The Humble Financial Report – Catalyst of Systemic Change
This post was originally published via the IFR4NPO website.
At Humentum, we are proud to be playing a leading role on the IFR4NPO project because it speaks to the very heart of our mission of helping the non-profit sector become more equitable, accountable, and resilient. In partnership with the Chartered Institute of Public Finance and Accountancy we are developing the first internationally applicable financial reporting Guidance for the non-profit organisations (NPOs).
The Guidance will certainly shape the future of financial statements (also known as the ‘annual audited accounts’) of NPOs. But, with many voices and forces coming in to influence its development, whose interests will be represented?
In our recent series of webinars, participants were asked to rank their reasons for preferring different accounting alternatives proposed for the Guidance. Based on the average results from about 150 people, it was encouraging to see that ‘No change from what I currently do’ was ranked last! The most common response was ‘Better and more transparent information’, which had strong consensus.
But it’s the middle ranking poll results where we see the beginnings of a real dilemma emerging. The second and third ranking priorities related to the technical aspects of conceptual integrity, and fit with the accounting framework proposed for the Guidance. The subsequent places related to the ease of use and implementation costs of new standards. As the Guidance is drafted, many of the choices could involve a trade-off between ease of use (which is related to cost) and consistency with the for-profit accounting convention. When these priorities come head-to-head, which should prevail?
Here are my personal hopes for the Guidance, and the priorities that will be shaping my responses to the consultation, currently open for responses until 24 September 2021.
The Guidance should accommodate the needs of all NPOs, but especially smaller NPOs in the Global South. It must be practical, simple to use and address common problems experienced by non-profit organisations, especially smaller local organisations implementing programmes or offering services for social good. These are the types of issues that we hear that cause problems:
- How to do accrual accounting when donors often require cash basis reports, particularly the expensing of donor funded assets.
- How to handle complexity over foreign exchange issues in relation to grant funding.
- How to recognise a donor’s contribution to overheads as both income to the organisation and a cost on the donor expense report.
- How to minimise the risk of a national tax authority perceiving a ‘surplus’ or unspent grant balance as taxable profit.
- While some of these issues are universal, we need to ensure that the concerns of larger northern NPOs do not dominate the conversation and direction of travel.
Transparent and consistent reports build the credibility and trust that is needed for funders and individuals to contribute financial resources, assets or time. We need robust guidance, respected by the accounting profession, that can help reduce current duplication of effort in due diligence and audits. And while we are at it – we have a not-to-be-missed opportunity to place more emphasis on the information needs of those impacted by an NPO’s work.
One idea presented during a recent review of the UK non-profit framework was to put the spotlight on expenditure as the item in the financial statements most closely linked to activities and impact. It was suggested to put expenditure above income on the Income & Expenditure Statement. This and other types of ‘outside-the-box’ thinking are exactly what we need to reframe general purpose financial reports for our sector so that they are relevant and useful, while continuing to respect fundamental accounting principles.
Financial reports need to tell us something about the real financial health of the sector. A key indicator of resilience is having a buffer to handle those times when a donor pulls out unexpectedly, or an unforeseen cost needs to be incurred. Holding an appropriate level of unrestricted reserves should not be a luxury available only to non-profits in wealthy countries. If financial reports can highlight reserve levels for this purpose, it would help shine a light on this important issue.
Many organisations fail to recover the indirect costs associated with the donor funded projects they implement. This reality means that NPOs often struggle to invest in the organisational structures and capacity necessary for increasing efficiency and leveraging economies of scale – let alone generating and saving unrestricted funds to grow their reserves.
The tendency for funders to pay for direct project costs, with minimal or no contribution towards the indirect costs of implementation and delivery has caused a starvation cycle. This cycle is felt particularly acutely by smaller southern NPOs who consequently find themselves unable to develop their own capacity and systems, meet due diligence requirements and qualify for grant funding. Consistent presentation of information about administration costs has the potential to fuel a more just and fair approach to cost recovery.
My hope is that our financial reports globally can focus first on celebrating the social good achieved, with transparency about associated costs and income. Information about organisational health and governance is key, as well as showing that any restrictions on the use of donations are honoured. And I believe that ease of use should not be sacrificed at the altar of conceptual flawlessness.
By developing guidance that supports the objectives of equity, accountability and resilience, we can leverage the humble financial statements as a catalyst for systemic change in our sector.
The IFR4NPO Consultation closes 24 September 2021.