Preparing financial statement: the restricted accountability of Non-profit organizations Massimo Saita1 & Maria Vittoria Franceschelli2 Abstract Previous research has analyzed the differences between Non-profit and For-profit organizations, for example divergences in vision, function, organizational structure and motivation. The present work is a conceptual paper where we have developed a deep analysis of the Non-profit literature, integrating the Italian literature to the international one within the institutional and organizational theory framework. Therefore, we have studied the reason why many Non-profit organizations use to prepare the financial statement used by For-profit organizations, in particular the economic and financial statement. We argue that because of normative isomorphism, legitimacy, in particular strategic legitimacy and because of the fundamental importance, for this type of organization, of internal and external control, a large number of Non-profit organizations tend to prepare the financial statement similar to the For-profit ones, also if it often does not fit well with their activities and can been even disadvantageous. KEYWORDS: financial statement; Non-profit organization; organizational and institutional theory; isomorphism; legitimacy 1. Introduction Prior research on Non-profit literature has been given intensive attention on the traditional management functions of planning (Powell, 1987; Steiner, Gross et al., 1994; Thibault et al., 1994), management style and leadership (Grasso, 1994; Bailey & Grochau, 1993; Herman, 1994; Hemovics et al., 1995; Powell, 1987), organizational structure (Martinez-Brawley & Delevan, 1993; Powell, 1987), and motivation (Perlmutter & Cnaan, 1993). In this paper, we have considered a wide literature on Non-profit organizations that means that we have analyzed not only the Italian literature but also the international one; in particular, following previous research (Maggi et al., 2008), the USA context. This choice was made to give a deep 1 2 Professor of Business Administration and Strategy. University of Milano-Bicocca. PhD student in Business Administration and Management. University of Milano-Bicocca. 1 overview of the field and to show that the issue is still causing a worldwide debate. Having identified the international context, also due to the different national legislation, we have focused on the Italian situation. In fact, our intent is to develop a deep analysis of the Non-profit literature, integrating the Italian literature to the international one within the institutional and organizational theory framework. We want to study the reason why many Non-profit organizations are driven to use the financial statement used by For-profit organizations also if it often does not fit well with their activities. This aspect stresses the necessity to develop an appropriate report (Maggi et al., 2008: 186). In fact, we believe that Non-profits must have their own business theory and standards not based on the “Forprofit financial statements”. This assertion is confirmed if we consider the sector from an additional point of view: the economic and financial one, whereas the GDP does not measure correctly the values generated by the Profit and Non-profit sector Therefore, our analysis does not just analyze the situation of Non-profits but helps to fill the gap in the literature on why the accounting of Non-profit still appears so anchored and dependent on the For-profit one. We believe that is very important to comprehend the differences and the analogies between these two types of organization in order to have a critical approach to the actual preparation of the financial statement for Non-profit organizations. Therefore, the present work is a conceptual paper that develops the current Non-profit literature in terms of organizational and institutional theory. In order to do that, it is structured as follow: first, we have stressed the importance and defined the Non-Profit organization. Second, we have analyzed the differences between For-profit and Non-profit organizations, mainly from an accountability point of view. Finally, we have developed four prepositions and made our conclusions. 2. Literature 2.1 Non-profit organizations. 2.1.1 Importance of the Non-Profit Sector The Non-profit sector has a great relevance in the economy of every country (Fuchs, 1968; Ginzberg et al., 1965; Ginzberg, 1975), as in Italy (Borgonovi, 2000). In the last 30 years, the number of Non-profits has increased all over the word (Young, 1999). For example, in the USA it has been grown particularly during the second half of the 1900: the share of national income it represents increased by roughly 33% in the period 1960-1974 (Hansmann, 1980: 835). 2 In 2010, Non-profits accounted for 9.2% of all wages and salaries paid in the United States (The Nonprofit Almanac, 2012) and according to the National Center for Charitable Statistics (NCCS), more than 1.5 million Non-profit organizations are registered in the U.S. The Italian situation is following the same trade: the number of Non-profit organizations increased by 28% in the period 2001-2011 amounted to more than 300.000 organizations. The number of people working in this sector has increased by 39,4% and it occupies more than 4,7 million of volunteers (Istat, 2011). We must keep in mind that in this period the financial crisis has led to an increase in the unemployment rate, which means that the Non-profit sector was bucking the trend. 2.1.2 Definition of Non-Profit Organization It seems mandatory to give a clear image of Non-profit organizations. To do so, among many, we have reported few definitions. We can see that they are different but not in contrast because each definition is stressing various features. Non-profit is, in essence, an organization that is barred from distributing its net earnings, if any, to individuals who exercise control over it, such as members, officers, directors, or trustees (Hansmann, 1980: 838). This definition emphasizes the importance of the earning, and its management. Because the scope of these organizations is not the profit, it is fundamental to understand how to handle it. It is clear that Hansmann is considering the most relevant difference with For-profit Organizations. But a Non-profit organization is defined also as an organization that protects, defends, promotes values and rights of individuals and communities, that helps the production of relational and social goods, and helps to create opportunities for participation and integration (Pucci and Vergani, 2002: 10, our translation). This definition stresses the importance of the mission and the aim of this type of organizations and it does not consider the type of activity carried out; in fact, Non-profits may also carry out commercial activities if marginal compared to the corporate purpose (Saita, 2015: 14). Salamon et al. (1992: 135), using a structural/operational definition, defined the third sector as a collection of organizations that are formal (that is, institutionalized to some extent), private (that is, institutionally separate from government), non-profit-distributing (that is, not returning profits generated to their owners or directors), self-governing (that is, equipped to control their own activities) and voluntary (that is, involving some meaningful degree of voluntary participation). 3 In the Italian context Istat (2011) has defined Non-profit as organization which produces goods and services that has no obligation to distribute profits or other different gains, even indirectly, as remuneration to the shareholders (our translation), and the legislation has defined it as the complex of private organizations, with non-profit aim, sets up to follow civic, solidarity and social assistance purpose. Implementing the subsidiarity principle and in accordance with their respective laws or articles of incorporation, these organizations promote and implement activities of general interest by voluntary and free actions or economic solidarity or production and exchange of goods and services (Riforma del Terzo settore, 2016, our translation). Finally, Andreaus et al., (2012) have defined it as an organization, which aim is not the profit but pursues economic and management balance for the prosecution of the human needs. The definitions, that identify significant differences between Non-profit and For-profit organizations, can exert an important impact on the preparation of the financial statement. In this context, we have developed this paper to understand why it is that many Non-profit organizations still prepare the financial statement alike the For-profits’ one although not only it does not represent their real economic situation, but often it hides their mission and values. 2.1.3 Comparison between Non-profit and For-profit organizations To understand what an organization is, it is used to define what it is not (Elsbach & Bhattacharya, 2001) that in our research means consider and comprehend For-profit organizations. For this reason, we judge extremely useful a deep comparison between them. Considering Eusake’s (2003) work, he has individuated six different areas that differ among private, public and third sector organizations: ownership, revenues, scope of impact, markets, performance expectations and incentives. According to this study, Hull & Lio (2006) have built a three-point model for the evaluation of organizational structure and policy that is related to strategic controls (Hitt et al., 2005), strategic choice theory (Child, 1972), and Porter’s (1990) discussion on the nature of strategy (Hull & Lio, 2006: 55). Our research is based in part on this three-point model that we consider extremely useful for our aim. Hull and Lio (2006) explain how the main difference between Non-profit and For-profit organizations depends on the difference in vision, strategic constraints and financial constraints. In fact, to understand how and why an organization acts, we have to consider its vision. In the Forprofit sector, it consists primarily in maximizing shareholder financial value, that means maximize 4 profit. For Non-profit organizations, vision can be equated to an organization’s ideals and goals, a symbol of what it is and what it does (Hull & Lio, 2006: 55). Therefore, the scope of Non-profit organizations does not consider its impact on profitability and shareholders wealth as high-priority, and they are less concerned with financial gain (O’Connor & Raber, 2001). This divergence should lead to two completely different statements. However, a coordination between mission and accountability is necessary (Matacena, 1999; Matacena, 2007). This is the reason why Non-profits can prepare the mission statement that is focus on the organization’s vision and scope; in fact, Nonprofit is a mission-oriented organization (Young, 1999; Francesconi, 2007), and because of that, the “mission statement” can be useful to show their nature and vision to their stakeholders (Ecchia & Zarri, 2004). With strategic constraints we mean the possible actions that an organization can do considering the possible choices they are faced (Hitt et al., 2005), and depends on the way on how organizations are organized and the market in which they operate. For the aim of this paper, we have decided to focus on the organizational constraints. Non-profits and For-profits are organized in a very different way because For-profits are primarily responsible to their shareholders instead Non-profits to their supporters and to almost all other stakeholders, more or less equally (Hull & Lio, 2006: 57). In line with this, when Non-profits face with a number of possible options, they are more limited in choices, because they need to pursue its own vision and scope, and inform all their supporters and stakeholders: in fact, Non-profits are considering as a multistakeholder organizations (Borzaga & Mittone, 1997; Borzaga & Depedri, 2002; Ecchia & Zarri, 2004). Acquiring money is an essential activity for both types of organization, but the way in which it can be done is dissimilar. This activity reflects the “financial constraints” that organizations have to consider. For-profits can raise money by offering products or services, Non-profits mainly by fundraising. The latter needs to maintain a positive cash flow while providing the highest level of service possible to their stakeholders (Sansing, 2000). The intention behind the activity of these organizations is the opposite: For-profits offer products or services to gain money; Non-profits acquire money to follow their mission and so to make the social change possible. Here below, Table 1 summarizes the most important differences between Non-profit and For-profit organizations that we consider relevant for the preparation of the financial statement. Table 1. Principal differences between Non-profit and For-profit organizations Non-profit For-profit 5 Definition Vision Organization al constraints Financial constraints Organizations that are formal, private, non-profitdistributing, self-governing and voluntary3 To protect, defend, promote values and rights of individuals and communities, to help the production of relational and social goods, and to create opportunities for participation and integration4 Responsible to supporters, employees, clients and to almost all other stakeholders Fundraising to follow their mission and so to make the social change possible Organization which produces goods and services to make profit To maximize shareholder financial value, that means to maximize profit5 Responsible to shareholders Offers products or services to gain money 2.2. Financial statement 2.2.1 Definition and purposes of the financial statement Considering the Zappa’s model, within business administration, exist three business systems: Management, Administration and control, and Organization (Zappa, 1929). The Management system can be defined as the system by which the company is governed (Corporate Governance); the Administration and control system manages the business information flow and amounts to measure the business phenomena; the Organizational system coordinates both resources and technologies, based on different variables (Saita, 2015). The financial statement is a fundamental tool for all these Zappa’s systems especially if we make an analysis at the company level, because it helps to not only manage and administer the company, but also to control it. In fact, stakeholders can check the economic and financial situation to see if the company is working correctly: internal stakeholders can see where and if it is possible to make changes and corrections; external stakeholders, instead, can decide whether start or continue or conclude their relationships with it. Therefore, the financial statement has several aims and purposes and, because of that, it can be defined in different ways. The table below summarizes its definition and purposes. Table 2. Definition and purposes of the financial statement (our elaboration from Saita, 2015). Standpoint Law – article 2423 of the Italian Civil Code Substantial Administrative and accounting Fiscal Definition and purposes Document that must be prepared by the Board of Directors of the company and must be approved by the shareholders Document that shows the economic, financial and patrimonial situation, made for the shareholders and third parties It is the annual output of the administrative and civil law system, or the general accounts It is the starting point for the tax return 3 Salamon, 1992. Pucci L., Vergani E. (a cura di), Il bilancio sociale nel terzo settore. Guida pratica alla re-dazione, Milano, Egea, 2002, p. 10, our translation. 5 Hull & Lio, 2006. 4 6 As we can understand from the table and the explanation above, the financial statement has crucial significance both at the internal and external level, for all of the three Zappa’s systems. 2.2.2 Main economic differences between Non-profit and For-profit organizations Social capital With social capital, we mean the “relations between people, relatively durable, for the promotion of cooperation and so for the production of material and symbolic values. This network is made by formal and informal trust relations that stimulate mutuality and cooperation” (Mutti,2008). Social capital is a fundamental part of Non-profit organizations and it can be bridging or bonding, that depends on if it brings benefits to all the community or just to the member of the organization (Ecchia & Zarri, 2004). It is evident the link between the social capital and the vision and scope of Non-profits (that is to protect, defend, promote values and rights of individuals and communities, to help the production of relational and social goods, and to create opportunities for participation and integration, Pucci & Vergani, 2002). Because of that, we believe that a good statement that represent a Non-profit should include the social capital as a value produced by the organization. Donations and volunteers Non-profits receive most or all of their income in the form of grants or donations (Hansmann, 1980: 840). So, donations are perhaps the main part of the income for the Non-profit (and this is stressed by the new Italian law that has facilitated donations). In fact, considering that the scope of Nonprofit organizations is to promote values and rights of individuals and communities, when individuals and communities perceive that the values they believe in have been promoted by the organization and so they have received a surplus, it is usual that they want to donate money or they decide to work for the Non-profit as a volunteer. As a consequence, volunteers are offering a services to the organization, and they work for it but they are not paid. This have an effect on the value of the organization, so it would be appropriate to also value the volunteers’ working hours, which might correspond to the remuneration at the market price based on the performance. 7 2.2.3 Financial statement for Non-profits in Italy We have analysed few of the main differences between Non-profit and For-Profit organizations from an institutional point of view (vision, strategy and financial complaints) and also from an accounting point of view; obviously these two field are strongly interconnected. Because of all these dissimilarities, the Italian legislation has developed few guidelines6 to help Non-profit organizations to prepare an adequate financial statement. In fact, economic and financial information is the major reference for the performance evaluation of profit-oriented enterprises. The fact that the Italian legislation is still developing guidelines support our assertion that many Non-profits are anchored and are dependent on the For-profit sector. However, the financial statement is necessary but not sufficient for Non-profit organizations (Matacena, 2002), where is necessary to evaluate the contribution they make in terms of improving the social welfare of specific categories of entities and/or community (GBS7, 2009: 8). 3. Discussion and Propositions Although the significant differences between Non-profit and For-profit organizations, the not-strict legislation and the detailed guidelines available, most of the Non-profit organizations still continue to have a “For-profit financial statement” or in any case a financial statement that does not reflect the organization characteristics. We have argued that most of the people working in Non-profit organizations are volunteers. Because volunteers are people who, most of the time, need to gain money to live, we can suppose that they have a job in another firm. Obviously, they are influenced by their job in the other firm, and normally they bring their skills and knowledge in the Non-profit, so many Non-profit practitioners are influenced by For-profit practices. Furthermore, education and professional network can lead people who works in a Non-profit to act as if they are working in other organizations as the For-profit ones, and also the employees are pushed to act in the same way. This phenomenon is called normative isomorphism pressure8 (Di Maggio & Powell, 1983: 152) that stems primarily from professionalization. For E.g. Atto di indirizzo n. / / Agenzia per il Terzo settore; OIC Principio n. ; OIC Principio n. . Gruppo di Studio per il Bilancio Sociale (GBS). 8 DiMaggio and Powell have argued that isomorphism is due to three mechanisms: coercive, caused by the dependence on common legal environment, pressure from other organizations, similar resources, academic credentials; mimetic, caused by uncertainty (visible alternatives, technologies); normative caused by education and professional network. 6 7 8 professionalization we mean the collective struggle of members of an occupation to define the conditions and methods of their work, to control “the production of the producer” (Larson, 1977) and to establish a cognitive base and legitimation for their occupational autonomy (DiMaggio & Powell, 1983: 152). As a consequence, DiMaggio & Powell, viewed normative isomorphism as a result of professionalization (Mizruchi & Fein, 1999) and it leads organizations to be similar. In other words, people working in Non-profit organizations can have or had a job in a For-profit, likewise they can have the same education that lead them to act in the same way as they do in a For-profit organization. And because the financial statement is prepared by volunteers or employees, for normative isomorphism they are driven to prepare similar documents regardless of the type of organization. Proposition1: workers of Non-profit organization, are driven to prepare financial statement similar to the For-profit ones because of normative isomorphism. Non-profit organizations are multistakeholders organizations (Borzaga & Mittone, 1997; Borzaga & Depedri, 2002; Ecchia & Zarri, 2004) that means that are strongly linked with a great number of stakeholders that have different interests and different backgrounds. Because the financial statement shows the actual situation of an organization, and the information should be clear to the most (Borgonovi, 2008), it seems logical to prepare the “most common document”. Therefore, Non-profit organizations cannot know if the document it will be read by internal or external stakeholders, by a donator or an entrepreneur etc.: the preparation of the financial statement is not related with efficiency and competition but it is connected with the environment condition. In fact, organizations, especially the Non-profit ones that are interconnected with a wide range of different stakeholders, when are preparing the financial statement, are looking for legitimacy more than efficiency (DiMaggio & Powell, 1983). So, institutions are bounded by the collective rationality, and this make organizations very similar (DiMaggio & Powell, 1983). With legitimacy, we mean generalized perception or assumption that the actions of an entity are desirable, proper, or appropriate within some socially constructed system of norms, values, beliefs, and definitions (Suchman, 1995: 574). Suchman has explained that legitimacy is so important because influences stability, comprehensibility, continuity and credibility. Legitimacy affects how people act toward organizations and how stakeholders can understand them (Suchman, 1995). 9 Proposition 2a: Non-profit organizations are driven to prepare financial statement similar to the For-profit ones because they are looking for legitimacy more than efficiency. Legitimacy can be interpreted in many different ways, depends on why and when organizations look for it, and on the environment (so other organizations and society) in which the organization plays (Suchman, 1995). Moreover, there are two main rhetoric on it: strategic and institutional tradition. Strategic tradition, (Ashforth & Gibbs, 1990; Dowling & Pfeffer, 1975; Pfeffer, 1981; Pfeffer & Salancik, 1978) adopts a managerial perspective and emphasizes the ways in which organizations instrumentally manipulate and deploy evocative symbols in order to garner societal support; instead institutional tradition (DiMaggio & Powell, 1983; Meyer & Rowan, 1991; Meyer & Scott, 1983; Powell & DiMaggio, 1991; Zucker, 1987) adopts a more detached stance and emphasizes the ways in which sector wide structuration dynamics generate cultural pressures that transcend any single organization's purposive control (Suchman, 1995: 572). Because of the importance of the social capital in the Non-profit organizations, which is stressed above, we can consider the strategic tradition the most important approach. In fact, Non-profit organizations to survive have to garner societal support that can help them to continue their activity and to receive their income in the form of grants or donations from the supporters. However, to achieve this kind of legitimacy, which we can call as “strategic legitimacy”, organizations must be able to share with their current and potential stakeholders these evocative symbols. To do that the easiest way is to prepare a document that can be understood by the most. Proposition 2b: Non-profit organizations are driven to prepare financial statement similar to the For-profit ones to acquire strategic legitimacy. In the section on the function and importance of the financial statement, we have argued that it is used also for the internal and external control (Saita, 2015). In fact, because Non-profits are considering as a multistakeholder organizations (Borzaga & Mittone, 1997; Borzaga & Depedri, 2002; Ecchia & Zarri, 2004) and they are responsible to their supporters and to almost all other stakeholders (Hull & Lio, 2006: 57), it is essential to control and create a strong bond between the organization and its internal and external stakeholders (Ecchia & Zarri, 2004: 2). Non-profit 10 organizations aim is also to create benefits for stakeholders that are different from the shareholders (Andreaus, 1996; Andreaus et al., 2012). We have also discussed the fundamental relevance of donators and volunteers for the Non-profit organizations, which receive most of their income in the form of donations (Hansmann p. 840) and can act primarily thanks to the works of volunteers. For-profit organizations can receive provisions in different form: goods, services9 that should be useful to achieve the business purpose: who confers provisions is a shareholder10. The owners of an organization are internal stakeholders. Donators have different role than shareholders: they cannot be considered as organization’s owners. This assertion is clearer if we reflect on volunteers. They provide services for the organization, but they cannot be regarded as owner as for the For-profits. Shareholders, and so owners, are considered as internal stakeholders, but donators and volunteers can be internal or external stakeholders. Because organizations need internal and external control (Walsh & Seward, 1990), and the financial statement helps with both of these types of control (Maggi, 2008), especially for organizations as the Non-profit ones, where internal and external stakeholders are not always and totally distinguishable, the financial statement is a good way to overcome this problem. Proposition 3: Non-profit organizations are driven to prepare financial statement similar to the For-profit ones to make internal and external control. 4. Conclusions and limitations Despite the intensive attention that has been given to the Non-profit sector, where researchers have found substantial evidence on the existence of fundamental differences between Non-profit and For-profit organizations (e.g. Hull & Lio, 2006; Ecchia & Zarri, 2004), there has been surprisingly little effort made to understand why these organizations are driven to use the financial statement used by For-profit organizations also if, often, it does not fit well with their activities. To develop this research question, we felt necessary not to limit our study on the Italian literature, but to analyze the Italian situation by using various international theories, in particular the Organizational and Institutional theory. In fact, we believe that Non-profits must have their own 9 Italian civil code, articles 2247, 2253, 2342, 2464. This is not the case for the Italian SpA. 10 11 business theory and standards that differ from the For-profit sector and it seems that the current Italian reform on the Third-sector supports our ideas. We have focused on the analysis of the divergences between Non-profit and For-profit organizations that are particularly important in relation to the preparation of the financial statement. We have discussed the differences in vision, in organizational and financial constrains (Hull & Lio, 2006) that have practical implication on the social capital role, on donors and volunteers importance, and on the relation with stakeholders in general. Despite all, a large number of Nonprofit organizations are driven to prepare the financial statement used by For-profit organizations also if it often does not fit well with their features. Our research has tried to fill the gap on this argument. In fact, using the national and international literature, we have argued that because of normative isomorphism, and so for professionalization, organizations are similar and act in analogous ways. Moreover, because Non-profits are multistakeholders (Borzaga & Mittone, 1997; Borzaga & Depedri, 2002; Ecchia & Zarri, 2004) and need to garner societal support to survive, they are looking more for legitimacy than for efficiency, in particular for strategic legitimacy (Suchman, 1995), that lead them to prepare the financial statement similar to the one prepared by For-profit organizations. At last, because it is particularly important to have an internal and external control, due to their particular structure, we suggest that many Non-profits are driven to prepare financial statement similar to the For-profit ones that can help them to develop a more thorough internal and external control. The Non-profit sector also suffers from a broader problem related to the world and national business and finance. In fact we believe that GDP does not measure correctly the values generated by the Profit and Non-profit sector. Future research would develop this issue that is crucial for the Non-profit sector. Our research is not without limitations. First, we have focused on the Italian’s Non-profit, and second, because we have developed a theoretical paper, we have no an empirical evidence on this phenomenon. Therefore, further research could deeply develop the four propositions using empirical data, for example analyzing a particular activity involved in the Nonprofit sector. 12 References: Andreaus M. (1996), Le aziende non profit: circuiti gestionali, sistema informativo e bilancio d’esercizio, Giuffrè, Milano. Andreaus, M., Carini, C., Carpita, M., & Costa, E. (2012). La cooperazione sociale in Italia: un’overview, Euricse Working Paper, N.027 | 12. Ashforth, B. E., & Gibbs, B. 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