Parsons, Linda M


Not-for-profit (NFP) organizations in the United States received charitable contributions of approximately $212 billion in 2001. This figure represents over two percent of the U.S. gross domestic product [Strom, 2002]. Charitable giving in the seven years ended December 31, 1999 totaled one trillion dollars [Arenson, 200O]. If the Federal government expands its dependence on charitable organizations for the delivery of certain assistance services, the relative importance of the third sector to the U.S. economy will likely increase.1 Despite the enormous size of the so-called third sector (the other sectors are business and government) and its importance to the U.S. economy, there is limited empirical research examining the impact of accounting data on charitable giving decisions.

An important function of accounting and financial reporting is to assist hi the analysis and evaluation of organizations. Currently, much is known about how investors and creditors use the financial statements of business entities. However, less is understood about how the financial statements of not-forprofit organizations play a role in charitable giving.

There are several important reasons to examine the value of accounting data to financial information users generally, and donors specifically. The first is the size and economic importance of the third sector in the U.S. and elsewhere. Second, contributions represent an “investment” in not-for-profit entities. Accountants in not-for-profit entities should understand whether and how accounting reports influence charitable giving by the donor community, just as corporate accountants understand how the investment community uses their financial reports. Third, standard setters are interested in providing the most useful information to financial statement users in both the business and nonbusiness sectors. Therefore, accounting researchers need to examine the usefulness of accounting reports in nonbusiness contexts. Finally, fundraisers should be interested in how accountability can be used to inform potential donors about the ways that charities put contributed funds to work.

Many factors other than an organization’s financial information influence a potential donor’s decision to give. Motivations to give to a particular organization include preference for the cause to which the entity is dedicated, discretionary income, religious affiliation and personal belief in altruism [Gordon and Khumawala, 1999a]. However, the purpose of this paper is to focus solely on the research that examines the value relevance of accounting information in the decision to make a charitable donation and to determine which aspects of the role of accounting reports in charitable giving remain unexplored. Statement of Financial Concepts (SFAC) No. 2 states that to be relevant, “accounting information must be capable of making a difference in a decision by helping users…” [FASB 198Oa, 1 47]. Beaver [2002, p. 459] asserts that value relevance research in the capital markets area “examines the association between a security price-based dependent variable and a set of accounting variables.” The users in Beaver’s example are investors and the decision is the valuation of the company (through its stock price). Capital markets research provides evidence that accounting information is associated with security price (the decision outcome).

Using these definitions, NFP value relevance research seeks to explore the association between donations and accounting numbers in order to assess whether NFP accounting is relevant to donors. The decision-makers are donors, and the decisions are whether to make a charitable contribution and how much to contribute. The dependent variable “donations” represents the capital that contributors invest in nonprofits. Value-relevance research in the nonprofit area seeks to demonstrate an association between accounting and donations (the decision outcome).2

The paper is organized as follows. The next section summarizes the current accounting practices of NFP entities. section three presents a discussion of how research addressing accounting issues in the third sector is evolving. That section summarizes the debate about the proper accounting framework for third sector entities and empirical research on NFP performance measures. The fourth section suggests areas for future research and the last section presents the conclusions.


The rules governing accounting and reporting practices of NFPs in the United States come primarily from the Financial Accounting Standards Board (FASB) and the Internal Revenue Service (1RS). The FASB regulations guide the preparation of annual reports of NFP entities, while the 1RS requires an informational tax filing (on Form 990) for certain charitable entities organized under section 501(c)3 of the tax code.

The focus of current accounting rules seems to support providing information about the stewardship (versus profit) of not-for-profit entities. Both the FASB and 1RS call for NFPs to present expenses by functional category (program, administrative and fundraising) and classify revenues as unrestricted, temporarily restricted or permanently restricted. This presentation is intended to allow a donor or other user to determine 1) how money was spent, 2) how much of total expenditures support the organization’s mission, and 3) whether there is compliance with donor restrictions. In other words, it permits a user to determine the degree to which available resources are directed to providing programs and used in accordance with donor-specified terms.

Accounting information prepared under current FASB and 1RS guidelines does not provide information regarding whether an organization is successful in carrying out its mission. The degree to which an organization fulfills its purpose is not necessarily measured by looking at the amount of funds received and expended. Most often, supplemental disclosures of nonfmancial accounting data are the best way to provide information about an organization’s accomplishments. One suggestion [Brace et al., 1980; FASB, 1980b] is to provide a report of service efforts and accomplishments (SEA). Both the FASB and the Governmental Accounting Standards Board encourage the provision of SEA disclosures. However, the current accounting rules of both boards make reporting SEA optional. Further, the 1RS does not require SEA disclosures on Form 990. A report by the FASB [Brace et al., 1980] finds that such nonfmancial accounting information is rarely provided and is usually not presented for multiple years (allowing donors to see trends).

Recent 1RS regulations require charitable organizations to make copies of tax filings available to any donor or potential donor who requests them [Gordon et al., 1999]. The 1RS does not, however, prescribe that NFPs prepare annual reports in accordance with FASB principles. As a result, current reporting practices among charitable organizations vary greatly. Christensen and Mohr [2003] find the amount of financial information and disclosures contained in annual reports from nonprofit museums vary far more than for annual reports of corporate entities. Gordon et al. [2001] also report large variation in the amount of financial information provided by tax-exempt environmental organizations and discover that accounting information in the annual reports is not always consistent with that provided in the Form 990. Keating and Frumkin [2003] find that information supplied hi annual reports differs from that required by Form 990, leaving donors with a wide range in the type and amount of accounting data available.3


Early accounting research in the for-profit field focused on financial accounting from an economic income perspective. Through the mid-1960s, accounting research was normative – it dealt with what accounting practices should be and how accounting information should be used [Mouck, 1993]. Researchers attempted to explain the desirability of alternative accounting approaches and focused the role of accounting in the measurement and valuation of economic income. Though there were a variety of measurement bases supported by the research community (historical cost, replacement cost, liquidation value, current value, historical purchase price adjusted for inflation), accounting scholars were working toward a common goal of establishing the best measurement of economic income. The general consensus was that accounting can be used to report the real value of a company’s financial position and its periodic income [Beaver, 1998].

Subsequent to the mid-1960s, accountants began to accept that all accounting was inherently arbitrary (i.e., no real measurement was possible). This realization led the community to view accounting from the informational perspective [Mouck, 1993; Beaver, 1998]. Subsequent accounting research has been labeled positive – it addresses what accounting practices are and how information is used. The informational perspective sees accounting as a tool to distribute information to interested parties to enable them to make their own decisions. Rather than trying to produce accounting numbers that represent the value of a firm or measure income directly, the financial statements tell a story about the economic events of an organization and allow individual users to determine their own value for a company. The informational perspective is a next best (indirect) procedure mainly due to the lack of complete markets (i.e., all commodities do not have market prices in all states). Complete markets would provide a measure of value directly. The informational perspective therefore implies that financial accounting reports assist in the efficient allocation of investor capital to businesses. The resulting research stream began with the pivotal work of Ball and Brown [1968], who were the first to examine the role of accounting in firm valuation.

In the not-for-profit research arena, a similar transition is underway, but decidedly of a much later origin. Until recently, scholars have focused on discovering the proper accounting methods for nonbusiness organizations in general and third sector entities in particular. The previous goal was to determine how best to directly measure the output of charitable organizations. However, researchers have now begun to examine the (indirect) value of notfor-profit accounting data to users, primarily donors. The premise of contemporary studies is that not-for-profit financial accounting reports are useful if they assist in the efficient allocation of donor capital to charitable organizations. The more recent research stream examines the association between donations and certain accounting numbers. Researchers have focused on donations because the net income number is not considered relevant to users of not-for-profit financial statements. Pye [1957] and Forbes [1998] say users are not interested in NFP net income because the organization’s net assets (residual) cannot be distributed to owners in the form of dividends, while Cherny et al. [1992] and Mautz [1994] claim net income is relatively unimportant to donors because producing a profit is not the purpose of a nonprofit entity’s operations. Contributions (often called nonexchange transactions because the donor receives no reciprocal economic benefit) serve as one proxy for the trust that donors place in a NFPs management to meet the stated purpose of the organization.

3.1 Normative Accounting Research – In Search of an Appropriate Framework

Third sector entities can and often do have characteristics of both business and governmental enterprises [Weisbrod, 1988]. Some NFPs frequently engage in transactions that resemble those of business organizations, such as selling private goods and services. For example, museums and zoos may charge admission to see their collections. Others act more like a governmental unit, where there is not a direct link between amounts contributed and benefits received. The Red Cross accepts contributions from one part of the world in order to provide relief efforts to disaster victims in another region. The benefits received by the injured parties are not dependent in any way on the recipient’s ability or willingness to pay for services.

Most commonly, however, NFPs do not completely resemble a business enterprise or a governmental unit. Rather, they concurrently possess attributes of both types of entities.4 Nonprofit hospitals are examples of institutions that may charge patients fees determined by their ability to pay (instead of the value of the service received) and solicit contributions from the public in order to cover the portion of patient care costs that are not charged to the beneficiaries. As a result of this hybrid structure, the issue of an appropriate accounting framework for NFPs has generated a great deal of debate and has lead to a wide variety of suggested models.

Accounting practices for NFPs have been debated in the United States since 1912 [FaIk, 1992], yet until recently there were no uniform accounting practices for the third sector. The lack of consistency resulted because preparers of NFP financial statements borrowed practices from both business and governmental accounting models. FaIk points out that past accounting practices for NFPs have included full accrual accounting (including the recording of depreciation expense), modified cash basis accounting (no depreciation expense is recorded), and cash basis accounting. Many NFPs used a fund accounting approach, while others did not. Some NFP entities included the value of donated goods and services in financial reports while others did not report these donations. The FASB has recently taken steps to make NFP accounting and reporting practices more uniform and comparable to those used by business entities.5

The comparison of NFPs to business organizations has dominated the focus of NFP accounting debates.6 Currently, the accounting and reporting practices of NFPs are primarily established by the FASB, which is responsible for setting accounting standards for all business entities. The following discussion uses the current business accounting framework as a comparative reference for an accounting framework for NFPs.

3.1.1 Support for Using the Same Framework for NFPs as Business Entities

Standard Setters: Until the Financial Accounting Standards Board issued SFAC No. 4 in 1980 dealing with nonbusiness entities, it had not specifically addressed the issue of NFPs [Martin and Floch, 1997]. With SFAC No. 4, the FASB stated that though certain differences exist, NFPs operate similarly to business entities. Accordingly, the FASB has recently prescribed accounting rules that attempt to bring the accounting practices of NFPs in line with those currently utilized by the business sector. Likewise in Canada, the Canadian Institute of Chartered Accountants (CICA) has also taken the stand that NFPs are not sufficiently different from business organizations to warrant a separate accounting framework [FaIk, 1992]. CICA has not, however, recommended that the capitalization of fixed assets and related depreciation be included in the accounting records of NFPs.

Robert N. Anthony: Anthony [1995] argues that there are differences between business and nonbusiness entities, primarily that contributors do not receive an equity interest in the NFP firm. he does not agree with the call for a separate accounting structure, but states that the differences should be understood when establishing accounting rules for NFPs. he contends that separate accounting practices would lead to confusion within the financial community and would decrease the informativeness of NFP financial statements [Anthony, 1989].

Anthony claims that financial statement users are most interested in performance. He notes that “a primary economic goal of a nonprofit entity is to provide a satisfactory amount of services with available resources or to provide a specified amount of services with reasonably few resources” [1983, p. 34]. He states that the focus of the framework should be the direct measurement of periodic surplus (similar to income).

Anthony [1995] suggests that the effort to fund and provide the primary services of an NFP should be separately reported as “operating results,” while contributions and expenditures which relate to the maintenance of the organization’s long-lived assets should be reported as “capital transactions.” he compares contributions of long-lived assets, such as plant assets or endowments, to equity contributions in a for-profit organization, because such contributions are not usually available for daily operations. he further recommends reducing the reported value of these contributed fixed assets by the cost of soliciting the gifts, just as stock issue costs would be deducted from the proceeds in a stock issuance. Additionally, Anthony distinguishes between assets that are acquired with operating resources (operating assets) and those acquired through direct contribution (capital assets). Specifically, he advocates depreciating purchased/operating assets, while suggesting that operating income should not include depreciation expense related to contributed/capital assets [Anthony, 1989].

Societal Model: Another call for a unified framework comes from Cherny et al. [1992]. They state that the current difficulties reconciling the framework for NFPs to that used by business entities result because neither framework includes the total societal impact of an organization. Their claim is that profit for an organization should be a “measure of well-offiiess” [1992, p. 115] that encompasses the effects of the organization’s activities on the individual, the firm and society.

The primary difficulty in establishing a measurement of performance for an NFP is that success is not determined by its profitability, but by the degree to which it maximizes the benefit provided to the people it serves. In other words, an NFP accomplishes its goal when it maximizes consumer benefits. The current model for commercial enterprises also ignores consumer benefit and focuses only on internal return. If the centrality of the consumer is adopted in the accounting framework for bom business and nonbusiness firms, and financial reports include a reflection of an organization’s externalities (societal costs and benefits), the problem of converging accounting systems of for-profit and NFP organizations would be resolved.

3.1.2 Arguments for Using a Framework Différent from that of Business Entities

Supporters on the other side of the debate claim that the differences between business and nonbusiness enterprises are so significant as to warrant a separate accounting and reporting structure. For example, Chambers [1966] admits that his suggested accounting model, based on market-valued transactions and residual equity ownership, is not appropriate for most social organizations, including NFPs.

Robert K. Mautz: Mautz was the most vocal among those calling for a separate accounting framework. He claimed that certain items which qualify as assets of a business organization are not necessarily assets of an NFP [Mautz, 1989]. Certain fixed properties are costly to acquire, but do not necessarily provide future cash flows to the not-for-profit firm. In fact, they may even require substantial future cash expenditures for maintenance and replacement. This requirement of future expenditures, according to Mautz [1994], is a characteristic of a liability, though buildings and other properties in the possession of an NFP do not possess all the characteristics of a liability and should not be so classified. Mautz [1994, p. 43] reasoned that “adding cash-producing property to cash-consuming property is almost like adding assets and liabilities.”

To solve the problem of classification, Mautz [1989, 1994] suggested a new classification for properties that require future cash expenditures and do not provide future cash receipts. Mautz labeled these items “service facilities” and recommended a separate disclosure in order to emphasize the value and cash commitment these facilities represent to the organization. he also asserted that depreciation of these service facilities is not meaningful to financial statement readers. Instead, maintenance expenditures should be recorded as expended.

Unlike commercial enterprises, NFPs are often not self-funding. Not only are donors concerned that a charity has the funds to operate today, but also that it can continue to meet financial needs into the future. Mautz [1988] recommended disclosing spending commitments or planned expenditures (which are not necessarily liabilities) in order to allow better evaluation of the entity’s needs. Pallet [1990] echoes this recommendation.

Alternative to Mautz: Pallet [1990] agrees with Mautz’s contention that fixed properties in the possession of NFPs are difficult to define. However, she disagrees with the creation of a new category that is a hybrid of asset and liability. She explains that assets “have both a resource dimension … and a property dimension” [emphasis is Pallet’s, p. 81]. Based on the theory of property rights, Pallet argues that NFPs have the right to manage these facilities and have a right to benefits that arise from possession. Therefore, such facilities are assets. However, these assets have a “social, rather than a commercial purpose” [p. 83], are usually available to the public at large, and are not typically salable. She therefore recommends separating these assets from ordinary fixed assets used to provide services and labeling them “community assets.” Ordinary fixed assets (such as vehicles or office furniture) would be subject to depreciation, but community assets (such as a museum building or a monument on the campus of a university) would not be. Separating community assets from ordinary fixed assets provides greater information regarding the solvency and adaptive capacity of an organization.

Contract Theory: Sunder [1999] emphasizes that accounting practice should accommodate the monitoring of contracts that are the nexus of organizations. The transactions of business entities involve trading residual interests and seeking to maximize return on capital. Capitalization of fixed assets is useful for estimating firm value, and depreciation of these assets is necessary in order to fully determine the cost to business entities of generating revenues. Contracts based on accounting reports prepared using business accounting help to align the goals of managers with those of owners (maximizing return). However, since the goal of contributors is not to maximize economic returns, designing accounting reports for nonbusiness entities in a manner similar to that used by for-profit businesses is not useful. As noted below, Sunder [1999] suggests there are more effective reporting mechanisms for monitoring and enforcing contracts between NFP managers and donors.

Donors often restrict the way managers can use contributed funds. Thus, Sunder recommends reporting restricted funds in segregated accounts using fund accounting. To do otherwise would imply to financial statement users that all resources of the organization were available to meet any need of the firm or its beneficiaries. The use of fund accounting serves to assure donors that restricted funds are being properly used.

Sunder [1999] also proposes that because fixed assets are not always available for sale or exchange, including depreciation of these assets as a cost of providing services is not helpful to financial statement users. he implies the use of cash or modified cash accounting is more appropriate when there is no causal link between expenses incurred and revenues generated. he also advises a comparison of expenses to a detailed budget as an important control.

3.1.3 No Need for Uniform Accounting Practice for NFPs

Mautz [1994] clarified that his recommendations should be viewed as guiding principles rather than rigid rules. He added that the operations of NFPs vary to such a degree that no one set of accounting rules would best represent the activities of all organizations. All for-profit business operate in order to generate (and presumably maximize) profit, regardless of the industry in which they operate. However, NFPs differ from one another in ways other than their “industry” (i.e., health care, education, arts, public benefit). Mautz [1994] classified organizations according to their stated purpose (mission). Some organizations work to solicit funds from outside sources (donors and grantors) and spend almost all these resources on their mission. Examples of these traditional charities include medical research organizations and homeless shelters. Other NFPs are “break-even businesses” that charge for their services, but do not seek profit from these activities. Nonprofit day care centers, hospitals and universities are examples of NFPs that operate similarly to a traditional business organization. Finally, professional societies and homeowners associations are examples of self-help organizations that provide members a way to accomplish a joint goal and share the costs. Due to the variation in the purposes and operations of NFPs, Mautz [1994] suggested NFPs should be allowed the flexibility to prepare financial reports in the way that management believes is the most informative.

Likewise, FaIk [1992] suggests that not all NFPs are created equal and accounting practices should vary based on the entity’s control structure. One organizational structure of NFPs is the club, in which the contributors and beneficiaries are the same (similar to Mautz’s self-help organizations). For members/contributors, participation is based on the quality of the NFP’s output. Membership can be initiated or discontinued at the discretion of each member based on the perceived “return on contribution.” This is similar to the decision in a competitive market, where investors decide to invest in or divest of an equity ownership based on the company’s financial results. “Ownership” or control lies with the members.

With this type of NFP structure, the primary financial statement user is the member/contributor. The concern is the entity’s efficient use of resources for a particular period. Matching expenses to the revenues of a period is necessary in order to evaluate performance of management. Falk argues that full accrual accounting, with capitalization and depreciation of fixed assets, provides the member/contributor with the best information regarding the operations of the club. Asset depreciation reports the portion of capital assets that was used by or available to members during the accounting period.

Another common organizational form for NFPs is the charity, where donors are not the firm’s beneficiaries. The donor/contributor typically does not see the output/service of the charity and cannot easily judge its quality. Beneficiaries can judge the quality of the services offered, but are not contributors and therefore do not have control or ownership of the charity. With this organizational structure, the donor/contributor relies on information from the NFP to assess the performance of the enterprise. The return to the donor is nonmonetary, consisting of the donor’s utility from offering assistance to those in need. In this situation, Falk maintains that a cash (or modified cash) basis of accounting best provides the information necessary for patrons to assess giving decisions. The primary concern for contributors is that adequate funding exists to provide goods and services in any period; capitalization and depreciation of fixed assets only confuses the financial statement user’s evaluation of the charity’s need for funding.

3.2 Positive Accounting Research – Is Accounting Information Useful?

Beginning in the mid-1960’s, accounting researchers began to shift their focus from which valuation and measurement method was the closest to the “true” economic value of a company and instead began to investigate the association between measures of firm value (such as stock price) and accounting measures. A similar change has taken place in NFP accounting research. Instead of looking for the “best” accounting framework for NFP entities, accounting researchers are asking whether NFP accounting reports are useful to decision-makers, primarily donors.

In the commercial sector, financial statement users look at measures of profitability or leverage to make judgments about a firm’s performance. However, in the nonbusiness sector, there is not a similar profit motive or an ability to reward equity stakeholders. Are there other accounting measures that are useful for evaluating performance in the third sector? If so, what are they? Drtina [1984] and Cherny et al. [1992] indicate that donors and regulators are most interested in the efficiency and effectiveness with which a not-for-profit firm operates.

3.2.1 Efficiency

A measure of efficiency should demonstrate how well an entity uses its resources [Drtina, 1984]. Anthony [1983] and Cherny et al. [1992] agree that efficiency is the ability to provide the greatest amount of services with the least level of resources. There are various proposals for determining whether a nonprofit organization is operating efficiently. Drtina [1984] and Anthony and Young [2003] suggest that the ratio of inputs (resources used to produce a service) to outputs (the services produced) summarizes organizational efficiency.7 This ratio, similar to a unit cost measure, allows donors to determine how costly the provision of a particular service is to an organization. It also allows a comparison across programs, firms and time periods. Henke [1972] and Cherny et al. [1992] point to the problem of quantifying NFP output (quality), which renders a unit cost measure difficult to obtain.

Current accounting standards prescribed by the 1RS and the FASB do not include reports of outputs (in the form of consumer benefit). However, the FASB recommends disclosing service efforts and accomplishments, or SEA. Service efforts are defined as the resources (inputs) and the way in which the resources are used (processes) to provide goods and services. Service accomplishments are the goods and services provided (outputs) and improved conditions (outcomes) that result from service efforts [Brace et al., 1980]. If NFP entities provide the optional SEA information, financial statement users can more easily discern the information necessary to judge efficiency as defined by Anthony [1983] and Cherny et al. [1992]. Without the voluntary disclosure of SEA, financial statement users cannot obtain traditional efficiency measures from financial statements or 990 reports. As a result, accounting researchers have concentrated on inputs instead of attempting to quantify outputs. Operational efficiency (a restricted measure), defined solely in terms in inputs, is a measure of the degree to which NFPs direct their available resources to the organization’s mission.

The “price” measure indicates the percentage of contributed (and other) resources that directly benefit the cause for which the charity has been established. A higher “price” suggests a less efficient organization. Watchdog agencies focus on this measure when setting guidelines for donors.8 Further, Hyndman [1991] and Khumawala and Gordon [1997] report that donors’ principal financial concern is the percentage of expenses dedicated to programs. Thus, a focus on this restricted efficiency measure, which employs input data available in current accounting reports, is reasonable.

Several studies find evidence to support the claim that “price” is negatively related to total contributions received, indicating that donors give more money to organizations that spend less of the gift on fundraising and overhead. These studies primarily examine combined donations from all sources (individuals, corporations, foundations) and have not distinguished among donor types. Wiesbrod and Dominguez [1986] use data from U.S. 990s and find that total donations are negatively related to “price.” Posnett and Sandier [1989] obtain the same result utilizing revenue and expenditure information from large charitable organizations in the United Kingdom. Tinkelman [1999] reports a similar result with data from New York State regulatory filings by not-for-profit organizations.

Callen [1994] examines Canadian tax filings from charitable organizations (similar to U.S. 990s). He includes the number of volunteer hours as a control variable in order to determine whether volunteered time was a better indicator of efficiency than “price” (because volunteer labor can reduce the cost of providing services, resulting in a more efficient organization).9 Additionally, Callen uses both total donations from all sources and the number of volunteer hours as dependent variables. He finds that “price” is a significant explanatory variable for total dollars contributed, regardless of the amount of volunteer labor available to a not-for-profit organization. However, “price” is not significantly related to donated time, indicating that while donors may consider efficiency before making a monetary contribution, individuals are not concerned with efficiency when deciding to volunteer time to organizations.10

Tinkelman [1998] uses financial data from New York State regulatory filings to separately examine contributions from individuals and institutional donors (corporations and foundations). He finds that contributions from individuals are significantly and negatively related to “price,” while total contributions from all other sources are not. Further, Tinkelman includes a new explanatory variable called “ratings,” which is a dummy variable coded as one if either the National Charities Information Bureau (NCIB) or the Council of Better Business Bureaus (CBBB) reported violations of their governance guidelines (including recommendations for appropriate levels of expenditures for fundraising and administrative expenses).11 Tinkelman explains that the “ratings” variable is intended to serve as a proxy for quality, which includes efficiency. The “ratings” variable is significant in explaining total contributions from institutional donors, but is not significant in explaining donations from individuals. Accordingly, Tinkelman [1998] demonstrates that efficiency is important to both individual and institutional donors.

Despite the body of evidence that shows donors care about “price,” Steinberg [1986] suggests that efficiency measures that consider fundraising expenses are not useful to donors. he develops a model to demonstrate that NFPs set fundraising levels such that the marginal revenue generated equals the marginal cost incurred. Currently, donors can only discern the average fundraising costs in NFP financial statements, so Steinberg’s argument implies that financial information related to fundraising expenses (as currently presented) is not useful to donors faced with a giving decision. He suggests instead that the percentage of funds dedicated to administrative expenses is the better indicator of efficiency (defined in terms of inputs).

In response to Steinberg, Okten and Weisbrod [2000] state that “nonprofits generally do not devote resources to fundraising at levels that maximize net profit from fundraising” (p. 271). Tinkelman [2002] supports this argument by presenting evidence that average fundraising costs are stable over time and at different fundraising levels. He also demonstrates that average fundraising costs are a lower bound for marginal fundraising, which implies average fundraising currently presented in NFP accounting reports has value for donors.

Two studies examine efficiency measures that focus solely on resources available to the organization, but differ from “price” in that they do not rely on average fundraising as currently reported. Greenlee and Brown [1999] use the percentage of expenses committed to administrative costs as an efficiency measure and find it is significantly and negatively related to total contributions. Parsons’s [2001] field experiment provided subjects with varying amounts of financial accounting data in a fundraising appeal. She finds that prospective donors, primarily those that previously contributed to an organization, are more likely to make a contribution when efficiency measures (specifically the percentages of expenditures dedicated to program services, fundraising, and administrative expenses) are provided directly with the request for funds. These studies address Steinberg’s concern about average fundraising and provide further evidence to indicate that current accounting reports provide donors with useful efficiency measures.

An alternative efficiency measure that also focuses only on inputs is fundraising ratio, calculated as fundraising expense divided by total donations revenue. This measure provides an indication of the cost of generating current contributions, thus addressing the efficiency of fundraising instead of the efficiency of operations. Watchdog agencies, such the Better Business Bureau’s Wise Giving Alliance, focus on this ratio when setting performance guidelines for NFPs. To date, accounting studies have not examined the relationship of this efficiency ratio with donations.

3.2.2 Effectiveness

Cherny et al. [1992] define effectiveness as the degree of satisfaction of the wants and needs of a firm’s beneficiaries and state that service effectiveness is “the principal criterion of agency performance” about which management of, and donors to, NFPs should be concerned. This organizational characteristic has proven the most difficult to quantify. Most suggestions for reporting organizational effectiveness involve supplemental disclosures of nonfinancial information instead of accounting ratios. Reports of effectiveness could recount the degree to which firm goals are met, the level of improvement in the lives of constituents, or the progress toward the elimination of the predicament for which the NFP was formed. Few empirical studies have examined the relation between effectiveness measures and contributions, because these measures are optional and, therefore, not frequently available.

Drtina [1984] suggests that management should define program objectives that are measurable, such as a number of clients or a percentage of satisfied beneficiaries. Demographic data, observed conditions or social surveys could be used to gather the information necessary to measure actual performance. A comparison of final results to the firm’s goals would assist management in assessing results and could be communicated to donors. The degree of success relative to the firm’s objectives could also be included in an expanded audit scope.

Another way to communicate nonfinancial information is to report an entity’s SEA, especially outputs (goods and services provided) and outcomes (improved conditions) [Brace et al., 1980]. SEA is similar to management’s discussion and analysis (MD&A) required by the securities and Exchange Commission (SEC) for publicly-traded commercial companies. The sec’s MD&A requires companies to describe, in narrative form, the events that underlie the financial statements. Similarly, NFPs could discuss efforts to obtain funding and give specific information about the success of their programs. Disclosure of SEA is optional under the FASB’s current rules, but Khumawala and Gordon [1997] and Coy and Dixon [1995] find that users of NFP financial statements want more information about the entity and its services than is currently provided. Further, Hyndman [1991] finds that donors, charity officials and auditors working in the third sector list output measures (similar to SEA) as one of the most important factors necessary for making a contribution decision.

Parsons’s [2001] field experiment creates a situation where some donors have access to SEA disclosures and others do not.12 She finds that while providing individual donors with SEA measures does not result in a larger number of contributions, the average donation (especially from donors who had not previously contributed to the organization) is greater when SEA is provided than when it is not. This implies that donors can and will use effectiveness measures in the donation decision.

3.2.3 Financial Stability

In addition to knowing that an NFP works effectively and efficiently, donors want to know whether the firm can continue to operate in the future (analogous to a measure of “going concern”). Anthony [1983] asserts that, just like business entities, NFPs must maintain positive net equity, with assets in excess of obligations, in order to continue to operate. Tuckman and Chang [1991] propose four specific indices for assessing an NFP’ s financial condition.

Adequacy of Equity: First, the ratio of net assets to total revenue can be calculated to determine the adequacy of “equity.” This ratio provides a measure of the number of periods of revenue a nonprofit currently has on hand. In the event of a temporary decline in revenues, a firm with greater access to funds faces a lower risk of collapse. An organization with a larger measure of net assets to total revenue is more likely to be able to a) liquidate existing assets or b) obtain credit in order to meet future needs. Without an adequate reserve of funds, a nonprofit firm will be unable to continue to operate normally when faced with a reduction in revenues.

Revenue Concentration: Second, a firm with a greater number of revenue sources is expected to be less susceptible to financial shocks. A firm that is dependent on one or a few revenue providers is vulnerable to declines in the economic health or changes in the donation preferences of those providers. To capture the extent of revenue dispersion, Tuckman and Chang recommend computation of an index of revenue concentration similar to the Herfindahl Index used by economists to measure market concentration. Specifically, Tuckman and Chang define the revenue concentration index as the summation of the squared percentage share that each revenue source represents of total revenue. If a single source of revenue exists, the index equals one. A firm with many sources of revenue has an index closer to zero.

Level of Administrative Costs: Third, Tuckman and Chang recommend computing a ratio of administrative expenses to total expenses. This measure is similar to the efficiency measure used by Greenlee and Brown [1999]. Tuckman and Chang reason that a firm with high administrative expenses could adjust to revenue reductions by taking steps to cut costs. When faced with a reduction in revenues, an organization with larger overhead costs has the option to cut those costs instead of reducing the overall level of program services offered. By contrast, a leaner, more efficient firm may have less ability to economize without cutting program expenditures. According to Tuckman and Chang, NFPs with the lowest ratios are the most vulnerable to financial crisis.

Operating Margins: Lastly, Tuckman and Chang suggest a measure analogous to the gross margin ratio used in a business setting. This ratio, called operating margin, is revenues less expenditures, divided by revenues. A higher operating margin is indicative of a greater potential surplus on which to draw in the event of unexpected financial difficulties.

Greenlee and Trussel [2000] include Tuckman and Chang’s [1991] financial stability measures in a logistic regression model to predict financial vulnerability (defined as a decrease in program expenditures for three consecutive years). Three of the four financial stability measures (all except the ratio of equity to revenue) are significant in predicting financial vulnerability.

Further, Trussel and Greenlee [2004] extend the Greenlee and Trussel [2000] financial vulnerability prediction model to control for size and sector, as well as to explore other definitions of financial distress. Financial distress is defined as a significant decrease in net assets over a three-year period. A significant decrease is identified as at least a 20 percent decline and alternatively as a drop of 50 percent or more. In both instances, two of the four financial stability variables (the ratio of equity to revenue and the operating margin) are significant predictors of financial distress.

Both studies by Greenlee and Trussel addressing Tuckman and Chang’s [1991] financial stability measures offer the first evidence that financial stability measures can be valuable to those assessing NFP organizations.


Several studies [Weisbrod and Dominguez, 1986; Posnett and Sandier, 1989; Callen, 1994; Tinkelman, 1998, 1999] provide evidence that total donations and efficiency measures that include average fundraising are positively related. Greenlee and Brown [1999] find efficiency measures that ignore fundraising expenses and concentrate on administrative costs are positively associated with contributions. However, questions about efficiency measures remain unanswered. Most of the prior studies do not address causality. Are more efficient organizations better fundraisers or are donors drawn to more efficient firms? Are efficiency measures that incorporate fundraising costs more or less useful than those that consider only general overhead expenses? Alternative research designs, such as experimental techniques, can assist in determining whether donors consider an organization’s efficiency before making a charitable contribution and which efficiency measures they find most informative.

Different types of donors have varying motivations for making charitable contributions. Individuals are more likely to make giving decisions for social, religious or emotional reasons [Gordon and Khumawala, 1999a]. Donations from other types of donors, such as corporations, foundations or government agencies, result from fiduciary decisions made by employees on behalf of their employers. Perhaps distinct types of donors use different financial information in the decision process. Only Tinkelman [1999] has separately considered the relation between efficiency and donations from different types of donors. The issue of whether different financial statement users use different financial information for donation decisions warrants further exploration.

Parsons’ [2001] study demonstrates that efficient firms can use financial information to increase fundraising from certain donors, but she looks only at individual donors and uses only one efficiency measure. Additionally, she studies an organization with a large percentage (over 92 percent) of funds directed to program services. Further work is needed to identify other financial measures, including balance sheet ratios or explanatory footnote disclosures, that play a role in the donation decision. Future research should also determine what level of efficiency is considered adequate by donors and whether the guidelines provided by the Better Business Bureau’s Wise Giving Alliance are in line with donor expectations.13

Accounting researchers have focused on efficiency ratios calculated to measure the use of resources for programs, overhead and fundraising. This measurement choice is largely driven by existing data from IRS 990s and FASB-compliant financial statements. Efficiency measures that communicate the amount or quality of services provided with a given level of resources or the unit cost of goods and services provided are not generally provided to potential donors. Accounting research should begin to investigate whether more comprehensive measures of efficiency, including reports of outputs, are practical to produce and valuable to donors.

Due to the lack of availability of nonfinancial effectiveness measures, there is little evidence to suggest whether SEA disclosures are useful to donors. Studies by Hyndman [1991] and Khumawala and Gordon [1997] indicate that donors want access to this form of information. Parsons [2001] suggests that SEA disclosures may assist certain individuals in their donation decision. However, more work is needed to determine how to present SEA disclosures and whether the usefulness of this information varies across different types of NFPs.

Greenlee and Trussel [2000] and Trussel and Greenlee [2004] provide evidence that Tuckman and Chang’s [1991] financial stability measures are useful for financial statement readers in predicting financial distress of NFPs. However, studies to date have not addressed whether donors use measures of financial vulnerability when making a contribution decision. The relationship between stability measures and donations should be explored.

The usefulness of accounting information to donors may depend on the context in which it is presented. Greenlee and Bukovinsky [1998] and Hager [2001] suggest that any analysis of accounting ratios should consider that differences may be due, in part, to the “industry” or sector in which the organization operates. Falk [1992] proposes that the usefulness of accounting information differs depending on the level of contact between the donors and the beneficiaries of a charitable organization. Baber et al. [2001] advise users of NFP financial statements to consider a charity’s fUndraising strategy (revenue-maximizers versus cost minimizers) in order to properly analyze efficiency ratios. Future accounting research should explore these claims about the variation of the value relevance of NFP accounting information to develop our understanding of whether and how usefulness is context-specific.

There is evidence that the amount of financial and nonfinancial accounting information provided by charitable organizations varies drastically [Christensen and Mohr, 2003; Gordon et al., 2001]. Additionally, both Keating and Frumkin [2003] and Gordon et al. [2001] suggest coordinating the accounting requirements of the IRS and the FASB and make recommendations for doing so. Currently, however, there is little research to determine whether donors benefit from the information that is currently available to them or want more information. To assist in determining the proper form and content of accounting reports, and to understand the effect accounting information has on donation decisions, NFP accounting researchers should address the following questions: Are the current financial statements produced by NFPs valuable to donors? Is the information in the Form 990 adequate for making donation decisions? Would the provision of SEA or some similar disclosure of outputs and outcomes be useful to donors? How should accounting information be presented to maximize the benefit to financial statement users?

A final suggestion for examining the usefulness of NFP accounting information is related to the way in which financial reports are made available to potential stakeholders. Institutional donors have greater access to accounting information from NFPs because of the relative importance of a single corporate or foundation grant compared to a typical contribution from an individual. Charitable organizations must often submit financial information and SEA-like disclosures in order to request a corporate contribution. Individuals, on the other hand, do not possess the same influence to require accountability from these entities. The SEC’s Regulation FD (Fair Disclosure) prohibits this type of selective provision of information by corporations. Does this imply that NFP’ s should be similarly limited? If so, what is the best method for making information available to potential donors and other stakeholders?


Is accounting information useful in the NFP sector? Some researchers indicate that when potential donors examine accounting measures, they are most interested in the efficiency and effectiveness with which a not-for-profit firm operates [Anthony, 1983; Drtina, 1984; Cherny et al., 1992]. Studies beginning with the work of Weisbrod and Dominguez [1986] offer empirical evidence that efficiency measures are valuable to donors. Parsons’ [2001] investigation is the first to provide evidence that effectiveness measures (specifically SEA disclosures) are beneficial to contributors.

Other researchers point to the need to assure donors that an organization can continue its operations in the future [Anthony, 1983; Tuckman and Chang, 1991]. Greenlee and Trussel [2000] demonstrate that financial stability measures are useful to certain users of NFP financial statements.

Notwithstanding the initial empirical evidence of the benefit of NFP accounting reports to donors, there is still progress to be made to expand our knowledge of whether and how financial and nonfinancial accounting data impact potential donors’ giving decisions. Given that nonprofit organizations receive over $200 billion annually [Strom, 2002], there is a need to understand the effects that accounting reports have on the allocation of resources to NFP entities. This paper makes three important contributions to the literature examining accounting in a not-for-profit setting.

First, it assists in establishing a framework for examining the value relevance of NFP financial statements to users, primarily donors. Prior studies incorporate implicit assumptions about the information that is useful for potential donors (and other financial statement users), but have not explicitly defined or uniformly used the concepts of efficiency, effectiveness and financial stability. This paper provides precise definitions of constructs that are included in a number of studies, but to date have not been consistently labeled and discussed.

Second, this review provides a report of the current state of the research addressing whether and how NFP accounting reports are used in the donation decision process. The debate among NFP accounting researchers is no longer how to measure results, but whether current accounting reports assist users (primarily donors) in the analysis and evaluation of nonprofit organizations. This summary outlines the progress that has been made in this area.

Third, the paper identifies a number of research questions that have not yet been thoroughly investigated. Current research has provided some evidence demonstrating the value relevance of NFP accounting reports to donors. However, there is still work to be done in order to advance our understanding of the role of financial and nonfinancial reports in the charitable giving process.


1. Weisbrod, B.A. and N. D. Dominguez. Demand for collective goods in private nonprofit markets: Can fundraising expenditures help overcome free-rider behavior? Journal of Public Economics 30 (1986): 83-96.

This study (W&D) develops an accounting ratio, called price, that measures the efficiency with which a not-for-profit organization operates. Price is defined as the after tax cost to a donor to provide one dollar of service to beneficiaries and is partially a function of fundraising expenditures. As a not-for-profit entity spends more on fundraising, the price of a donation increases. Using data from IRS Form 990s for the years 1973-76 in a regression model, W&D find that price is negatively associated with total donations received. This evidence indicates that organizations that report more efficient results received larger contributions. However, because fundraising is similar to advertising in a for-profit organization, fundraising is positively associated with total contributions. Fundraising seems to have an immediate direct effect on contributions and a negative indirect effect on donations in the long term.

2. Posnett, J. and T. Sandler. Demand for charity donations in private non-profit markets. The case of the U.K. Journal of Public Economics 40 (1989): 187-200.

This research (P&S) tests the W&D model using data from charities in the United Kingdom for the years 1985-86. The results confirm that price (an efficiency measure) and total donations are negatively related. P&S also add variables representing forms of revenues other than contributions (such as grants and program income) to the W&D model. P&S hypothesize that other sources of income, whether government grants or income earned by the nonfor-profit firm, can “crowd-out” donations (cause donors to believe their donations are not necessary). However, separately including variables representing other income sources in the regression model does not provide evidence that donors give less when an organization has non-donation income.

3. Callen, J. Money donations, volunteering and organizational efficiency. The Journal of Productivity Analysis. 5 (1994): 215-228.

This research uses Data Envelopment Analysis (DEA), a nonparametric technique, to establish an efficiency measure at an organizational level. Both the DEA efficiency measure and total volunteer hours were added to the W&D model, which is tested using data from Canadian tax filings (similar to U.S. IRS Form 990s) for 1986-87. Both the new variables are positively related to total donations, while the relationship between donations and price remains negative and significant. The study also examines the expanded W&D model substituting volunteer hours (vs. total donations) as an alternative dependent variable. Neither the DEA efficiency measure nor price variable was significantly related to volunteer hours. The results indicate that donors use efficiency measures before making monetary contributions, but are not concerned about these measures when deciding to volunteer time to organizations.

4. Tinkelman, D. Differences in sensitivity of financial statement users to joint cost allocations: The case of nonprofit organizations. Journal of Accounting, Auditing and Finance (Fall)(1998): 377-393.

Tinkelman extends the W&D and P&S models using data obtained from New York State regulatory filings from 1991-92. He uses the W&D price model and controls for organization size by including beginning assets in the model. Tinkelman uses an additional dummy variable which indicates whether a ratings agency cited the organization as violating one of their standards (an additional proxy for quality or efficiency). Tinkelman’s results agree with those of W&D and P&S, except that he finds some evidence that earned income does crowd out donations. Next, Tinkelman separately examines individual contributions and other (non-individual) contributions. The results are similar to those obtained for total contributions, except that a) fundraising expenses are positively related to individual contributions, but unrelated to other donations, b) price is negatively associated with individual contributions, but is not significantly related to other donations and c) cited violations by watchdog rating agencies are negatively related to other donations, but are not significantly related to individual contributions. These findings imply that perhaps individual donors and corporate and foundation donors use different indicators of efficiency.

5. Tinkelman, D. Factors affecting the relation between donations to notfor-profit organizations and an efficiency ratio. Research in Government and Nonprofit Accounting 10 (1999): 135-161.

This study identifies factors that affect the relation of price with total donations. An expanded W&D model is used to investigate variables that determine the impact of efficiency on total contributions. Evidence obtained using data obtained from New York State regulatory filings for 1992-94 indicates the negative relation between efficiency measures and contributions is stronger for larger, older organizations and for those with more dependence on contributions as a revenue source. Also, the concern that donors have for efficiency varies depending on the mission of the charity (e.g. arts, education or social service).

6. Parsons, L. M. The impact of financial information and voluntary disclosures on contributions to not-for-profit organizations: A field-based experiment. Unpublished Doctoral Dissertation in Accounting, Bauer College of Business at the University of Houston (2001)

This research examines the effect on donations of directly providing accounting information to donors. A field-based experiment was used to provide potential donors with varying amounts of financial accounting information and/or nonfinancial voluntary disclosures in a fundraising appeal. A two-by-two blocked experimental design is used to vary 1) financial information (provided directly with the funds request versus available only if requested by the donor) and 2) voluntary disclosure of nonfinancial accounting information (provided versus unavailable). Using logistic regression analysis to examine the actual cash contributions that resulted from the appeal, the study finds that donors who had previously contributed to the organization are more likely to donate when they are directly provided with financial information. Further, the results of an OLS regression indicate that new prospective donors made larger contributions when either financial or voluntary, nonfinancial accounting disclosures were included with the basic fundraising appeal.

7. Tuckman, H. P. and C. F. Chang. A methodology for measuring the financial vulnerability of charitable nonprofit organizations. Nonprofit and Voluntary Sector Quarterly. 20 (4) (Winter) (1991): 445-460.

This study (T&C) develops accounting ratios to measure the financial stability of not-for-profit organizations. These measures are suggested as indicators of the financial vulnerability of a nonprofit firm. The adequacy of equity is calculated as net assets to total revenue. An organization with a larger adequacy of equity measure faces a lower risk of collapse in the event of a decline in revenue. The revenue concentration index, similar to the Herfindahl Index used by economists, captures the extent of revenue dispersion. A firm with many revenue sources will have an index closer to zero and will be less susceptible to declines in the economic health or changes in the preferences of a single donor. The level of administrative costs is a measure of the portion of total expenses that is devoted to overhead costs. When faced with a reduction in revenues, an organization with greater administrative costs can cut those costs without reducing the overall level of program services offered. The operating margin, similar to gross profit, is revenues less expenditures, divided by revenues. A higher operating margin is indicative of a greater potential surplus on which to draw in the event of unexpected financial difficulties.

8. Greenlee, J. S. and J. M. Trussel. Predicting the financial vulnerability of charitable organizations. Nonprofit Management & Leadership. 11 (2) (Winter) (2000): 199-210.

This research examines the ability of the T&C measures of financial stability to predict financial vulnerability of a not-for-profit organization. Financial vulnerability is defined as a decrease in program expenditures (deflated by revenues) in each of three consecutive years. Similar studies investigating business entities have used bankruptcy as an indicator of poor financial health, but it is unusual for nonprofit organizations to formally file for bankruptcy. Using data from IRS Form 990s for 1986-95 m a logistic regression model, the study finds that three of the four T&C measures (all except adequacy of equity) are significant in predicting the probability that a nonprofit entity will experience financial vulnerability. The evidence supports the validity of T&C’s financial stability measures.

1 The debate between the two major political parties is no longer whether to privatize the distribution of social services, but to what degree this privatization will occur. Leaders of both the Democratic and Republican parties are calling for an increased reliance on “faith-based and community organizations” for the provision of temporary assistance to the poor, instead of directly providing these services through government bureaucracies.

2 There are possible alternative dependent variables to represent decision outcomes by users. One is the amount of government grants received. This variable is similar to donations, except the contributor is a government entity instead of an individual, foundation, or corporation. Another is the interest rate paid on debt when it exists (similar to the variable used in studies that examine the relation between accounting information and interest rates of corporate or government bonds). Donations are more commonly used to measure decision outcomes because 1) donations are far more prevalent than government funding and 2) many nonprofit entities do not have debt and information on interest rates is often not publicly available information. Donations currently include only money and goods, as donations of time are not reported by nonprofits and volunteers involved in the operations of a nonprofit do not have the same information asymmetry problem that cash contributors experience.

3 Keating and Frumkin provide a thorough description of the ways in which the 1RS 99Os and GAAP-compliant financial statements differ.

4 See Hansmann [1980] and FaIk [1992] for a discussion of the theories explaining why not-for-profit organizations exist in markets that also include business and government entities.

5 Statement of Financial Accounting Standard (SFAS) No. 93 [1987] required the capitalization of fixed assets and recording of related depreciation expense. SFAS No. 116 [1993b] required the accrual of pledged contributions, net of estimated uncollectible amounts, and the recording of donated goods and services at fair market value. SFAS No. 117 [1993c] required that net assets be shown as unrestricted, temporarily restricted or permanently restricted. SFAS No. 124 [1995] required that investments be carried at fair market value, which is similar to the accounting treatment prescribed for business enterprises in SFAS No. 115 [1993a]. SFAS No. 136 [1999] required that an organization mat accepts cash or another asset on behalf of an unrelated beneficiary organization record the receipt as a liability, while the unrelated beneficiary organization records a receivable.

6 See Gordon and Khumawala [1999b] for a complete discussion of the varying options proposed for accounting for NFPs.

7 The measure of resources used to provide a service could be calculated both with and without an allocation of the organization’s indirect costs, such as fundraising and administrative expenses.

8 The Better Business Bureaus’ Wise Giving Alliance recommends mat NFPs spend at least 50 percent of all revenues on programs and fundraising expenses not exceed 35 percent of contributions (see htto://

9 Information regarding volunteer hours is not typically available in U.S. tax filings or annual reports.

10 One possible explanation is that individuals are less likely to use reported financial measures to evaluate NFP performance when they have direct exposure to the organization and its beneficiaries [Gordon and Khumawala, 1999a].

11 Effective 2001, the NCffl and CBBB merged to form one watchdog agency called the Better Business Bureaus’ Wise Giving Alliance (see

12 Parsons’s SEA disclosures discuss the charity’s output, but do not compare actual results to film goals.

13 See


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Linda M. Parsons

George Mason University

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