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Watchdog Barks Louder On Cost Allocation Issues

By The NonProfit Times - October 1, 2012

A move by one of the nonprofit sector’s watchdog organizations is being described as going back to the “dark ages” when it comes to nonprofit accounting.

Charity Navigator, in Glen Rock, N.J., decided to tweak its rating system and consider joint allocation costs entirely as fundraising expenses. Joint allocation costs, under certain guidelines and criteria in accounting standards, allow a portion of certain materials to be split between program expenses and fundraising expenses.

In cases where joint costs are extreme, Charity Navigator President & CEO Ken Berger said it would affect the rating of a charity, but probably fewer than a dozen organizations. “It’s the extreme outlier cases, where you have 30, 50 — sometimes 80 percent — in joint allocation. Unless the charity can show us something that really justifies this, many times it’s smoke and mirrors. It really is many times fundraising expense under the guise of education. It doesn’t really pass the smell test,” said Berger.

“If that much money is going to administration and fundraising, we just find that so beyond the pale that in those cases it (the rating) goes straight to zero. We don’t have to look at anything else. If it’s that extreme, something very odd is going on,” Berger said. “Unless the charity can show there’s something extremely unusual about that, it’s just so beyond anything you can argue. It goes beyond rationales for high overhead and specific infrastructure costs,” he said.

Kelly Browning, president and CEO of the American Institute for Cancer Research (AICR) in Washington, D.C., said Charity Navigator has essentially decided they won’t accept an auditor’s report and instead will come up with their own allocation and restate an organization’s financial statements. Browning also is a leader within the nonprofit direct response marketing community.

“Auditors are the professionals paid to look at an organization’s finances and come up with an opinion as independent auditor,” Browning said.

Charity Navigator has “some subjective reason why they don’t want to do that. From my view, they don’t have the expertise to make this decision,” said Browning. “They do the charities a real disservice in the fact that they come up with some subjective type of analysis that really has very little basis except it’s their opinion,” he said.

“If you look at charities that do a lot of activity, where you have specific direct mail or phone activity that includes a fundraising appeal, a lot of those organizations certainly think it’s a much more efficient way to build the particular mission of the organization, in such a way that you can call people to action to help them,” said Browning.

Browning said disregarding accounting standards and guidelines is akin to “reverting back to the dark ages,” before methodology was devised during the late 1970s and early 1980s to take into consideration activities that include fundraising appeals. “It’s a fairly sophisticated body of work that outlines methodology, how an organization should go about doing evaluation, which costs are program, which are fundraising,” he said.

The Better Business Bureau’s (BBB) Wise Giving Alliance (WGA) historically has relied more heavily on audited financial statements than the Form 990 when it comes to evaluating charities. WGA typically reviews about 1,300 charities each year and as many as two-thirds of those implement joint cost allocation, according to Chief Operating Officer Bennett Weiner. “In general, if organizations are following GAAP rules, allocating appropriately, we don’t object to joint cost allocation,” Weiner said.

“The bottom line for us is accuracy,” said Art Taylor, WGA’s president and CEO. “You have to take the time to read the solicitations. That’s part of our culture, to check out the claims people make in their appeals,” he said. “We do have occasions when we have to question what a charity has done. We’ll disagree with what auditors say sometimes, if we read through an appeal and it doesn’t align with what the charity has stated,” said Taylor.

Generally what will trigger more questions is if a nonprofit is allocating more than 50 percent of joint costs to program services. There may be other circumstances as well, according to Weiner. “The other thing we’ll see is whether there’s actually a call to action to do something other than give a gift to an organization. Without a call to action, you can’t really allocate anything to program services area,” said Weiner. A call to action can take a variety of forms, such as urging the recipient to sign a petition, or advocate for the environment. “That’s where sometimes appeals are lacking in a specific call to action,” he said.

Quite a few large, national charities do joint cost allocation but in the past year, if a charity did not meet WGA’s 20 standards, only 7 percent of the time it was because of Standard 13, which involved concerns about joint cost allocation, according to Weiner.

Eliminating joint costs is just one of the many changes Charity Navigator has made in recent years as it aims to evolve and improve its ratings formula. Another change the nonprofit is considering is three-year averages of data versus snapshots of time, according to Berger. “Because of the nature of the sector, you have lean years, you have rich years. We think that will better reflect realities,” he said.

When it comes to overhead, there’s a group of chief financial officers from several nonprofits that try to help tease out ways to show “how we should do that, some tweaking but the fundamental measure of overhead is not something we think we should discontinue,” said Berger.

“I agree with critics, having it as a primary metric is not the right way. There are multiple ways and things to look at, but to throw out the baby with the water would be foolhardy,” said Berger.

When Charity Navigator was launched a decade ago, it focused on finance. The second version rolled out a year ago called for more accountability and transparency from the sector. What he calls Charity Navigator 2.0 shifted the weight of finance from 100 percent of the rating to 50 percent, and the question over overhead – with which some people have issues — was weighted from 60 percent of the rating to 30 percent of the rating.

“Some people like the direction we’re going in, others don’t. We can’t please everyone, we hope we please the people we serve,” said Berger. “Sometimes there’s no easy answer, you have to make a judgment call,” he said. NPT

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