GAAP: The Leaky Ceiling

Thinking back to audits past

GAAP and the not for profit sector.

(A fragment from a speech not made)

First, a word on us, the charitable agency folks. We’re big, really big. As a sector of the economy, we’re talking billions of dollars. Smallish, but high-profile activist groups promoting radical empowerment types of things get all the press, but the vast majority of the sector is old-fashioned meat & potato folks like the Y and Sally Ann and food banks, to say nothing of the foreign aid guys.

And boy do we struggle with GAAP (Generally Accdepted Accounting Principles). In general terms, GAAP poses three Big Problems, and a host of smaller ones. (Continued)

Big Problems

Intelligibility. First of all, GAAP produces financial statements that make no sense to any of the people that really care about us. At the end of the day, people want to know how much money are we spending helping people vs how much are we spending raising money and administering it, and GAAP is (are?) utterly useless for this purpose. Most of the people who deeply care are not rich nor financially sophisticated, but are big-hearted and feeling rather ripped-off of late. GAAP style financial statements do not make them feel better.

Inducement to Dishonesty. Secondly, those who give us money want to know if we are losing money, or making money—both are bad, for us. If you lose money, you are irresponsible, and most people have the somewhat accurate suspicion that we have a tendency towards financial irresponsibility—in fact, we will blow the whole wad to save one lost sheep, it’s a deeply human and Christian/Muslim/Buddhist/Jewish and for all I know Taoist thing to do. It’s basically why we are in the business.

However, for all that, we are all deeply interested in having a rainy day fund. One reason is that people who give us money to do a particular thing, say help street youth, want it to be spent for that, on their terms, ie applying their distinctions between the “deserving” and “undeserving” poor, and they take a dim view of it if we can actually do what we say at less cost—we don’t get to keep the savings, and use them to help “less-deserving” (but still hungry, cold, and abused) street youth let alone street adults say. Sometimes, usually in fact, we have a better idea as to where money should be applied than donors and funders, who have little experience of the realities of distress, but many groovy theories.

(Digression: I think if I hear one more “You can give a man a fish, and feed him for one day, or you can teach a man to fish and …” parable from a donor I will puke. Aside from all the evident problems around funding people to fish for fish that are rapidly disappearing because we are funding so many people to fish them, the basic truth is that you need more than knowledge to fish, you need a rod, a boat, a net, a bucket, a knife, and not least of all, a full belly while you try. Aside from that, realistically you need a home to come back to, and a market to trade your fish for clothing, shelter, and vegetables. If you are poor you have to rent these things: its expensive being poor. By and large, in my experience, and I have a lot of experience, people that need help generally have a pretty clear idea of what kind of help they need, and its rarely a new paradigm or puritan work ethic or any other notional thing, its mostly capital, both financial and social [social capital is a whole ‘nother topic, a very big and important one]. End digression)

Another reason is the vagaries of funders/donors. The flavour of the week changes, and suddenly people are cut off— but we wouldn’t be doing it if we thought it wasn’t needed, well the better of us anyway. (Honestly, there are many charities that engage in useless activities because funds are offered for them, which generates economies of scale and opportunities to, in effect, subsidize more useful activities—and nobody is fooling anyone, funders are very suspicious of this, so they want to see financial statements—fortunately, all they get is GAAP.)

So unlike the Enrons and Global Crossings, healthy charitable organizations have every interest in understating income and overstating liabilities. To create reserves, to do things they actually want to do, and not least, on occasion, to create a sense of desperation. GAAP is really good for this, actually, because all the trip-wires auditors look for are about catching people trying to overstate financial health, not the reverse.

So in one sense, many financially healthy not-for-profits actually like GAAP, but personally, I think this is wrong. It promotes fundamental dishonesty, which is a slippery slope; and it is pusillanimous: we have an obligation to point out real needs and gaps in our social fabric, and attempt to address them openly. (I should mention that I am in something of a minority on this in practical terms.)

The Liquidation Model. If I were an investor, I most certainly would not invest in a charity. Charities burn money. That is in fact their whole purpose—if they aren’t burning money hard and fast enough, you should be suspicious. For us, a liquidation model makes no sense at all, in any respect (save one—in many jurisdictions, volunteer members of the board of directors of a corporation, charitable or not, are personally liable for employee remuneration in the event of catastrophe—you can buy insurance for this, but anybody that has dealt with an insurance company has good cause to be nervous).

For anyone investing in a company, the liquidation model is an important factor—at the end of the day, what are the assets and so on. “Good Will” and other intangibles become pretty important in that kind of assessment, as do capital items, and GAAP rightly worries (very poorly in my inexpert opinion) a great deal about this stuff. But folks, a good charity simply isn’t going to liquidate. Sure, we can lose funding and donations, but if we are about anything, we are about social service, and we aren’t going to stop doing that no matter what. Or else we shouldn’t be in business. We are also, legally in Canada, the Voluntary Sector, and that’s what its all about at the end of the day. We grew out of church basements, and we can go back there any day (more than once I’ve heard government officials refer to us as “the church basement crowd” meaning that we are stupidly obstinate about helping individuals and don’t see the bigger picture, which I take as a badge of pride, actually).

For us, real-estate capital depreciation simply works differently. The real question is what does it cost us to occupy space, not how much is going to principal and how much to interest, vs a nice simple line item if we were renting (funders much prefer it if we rent rather than buy, no matter if it costs a ton more). Charities very rarely sell real estate, and very very rarely do so to acquire cash. Depreciation is not a factor at all. To operate we need space, and the cost of that space is crucial to understanding us. The cost of that space in any meaningful sense has nothing at all to do with capital depreciation.

Similarly with computers. Computers are driving accountants and auditors quite mad these days. From our point of view, they are simply a cost of doing business. (When I started in this business, about 30% of staff were essentially clerical, now its about 10%, and on top of which we are producing much better data [no less trees getting slaughtered for paper though, alas].) I don’t want to amortize this shit, lets just pay up front and assume a 2.5 year replacement cycle if you must.

Worst of all is vacation liabilities. We get spanked by the auditors year after year about this. Its so silly really, in the normal course of affairs, we have arrangements to cover the work of people on holiday. So if someone quits or is let go, those same arrangements kick in to cover the work whilst the time is used up. No biggie, you would think. But no. It’s the liquidation model biting you in the ass—every un-taken vacation day on March 31st is a liability, plain and simple, and is burned onto our financial statement in glowing red ink.

Now, in our business, a lot of our staff don’t take all their vacations. Its because they love doing what they do, otherwise they wouldn’t be doing it for such shitty wages. The old theory, that we do what we do for love, charity as it were, and just receive a stipend to allow us to keep on doing it is often surprisingly accurate. So we have all this red ink. Which is utterly meaningless.

Because the thing those people do when they work is spend money, not make it. When they are gone, we spend less money. From a realistic financial point of view, having them take vacations or get sick actually improves our balance sheet. And that’s what happens if they quit—we cover for them or just don’t do that chunk of charitable work in their absence. This is not a liability in any meaningful sense.

But as I found out, never ever use the phrase "not a real liability" in front of an Accountant. They live in a different world than the rest of us, and from almost any point of view, an insane one.

For a charity anyway, its all about cash flow: how much did you take in, how much did you spend, how much do you have in the bank. How complicated is that?

If continued....