Viewpoints

Non Profits Need to Learn New Accounting Methods

Gerald Archibald

Originally Published In:
ROCHESTER BUSINESS JOURNAL
March 2005
Author: Gerald J. Archibald, CPA

“It is no use saying, ‘We are doing our best’  You have got to succeed in doing what’s necessary.”  Winston Churchill

“What does it cost?”  A common refrain in the business world these days.  Advancements in technology have led our country to an obsession with cost.  And, in order to know its costs, businesses must have an effective cost-accounting system.  Job security for the accounting profession, I trust.

As our economy continues through its inevitable cycles, global data is but a few keystrokes away.  Margins, productivity, and cost effectiveness are increasingly important to business success.  In fact, thinner margins are demanding more attention to cost.
 
The non-profit sector has been somewhat insulated from the need for sophisticated cost-accounting systems – until now.  It used to be that government and third-party funders of non-profits were focused on paying for programs as opposed to buying specific services on a unit cost basis.  Now, everyone wants to know what they are buying and how much they are paying.

Since the Industrial Revolution of the 19th century, manufacturing entities have focused on cost-accounting as a key ingredient to financial success.  A century of experience with developing cost-accounting systems led to many different approaches to determining the cost of producing a product.  The three most common approaches that were developed are known as “standard cost”, “job cost”, and “process cost” accounting systems.

For example, in the auto industry, the Ford accountants can tell you the cost of every part that is used in the production and assembly of an automobile.  The same is true of most industries where manufacturing, production, construction, and assembly are appropriate descriptions of the business activity.

The non-profit sector is different in that most often the non-profit entity provides a service instead of a product.  The service sector offers a different set of issues for cost-accounting.  First and foremost is the historical issue that non-profits have not been required to have sophisticated cost-accounting because of the wide variety of funding mechanisms used to pay for their services.  As a result, pricing and charges for services, in many cases, varies based on who pays the bill.

One non-profit program may consist of many individual services.  However, payment for these services may come from funding sources on a basis that is not directly tied to actual services provided.  For example, many government grants are not based on specific units of service provided. 

Deficit funding of programs means just that.  If the program generates a deficit, then the funding source pays some or all of the deficit amount.

What does this mean?  Where are we going with this?

The non-profit sector is in the midst of a revolution of sorts.  Funders are demanding accountability and cost justification on the basis of units of service.  More and more funding sources are paying for services on a unit cost basis as opposed to a program or deficit funding approach.

As a result, success in today’s non-profit is being redefined.  Competition and cost are the important elements for determining bottom line success.  The challenge is to accomplish this transformation while maintaining or improving the quality of the services provided.

Now that you have a sense for the problem, let’s talk about the solution.  Whether you are a board member, volunteer, management, staff, or donor to a non-profit, please consider the following for developing your own circumstances specific solution.

• Complete a thorough needs assessment of the current accounting system.  Does it provide you with the necessary management and cost information?
  
• Be prepared to develop a cost-accounting system that will allow you to price your services, not just programs or departments.
  
• Determine the need for reengineering the traditional general ledger accounting system to integrate it with the cost-accounting system.
  
• Develop internal capabilities necessary to implement activity based costing in the organization.  With ABC, you can evaluate the true costs of products within programs, thus ensuring that you make the right long-term decisions on whether to continue to provide certain services or programs.
  
• Be prepared for ever-increasing competition on price.  There is an instructive lesson to be learned from the experience of the airline industry, the Big Three automakers and the independent retailers.  I believe that we are in the early stages of what I call “the Wal-Marting of the tax-exempt sector”.
  
• Think like a manufacturer.  Identify your fixed and variable cost components.  Management must agree on those cost elements that need to vary with volume of services provided.
  
• Make sure that you are compliant with the cost reporting regulations of the funding sources, the Federal, and State Medicare, Medicaid, grant makers and our friends at the IRS.

There is continued focus on administrative costs of non-profits.  In your cost-accounting, be sure to properly identify and segregate administrative and fund raising costs from direct program costs.

In most cases, time is of the essence.  What may have developed in the manufacturing sector over a century ago is a necessity in the non-profit sector today, tomorrow, or yesterday depending upon your situation.  Fortunately, there are many resources available to move rapidly toward a cost-accounting solution that fits.

There is a significant difference between cost-reporting and cost-accounting.  To understand the difference puts you one step closer to the solution.

Remember, information is power.

Disclaimer: The Bonadio Group provides the information in Viewpoints for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. Tax articles in Viewpoints are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided "as is," with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.