Nonprofit organizations make accounting errors at a relatively high rate, in part because they try to avoid devoting a high percentage of their funding to administrative costs, according to a new study.
The study, by Jeffrey Burks, associate professor of accountancy at the University of Notre Dame’s Mendoza College of Business, noted that the rate of accounting errors at not-for-profits is nearly double that of for-profit businesses of similar sizes.
“Nonprofits of all sizes tend to have high error rates,” Burks said in a statement. “The rate of errors does vary with the size of the nonprofit’s audit firm. The clients of the largest eight audit firms in the country have a significantly lower rate of errors. The clients of these large audit firms tend to be large nonprofits, but the effect does not translate into a lower error rate for large nonprofits overall because so few nonprofits are audited by the top eight audit firms—only about 7 percent of my sample.”
Burks asked a team of undergraduate research assistants to download the audited financial statements of nonprofits and pore through them to identify cases when the nonprofit disclosed it was correcting an error.
“The financial statements were downloaded from the Guidestar website, through which many nonprofits make their financial statements available to the donor community,” he said. “I then reviewed each error, recording details such as the amount of the misstatement, the accounts involved and the circumstances surrounding the error. I also used statistical analysis to identify factors that are associated errors, such as the type of auditor and the presence of internal control weaknesses.”
Burks believes the low administrative costs that nonprofits cite to attract donors may actually be contributing to their high rate of accounting errors.
“From talking with nonprofit CFOs and auditors, nonprofits have limited resources and understandably seek to expend the vast majority of those resources on mission-related activities rather than on administrative functions like accounting,” he said. “Although investments in high-quality information systems can pay off by improving a nonprofit’s efficiency and effectiveness, there are difficult tradeoffs to make because dollars spent to upgrade systems or to hire an accountant could mean fewer dollars going to mission-related activities.”
The study appears in the journal Accounting Horizons, published by the American Accounting Association, and can be viewed online here.