Do Non‐profit Organizations Manage Earnings toward Zero Profit and Does Governmental Financing Play a Role?

Abstract

Prior research has documented earnings management in for‐profit settings. Non‐profit organizations are thought to pay less attention to the bottom line and earnings management research has therefore focused on the manipulation of expenses in order to improve efficiency ratios or taxable income, not reported earnings per se. Considering an institutional setting characterized by the absence of such ratios and the presence of important subsidies, management of the actual bottom line is analyzed in light of these subsidies. The results suggest that organizations drive their results toward zero profit, which is intensified by increased governmental funding when unmanaged results are positive. The relation between downward earnings management and the presence of subsidies is particularly evident for organizations whose accumulated reserves are high. Copyright © 2012 ASAC. Published by John Wiley & Sons, Ltd.

NPO Financial Statement Quality: An Empirical Analysis Based on Benford’s Law

“…9 Nevertheless, the fact that FS serve a more prominent monitoring role for donative NPOs also gives rise to certain financial reporting incentives. As argued by Verbruggen and Christiaens (2012), when trying to increase their funding, theory, and evidence suggests that NPOs will manage earnings downward in order to demonstrate a need for funding. Various studies document the prevalence of earnings management practices among NPOs (see e.g., Leone and Van Horn 2001;Krishnan et al 2006;Verbruggen and Christiaens 2012;Jegers 2013).…”

“…As argued by Verbruggen and Christiaens (2012), when trying to increase their funding, theory, and evidence suggests that NPOs will manage earnings downward in order to demonstrate a need for funding. Various studies document the prevalence of earnings management practices among NPOs (see e.g., Leone and Van Horn 2001;Krishnan et al 2006;Verbruggen and Christiaens 2012;Jegers 2013). In line with the aforementioned argument, Verbruggen and Christiaens (2012) find that NPOs that rely more heavily on governmental funding are more likely to manage earnings downward toward a zero profit.…”

“…As discussed in Durtschi et al (2004), various authors have promoted Benford's Law as a simple and effective tool to uncover irregularities in accounting numbers. Whereas prior studies already explore FS quality among NPOs, they typically focus on very specific items (e.g., the reported earnings figure) (see e.g., Verbruggen and Christiaens 2012;Jegers 2013); taxable income (see e.g., Omer and Yetman 2003); and fundraising expenses (see e.g., Krishnan et al 2006)) or the formal quality of the FS 1 (see e.g., Verbruggen et al 2011). Unlike prior studies, I do not focus on one or more specific figures reported in the FS, rather I assess the overall accuracy of figures reported in the balance sheet and the income statement.…”

“…Prior research indicates that donors and governments do indeed rely on financial statement information in their decision to provide funding to an NPO (see e.g., Parsons 2003;Kitching 2009;Thornton and Belski 2010;Feng et al 2011;Verbruggen et al 2011;Amin and Harris 2012). As a result, the reliability and quality of NPOs' financial statements (henceforth FS) is important to, and relevant for, various NPO stakeholder groups, including donors, governments, and volunteers (Verbruggen and Christiaens 2012).…”

“…the earnings figure) in NPOs' FS. As discussed in Verbruggen and Christiaens (2012), subsidizing governments do not merely consider the reported earnings figure, but consider a mixture of FS items (e.g., accumulated reserves, the presence (and magnitude) of other types of revenues, the (relative) magnitude of operating expenses, etc.) in order to make their funding decisions.…”