This article was first published in the IS Chartered Accountant, January 2017. Re-published with permission from the Institute of Singapore Chartered Accountants (ISCA).
Charities rely largely on donations and grants from individuals, government entities and other organisations to carry out their charitable activities. In return, Charities are expected to be accountable to their stakeholders. The first four articles in the “Accounting for Good” series have looked at regulatory frameworks and organisational governance for Charities to help them ensure accountability and transparency. This article explores how accountants can assist Charities in developing full-cost accounting systems so they can meet numerous social demands despite their limited resources.
As explained by Gerard Ee, Chairman of the Charity Council, Singapore, “knowing the full cost of programmes will help strategic decisions to be made as to which ones to focus on and the actions required to make them sustainable”. Mr Ee is also President, ISCA. Indeed, given that Charities operate in a rapidly-changing and competitive environment, the need for Charities to gain economic clarity around costs has become even more critical.
WHAT IS FULL-COST ACCOUNTING?
Charities incur various types of costs when delivering their charitable programmes to advance their missions. A full-cost accounting system provides economic clarity by allocating indirect costs, in addition to direct costs, across programmes to provide a realistic picture of their full costs. This concept is elaborated in Box Story 1.
Charities would have a clearer understanding of how resources are being currently used when the full costs of programmes are computed. With this full cost information, Charities can make, in the words of Mr Ee, better “strategic decisions… as to which ones (programmes) to focus on” and “make them (programmes) sustainable” by recovering their full costs. We will examine these benefits in the following two sections.
FULL-COST ACCOUNTING AND RESOURCE ALLOCATION
Full-cost data allows a Charity to review each programme based on its affordability vis-à-vis its intended outcomes, and decide if scarce resources are being utilised in the most efficient manner to advance its mission. Figure 1 provides a framework that could assist Charities in identifying cost-effective programmes to make better strategic decisions in the allocation of their scarce resources. Following that, the Charity can better make decisions as to whether it should terminate (Quadrant 1), continue or perhaps even expand these programmes (Quadrant 4). In other cases, the Charity, with the knowledge of full costs, would be in a better position to consider the trade-offs between a programme that is expensive but relevant to its mission (Quadrant 2), with one that may be cheaper but less relevant (Quadrant 3).
To illustrate this, a Charity was called upon by many to expand its programme to another region, including one region that was willing to provide short-term funding. However, the Charity declined after a full-cost analysis of the programme as the analysis revealed it to be more expensive than originally believed (Quadrant 2 instead of Quadrant 4). Higher indirect costs would be incurred for the expansion as most of such costs will have to be borne by the programme alone, rather than shared across many. Expansion would have been a drain on the programme’s resources over time and therefore, an unwise strategic decision.
FULL-COST ACCOUNTING AND SUSTAINABLE FUNDING
Charities that can communicate their full cost information would be more transparent and accountable to stakeholders. Such information will also enable Charities to have more meaningful discussions with donors about their funding needs. With clearer information on funding needs, Charities and donors can then work towards developing a more sustainable funding model. For a programme to be sustainable, its full cost should be fully recovered. Having economic clarity not only helps Charities to make better strategic decisions in the allocation of their scarce resources, it also allows them to have a defensible basis to justify their level of spending as well as obtain funding for their programmes based on full costs. Donors are more likely to agree if they are able to fully understand the operations and expenses (both direct and indirect) associated with these programmes.
Additionally, knowledge of full costs would also assist Charities in setting the appropriate level of fees to charge beneficiaries for their various programmes. Programme fees constitute another important source of funding for Charities. Such fees allow the level of income received to be proportional to the delivery costs, creating a sustainable model that, at the very least, ensures partial cost recovery. Charging the appropriate programme fees, through a better understanding of their full cost (as opposed to charging only direct cost), will improve financial sustainability. Charities will be better equipped with the ability to provide services of greater quality.
In fact, in the United Kingdom (UK), the government is strongly promoting full-cost recovery, enabling organisations to recover the legitimate portion of overhead costs for the work they do. Otherwise, there is a danger of a Charity running into deficit and becoming unsustainable. The importance of full-cost recovery as a sustainable funding model is encapsulated in the following quote by the UK Minister for the Voluntary Sector, Fiona Mactaggart, “To build a strong, thriving voluntary sector, it cannot be living from hand to mouth.”
AN APPROACH TO FULL-COST ACCOUNTING
Some US and UK Charity networks have proposed strategies to guide accountants and professionals on full-cost accounting practices for the non-profit sector. One widely-adopted approach, developed by ACEVO, the UK’s leading network for Charities and social enterprise leaders, is illustrated in Figure 2.
The full-cost accounting approach has been lauded as a good way for Charities to make better decisions and obtain sufficient funding. Box Story 2 features a UK Charity that has benefited from the implementation of full-cost accounting.
CHALLENGES OF IMPLEMENTING FULL-COST ACCOUNTING
Despite the benefits of adopting full-cost accounting, some Charities may be reluctant to present the full cost data to donors as they are afraid that donors will refuse to fund the programme if indirect costs, which do not directly translate to outcomes for beneficiaries, are too high. This is in line with studies showing that some Charities under-state indirect costs to obtain donations as donors may erroneously view it as a metric for efficiency. Other Charities, however, may be keen to adopt such a system but unfortunately lack the requisite skills and resources to implement it (Box Story 3). Indeed, a survey conducted in 2015 by the Charity Council identified cost accounting as one of the top three skill sets Charities in Singapore would like to improve on . Hence, this presents another avenue for accountants to contribute toward building a strong and thriving Charity sector.
Box Story 3 Challenges in adopting full-cost accounting in Singapore
Locally, there are some Charities that have tried to implement full-cost accounting. Ang Chee Wee, Director of Corporate Services and Operations at the National Kidney Foundation (NKF), shares some of the challenges that the Foundation faces. NKF is a non-profit health organisation that provides medical care and support for kidney patients as well as public education for the prevention of kidney disease.
In terms of implementation costs, “I would like to think that most Charities will not have fully-computerised systems in place to help them cope with the increasing complexities of service needs. NKF faces similar challenges in getting our systems up to speed to meet with such demands,” says Mr Ang. In terms of technical expertise to conduct proper allocation of indirect costs, “allocation of indirect service costings may not be able to be so specific to reflect true (or full) costings”.
Charities rely largely on donations and grants from individuals, government entities and other organisations to carry out their charitable activities. They are, however, finding themselves having to compete, increasingly, for funding to pursue their mission. As donors seek more information to make informed giving decisions, Charities could provide greater economic clarity on the full costs of their programmes, to help them better articulate their strategies and secure sustainable funding. Additionally, to cope with the uncertainty associated with their income, Charities would also need to put in place other financial policies and strategies to enhance their financial health, and better manage their cash flow on a day-to-day basis.
We will look at the area of cash flow, investment and reserves management in the next article.
Dr Isabel Sim is Senior Research Fellow, Department of Social Work, Faculty of Arts and Social Sciences, National University of School (NUS) as well as Director (Projects), Centre for Social Development (Asia). Associate Professor Alfred Loh and Professor Teo Chee Khiang are both from the Department of Accounting, NUS Business School. The writers gratefully acknowledge the contributions of Gong Yuan, Persa Chowdhury, Claribel Low and Koh Luwen, Research Interns, NUS.