By Patrick J. Yogus

In Brief

A Tool that Must Be Used in Good Faith

SOP 98-2, Accounting for Costs of Activities of Not-for-Profit Organizations and State and Local Entities that Include Fund-Raising, replaces SOP 87-2. Under the previous SOP, not-for-profits did not allocate joint costs consistently, and the result was often overstatement of program expenses and understatement of fund-raising expenses.

The changes in the technical re-quirements of SOP 98-2 are not earthshaking. One major change under 98-2 is that the criteria of purpose, audience, and content must all be met in order to allocate costs of the activity to program or management and general. The SOP's intent is to ensure that a program activity is substantial before costs are allocated to it. The enhanced specificity of the SOP will allow independent auditors a higher and more consistent level of scrutiny of a not-for-profit's allocation methods and rationales.

The SOP does not require the use of a specific allocation method, but an appendix does provide illustrations of commonly used methods. This area of allocation methods will require the good faith application of the spirit rather than the letter of the guidelines.

The answer to whether a not-for-profit is worthy of a donor's support will not ultimately be found in examining its fund-raising ratio, but rather, by observing the value it adds to society. A sidebar presents the author's thoughts on the subject.

he Accounting Standards Executive Committee (AcSec) of the AICPA undertook a project in 1992 to provide clearer guidance for allocating costs of joint program and fund-raising activities than was provided under SOP 87-2, Accounting for Joint Costs of Informational Materials and Activities of Not-for-Profit Organizations that Include a Fund-Raising Appeal. The initial exposure draft of the revised guidelines generated more than 300 comment letters from interested parties. Changes were made to the exposure draft based upon these comments, and the revised exposure draft was field tested to determine whether it was sufficiently clear and definitive to generate consistent and comparable application of the guidelines. SOP 98-2, Accounting for Costs of Activities of Not-for-Profit Organizations and State and Local Entities that Include Fund-Raising, was finally issued March 11, 1998. It is effective for financial statements for years beginning on or after December 15, 1998, almost seven years after the project began.

During the long gestation period, and after the issue date of the exposure draft, numerous articles appeared in accounting and not-for-profit related periodicals, magazines, and other professional publications reporting on its progress and critiquing its results. The technicalities of applying the SOP have been analyzed, criticized, applauded, and explained ad infinitum. I will attempt to look at the spirit as well as the letter of the "law" and examine the underlying issues that generated the wide range of impassioned responses on the potential impact of implementing SOP 98-2.

It's a Matter of Credibility

The joint costs project was launched to address concerns of regulators, as well as others, that not-for-profit groups did not allocate joint costs consistently with the result that program expenses were overstated and fund-raising expenses understated. To my knowledge, the magnitude of this problem was never publicly quantified and perhaps it is not possible to do so. Nevertheless, the thought was that "better and clearer" standards would solve the problem. Better and clearer standards will certainly help. However, whether SOP 98-2 meets the criteria of better and clearer remains a subjective judgment, and its impact will only be known after years of experience. Comments from equally knowledgeable sources on how well the SOP will meet its objectives range from--

* the requirements contained within the new SOP are even more convoluted than under SOP 87-2 to

* the new SOP makes the lines between fund-raising and program clearer and presumably easier to implement consistently.

The intent of SOP 98-2 is to provide sufficiently definitive criteria to allow all not-for-profits to conclude that if it looks like a duck, walks like a duck, and quacks like a duck, it is a duck. The "duck," of course, is fund-raising. A good-faith application of SOP 98-2 should result in a fair and consistent reporting of fund-raising and program expenses among all not-for-profits that solicit contributions. However, there needs to be an ongoing educational process within the not-for-profit community as well as within the public accounting industry to have fair and consistent results among the diverse not-for profit organizations covered under the SOP.

What Are the Changes from SOP 87-2?

The technical differences between SOP 87-2 and SOP 98-2, at first glance, do not appear to be earthshaking. They can be summarized as follows:

* 98-2 applies to all entities that solicit contributions, including state and local governments.

87-2 applied to entities that follow the AICPA Audit Guide Audits of Voluntary Health and Welfare Organizations, or SOP 78-10. 87-2 was not applicable to governments.

* 98-2 covers all costs of the entire joint activity, not just the joint costs (such as the envelope, stamp, and labor for stuffing envelopes in a joint purpose mailing). For example, a discrete program pamphlet included in a mailing that does not meet the criteria for allocating a portion of the costs to program would be charged to fund-raising.

Under 87-2, only the joint costs were covered (the envelope and stamp--unclear as to labor). A discrete program pamphlet would have been charged to program even if no portion of the joint costs of the mailing could have been allocated to program under 87-2 criteria.

* The costs of goods or services provided in exchange transactions (such as a meal at a special event) are not fund-raising costs under SOP 98-2, nor were they fund-raising costs under SOP 87-2.

* Under 98-2, the criteria of purpose, audience, and content should all be met to allocate costs of the activity to program or management and general.

Under 87-2, it was unclear whether all criteria should be met to allocate joint costs of the activity to program or management and general.

* 98-2 does not prescribe nor prohibit any allocation methods. It includes a discussion to help users determine whether an allocation is reasonable and provides some illustrations.

87-2 did not prescribe nor prohibit any allocation methods; nor did it provide any illustrations.

* 98-2 requires footnote disclosure of the types of activities for which joint costs have been incurred; a statement that such costs have been allocated; and the total amount allocated during the period and the portion allocated to each functional expense category.

87-2 required footnote disclosure of the total amount allocated during the period and the portion allocated to each functional expense category.

The devil is always in the details of implementation, and I will explore some of the practical issues of implementing the spirit as well as the letter of these changes.

What Will the Impact of These Changes Be?

This SOP generated much interest and response from industry and the public accounting profession. So what is the big impact SOP 98-2 will have on the not-for-profit industry? The answer depends upon whom you ask. The following opinions were reflected by a number of observers in two well-respected publications within weeks after the issuance of the SOP:

* [The SOP] makes it almost impossible to allocate any costs at all. There will be a dramatic increase in money attributed to fund-raising costs.

* It will impact some non-for-profits, but it won't impact a lot.

* The standards are only a modest refinement of the 1987 rules. The underlying concept is still the same. The difference is only in the details.

* [The SOP] is vague and full of loopholes. It's still open to creative interpretation.

* The complexity of the new rules may be dangerous. If charities have trouble following the nuances of the new policy, accountability in the non-for-profit world could be eroded. It fails to require charities to use a specific allocation method.

Activities Must Be Substantive. I tend to agree with the third comment above. The new SOP did not change the nature of a program activity or the nature of a fund-raising activity. The SOP's intent was to ensure that a program activity is substantive before costs are allocated to program. More is required than inserting an education or other program message in a fund-raising appeal to an audience who may or may not have a need for the information or the ability to advance the not-for-profit's mission in other ways. The criteria to meet that objective is addressed in the details of the SOP.

Auditors Must Be Consistent. A likely impact of the SOP may be that the not-for-profits that reported program and fund-raising costs fairly under SOP 87-2 will continue to do so under SOP 98-2, and those that abused reporting under 87-2 will continue to find ways to circumvent the spirit of 98-2. There is, however, one new element that may move organizations operating outside the spirit of the SOP closer to the norm. The enhanced specificity of the SOP will allow independent auditors to exercise a higher and more consistent level of scrutiny of a not-for-profit's allocation methods and rationales. The auditors' challenges will be to consistently apply the standards within their own firms, and, most importantly, among clients.

More Joint Activities. In today's competitive world, every business must target maximum resources on customer service. If resources are expended that do not benefit the customer, those expenditures will ultimately be redirected. After all, a business will survive only if it can attract and maintain customers. The same principle applies to not-for-profits who count donors among their most important constituents, along with beneficiaries of their services and volunteers. The business plans of every progressive not-for-profit will include strategies to maximize the use of contributed resources by making every possible donor contact an opportunity to deliver its program and raise funds. Accordingly, I expect that more activities will include a joint purpose rather than fewer.

Meeting the Criteria of Purpose, Audience, and Content

Not-for-profits are already moving in the direction of linking fund-raising to program delivery whenever that combination can be effective. Marketing professionals and experience have indicated that where the link to program activities and mission is apparent to the donor, it is easier to raise funds. Accordingly, it is incumbent upon fund-raisers and program developers/managers (even more so than accountants) to understand the criteria that must be met under purpose, audience, and content before costs of joint activities may be allocated. If any of these criteria are not met, all costs of the activity are fund-raising costs. The following comments do not give all of the details contained in the SOP. Consequently, a full reading of the SOP is necessary to gain a comprehensive understanding of all the nuances. These comments attempt to capture the essence of the requirements.

Purpose. The joint activity should help accomplish the not-for-profit's mission. It should call for a specific action by the audience to help accomplish that mission. Asking an audience for a contribution is not a call for a specific action that will help accomplish the organization's mission. Educating the audience about the causes, programs, or organization itself, is not a call for a specific action that will help accomplish the organization's mission and is considered in support of fund-raising. The call to action must be something the audience can do to benefit itself or to benefit the not-for-profit's mission other than giving a contribution. Some cautionary notes:

* If the majority of compensation for performing any part of the joint activity is based upon contributions raised, the entire activity is considered fund-raising.

* If a similar program component of the joint activity is never conducted on a similar scale using the same medium without the fund-raising component; other evidence must be used to meet the purpose criterion, such as the following:

* Are the program results and accomplishments measured and evaluated?

* Other facts and circumstances may indicate the purpose criterion is met if the organization conducts the program component of the joint activity without the fund-raising component in a different medium.

* If evaluation is based largely upon contributions raised, the purpose criterion may not be met.

* Are the consultants or staff performing the program activity qualified to do so, or are they expert only in fund-raising?

* Is there other tangible evidence of intent that will demonstrate the intended program purpose of the joint activity, such as committee minutes, written instructions, etc?

Audience. The audience criterion is presumed not to be met if the audience includes prior donors or is otherwise selected based on its ability or likelihood to contribute. That presumption can be overcome if the audience is selected in a significant way for one or more of the following reasons:

* The audience has a need for, or reasonable potential to use, the specific action called for by the program component of the joint activity.

* The audience is able to take specific actions to assist the entity in meeting the goals of the program component of the joint activity.

* The not-for-profit is required to direct the management and general component of the joint activity to the particular audience or the audience has reasonable potential for use of the management and general component.

Content. The content criterion is met if the joint activity calls for a specific action by the recipient that will help accomplish the entity's mission, or it fulfills one or more of the not-for-profit's management and general responsibilities. Information identifying and describing the not-for-profit or what the not-for-profit does, the not-for-profit's causes, or how the contributions provided will be used is considered in support of fund-raising and is not allocable to program.

Are There Winners and Losers Because of Mission?

SOP 98-2 will encourage many not-for-profits to reevaluate their current methods of fund-raising and program delivery to make both components more cost-effective. Some organizations will have an easier time than others in meeting the purpose, audience, and content criteria because of the nature of their missions. It appears the toughest criteria to meet in a joint activity for many not-for-profits will be the audience criteria. Today's technology and availability of demographic databases make the ability to select specific audiences a reality. When an audience of 65 year olds with a sedentary lifestyle can be selected for the joint purpose of enrolling the recipient in an exercise program to promote cardiac health, and at the same time ask for contributions to continue the not-for-profit's mission, it is a win-win situation. An effective program has been delivered to an audience with the means and motivation to support the not-for-profit, and the costs of the joint activity can be shared in an equitable manner.

The same scenario, on the other hand, may not be possible for a not-for-profit whose mission is to maintain a housing facility for the temporarily homeless. Any audience with a home would likely not meet the criteria of "need to use" or "ability to take specific action (except to contribute money) to assist in carrying out the mission." The full costs of the activity would be fund-raising. If the not-for-profit expanded its mission to increasing government funding for facilities for the homeless, it could more readily design a joint activity for an audience that is likely to contact elected officials on behalf of the cause and also likely to contribute to the cause. Consequently, the particular mission of a not-for-profit can significantly influence the fund-raising cost ratio.

The Thorny Question of Joint Cost Allocation Methods

The method used to allocate costs of joint activities can also significantly affect the fund-raising cost ratio. A representative of at least one regulatory agency suggested the failure of SOP 98-2 to require a specific allocation method created a loophole for abuse. The SOP guidance simply says that the allocation methodology used should be rational and systematic, result in an allocation that is reasonable, and be applied consistently. AcSec presumes the most reasonable allocation method will be used based upon facts and circumstances.

Appendix F to the SOP provides illustrations of the following commonly used allocation methods:

* Physical Units Method--For example, counting fund-raising words and programmatic words (say in a mailing) and allocating costs based upon the ratio of words.

* Relative Direct Cost Method--For example, allocating joint costs (costs not specifically identifiable) of the activity based upon the ratio of specifically identifiable program costs and fund-raising costs (direct costs) included in the activity.

* Stand-Alone Joint-Cost Method--The joint costs (such as paper, postage, and envelopes) to conduct each component of the joint activity separately are estimated. The costs of the joint activity are then allocated based upon the ratio of the cost of each separate component to the total costs of the combined components.

The appendix also does a fine job of noting how each of these methods can result in unreasonable cost allocations. And the concerns of the industry's regulators are not unfounded if the fund-raising cost ratios can be easily managed by counting words. The area of allocation methods, perhaps more than any other in the SOP, will require the application of the spirit rather than the letter of the guidelines for the objective of fair and consistent reporting among not-for-profits to be met.

A Step in the Right Direction

The SOP is not the perfect solution to a complex issue. But it provides a tool that, if used in good faith, will bring all not-for-profits closer to the norm in reporting program and fund-raising expenses. It will not, however, make not-for-profits comparable across the board because of the inherent differences in their operations. That is an issue for another day. The answer to whether a not-for-profit is worthy of a donor's support will not ultimately be found in examining its fund-raising ratios, but rather by observing the value it adds to society. It is time to move on to the "bottom line." *

OBSTACLES TO FAIR AND COMPARABLE REPORTING AMONG NOT-FOR-PROFITS

Unfortunately, the credibility of a not-for-profit is tied much too closely to a set of flawed relationships and assumptions.

Few would deny that magazines, regulators, and, consequently, the public point first to the amount of money spent on fund-raising versus program to separate the "good" not-for-profits from the "bad." A not-for-profit with a low fund raising ratio is considered to be worthy; while the not-for-profit with a higher fund-raising ratio is considered suspect.

Consider a hypothetical not-for-profit organization that houses X number of homeless per year at a cost of $100,000 (including fund-raising costs) per person, but has a fund-raising ratio of 10%. Based upon the fund-raising ratio, this organization would be at the head of the class. Based upon its program results, the organization would be more effective by giving five homeless people $20,000 per year to provide their own housing. Contrast that scenario with a not-for-profit whose mission is the eradication of a deadly disease. If its programs were responsible for preventing X number of cases of the disease from occurring per year, would a fund-raising ratio of even 50% be inappropriate? The point is that the public should be able to make its giving decisions based upon more relevant financial and program-results information than is currently available. If the not-for-profit industry found ways to hold itself more accountable for the results of its mission (the value it is adding to society), fund-raising costs would become less and less relevant as a measure of success.

Secondly, there is seldom an acknowledgment that not-for-profits as a group can be extremely diverse and inherently incomparable. In spite of this, diverse not-for-profits are often listed next to each other in magazine articles with reports from monitoring organizations comparing fund-raising ratios. One organization may raise the vast majority of its funds from government grants or contracts that generate no fund-raising costs and be compared against an organization that raises all of its funds through small, individual donations. A new organization just building a base of contributors may be compared with an established organization with a dependable base of contributors. To imply that the fund-raising costs of these organizations should be comparable is misleading. To imply that one organization is better than the other based upon the evaluation of a single ratio does a disservice to the organizations involved as well as to the public.

Selling and administrative expenses are not the main issue with a stockholder for GM as long as the return on investment meets expectations. Likewise, fund-raising and management and general expenses should not be the main issue with contributors and regulators as long as return on investment meets expectations. The problem is that GM has a built in, simple measure of success--the "bottom line," called earnings per share. There is no such similar measure for a not-for-profit organization.

These are not easy obstacles to overcome. We are a society that likes simplicity. If we cannot reduce a complex issue to a single bullet or phrase, it will often be ignored. The AICPA took more than six years to issue SOP 98-2. It should be challenged, along with the not-for-profit industry, to develop financial models that begin to relate the value a not-for-profit adds to the society whose resources it expends. Admittedly, valuing program results is not an easy task in a not-for-profit organization, but program results are the "bottom line" for the not-for-profit industry. *

Patrick J. Yogus, CPA, is national vice-president for finance of the American Cancer Society, Inc. and a member of the AICPA's Not-for-Profit Organizations Committee.