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AccountingAICPA SOP 98-2 and its Impact on Financial ReportingSummary:Rules that took effect 12/15/98 require organizations to screen activities carefully if they include a fund-raising appeal and are not classified as fund-raising in the accounts; three writers explain the background. Answer:Later, Putnam Barber <pbarber@eskimo.com> posted this commentary to the same list: Mr Cassidy and others have been vociferously objecting on behalf of some nonprofits to the standards contained in the draft revisons to SOP 87-2 for a long time now. (The "87" in the name means, I think, that this standard was first proposed a decade ago.) Their objections have not been accommodated by the AICPA (at least not to everyone's satisfaction) and a new Standard of Practice is about to be issued that will require significant changes in the way allocation of joint costs is done by organizations that want to follow Generally Accepted Accounting Practices (GAAP) in preparing their financial statements. Note: The new rules were published at AICPA Standard of Practice 98-2 and took effect on December 15, 1998. It may well be true that the new SOP on this complex set of issues suffers from the defects Mr Peters describes in his email above ("vagueness, lack of ability to operationalize, and general misguidedness"). I don't have experience with trying to allocate joint costs. This is a highly technical issue, and I doubt that those who are the intended beneficiaries of the new rules understand the issue enough to care about it. Probably someone closer to this issue can do a better job than I of describing what's at stake here. Indeed, part of the point of this post is to try to start a discussion about what these standards are going to mean for scrupulous nonprofits once they take effect. BackgroundHere is my attempt at providing a fuller briefing about what's going on. Many organizations that expend a lot of money communicating with the public have adopted procedures that "allocate" (that is divide) these expenditures among the three standard "functions" (administration, program and fund-raising). The effect of these procedures has been to allow the expenditures described as "program" to include a portion -- often a large portion -- of money that had been spent on direct-mail, telemarketing, canvassing, and other techniques for reaching relative strangers with appeals for support. Being able to do this sort of allocation is important because of the attention paid to the "Cost of Fund-raising Ratio" (CFR) by outsiders.
What's going on now?Why does the publication of revisions to SOP 87-2 excite this kind of attention? As I understand it, what the revisions say is that fund-raising is fund-raising and should be called fund-raising when financial statements are prepared. (Here's a taste of how it does this: One of the examples declares that if any consideration is given to "potential financial yield" when selecting a list of addressees for an appeal, then all the costs of preparing and sending that appeal are fund-raising pure and simple; no "allocation" allowed!) AICPA, that is, sets very restrictive standards for allocation of joint costs. Organizations which have been allocating many expenses out of "fund-raising" into "program" (or less frequently "administration") will not be able to do that any longer. Not if they want "clear" audits from members of the AICPA and those who follow its rules. So? Fund-raising costs money. We all know that. Without fund-raising, many worthy enterprises would simply be impossible. We all know that. When these revised rules hit the books -- starting with fiscal years ending after 12/15/98 -- many familiar organizations will be affected. Further, organizations vary widely in the degree to which they depend on the kind of activities defined as fund-raising in the SOP. Those that rely heavily on such activities, but who have been allocating many of those expenses to "program" under the old rules, are going to come out looking bad when the new rules take effect. They are going to look bad absolutely -- because of high CFRs. And they are going to look bad compared with their own history -- because the change in reported CFR is going to be sudden (and, in some cases, drastic). The CFR is not a good measure of effectiveness, bona fides, or even efficiency. Instead of dealing with that problem, though, nonprofits have invested vast amounts of creativity and bookkeeping time making sure that CFRs are adjusted to give the desired appearances. (Some just plain shabby efforts have been spent doing this as well: remember the "surplus goods" collectors who swapped their inventory around from organization to organization -- without even bothering to move the goods -- so that each could claim donations to the others as a "program" expense. They got caught.) Yet in the end, the CFR does get at something. An organization with a long-standing CFR of 100% just doesn't meet the "how do you tell your mother" test. There are too many stories of organizations that are content to receive a tiny fraction of the proceeds of fund-raising done on their behalf -- this devil's bargain appears to be that if "we" don't have to think about the fund-raising at all, then we also don't have to worry about any sums of money which donors think support our services when we know very well we will never see most of what has been collected in our name. And there are a few well-documented cases of "shell" nonprofits operated for no other reason than to provide a vehicle for aggressive fund-raising: The "National Kids Day Campaign" of precious memory raised millions of dollars (and those were mid-century dollars!) "because raising money is a good way to increase the public's awareness of the needs of kids." Actually doing something about the needs of kids was, apparently, somebody else's problem. What now?Now we are going to have standards that move the boundary line sharply, that require scrupulous organizations to show larger expenditures for fund-raising or to change the way they do business to accomodate appearances in their financial statements. The result may well be a long-term benefit. But the immediate effects are going to be disruptive. And there doesn't seem to be any preparation underway. There is no evidence that the watchdog groups are revisiting their standards with an eye to adjusting them. I've seen not a word in any appropriate medium about what might be done in advance to educate the public, the donor community, the administrators of cooperative campaigns, any of us, about the effect of these rules. (Note 8/9/99: The Philanthropic Advisory Service of the Council of Better Business Bureaus is undertaking an eighteen month study of all its published standards and has assembled a large advisory committee from throughout the nonprofit sector to assist. See http://www.give.org/srp/ ) Worse, it's not clear what the "education" should say. We don't have frank, candid and illuminating discussion from a public-benefit point of view of functional expenses, joint costs, cost-of-fund-raising-ratios, and all these related issues. Without it, even careful observers don't know what to think. It is unlikely that people whose interest in charitable activities is restricted to writing a few checks a year -- or tossing coins in the jars next to cash registers -- are going to give this issue the kind of scrutiny the pro's haven't been able to muster. Putnam Barber Seattle Mr. Peters' post, quoted above, also contained useful interpretations of some of the alphabet soup used in these discussions:
Washington, DC, based accountant Margaret DeBoe <mdeboe@aol.com> added depth to this discussion with a note, also posted on February 26, 1998, under the title: A little history would be helpful. The following is an excerpt from an expert witness report I recently prepared in connection with a lawsuit involving joint costs. Cite references appearing in the original have been dropped, but if anyone if really interested, I'll be glad to supply them. The original, 1964 edition of the "black book" (Standards of Accounting & Financial Reporting for Voluntary Health & Welfare Organizations), addressed the method of accounting to be used when efforts were undertaken that included elements of fundraising combined with elements of program services and/or management and general functions. This method came to be known as the primary purpose rule. "[Under the primary purpose rule] all joint costs involving fund-raising costs are charged to fund-raising expense except for those incremental costs directly attributable to a separate educational or other informational material or activity. For example, only the incremental costs of joint mailings, such as the direct costs of an educational pamphlet, are charged to functions other than fund-raising; all other costs, such as postage, are charged to fund-raising expense." The AICPA's subsequently-published A&A (Audit and Accounting) Guide for Voluntary Health and Welfare Organizations ("VHWOs") also adopted this method. However, in 1978, SOP (Statement of Position) 78-10 introduced the concept of allocating such costs. This was done because many accountants and industry representatives were concerned "that the primary-purpose concept may cause fund-raising expense to be misstated." SOP 78-10 stated: "If an organization combines the fund-raising function with a program function (for example, a piece of educational literature with a request for funds), the costs should be allocated to the program and fund-raising categories on the basis of the use made of the literature, as determined from its content, the reasons for its distribution, and the audience to whom it as addressed. " The AICPA's 1981 Audit Guide for nonprofits described in SOP 78-10 reinforced this concept by declaring, that: "The cost of printed material used should be charged to program service, management and general, or fund-raising on the basis of the use made of the material, determined from the content, the reasons for distribution, and the audience to whom it is addressed." Thus, in the late '70s and early '80s, the accounting profession and the nonprofit industry were coming to the realization that the primary purpose rule was bad accounting. From an accounting theory point of view, if a mailing had more than one purpose, the costs of the mailing should be charged, in an equitable method, to all functions involved - a concept that came to be known as the joint cost rule. Despite the fact that this rule represented the latest thoughts of the profession and the industry, however, it only specifically applied to those "certain nonprofit organizations" covered by SOP 78-10, not to VHWOs, Colleges and Universities, Hospitals or Government Units. Thus many charities felt bound by the primary purpose rule while many others did not and a disparity grew between various types of organizations with similar traits. There was increasing pressure on the accounting profession, by both accounting professionals and the affected nonprofits, to broaden the joint cost rule to apply to all nonprofits. There was similar, but opposite, pressure to stay with the primary purpose rule coming largely from the charities regulation officials in various states and, to a lesser extent, the Internal Revenue Service. The AICPA thus undertook an effort to promote consensus among the various interests so that uniform guidance could be developed. I was a member of the AICPA's Nonprofit Committee during part of this process and served on the sub- committee that negotiated the agreement among the various interested parties that ultimately resulted in the issuance, in August 1987, of Statement of Position 87-2, "Accounting for Joint Costs of Informational Materials and Activities of Not-for-Profit Organizations That Include a Fund-Raising Appeal." SOP 87-2 superseded the guidance in all previous publications and clarified the circumstances under which it is appropriate to allocate joint costs, namely, "...if it can be demonstrated that a bona fide program or management and general function has been conducted in conjunction with the appeal for funds, joint costs should be allocated between fund-raising and the appropriate program or management and general function." One example provided as a situation where the allocation of joint costs would be proper accounting said "it may be appropriate to allocate such joint costs [where a] voluntary health and welfare organization describes the symptoms of a disease and the action an individual should take if those symptoms occur." Contrary to the opinion of some (mainly professional fundraisers and certain organizations that do a lot of mass media solicitations -- the source, by the way, of the vast majority of the negative comments received by the AICPA), the new SOP (98-2) does not change any of the rules contemplated in SOP 87-2. It clarifies what was the original intent of the accountants, state charity regulators and nonprofits who were involved in the drafting of 87-2. Consequently, it should make all joint cost allocations more consistent among various organizations conducting mass media appeals. Margaret DeBoe, CPA Rubino & McGeehin, Chartered Bethesda, Maryland (301) 564-3636 Posted April 9, 1998, by Putnam Barber; updated 8/9/99; 5/9/00; address for Lee Cassidy updated 6/19/01 -PB |
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