it in country B. Of course, defending the Human Rights Charter of the United Nations is an honourable thing, and accordingly, associations of this kind have undoubtedly a public benefit status in many countries of the world. If they support activities in countries where the state is less supportive, does this undermine the public benefit status of the donor? If you ask a question like this, most people will answer: “No, of course not. This was exactly the purpose why the funds were collected!”

However, if you asked a German tax inspector, whether it would be compatible with the public benefit status to support actions that are – in the framework of the state of performance – clearly and systematically illegal, he would be confused. The reason is that the tax inspector needs clear instructions, and not an ideological brain wash.

This is what our legislation says (Schauhof, “Handbuch der Gemeinnützigkeit”, 2005):

·       In case a German public benefit organisation simply exists in order to collect funds for another entity in another country, the statutes of the collecting public benefit organisation must contain a provision in its statutes that explicitly mentions the receiving entity. In any case, the receiving entity must have a similar status (i.e. a public benefit status in the country where the funds are received). The statutes of the receiving entity must be available and translated.

·       It is also possible to engage and to pay individuals in other countries, within the framework of the mission.

·       The financial administration requires that the usage of funds (which were collected in Germany) is not used “against national interests”, whatever this means. There is no special requirement, how the final usage of funds should be proven – the administration allows a “free style” reporting. (This regulation allows introducing a sense of cultural hegemony into administration. As long as the purpose of the NPO is somehow within the range of the public opinion, it seems to be okay!)

·       Compliance with laws is required. A systematic ignorance of existing laws would lead to a withdrawal of the public benefit status.

Compliance with laws is, of course, a condition precedent for the public benefit status. The question is: which laws? Typically, human rights organisations rather rely on superordinate regulations (the UN Charter, the national constitution), while their opponents, usually civil servants of the respective state, will use the full arsenal of detailed tax instructions. As a rule of thumb, we can say that human rights activists are not sacked because they are human rights activists, but because of allegations of tax evasion.

A single non-compliance with some law (either in the country of registration or in the country of performance) does, in our understanding, not justify the withdrawal of a public benefit status in the country of registration. The non-compliance must be systematic.

However, it could also be that the whole NGO sector in a country does not pay income tax on salaries – in tacit agreement. Is a donor organisation allowed to support such a practice, within its public benefit status? A strong defense could be that the non-compliance with laws resulted from the action of a person or another entity, not from the public benefit organisation’s activity itself. But did the supervisory bodies know about the practice? An audit report, indicating the non-compliance, is an argument that the controllers could have been aware of the non-compliance.

After this point, we lose track of the actual legal situation: It could be that local grassroots organisations exaggerate the dangers in the country of performance and would like to preserve their “Robin Hood” status (because of different reasons); or it could be that the dangers are real – people will actually go to prison for the sake of the mission. It could be that the supporting public benefit organisations are more or less “astroturf” NPOs , i.e. not real grassroots organisations of citizens, but extensions of the state apparatus of country A that would like to realize projects in country B. Or it could be that the supporting NPOs try to create mechanisms of self-regulation, as Alice Obrecht described in her briefing (“One World Trust”, July 2012). Who can tell under these conditions of what true grit is and what is not?

And here is the dilemma: The question of what public benefit means is a political one. Democracies have a tendency to extend the public benefit status so far that the original substance (“citizens organise themselves for a public benefit”) is no longer visible. The status is diluted, by including also non-citizens, or including  other than public benefits. The result would be that there is no longer is a clear notion of what can be regarded as public benefit.

 Like private drones in public parks.

 Frank Fabel, CPA, MA 

Governance in countries of limited statehood or in a hostile environment

January 3rd, 2013

Non-profit organisations are like a “civil society” in a nutshell. Members could be compared with citizens, having voting rights. The Board is a bit like a parliament, with control duties. Management is, in this comparison, like the executive power. The strength of NPOs is, to a large extent, that management is somehow controlled through democratic process.

Can NPOs exist in an environment that is clearly no “civil society”? Is it possible for a human rights organization, working in a dictatorship, to establish a system of checks and balances? Is it possible for a self-help group in a country suffering from civil war to be governed in a democratic way? Governance in a stable society is not like governance in chaotic circumstances. Of course there will be differences.

 In a hostile environment, i.e. in a surrounding, in which all activities of an NPO are carefully scrutinized by an over mighty state, the organization would, at least partly, try to work “under cover”. Internal affairs would be negotiated secretly – one cannot expect that all decisions are put into the minutes of the meetings of the Board. On the other side, the organization cannot expect that legal claims could be enforced with the help of the state. Consequently, the organization would rely more on other mechanisms in order to enforce its claims – usually these are networks of relations. This makes NPOs sometimes “opaque” – internal control is weakend. The decision making power might be focused on very view individuals – a system of checks and balances is mostly absent.

Please note that this process of concentrating power in very few hands is not necessarily an objective need. Due to my experience, it is more like this that all stakeholders (i.e. companions, supporters, beneficiaries) tend to allow this process to happen. Sometimes, there is a nuance of self-defense in this: It is better for the collective, if the permanent legal threat is limited to one or at least very few individuals. The person, who takes the lead, has more a feeling of a scarifying him- or herself, than of usurping power – this also contributes to this tendency. If fully developed, the relationship between leader and companions is by no means a contract in the framework of a civil code. It is a heroic pact.

However, it could be that these kind of conspirative behaviors survive even political changes. A habit that was acquainted in a period of harsh repression might be still kept in a period of thaw – unnecessarily, like an atavism. For a supporter or donor, it is sometimes difficult to say in which stage the organization is. Management has an interest to exaggerate the dangers of the hostile environment, because this enforces the individual power position.

Similar situations appear in countries of limited statehood. While there is no reason for conspiracy, anyway claims cannot be enforced by law. These cases lead to situations in which auditors may play a role as an independent arbiter in order to settle mutual claims. This has also an effect on the legitimacy of the auditors. The legitimacy is not created by law or by a process of certification, but by mutual consent of the parties under audit. In other words, legitimacy is generated on the spot. It would be worth to go deeper into this phenomenon.

 Frank Fabel, CPA

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Accounting of Grants to Sub-Grantees

December 17th, 2012

The situation: The association A receives grants from the donor D. Partly the grant is used for the needs of A, partly the amounts are given to sub-grantees S1, S2 and S3. The sub-grantees are located in different countries. The chief accountant of A decides to register the grant inflow as an income (an increase in restricted net assets), while he recognizes the transfers to the sub-grantees as an expense, when transferred to these entities. The sub-grantees account for the amounts received and send reports to A. A combines these reports with his own financial project report and sends the combined report to D, the donor organization.

The Director of A asks his Chief Accountant:  “Is our practice correct? Or would it be possible to register the payments to our sub-grantees as a kind of prepayment or advance, for which those entities have to account? Would it be possible to introduce their expenses as our expenses into our soft? It would be convenient for me, as I would see our project report as part as of our general accounting system. I would see who of our sub-grantees did not report in time. Is this second practice allowed or prohibited or recommended?”.

The Chief Accountant answers: “As you know, expenses have to be documented in accordance with the laws in our country. The documentation of our sub-grantees stays with them. On their invoices, their names are introduced. But we need originals and the invoices should show our address. Thus, we cannot introduce these expenses as our expenses. Moreover, the accounting of accounts receivables in other currencies is complicated, and I do not want to do this additional work.”

How is your position? Is the Chief Accountant right? Or would you support the position of the Director?

As we know, there is no guidance on NPO-accounting in IFRS. However, the anglo-saxon literature offers some advice:

The transfer from D to A has to be registered as a contribution to A, if A has variance power and if the transaction is not an exchange operation – this is the position of US-GAAP. Obviously, the operation is – in this case – no exchange operation: There is no sign that cash is given from D to A for services rendered by A to D. Consequently, the only remaining question is: Has A variance power? In the example above, this is not explicitly said.

If A has no variance power, the respective booking would be

Debit Cash         Credit Liabilities to S1, S2, S3

In other words, A acts as a mailman or like a bank. Cash comes in, cash goes out, nothing else. The operation is recognized as an agency transaction.

If A has variance power, the inflow has to be registered as a contribution with

Debit Cash         Credit Restricted Net Assets

when received.

But what happens on the expense side in this case? Should we register the payment to the sub-grantees as an expense when given to them, or when they report to us?

In the introduction, the Chief Accountant uses one argument: That the underlying invoices of the sub-grantees are not an acceptable evidence to him, and thus, he cannot introduce these documents as expenses of A. This argument is misleading. While it is correct that the invoices of the sub-grantees cannot be introduced as expenses of A, the reports of the sub-grantees can: A financial report is also a financial document. This financial reports from the sub-grantees to A exist as an original and they are (hopefully) addressed to A: So the Chief Accountant may accept this financial report as an expense document – after examination of these financial reports.

There are good arguments for registering the reports of the sub-grantees as an expense:

·       It is not logical, why the inflows should  be registered as an contribution, but then the outflows to the sub-grantees flip back to the simple “cash in – cash out” scheme. In this case, nothing is won in relation to the mailman approach.

·       If A has variance power this would also mean that A has a duty to control. A should take care of the usage of the funds given to the sub-grantees. This would mean that the reports from the sub-grantees to A are controlled by A. If the reports are not acceptable, A should register its claims against the sub-grantees in its books. Not doing so, would be carelessness or negligence.

The last argument of the Chief Accountant, that accounting of receivables in other currencies is to complicated, does not prevail.

In other words, the argumentation of the Chief Accountant is wrong. The way of thinking of the Director is right, in my opinion, because it is closer to the substance of the underlying transaction.

Frank Fabel, CPA

P.S. The report from the sub-grantees to A could appear in the form of a pro forma invoice. I am not against such a practice. A pro forma invoice makes clear that the document does not merely consist of a list of incurred expenditures. Also other effects could be added to an pro forma invoice, like: different exchange rate schemes, administrative charges, bridging calculations like add-backs for investments or subtractions like depreciation. A pro forma invoice is a document that links our bookkeeping registers with reporting to the donor. If done regularly (for instance, monthly), this could be also a good basis for an ongoing grant monitoring.


Audire or Audere: Does Auditing mean “to listen” or “to dare”?

July 1st, 2012

What is auditing? Many books and websites explain that auditing is derived from the Latin word audire.  Audire means to hear or to listen.  Audio: I hear.  Audis: You hear.  Audit: He, she, it hears. And so on.  Other sources surprised me: The word is supposed to be derived from the Latin root “audere”: to risk something, to dare.  Audeo, audes, audet, audemus, audetis, audent.

Both versions stimulate the imagination:

Yes, auditors should listen to their clients – they should not demonstrate their superior knowledge of financial matters in endless monologues. To listen: This should be the heart of our profession, shouldn´t it?

Or: Yes, auditors should dare to speak out what is necessary to say; they should not write or say what everybody would like to hear.  Sapere aude! – Like Horace, Kant and later Foucault said: Dare to know! This also is the very heart of our profession, isn´t it?

But how can we have two hearts in our breast?  What is at the root of our profession: The ability to listen or the ability to dare?

We all know other words deduced from the Latin root “audire”. An audio cassette is a device to hear something. An auditorium is an assembly of people who listen. An audience is a kind of hearing.*  My good old school dictionary, the Stowasser (Munich 1971), determines: Auditor, auditoris, m. hearer, listener.  In etymological terms, the question seems to be more or less clear** : The audit is a one way ticket of reception. But is this all?

A hearing could have different meanings: It could be hearing oppressed statements under torture –this is probably what a sadist would like to hear;  it could be hearing a confession in the confessional – this way of hearing is the task of a priest; it could be hearing the complaints of a patient – doctors have to listen to those;  it could be hearing the lies of a client – lawyers are trained to listen to those; or it could be hearing the secrets of a friend – this would be the duty of a friend. We all know auditors, who act as if they are torturers, priests, lawyers, doctors or good friends, don’t we?

On the other side, there is no hearing without questions. There is no hearing without conclusion in the mind of the listener. I suppose  it is not by chance that the Latin words “audere” and “audire” are so similar. In fact, both activities are interlinked: If you dare to put the right questions, you may listen to a meaningful answer. If you listen carefully, you will find the right questions. If you make a conclusion, it is sometimes challenging to tell the insight to the client. The way of finding the truth is a dialogue.

There are different modes of discourse (as Foucault said) which reach from inquisition to the most tender notions. Foucault even supposes a highly developed practice of listening and daring in the Greco-Roman culture. It seems as if in the ancient world, these elements were more closely related than in our world.

Which element in auditing is more important – sensitivity or bravery – I dare not say. But usually, I do not find these qualities in standard audit work papers. As our comedian W. Neuss said: “It is not sufficient, to have no opinion; moreover, you are also required to be unable to express it.”

Frank Fabel, CPA, MA

*  Less known:  When the German car engineer Mr. Horch left the Horch-factories, he founded a competing car manufacturing company. Because of trademark rights, he chose the Latin translation of the German word “horch!” for its name, which is “audi!” or “listen!” in English. In other words, if you drive an AUDI, you drive a car with the name “Listen!”.

**…  “The verb is attested from 1557.  Auditor id attested from 1377, from Anglo-Fr. auditour, from L. auditorem (nom. auditor) “a hearer,” from auditus”. Some sources use the word “audere” in the meaning “to hear”, “to listen”.

How to expense Funds before they are received? An Experience from Croatia

June 12th, 2012


Cash is cash, and trust is trust; and, of course, we are not so cash-minded that we only trust into the US-dollar. First of all, we trust into each other, isn´t it? 

Thus, the question arises: May I spend funds before I received them in cash? I mean, when I trust into the integrity of my donor, why should I not belief into his promises. I could take cash from my unrestricted funds or from other donors to prefinancance other projects – why not? However, there is a problem, how to book these expenses. I would like to book them against a receivable from the donor. If I do so, I should probably book all trust worthy receivables from donors into my balance sheet. In this case, many accountants would panic. Isn´t this a overestimation of our financial position? May I be charged with financial fraud? Panic, panic, panic!  So, better to book only in these very special cases a receivable… However, then, I would create an inconsistency: Sometimes, I would book a receivable, sometimes not. This is also not nice. What to do?

 When one of our clients in Croatia faced this problem, the following discussion emerged between me and my deeply honoured colleague from Rijeka, Mr. Boris Vidas, which we would like to document here:


 Dear Boris,

 I would like to make the following bookings:

 a)            When the project contract is signed

Debit agreed rights                                    Credit contractual duties to perform

And in order to calm your nerves, this should be a back-balance sheet account.

 b)           When amounts are expensed (before cash from the donor is received)

 to book the expenses:

Debit expense account                               Credit cash/accounts payable

To book the receivables from the donor on the basis of a monthly report:

Debit receivable from donor                     Credit restricted net assets

Debit restricted net assets                         Credit Revenue (a reclassification booking)

 And of course a memory booking in order to reduce the amount of contractual duties

Debit contractual duties to perform        Credit agreed rigthts (memory entry)

Note: Revenue and expense can be different as the report to the donor might have other regulations (other exchange rate or other accounting basis). In fact, the report to the donor is very similiar to an invoice. The comparison of revenue and expenses show whether the project handling was efficient.

 c)           When cash is received from the donor:

Debit cash                                                     Credit receivables from donor 

Please write down your suggested bookings. You mean that these advance payments would be first reduce our unrestricted net assets, and later, when the restricted funds are received, they should be classified somehow as unrestricted revenue?

I would say that, in this style, the financial position is underestimated, and that there is a risk that receivables are lost, because they are not recorded. This is certainly no good idea.

 Are  you allowed to book revenue, when collection is reasonably assured? I mean, we have very little reasons to believe that our donors are less reliable than commercial firms.  Look, a default of the church is less probable then a default of General Motors, for instance. This is a difference in stability (2000 years against merely a century). So why not?

Also, we could say, that project contracts are LONG TERM contracts, similiar like construction contracts. This would also allow a kind of“ completion of contract method“.

However, these are only auxiliary arguments. The main argument should be: The above indicated booking gives a true representation, while the regulation in your Croatian instruction does not give a true representation. In these cases, we should stick to the booking that would give a true representation. The booking could be supported be a reconciliation between grantor and grantee, in which both sides agree on the receivable.

Yours cordially, Frank



Dear Frank, 

I just wanted to discuss with you the unrestricted and restricted revenue recognition.  I went now through the law searching for the revenue recognition criteria and I think that Article 20 is very precise in defining how revenues can be recognized.

Article 20 of the mentioned law deals with revenues and in paragraph 1 it states: 

– recipročni prihodi (prihodi na temelju isporučenih dobara i usluga)priznaju u izvještajnom razdoblju na koje se odnose pod uvjetom da se mogu izmjeriti neovisno o naplati // Reciprocal revenues or (revenues arising from provided services or sold goods) are recognized in the reporting period to which they relate provided that they can be measured reliably regardless of their collection

– nerecipročni prihodi (donacije, članarine, pomoći, doprinosi i ostali slični prihodi) priznaju u izvještajnom razdoblju na koje se odnose pod uvjetom da su raspoloživi (naplaćeni) najkasnije do trenutka predočavanja financijskih izvještaja za isto razdoblje // Non-reciprocal revenues (donations, membership fees, supports, contributions and other similar revenues) are recognized in the reporting period provided that they are available (collected) at the latest at the time of submitting the financial statements for the reporting period. Basically, it means that you can recognize revenues, for example as at 31 Dec 2011, if they are not collected but they must be collected at the date when you are submitting the FS (for example 30 April 2012). Therefore, in case that grant revenues are not collected they cannot be recognized.

 So in my opinion the bookings that you are proposing should be amended in the step b) when dealing with the revenues – Debit receivable from donor  Credit revenue can only be made if donation is collected, if not, they stay off-balance sheet until the cash is received.

 What do you think?

 Best regards



Dear Boris, No, no, no! Doing so would be totally state-minded. I mean, we work here in the non-governmental sphere – the indicated treatment would be okay for budget organisations, but not for organisations of a true civil society. It is an indicator of civil society that people enter into agreements and may trust each other. It is not like this that we have only to accept state-paper as only valid commercial paper. And, let me say this: Sometimes a word of my neighbor has a higher value than some kind of state promises! Thus, because the regulation does not give a fair representation, we must ignore it.

 Yours cordially,




 Dear Frank

 I am sorry for not replying earlier but it is very busy these days with all reports that are going out.

 Anyway, I could not agree more with you on your argument that we should stick to the booking that would give a true representation, however, I was just pointing out what the current law says and this is just a confirmation of the fact that the law is very deficient in this respect. My point is that under current situation people who prepare FS for NGOs in Croatia and who in most of the cases do not take substance under the form will argue on the grounds that the law is specific and says that revenues from donors can be recognized only if collected.




 Dear Frank and Thomas,

 just to update you on the news in Croatia. It seems that our new Government is planning to change and introduce new law on accounting for non-profits. The thing is that people over here are quite unhappy about the fact that enormous amounts of money (7,4 billion HRK in period from 2006.-2010.) from the state budget are given to non-profits and nobody is checking how this money is spent.

 Best regards



NOPA @ google +!

February 5th, 2012

NOPA is now available at google +. This gives the possibility that readers register as followers (you will be updated on all changes at the site). Moreover, you have the possibilty to contact other readers of the forum. Write an e mail to  for further information.

The balance sheet as a frozen picture

February 5th, 2012

I still remember the time when, in my first year as a responsible director, I had to draw up a balance sheet. I still remember this as if this was yesterday. It was not only the figures: It was more the process of calming down, to look into a mirror, and to reflect and think about what you have done in the last year that fascinated me. It was so calm in the office  that was usually boiling at full speed, and so it was in nature. Nature in Europe supports the process of drawing up a balance sheet: If it is below zero, it is easier to create a frozen picture of yourself and your firm. Could it be that the process of drawing up balance sheets as of 1 January is a bit Euro-centric view?

Thus, I would like to ask the readers of the NOPA-blog, to give me the chance to talk a bit about Euro-centric thinking. Just in front of me, I have a book of Michel Foucault, “Le courage de la verite” (“the bravery of the truth”, it should be in English), Paris, 1984. Of course, it is not a book that is written exclusively for auditors. But, I think, it is a good introduction for non-Europeans to understand, which difficulties Europeans have with the truth.

I mean, everybody has difficulties with the truth, not only auditors and not only Europeans. In this book, with a surprisingly understandable language, Mr. Foucault explains under which conditions it is possible to say the truth. And thus he has to go back to Socrates. Here is the story in short: Socrates, a citizen of the city of Athens in ancient Greece, was famous for drawing other citizens into conversations with the aim that his partners in conversation would better understand themselves. Though Socrates stayed away from politics, his behavior was suspicious to the young Greece democracy. The democratic authorities accused him of “attempting the Gods”, of course an accusation that could mean everything and nothing. 

In his famous defense speech, Socrates claimed that in the public there is no possibility to say the truth. The truth is, in his understanding, something that you can say about your partner in conversation that enables him to better understand himself. Why there is no possibility? Because in the public, always the yes-sayers will win. Why it is like this? Because in the public, there is no ethical differentiation. Thus, those who talk in favor of the majority, have always an advantage. This can be very uncomfortable to persons who would try to draw the audience to a different, critical point of view. In other words, Socrates talked about the difficulties, the risk, and the duty to say the truth against the mainstream opinion. To say the truth against the mainstream is, of course, a challenge for the legitimacy of the current order. The result was that Socrates was sentenced to death.

From this shocking event, his pupil Plato made the following conclusions: If it is not possible to say the truth in the public, then the philosopher has to switch to consulting services (in order to bring wisdom into the stupid world). His first consulting engagement was in Syracuse, where he tried to explain the principles of good governance to a dictator, named Dionysus. Dionysus was so offended by hearing the words of Plato, that he immediately decided to punish the consultant. Plato had to flea his client, he escaped on the last Triera (a Greek ship) in the harbor. In commercial terms, his consulting job was not very successful. However, it was the birth of European philosophy. This may serve as a consolation.