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Annual Reports of Non-profit Organizations

(NPOs): An Analysis

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Journal of Modern Accounting and Auditing, ISSN 1548-6583
February 2013, Vol. 9, No. 2, 183-192 D DAVID PUBLISHING

Annual Reports of Non-profit Organizations (NPOs):

An Analysis∗

Saunah Zainon, Marshita Hashim, Nadzira Yahaya, Ruhaya Atan

MARA University of Technology, Kuala Lumpur, Malaysia

Non-profit organizations (NPOs) in Malaysia are not subjected to statutory requirement to follow the accounting
standards when preparing their annual reports. This study analyzed the annual reports of 100 NPOs registered with
the Registry of Society (ROS) under the charity and religious categories. The objectives of this study are: (1) to
determine the current state of reporting practices by NPOs; and (2) to describe the contents of a set of annual
reports and the financial statement presentation of NPOs. This study found that there were variations in reporting
practices among the charity and religious categories of NPOs. On average, the results show that NPOs do not focus
on the disclosing information required by the ROS, the governing body of NPOs. This indicates that the regulators
need to strongly practice enforcement to strengthen the compliance of the annual reports submission. Overall, the
findings of this study provide useful information to regulators as a basis for preparing and presenting NPOs’ annual
report framework in the future.

Keywords: annual reports, charity, non-profit organizations (NPOs), religious

Introduction
In recent years, non-profit organizations’ (NPOs) annual reports have come under scrutiny due to major
financial scandals of frauds and misrepresentations (Normah & Katerina Maria, 2012). NPOs need to look for
ways to ensure the integrity of their annual reports (Flynn, 2009; Neely, Khumawala, & Gordon, 2007). This is
important, as NPOs have stewardship obligations to various stakeholders such as the contributors, members,
grant providers, and government, including the public at large. High-quality annual reports help organizations
fulfill their needs to be accountable for good stewardship, and generally accepted accounting standards provide
high-quality annual reports (Lam, 2009). However, NPOs in Malaysia are not able to demonstrate high-quality
reporting standards in preparing their annual reports for the stakeholders, as standards and minimum regulatory
requirements are absent. NPOs’ unique features of not having a definite ownership represented by voting
shareholders as in the private sectors only complicate the preparation of NPOs’ general-purpose annual reports.
NPOs’ organizational structure also differs according to categories, such as healthcare, women, education

∗
Acknowledgments: The authors would like to acknowledge the support received from the Faculty of Accountancy. This paper
draws from grants awarded by the Research Excellence Fund under the Research Intensive Faculty (RIF) 600-RMI/DANA
5/3/RIF (603/2012) titled “A Framework for the Preparation and Presentation of the Non-profit Organizations (NPOs) Annual
Reports”.
Saunah Zainon, senior lecturer, Faculty of Accountancy, MARA University of Technology. Email: [email protected].
Marshita Hashim, senior lecturer, Faculty of Accountancy, MARA University of Technology.
Nadzira Yahaya, senior lecturer, Faculty of Accountancy, MARA University of Technology.
Ruhaya Atan, professor, Accounting Research Institute, Faculty of Accountancy, MARA University of Technology.
184 ANNUAL REPORTS OF NON-PROFIT ORGANIZATIONS (NPOS): AN ANALYSIS

(colleges and universities), charity, religion, human resource, sports, youth, culture, and others. These
differences in categorization also need to be addressed in the preparation of NPOs’ general-purpose annual
reports (Holder, 1987).
NPOs’ annual and financial reports are the primary means of communication between the organization and
its stakeholders. Hence, the reports should provide timely and regular information on the NPOs and their funds,
which will enable donors and funding entities such as the government and other stakeholders to gain a full and
proper appreciation of the NPOs’ activities and financial transactions. As there is no rule obligating the NPOs to
have a standardized form of disclosures in the annual reports, the contents provided are not consistent and
cannot be compared. The presence of such uniformity enhances comparability and provides interested parties
with useful information to evaluate organizations’ effectiveness and efficiency for decision making.

Research Issue and Problem Statement

Numerous examples exist of two different organizations reporting the same activities or events in two
different ways. The Financial Accounting Standards Board (FASB), being committed to obtain uniformity in
financial reporting among NPOs, has issued statement No. 124 to resolve inconsistencies in accounting and
reporting of NPOs which require certain disclosures about NPOs information in the annual reports including
the returns on investment held by NPOs.
Scholars and practitioners agreed that NPOs have been in operations with little guidance over the years
(Anonymous, 1996). The absence of regulatory framework and proper guidelines on the reporting of
information (APG, 2011; Weiner, 2003) results in inconsistent reporting in NPOs’ annual reports, including
those within the same category. It is also difficult for the stakeholders to read and find the information needed
in annual reports. Evidence in the media proved that the public at large demanded the information from NPOs
in Malaysia (Chandranayagam, 2010). Thus, it is essential and important to standardize the information
provided by NPOs to determine the current state of NPOs’ reporting practices.

Objectives of the Study

This study aims to provide a foundation in subsequent researches on which the development of hypotheses
can be based (Tukey, 1977). The objectives of the study are twofold: (1) to determine the current state of
reporting practices by NPOs; and (2) to describe the contents of a set of annual reports and the financial
statement presentation of NPOs.

Significance of the Study

This study contributes to the knowledge on content information and overall presentation of the annual
reports currently provided by NPOs in Malaysia. Although this study is primarily descriptive in nature, it is
important to explore the current state of accounting methods employed so that they can be compared, judged,
and evaluated. Lee (2004) queried whether the NPOs were accountable to the public at large, as they received
certain tax benefits. He proposed that the NPOs should render an account to the public. This study analyzes the
annual reports of the charity and religious categories of NPOs, as annual reports act as a means of
accountability to the public at large. In his significant conclusions, Rowles (1999) pointed out that there were
three purposes of preparing annual reports: (1) to discharge legal obligation; (2) to help in the evaluation of
operational efficiency and effectiveness of the utilization of resources; and (3) to communicate the operational
 ANNUAL REPORTS OF NON-PROFIT ORGANIZATIONS (NPOS): AN ANALYSIS 185

and financial information to the persons interested. This study can be used as a basis for preparing and
presenting NPOs’ annual report framework.

Literature Review
Financial Reporting and Financial Statements
A number of researchers have noted that financial reporting serves as a vital instrument in discharging
accountability (Connolly & Hyndman, 2004; Gurd & Palmer, 2010; Hooks, Coy, & Davey, 2002; Kilcullen,
Hancock, & Izan, 2007; Wei, Davey, & Coy, 2008). Marston and Shrives (1991) reiterated that the annual
report was the most comprehensive document available to the public and therefore was the “main disclosure
vehicle” (p. 196). It should include a comprehensive disclosure of the organization’s financial elements of
performance and financial position. In the scope of accountability, financial reporting and financial statements
are fundamental in providing the response to the stakeholders for the purpose of discharging accountability
(Gurd & Palmer, 2010). The difference between financial statements and financial reporting was highlighted by
Higson (2006). Financial statements, consisting of balance sheet, cash flow statement (CFS), statement of
income and expenditure, notes to the accounts, and other supporting documents to reflect the “true and fair”
view of the financial position, are important as they provide information about the organization’s financial
position and performance, while financial reporting provides other additional information, including financial
information which supplements and complements financial statements. Hyndman (1990) suggested that
simplified financial statements would better serve the contributors of such organizations. Information is
important for the stakeholders, particularly the donors, to decide whether to continue contributing and
supporting the charity (Caers, Bois, Jegers, Gieter, Schepers, & Pepermans, 2006). Donors are important to the
charity for future survival, and the area in which the charity organizations are communicating well is in terms
of financial information (Howson & Barnes, 2009).
Regulatory and academic interests in NPOs’ reporting (Beattie & Jones, 1994; Christensen & Mohr, 2003;
Connolly & Hyndman, 2004; Hooper, Sinclair, & Hui, 2008) emerge in correspond to the growth of NPO sector
in the economy. Subsequently, there have been pressures on the NPOs to improve their transparency and
accountability in discharging their responsibilities through their reporting, which is a tool for the stakeholders
to be assured whether these NPOs are transparent and accountable. Although the literatures on financial
reporting practices in NPOs are extensive, there is a limited number of researches undertaken on the charity and
religious NPOs’ annual reports and financial statements, except for the study of Miller (1997) on the 91 annual
reports for fiscal years from 1991 to 1994 based on Hong Kong and a study from Malaysia by Noraini, Radiah,
Jamaliah, and Erlane (2006) on the annual reports of 32 charity organizations, but none for religious NPOs.
Furthermore, lack of standardization and application of Generally Accepted Accounting Policies (GAAP) has
resulted in difficulties for users to understand and compare NPOs’ annual reports (Bird & Morgan-Jones, 1981;
Connolly & Hyndman, 2001). It is also difficult to compare performance and achievement, as the NPOs are
established without standardized objectives, and their condition is diverse, as profit is not a bottom-line
measure of success in managing resources (Anthony, 1978). These issues further complicate the challenges in
determining NPOs’ performances. Since there are profound challenges within the NPOs, the accounting for
NPOs is regulated by certain standards in the same manner of the private sector in the developed countries. The
financial reporting regulatory environments of the developed countries in the UK, US, and Canada have
adopted all similar conceptual frameworks based on the decision-usefulness model.
186 ANNUAL REPORTS OF NON-PROFIT ORGANIZATIONS (NPOS): AN ANALYSIS

Types and Regulatory Framework for NPOs in Malaysia

NPOs in Malaysia are in the form of either charitable corporation or a society. The societies, which are
registered, monitored, and controlled by the Registry of Society (ROS), are governed by the Societies Act 1966
and Societies Regulations 1984 within the Ministry of Home Affairs. The main statutes dealing with the
establishment and regulation of NPOs in Malaysia are the Societies Act 1966 (Act 335), Societies Regulations
1984, and the Income Tax Act (ITA) 1967 issued by the Inland Revenue Department (IRD). Some NPOs may
register under specific acts (e.g., the Sports Commission Act, the University and University Colleges Act 1971,
and Youth Commission). Otherwise, they can register themselves under the Companies Act. NPOs in the form
of company are incorporated as companies limited by guarantees (known as “charitable corporation”) and are
governed by the Companies Act 1965. The organizations registered under the ROS must submit Form 9 that
consists of the statement of receipts and payments of the last financial year, together with a balance sheet
showing the financial position closely of the last financial year to the ROS within 60 days after holding its
annual general meeting1. This requirement is in accordance with Section 14(d) of the Societies Act 1966 (Act
335) and Societies Regulations 1984. However, the accounts submitted may not necessarily be audited. Other
statements that supplement financial statements, such as CFS, statement of changes in general fund and notes
comprising a summary of significant accounting policies, and other explanatory notes, are not required by the
ROS.

Sample of the Study

The sample of the study consists of 100 annual reports for the financial year of 2010 of NPOs registered
with the ROS. The sample is further divided into 50 annual reports of charity category of NPOs and 50 annual
reports of religious category of NPOs. Charity and religious categories of NPOs are the second and the third
largest categories among all categories of NPOs registered with the ROS. The first largest category of NPOs is
categorized as “others” that form various types of NPOs which are excluded from this study. Table 1 presents
the years of establishment in the sample.

Table 1
Years of Establishment
Charity NPO Religious NPO
Year Establishment
N % N %
More than 40 years Very old 7 14 7 14
30-39 years Old 2 4 7 14
20-29 years Very matured 8 16 9 18
10-19 years Matured 17 34 10 20
5-9 years Established 14 28 12 24
Less than 5 years New 2 4 5 10
Total 50 100 50 100

Table 1 highlights that the majority (34% charity NPOs and 40% religious NPOs) of the sampled
organizations were established 10 to 19 years ago and are deemed to be “matured” organizations. The least is
from “new” organizations which were established less than five years ago (4% charity NPOs and 10% religious
NPOs). On average, most organizations were “established” five to nine years ago.
1
Section 14(1) of the Societies Act 1966 (Act 335) and Regulations.
 ANNUAL REPORTS OF NON-PROFIT ORGANIZATIONS (NPOS): AN ANALYSIS 187

Data Collection and Methodology

The ROS maintains and keeps a proper record and filing of annual reports for NPOs registered at their
offices. A few visits were made to the ROS to obtain the copies of the annual reports that also contained the
financial statements of the respective NPOs. One hundred annual reports containing the financial statements,
for the financial year of 2010, were finally collected.
The contents and the overall presentations of financial statements were analyzed using the content analysis.
Content analysis is “… a method of codifying the text (or content) of a piece of writing into various groups or
categories depending on the selected criteria…” (Krippendorff, 1980, p. 20). Content analysis was often used in
the financial statement analysis and disclosure studies (Arnone, Ferauge, Geerts, & Pozniak, 2011; Roshayani,
Normah, Rashidah, Jamaliah, & Intan Salwani, 2012; Saunah, Ruhaya, Bee Wah, & Raja Adzrin, 2012). In the
disclosure study, a dichotomous technique was used to give scores to the amount of disclosure made, i.e., an
item scores one if it was disclosed and zero if otherwise. This is commonly known as unweighted index. The
main drawback of content analysis is the subjectivity of the technique itself. Hence, the instruments’ reliability
used in a content analysis can be questioned. To overcome this issue, a test-retest approach was adopted as
recommended by Krippendorff (1980). The test-retest for this study was performed by two independent raters
who had a qualified accounting background. The purpose of test-retest or inter-rater reliability or inter-observer
is to achieve the level of agreement in viewing the same activity or setting. Inter-rater reliability measures
assess the relative consistency of judgments made by two or more raters (Michael, Bryman, & Liao, 2004). The
results show that there are some levels of agreement and consistency of the annual reports analyzed.

Research Findings
Descriptive statistics (percentage and frequency) were used to describe the contents of the annual reports
and the overall presentations of financial statements. This study further looks into seven selected items
contained in the NPOs annual reports. This follows studies carried out by Miller (1997) and Noraini et al. (2009)
in more detailed analyses. In general, less than 50% of both charity and religious NPOs complied with the ROS
requirement to submit the statement of receipts and payments, along with the balance sheet. This indicates that
the organizations did not fulfill the basic requirements of the ROS to furnish both of the two statements. A more
detailed and in-depth analysis is then conducted to analyze the contents and the overall presentations of the
financial statements. The analysis is sub-grouped into: (1) balance sheet; (2) CFS; (3) statement of receipts and
payments; (4) statement of income and expenditure; (5) auditors; (6) disclosure; and (7) accounting method.
Balance Sheet
Not all of the sampled organizations included a balance sheet in their financial statements, even though it
was required by the ROS. Seventy five percent of the overall organizations submitted the balance sheets in
vertical form of presentations. Twenty-four organizations, all from charity category of NPOs, supplemented the
information on general fund provided in the balance sheet by a separate statement of changes in general fund.
This statement is a separate component of the financial statements showing the changes and movements in
general fund for one period of time. The statements reconcile the general fund at the beginning of the period
with the general fund at the end of the period combining the information on net surplus or deficit of the
organization. As NPOs’ multiple stakeholders have legitimate interests in the financial position of NPOs, the
statement of changes in general fund represents the net resources that the NPOs have built up and not to
188 ANNUAL REPORTS OF NON-PROFIT ORGANIZATIONS (NPOS): AN ANALYSIS

represent ownership interests as in the profit sector. Eighty six percent (i.e., 44 charity NPOs) and 42 religious
NPOs showed surpluses with some NPOs having surpluses more than a million for the financial year end of
2010. The remaining suffered deficits. The contents of the balance sheets were inconsistent, and there was
no uniformity. For example, some NPOs showed only the fixed assets, while others only showed the current
assets.
CFS
Complementing the balance sheet and the statement of receipts and payments, the CFS is a mandatory part
in the profit organizations. It records the amount of money coming and how it is being spent. CFS can exhibit a
healthy or positive cash flow and can raise a red flag on a negative cash flow for an organization to continue
running its activities. By having the CFS, it allows the management of the NPOs to make plans on providing
more programs and services in the excess of cash, and conversely, cut the program services. The two methods
of presenting the CFS under the Financial Reporting Standard (FRS) 107, the direct method and the indirect
method (Malaysian Accounting Standards Board, 2005), have different procedures but yield the same results on
the amount of cash flow. However, FRS 107 encourages entities to report their cash flows using the direct
method (Lazar & Ching Choo, 2008). The analysis in this study revealed 31 NPOs (31%), 19 from charity
NPOs and the balance from religious NPOs, included a CFS as a part of their financial statements even though
it was not required by the ROS. This is considered as providing voluntary information in fulfilling the
stakeholders’ needs. Sixteen out of 31 NPOs applied the indirect method. By having the CFS, the cash flow
ratio can be computed to evaluate the liquidity, financial health, and performance of the NPOs. This statement
allows the users of the information to understand the way an NPO’s operations are financed. The results from
the previous study confirmed that all large charity NPOs included a CFS (Williams & Palmer, 1998).
Statement of Receipts and Payments
The ROS requires the NPOs to submit their annual reports including the statement of receipts and
payments. This statement is important, as it records the amount and form of payments made. It also addresses
the way the NPO’s receipts and payments are changed during the period. This is to determine whether the
NPOs have surplus or deficit due to large expenditures incurred or shortfall in revenues. Even though it is
required, only 67% from the whole sample complied with this requirement. Out of 67%, most of them were
from charity NPOs (45 NPOs).
Statement of Income and Expenditure
Eighty four percent of the NPOs (i.e., 52 charity NPOs) and 32 religious NPOs prepared the statement of
income and expenditure. The statement was prepared in general, and only four NPOs provided a detailed
classification of expenses into mission-programs expenses and administration expenses. The classification of
these mission-programs expenses and administration expenses would assist the IRD in determining the
percentage of mission-programs expenses, since it is a requirement to have at least 50% expenses incurred for
mission-programs in order to qualify for the tax-exempt status. However, the amount of donation made to the
religious NPOs is not eligible for tax exemption by the IRD. Thus, the 50% rule can only be applied to charity
NPOs. In the US, the Internal Revenue Service (IRS) requires to present the expenses by a functional category
of fund raising, administration, and program expenses in their annual reports submission. For tax-exemption
eligibility, the 70% rule of mission-programs expenses is applied in the US.
 ANNUAL REPORTS OF NON-PROFIT ORGANIZATIONS (NPOS): AN ANALYSIS 189

Auditors
Out of 100 NPOs, 64 charity NPOs which furnished the financial statements in applying for tax-exemption
status as a requirement of the IRD were audited by the external auditors. Nevertheless, none of these 64 charity
NPOs was audited by the “Big 4” accounting firms, i.e., Pricewaterhouse Coopers (PwC), Deloitte Touche
Tohmatsu, Ernst & Young, and Klynveld Peat Marwick Goerdeler (KPMG), which are the largest international
accountancy and professional services firms that handle the vast majority of audits for publicly-traded
companies. None of the religious NPOs’ financial statements was audited by the external auditors.
Disclosure
FRS 132 states that the purpose of the disclosure is to enhance the understanding about the significance
of financial instruments to the entity’s financial position, performance, and cash flows. The disclosure should
provide information to assist users of financial statements in assessing the extent of risk related to financial
instruments. However, the standard does not prescribe the format or location for disclosure of information
which may be of narrative commentary or quantified data. An entity should describe the objectives and
policies of the financial risk management. The findings in this study indicated that 16 NPOs disclosed risks
related to financial instruments. The four types of risks are market risk, credit risk, liquidity risk, or funding
risk and cash flow interest rate risk. The market risk encompasses currency risk, fair value interest rate risk,
and price risk. The disclosures about fair value of financial instruments are disclosed by two religious NPOs.
It was also found that the charity NPOs that appointed the external auditors did provide the disclosure of
accounting policies in their notes to the accounts. This finding is similar to the study carried out by Radiah,
Jamaliah, and Noraini (2006). Another interesting finding is on the transparent disclosures made by the NPOs
in revealing the names of their donors in the notes to the accounts as a means of gratitude and appreciation.
This disclosure was made by the charity NPOs, partly to acknowledge the donors through the means of
reporting.
Accounting Methods
The accrual accounting system is required by the standards for all profit sectors. The NPOs may apply
either the cash basis or the accrual accounting system. This study indicated that 36% of all charity NPOs had
used accrual basis of accounting in the preparation of the financial statements. The most likely explanation is
that the application of either the accrual or the cash basis may not be significant, since it is not a violation to
any accepted accounting standard.

Summary of Research Findings

From the above findings, it can be pointed out that NPOs are not effectively using the financial statement
as a means of communication for information. None of the sampled NPOs provided uniform information due to
the lack of uniform guidelines, which had resulted in various accounting practices by the NPOs. The
differences in financial statement presentations have caused difficulties in comparing the performance of the
respective NPOs. The above findings are summarized in Table 2.
Comparing the descriptive findings in Table 2, it can be seen that charity NPOs dominate religious NPOs
in terms of compliance with the regulatory requirements (i.e., both the ROS and the IRD). In addition, the
tax-exempt benefits could be one of the most possible reasons for the charity NPOs to have a greater
compliance with the regulatory requirement. The tax-exempt status and the information provided in the annual
190 ANNUAL REPORTS OF NON-PROFIT ORGANIZATIONS (NPOS): AN ANALYSIS

returns would enable more donors to donate in their organizations (Khumawala & Gordon, 1997; Parsons,
2003). The survival of NPOs depends on the supports of funds from various sources, such as donations, grants,
and fees. With more funds, they would be able to hire the external auditors to ensure the quality of reporting
information in their annual reports. Based on the findings, charity NPOs are able to appoint external auditors
and at the same time fulfill the IRD requirement for tax-exempt status purposes.

Table 2
Summary of Findings
Charity NPO Religious NPO Overall NPO
Variable
(N = 50) (N = 50) (N = 100)
Balance sheet* 24 51 75
CFS 19 12 31
Statement of receipts and payments* 67 45 22
Statement of income and expenditure 84 52 32
External auditors** 64 nil 64
Disclosure of risks related to financial instruments 16 nil 16
Accrual accounting method 36 nil 36
Notes. * stands for the requirement by the ROS and ** stands for the requirement by the IRD.

Conclusions, Limitations, and Future Research

The objective of this study is to determine the current state of reporting practices by NPOs and to describe
the contents of a set of annual reports and the financial statement presentation of NPOs. By identifying the
items contained in the financial statements of the selected samples of NPOs, this study can be used as a basis of
framework preparing and presenting NPOs’ annual reports for better improvement of NPOs’ annual reports
which are hoped to disclose necessary information required by various stakeholders. The importance of
information in the annual reports is highly expected as the “appropriateness of stakeholder decisions for at least
partly a function of the quality of the financial reports used” (R. J. Yetman & M. Yetman, 2004, p. 2). As the
annual reports are major sources of information for the stakeholders, the reports should be prepared and
presented according to the stakeholders’ needs. Even though it is mandatory that the balance sheet and the
statement of receipts and payments are submitted to the ROS annually, it was found that they were not being
fully submitted. Thus, there is a strong need for enforcement to strengthen the compliance of the annual reports
submission. Furthermore, the results portray that most NPOs do not focus on the disclosing information as
required by the ROS. As suggested by Irvine, Mack, Ryan, and Tooley (2010), a stewardship model can act as a
foundational pillar for NPOs’ reporting in order to cater the uniqueness of the NPOs in the absence of a single
bottom line to measure NPOs’ performance. Therefore, there is a need for legitimacy through the regulatory
body such as the Malaysian Institute of Accountants (MIAs) to provide basic guidelines for the financial
statement preparation by NPOs. However, this study has a number of limitations. A small sample size of 100
NPOs from only two categories of NPOs may not reflect the full sample of the organizations. The use of the
content analysis may need to be extended to the perspectives of the preparers of the annual reports as the
reasons for disclosure and non-disclosure of information. Future research may focus on the information needs
from various stakeholders of NPOs, so that more reliable information can be included in the preparation of
annual reports.
 ANNUAL REPORTS OF NON-PROFIT ORGANIZATIONS (NPOS): AN ANALYSIS 191

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