Turning the Tables on Charity Navigator 3.0: Is the Causal Logic Plausible?

“GetInvolved Nonprofit Guide” Article for October 2013 from Cover & Rossiter, P.A.

By Pete Kennedy, CPA, CVA - Director at Cover & Rossiter, P.A.

Charity Navigator

For readers who are not familiar with Charity Navigator, I’ll begin with a quick refresher. Since it first went live in 2002, CharityNavigator.org has been a free nonprofit website whose stated mission is to guide intelligent giving.  Primarily using information from a nonprofit’s IRS Form 990, Charity Navigator synthesizes data into what it hopes are decision-useful metrics to assist donors in making gifting decisions.  Since 2008, the data has been expanded to include information gleaned from nonprofits’ websites in an effort to gauge transparency and accountability.  Many nonprofits put forth considerable effort to attain a coveted “4 Star” ranking.  Many others have howled in protest at less favorable rankings or (worst of all) inclusion in a “Bottom 10 List.”

In my opinion, the information presented often lacks necessary analysis or interpretation.  As an example, at this writing the Reynolda House Museum of American Art appears at the top of the “10 Charities Routinely in the Red” by a wide margin with a Charity Navigator computed ratio of deficit to expenses of negative 131.6%.  It doesn’t take a statistician or a CPA to know that the only way you can have such a ratio is to have the deficit exceed total expenses – not a logical result.  A little digging in this case reveals that the charity’s board made the decision to sell a large portion of its endowment and in doing so realized a large amount of previously unrecognized investment losses – large enough to eclipse all other revenue sources, push the gross revenue amount (as required to be presented on the Form 990) negative … and land at the very, very bottom of a blindly calculated Charity Navigator ratio.

CN 3.0

In its most recently announced initiative, Charity Navigator will attempt to assign ratings based on a nonprofit’s efforts to measure their effectiveness at achieving the desired outcomes.  This has been termed “CN 3.0” and is described as “the third dimension of intelligent giving.” The questions and their interpretation are prominently placed on the Charity Navigator website.

The Holy Grail of nonprofit metrics has always been outcome measurement.  Outcomes by their nature are long-term changes.  Determining a direct cause for a positive outcome is often very difficult. That an at-risk youth winds up going to Harvard may have one primary reason or be the confluence of many factors.  Trying to gauge the accuracy of any charity’s claims of outcomes given the inevitable subjectivity of such information would be next to impossible.  Recognizing this, CN 3.0 does not directly ask nonprofits to measure their outcomes.  Instead, it poses a series of questions or grading areas aimed at determining a nonprofit’s internal efforts toward measuring its own effectiveness.  A “yes” answer gets a green check mark.  A “no” means a red X.

Is the Causal Logic Plausible?

One of the questions asked by CN 3.0 is “Is the causal logic plausible?”  For folks like me that need a translation, it is explained as “Does the charity’s explanation of how it plans to achieve its goals seem possible or likely?”  More plainly still: do a nonprofit’s actions / programs align with their stated mission?

I think it’s only fair to turn the tables and pose the same question as it relates to CN 3.0: does reporting on a charity’s efforts to measure its outcomes (rather than the outcomes themselves) really provide a decision-useful metric of mission effectiveness?  Is it logical that such information can “guide intelligent giving?”

My answer would be yes, but only marginally and indirectly.  Is it a good sign that a nonprofit is diligently attempting to discover from different outside sources the impact of its programs?  Absolutely, and you have to give CN 3.0 credit for providing a roadmap of sorts as to how such an introspective effort might look through the questions that are asked.  In the absence of that Holy Grail metric of nonprofit effectiveness, this is certainly better than nothing.  But is diligent introspection a sure indicator of nonprofit effectiveness?  No.  Most dangerously of all, can the number of green checks vs. red X’s be used as a reliable means to rank the effectiveness of programs among nonprofits? Again in my opinion, no.

The Best Guide to Intelligent Giving

If you want to make gifting decisions based on derived financial ratios and a series of green check marks or red X’s, hey, it’s your money.  But we have made this statement many times before – there is no substitute for direct knowledge of a nonprofit.  The surest possible “Guide to Intelligent Giving” is your own personal experience with a charity.  If you go to events, volunteer to help with programs or even become a board member, then and only then will you have direct first-hand knowledge of how effectively your money will be spent.

If you have questions about intelligent giving or any other nonprofit topic, please contact Pete Kennedy, or any other member of our Nonprofit Practice team, at Cover & Rossiter at (302) 656-6632.

Cover & Rossiter, P.A. is one of the most respected and experienced CPA firms serving the accounting, tax and audit needs of the nonprofit community in Delaware.

IRS Exempt Organizations Branch – A Perfect Storm

By Amy Driscoll, CPA
GetInvolved Nonprofit Guide Article published in the July 2013 News Journal

After years and years of anonymity, the IRS Exempt Organizations Determinations Office is in the eye of a raging political storm. In reading the headlines, you may be thankful that you are not trying to gain exemption for a group with “Tea Party” or “Patriot” in its name, but the surge from this storm may spread farther than you think.

In 2008, the Pension Protection Act of 2006 started requiring many more organizations claiming exempt status to file reports with the IRS. All nonprofits are now required to file a form annually, even those with fewer than $25,000 in gross receipts. Small organizations are required to file a 990-N “e-Postcard,” whereas previously there was no reporting requirement at all for entities of that size.

The consequence of not filing for three consecutive years is a revocation of tax-exempt status. Starting in 2011, organizations that were unaware of these changes or did not comply for various reasons had their status revoked. Reasons for non-compliance ranged from frequent change in board members who were unaware of the requirements to previous notices to an address change whereby no IRS notices were received. The reason didn’t matter - revocation became widespread. According to the IRS website, over 1,600 entities in Delaware alone automatically lost their exempt status.

In order to be reinstated as a tax-exempt entity, organizations are basically required to start over. A 40-page Form 1023 (or 1024 depending on the type of organization) needs to be submitted, with accompanying fees ranging from $300 to $850. In what you might presume was a predictable event, a wave of re-applications has hit the IRS since the revocations began and the already-reeling Exempt Organizations Determinations Office has been trying to cope with the increased volume.

To complete the disaster, the recent scandal hit. As a quick recap, some IRS agents within the Exempt Organizations Determinations Office were found to have inappropriately targeted groups with politically sounding terms in their names, such as “Tea Party” or “Patriot.” There are continuing revelations resulting in senior officials being fired, resigning or “taking the Fifth” in congressional hearings. An ironic side note is that, as 501(c)(4) organizations, these groups had not been required to file for formal approval of their exempt status.

As someone who calls the IRS often on behalf of my clients, I can tell you that there are many helpful, professional and courteous IRS employees. There are also a few who are challenged in those areas. While some may see a high-level conspiracy here, from our experience, whether you are able to get anything accomplished often depends simply on who picks up the phone (or file) at the IRS.

The Exempt Organizations Determinations Office of the IRS is at a near standstill with reviewing applications. At the AICPA's Not-For-Profit Industry Conference on June 20, Ms. Lois Lerner was scheduled, but not available to present (she had been in charge of the Exempt Organizations Division of the IRS before infamously taking the Fifth at a congressional hearing). Her replacement at the conference, Mr. Marcus Owens, reported that the IRS Exempt Organizations Determinations Branch is in a virtual lockdown. He also noted that the Branch is now assigning for review applications received in April of 2012. That's not a typo – they are now reviewing applications that were received 15 months ago! Mr. Owens may have been channeling Ms. Lerner when he suggested that the audience of CPAs write to their representatives in Congress, implying the delay was primarily their fault.

If you have filed a Form 1023, 1024 or 8734 (used to convert private foundations into public charities) or are planning to file one in the near future, be ready to hunker down and ride out the storm – I wish we had better news. When your application is eventually reviewed and hopefully approved, the exempt status will be retroactive to the date the form was filed. It is possible to request an earlier retroactive date, but that may result in further delays in processing.

If you have questions about changes to your organization’s exempt status, please contact Pete Kennedy, Amy Driscoll or any other member of our Nonprofit Practice team, at Cover & Rossiter at (302) 656-6632.

Cover & Rossiter, P.A. is one of the most respected and experienced CPA firms serving the accounting, tax and audit needs of the nonprofit community in Delaware.

This article can also be found on our website here.

Lease Accounting: FASB Revised Exposure Draft

Director, Pete Kennedy

On May 16th, the FASB issued its revised exposure draft on Lease Accounting. This is the second time an exposure draft has been released on this topic. The draft details a major re-write to the rules around accounting for leases. In a nutshell:

Lease accounting as it currently stands separates leases into two basic types; Operating Leases and Capital Leases. The majority of all leases are accounted for as Operating Leases. The accounting is simple – you expense the lease payments ratably over the lease term. In most cases the expense is recorded as the lease is paid. Capital Leases presume that a substantial portion of the ownership of an asset has transferred due to the lease terms. If the term of the lease meets certain capital lease parameters, an asset is recorded on the books and an offsetting liability for the present value of the lease payments is recorded and those are both amortized away as the lease term progresses.

The proposed change would do away with the traditional operating lease vs. capital lease concept and would treat nearly all leases as capital leases are currently treated. This includes many mundane leases (think vehicles, construction equipment, medical equipment, copiers, office space etc.).

My opinion: Not a good idea. This will create an accounting fire drill. Where previously organizations would only need to expense lease payments as they are paid, they would now need to expend a significant amount of accounting resources calculating the net present value of lease payments (using an appropriate discount rate) to capitalize the “right of use asset” and an offsetting liability and expense the lease payment with an interest component for each and every lease with terms over one year. Where there are renewal options those may need to be incorporated also. This sets up book vs. tax differences, throws off financial ratios, renders many debt covenants invalid and in general makes a mess of a previously relatively simple accounting area for most organizations.

In reading through some of the letters in response to the initial exposure draft in 2010 (there were nearly 800 of them), I was struck by the dividing line between those in favor of the changes – generally from academia or from a State Accounting Society, and those opposed – generally someone who would actually need to implement and comply with the revised standard. As an editorial comment, although the FASB goes to great lengths to solicit public input, the volume of responses is weighted in most cases disproportionately in favor of those whose interest is more academic than practical.

The feedback I’ve been getting at seminars and the like over the past few years is that the train has left the station; that this is a done deal and we should all begin preparing to comply in the next few years.

But...all is not yet lost. There appears to now be some divided thinking on the FASB Board regarding this issue. Also; a letter to the FASB Chairman signed by 57 members of the US House of Representatives discusses a study on the projected economic costs of the change. The letter urges the FASB to conduct a detailed study on the costs and benefits of the change before proceeding. I think I see Delaware’s own John Carney on there along with Rep. Peter King (R-NY) and Rep. Maxine Waters (D-IL) – safe to say that’s a pretty broad spectrum. They can’t agree on gun control, government spending, same-sex marriages or much of anything else, but they do agree that pushing this change through is a bad idea. So here’s what we can do:

The FASB does read and consider the feedback it receives. The responses are cataloged and published on the FASB’s website so some of us have to limit our vocabulary to words that are professionally acceptable. My response is already on there. The closing date is September 13, 2013. If you have time - make your voice heard and help the FASB to see the bigger picture here. I believe that there is a possibility this change can be turned back and a significant amount of administrative effort and cost saved.

Go to www.FASB.org to see the Lease Accounting Exposure Draft. Comments can be submitted via e-mail to director@Fasb.org – indicate the File Reference # of 2013-270.

If you have any questions, please contact Pete Kennedy at pkennedy@coverrossiter.com.

The original article can be found on our website here.