Chapter 4 Analyzing Applied Accounting Basis for Non-profit Organizations in Indonesia
4.2 Literature Review
(a) Accounting Basis
Accounting basis is a part of accounting systems. It is about how to recognize revenue and expense regarding the period of financial reporting. In general, there are three accounting bases:
cash, accrual, and modified cash/accrual.
The cash basis can be defined as:
Simply meaning the method of recording transactions by which revenues and expenses are reported in the period in which the related cash receipts or disbursements occur (The Canadian Institute of Chartered Accountants, 1981, p.50).
While, the accrual basis is:
The method of recording transactions by which revenues are reported in the period in which they are considered to have been earned or restrictions satisfied, and expenses are reported when incurred, whether or not the transactions have been finally settled by the receipt or payment of cash or its equivalent (The Canadian Institute of Chartered Accountants, 1981, p.50).
Another definition of the accrual accounting:
Accrual accounting attempts to record the financial effects on an entity of transactions and other events and circumstances that have cash consequences for the entity in the periods in which those transactions, events, and circumstances occur rather than only in the periods in which cash is received or paid by the entity. Accrual accounting is concerned with an entity’s acquiring of goods and services and using them to produce and distribute other goods or services. It is concerned with the process by which cash expended on resources and activities is
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returned as more (or perhaps less) cash to the entity, not just with the beginning and end of that process (FASB, 1985, p.45)
The modified cash basis combines elements of the two major accounting methods, the cash method and the accrual method. The cash method recognizes income when it is received and expenses when they are paid for, whereas the accrual method recognizes income when it is earned (for example, when the terms of a contract are fulfilled) and expenses when they are incurred. The modified cash basis method uses accruals for long-term balance sheet elements and the cash basis for short-term ones.
The main advantage of cash basis accounting is its simplicity and ease to understand and report. Some organizations dispute that the difference between financial results on cash and accrual is not significant substantial. Furthermore, some organizations tend to uncomfortable reporting contribution receivable as revenue until they have been collected as cash in the bank (Larkin & DiTommaso, 2014, p.14). However, accrual basis provides a degree of sophistication, since it fully estimates the financial picture of the organization. Also, it becomes a more appropriate basis when organizations have substantial unpaid bills or uncollected income at the end of a period. These bills and income can considerably disfigure financial reports (Larkin &
DiTommaso, 2014, p.14).
Besides a combination of cash and accrual accounting, organizations may develop a modified cash basis. On this basis of accounting, certain transactions will be recorded on an accrual basis and in other transactions on a cash basis (Larkin & DiTommaso, 2014, p.18). For instance, receipts are recorded on a cash basis and expenditures on an accrual basis (The Canadian Institute of Chartered Accountants, 1981, p.50). However, it is not necessary for NPOs to have a complex set of books to record all transactions (Larkin & DiTommaso, 2014, p.19). One convenient way to avoid the complication and still provide relevant financial reports, is to keep the reports on a cash basis but make the necessary adjustments, for instance on different worksheets of financial reports for necessary records (Larkin & DiTommaso, 2014, p.17). The modified cash or accrual basis of accounting, as appropriate, should be used in measuring financial position and operating results (Hara, 2006, p. 10).
Table 4.2 provides an overview of the international adoption of accrual based accounting and financial reporting for budget funded agencies, such as the public sector and the NPO sector. A
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three way classification system is adopted, jurisdictions being categorized as using the full accrual (largely indistinguishable from typical commercial practice), the modified accrual (essentially reflecting commercial practice but with less emphasis on comprehensive statements of financial position) or the cash with accrual disclosure models of reporting (Carlin, 2005, p. 312).
Table 4.2 Accrual Financial Reporting by Budget Funded Agencies
Full Accrual Basis Modified Accrual Basis
Cash Basis with Supplementary
Australia X
Belgium X
Canada X
Finland X
Germany X
Hungary X
Iceland X
Ireland X
Japan X
Netherlands X
New Zealand X
Portugal X
Sweden X
Switzerland X
United Kingdom X
United States X
Source: Adapted from Carlin, 2005
Indonesia also gives responses to the world debate of using the accrual basis in the public sector. For about 12 years, since preparation in 2003, the public sector has been changing from cash-based accounting system to the accrual (the Government Regulation No.24 of 2005) to full accrual-based system (the Government Regulation number 71 of 2010). The reason is that his change will have an impact on the quality of the financial statements which is more comprehensive
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and recognize receivables and payables in terms of revenue and expenditure (Negara, 2015, p.48).
Regarding the positive impact on financial reporting and successful implementation in the public sector, the Indonesia government seems to urge NPOs to apply the accrual accounting implementation as well.
(b) Revenue and Expense
According to Not-for-profit GAAP (Larkin & DiTommaso, 2014, p.35), in this definition below, revenue is an outcome of an organization’s main operation.
Revenue is cash inflows (or the equivalent) from delivering or producing goods, rendering services, or other activities that have occurred or will eventuate as a result of an entity’s major or central operation.
The other important terminology in accounting basis is an expense. Not-for-profit GAAP (Larkin & DiTommaso, 2014, p.35) defines that:
Expense is outflows or other using up of assets or incurrences of liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity’s ongoing major or central operations.”
(c) Information Quality
The purpose of financial reporting is to produce a high-quality information. Information quality consists of seven criteria (Romney and Steinbart, 2015, p.4), explained as follow:
1. Relevant
Information reduces uncertainty, improves decision making, or confirms or corrects prior expectations.
2. Reliable
Information is free from error or bias, accurately represents organization events or activities.
3. Complete
Information does not omit important aspects of the events or activities it measures.
4. Timely
Information is provided in time for decision makers to make decisions.
5. Understandable
Information is presented in a useful and intelligent format.
6. Verifiable
Two independent, knowledgeable people produce the same information.
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Information is available to users when they need it, and in a format, they can use.
(d) Information in NPOs
Three types of information should be provided by NPOs for their stakeholders:
1. Information about operations
The bottom line on an NPO operating information requires a different interpretation from that of POs. The financial operation of an NPO is satisfactory if, on average, the organization at least breaks even (Anthony, 1991, p.372). In some years, the organization may generate a reasonable amount of surplus to provide reserve funds in cases against difficult situations. In other years, a deficit is tolerated. If the organization consistently generates large surpluses, there is an indication that it has not provided the quantity of services that beneficiaries, grantors, donors, and other supporters have a right to expect. If it consistently generates losses, the organization will go bankrupt, just like a business.
In other words, the operating information might be seen from revenues and expenses through the Statement of Activities. While revenues are the inflows of resources applicable to the operations of the current year, Expenses are the cost of the resources consumed (that is, used up) in carrying out the organization’s operations during the year (Anthony, 1991, p.373). Expenses are to be distinguished from expenditures and disbursements. An expenditure occurs when an asset is acquired. An expense is incurred when the asset is consumed. A disbursement occurs when the bill is paid.
2. Other financial information
Along with the Statement of Activities, stakeholders also need the provided information in the Statement of Financial Position and the Statement of Cash Flows. The information provided in a statement of financial position, used with related disclosures and information in other financial statements, helps donors, members, and others to assess NPO's ability to continue to provide services and organization's liquidity, financial flexibility, ability to meet obligations, and needs for external financing. Besides, the information in a statement of cash flows is to provide relevant information about the cash receipts and cash payments of an NPO during a period.
3. Non-financial information
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Stakeholders also need non-financial information, both quantitative and qualitative. For instance, a long-range plan and program evaluations. A long-range plan contains both programs and financial plan, especially in mission and vision of organization circumstances. Supporting the long-term plan, program evaluations provide the explanation how well the programs run in order to achieve organization’s missions.
(e) Stakeholders of NPOs
Stakeholders who have interests in NPOs’ information, as follow:
1. Donors or funding sources
The donors and the funding sourcesare those who help and donate their money, goods, or time to deliver services operations of the NPOs. Despite differences in behavior, all donor categories (individuals, advisors, and foundation grant makers) want similar types of information from NPOs presented in similar ways.
Regarding the type of information, all donors want to understand the full story of an organization, including the financial picture, including how an organization spends its money; that a nonprofit is legitimate; the basics of the organization—its mission, approach, and make up; and the nonprofit's impact.Information on a nonprofit's impact can be very difficult to obtain. This information—how effectively nonprofits achieve their missions—is the true "unmet need" for donors. In a comprehensive study on donor motivation, many donors indicated they want to see financial data before deciding where to give their money.
2. Beneficiaries
The people, NPO’s “customers,” NPOs are trying to support. The people who actually use the services and goods created, distributed, or allocated by the NPO.
3. Employees
Employees provide vital services to keep the nonprofit running and are important stakeholders for NPOs. In return, they seek emoluments or recognition of its services.
4. Partners
Parties can be suppliers or providers of goods and services for NPOs or other organizations who have an agreement with NPOs.
5. Volunteers or supporters
From board members to the generous folks who help NPOs keep on the operation running.
70 6. The government
Government at all levels is an important stakeholder for NPOs. It requires the organization to furnish periodical reports of various kinds, and in return, it provides the organization with benefits like tax exemptions, tax deduction, government grants, and several other benefits
7. Communities
Every nonprofit is a part of larger communities, a citizen of society. As such, NPOs must honor and participate in community activities and cultivate community leaders, institutions, and government agencies.
(f) Previous Research
Some researchers have investigated accounting basis. Most research talks about accounting basis in business enterprises. There has been limited research and discussion about NPOs.
However, it warrants discussion since for non-business organizations, the public sector is more popular than NPOs.
Beechy (2007, p.2) has researched the concept of full accrual accounting. The research has argued that full accrual accounting is never appropriate for NPOs. For some NPOs (and public sector such as governmental organizations), full accrual accounting is appropriate. But, it has been stated that cash-basis accounting is appropriate for all NPOs since most accountants do not understand NPOs.
Adoption of accrual accounting has been increasingly in popularity done in the last two decades, especially in the public sector (Kober, Lee, & Ng, 2010, p.267). The research has examined the usefulness of various accounting systems for public sector decision-making, especially in Australia. The study used a postal survey to financial statement users and preparers across federal, state and territory departments. It has been stated that the controversial issues of accrual accounting implementation are its usefulness for decision making and how well it meets the needs of the users. They concluded that the cash basis accounting system is no longer considered sufficient for modern financial management.
Other publications have emphasized the conclusion and encouraged moving away from cash towards accrual accounting, since it creates smoother financial flow (Cathedral Consulting Group, 2014, p.1). Moving from cash to accrual accounting achieves two purposes, which are more
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business-like and performance-focused public sector (Hyndman & Connolly, 2011, p.36). Accrual accounting is also important in the financial reporting process, since it is generally more informative (Francis & Krishnan, 1999, p.139).
Hara’s research (2006, p.3) has focused on double-entry bookkeeping and accrual accounting, and its relationship to the accounting system. The researcher has concluded that countries who have adopted accrual accounting have specially managed journal systems, and surprisingly none of them prepares inventory records.
Especially in Indonesia, Shonhadji (2010, p.22) has researched accrual accounting and financial reporting. The study used qualitative research base on a case study. It concluded that the adoption of accrual accounting should be analyzed in depth in several entities, regarding the implication of accounting system diversification. With accrual accounting, the government might compare cash budget balance to fiscal balance. The research has also found that the implementation of modified cash basis system in the public sector has switched to accrual accounting as the basis for the reformed accounting policy.
Additionally, McLeod & Harun (2014, p.238) have analyzed the challenges in reforming public sector accounting in Indonesia. The researchers have examined government regulations and other sources, such as ministerial regulation on local government financial reporting, media reports, and BPK audit reports. They conducted interviews with central government policy makers.
It has been concluded that a lack of staff with the required accounting skills has been the barrier to implement new accounting systems such as moving from cash-based to accrual-based reporting.
All research have not discussed about accounting basis for NPOs in Indonesia yet. This research, therefore, is supposed to be a new reference in applied accounting basis, especially in Indonesia.
(g) Previous research on CDCs
Child Development Centers (CDCs) are the chosen multisite-operation NPO in this study. The main reason choosing this NPO is that CDCs are an appropriate representative of multisite-operation NPOs. They not only have more than 500 centers in Indonesia, but also been spread from the east to the west side of Indonesia and from rural to urban areas.
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Figure 4.1 has shown the users that benefit the accounting information which is produced in the general ledger and reporting system as drawn in Figure 4.2 below. The main entities are Compassion Indonesia Foundation (CIF) and partner churches (CPs) since CDCs are a form of partnership between two organizations. Both financial reports and operational reports are used to inform the performance of the partnership and how well CDCs achieve the goal of the partnership.
Figure 4.1 Modified Give and Take Exchanges in CDCs
Source: Adapted from Haryani & Pranoto, 2014
Financial reports include five transaction cycles as shown on Figure 4.2; revenue, expenditure, finance, human resource/payroll and operation. Fiscal year financial report is the base to plan program/budget master. When there is a high balance condition, the center should set proposals.
Based on the approved program/budget master and program and also proposal, CDCs get support from CIF monthly. Support will be forwarded through the finance cycle to be distributed according to planned programs. Support will be spent to provide services or goods in order to conduct programs. Support from CIF is calculated based on the number of registered children, both sponsored and unsponsored.
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