2 Accounting Issues You Need to Understand
Such a characterization is patently false. Those charities with the greatest impact tend to be those with the best management and the most effective fundraising. Not surprisingly to anyone familiar with either the business or nonprofit worlds, the most successful management and marketing programs cost money. Thus, the way to judge a charity is not on overhead ratios (high or low), but rather on the effectiveness of the organization. The most important metric is the outcome of its programs. Other important metrics can include its growth, the quality of its management and, of course, the importance of its mission to the donor considering where to give.
A bedrock principle of accounting (also recognized by the IRS) is that many expenses need to be subdivided into categories. For example, if a person oversees a nonprofit’s operations but also teaches literacy, her salary needs to be divided between administration and program. The cost of a brochure, video or mailing that advocates for recycling but also invites people to give should be divided between program and fundraising.
The acknowledgment that some expenses fit into more than one bucket is called joint cost allocation. The American Institute of Certified Public Accountants (AICPA) in its Statement of Position 98-2 developed guidelines to help nonprofits determine which expenses fall into which buckets based on the content of the activity, the purpose of the activity and the audience targeted.
Allocating the costs in this way provides donors a much clearer and more accurate understanding of how a nonprofit spends its money. So far so good, right?
But … in a disturbing development, and in total disregard for the IRS and AICPA, some self-anointed charity watchdogs are making headlines by unilaterally proclaiming that they won’t honor joint cost allocation. The result? Needless confusion among the giving public by arbitrarily assigning all the costs of a complex activity to “overhead,” instead of allocating the costs to where they honestly belong.
Tom Harrison is the former chair of Russ Reid and Omnicom's Nonprofit Group of Agencies. He served as chair of the NonProfit PRO Editorial Advisory Board.
