Accounting – What’s the problem?

In War Games, Polman outlined many problems that humanitarian aid organizations face when providing aid. One problem that was interesting was the fact that many organizations have funds going to unintended sources. This occurs when militias or governments limit access to the intended recipients of aid. They will only allow passage if they are bribed by receiving a percentage of the aid being given or getting a cash equivalent. It occurs not only when militias or governments limit access, but can occur when aid work is subcontracted, as was the case in Afghanistan. The fact that money or goods were going to unintended sources was surprising and even more surprising was the fact that they weren’t being held accountable for these “missing” funds. From an accounting standpoint, this seems almost impossible. How is it possible that these funds are not being used for their intended purposes and why isn’t management being held accountable for what does happen to these funds? To try to understand this, we will look at the differences that exist between corporations and humanitarian aid organizations.

In researching, it’s not surprising that most corporations are classified as for-profit corporations, while humanitarian aid organizations are classified as not-for-profit organizations (NPOs), or non-profit organizations. For-profit corporations, their primary mission is to earn profits for stakeholders. With NPOs, their mission is to provide services that are needed by society. On the surface, this is a simple concept and probably stands out as pretty obvious to anyone, even if you don’t have an accounting background. But this difference could be the key to why there is little accountability when it comes to humanitarian aid organizations.

In corporations, management’s decisions are judged by their stockholders, or principal investors. It is commonly referred to as the principal-agent relationship. This relationship can be judged by some sort of numerical, statistical, financial, or comparable data, which can be found in the financial statements. For example, how much did the corporation’s net sales increase? A look at the corporation’s financial statements can easily determine this increase or decrease. Progress, or digression, is easily quantifiable. In essence, the principal investors (principal) are able to judge the corporations management (agent) and evaluate their performance based on the data. The principal expects and relies on the agent do what is in the best interest for the principal. They are able to offer incentives that can help deter the agent from seeking their own personal agenda.

However, when we look at the principal-agent relationship for humanitarian aid organizations, we find that it is much harder to distinguish who belongs where in this relationship. It is clear in for-profit corporations that the primary goal is to earn profits for the stockholders. So that principal-agent relationship is spelled out clearly in the mission. The mission of the NPO is to provide services to society. Should the people receiving aid be the principal? Should it be the people donating money? Is it society? Is it the NPO itself or its workers? There is no clear answer to this question and even if there was, we would be faced with another problem, the financial statements.

The financial statements for NPOs and corporations differ significantly as well. For corporations, there are four major financial statements.

They are: (1) balance sheets; (2) income statements; (3) cash flow statements; and (4) statements of shareholders’ equity. Balance sheets show what a company owns and what it owes at a fixed point in time. Income statements show how much money a company made and spent over a period of time. Cash flow statements show the exchange of money between a company and the outside world also over a period of time. The fourth financial statement, called a “statement of shareholders’ equity,” shows changes in the interests of the company’s shareholders over time. (“Beginners’ Guide to Financial Statements”)

All publicly traded corporations on the US stock market are required to file these financial statements annually with the SEC. For NPOs, these reports are not required annually, or at all. However, in order to qualify for tax exempt status, NPOs must file a set of completely different financial statements.

They are: (1) Statement of Financial Position; (2) Statement of Activities; (3) Statement of Cash Flows; and (4) Statement of Functional Expenses (for some NPOs). The statement of financial position is similar to the above balance sheet. The statement of activities shows revenue and expense amounts. The statement of cash flows is also similar to the above statement of cash flow. The statement of functional expenses reports expenses by their function and by the nature or type of expense. (“Differences between Nonprofits and For-Profits”)

While some of these reports appear to be the same, it would be impractical to compare NPOs to corporations because they do not share a similar business structure or objective. It would also be impractical to compare NPOs because these numbers will depend solely on the size of the organization, number of donors, and amount received by donors. Unlike corporations, whose financial statements can evaluate the running of the business, NPOs financial statements are not able to quantify the success of aid missions or show the exact amount that actually reached its intended user.  It appears the only purpose the financial reports provided by NPOs is to qualify them for tax exemption.  It does not really show or grade the performance of the organization or the aid they are providing.

These two seemingly small problems lead to the the problems we see presently in humanitarian aid organizations.  The inability for accurate financial statements allows for funds to go missing and not reach their intended target users.  The fact that there is no clear principal-agent relationship continues to allow this to go on without anyone to answer for it.  Do some people just donate to humanitarian aid organizations in order to receive a tax break and not care where the money actually goes?  Sure, but there must be something done to increase accountability and awareness for when, how, and who receives their funds.

 

Bennett editorial cartoon

 

Works Cited:

“Beginners’ Guide to Financial Statements.” U.S. Securities and Exchange Commission. SEC, 05 Feb 2007. Web. 1 Jul 2013. <http://www.sec.gov/investor/pubs/begfinstmtguide.htm>.

“Differences between Nonprofits and For-Profits.” Accounting Coach. N.p.. Web. 1 Jul 2013. <http://www.accountingcoach.com/nonprofit-accounting/>.

N.d. Photograph. n.p. Web. 1 Jul 2013. <http://media.timesfreepress.com/img/photos/2009/02/20/090221_crunching_numbers.jpg>.

Polman, Linda. War Games. London: Penguin, 2010. Print.

Wikipedia contributors. “Financial statement.” Wikipedia, The Free Encyclopedia. <http://en.wikipedia.org/wiki/Financial_statement>.

This entry was posted in Individual research. Bookmark the permalink. Follow any comments here with the RSS feed for this post. Both comments and trackbacks are currently closed.