Research objectives. TECS April

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1 Tracking Trends in Ethiopia s Civil Society 1 POLICY BRIEF 5 Early Evidence of the Impact of the 70/30 Guideline to Determine Operational and Administrative Costs (Guideline 2/2003 EC) Phase II Issue: The Guideline to determine the operational and administrative costs of charities & societies (ChSOs) was one of the eight guidelines approved by the Charities and Societies Agency s (CSA s) Board in July All ChSOs and donors agree that the 70/30 ratio is reasonable in principle but there is widespread concern that the actual classification of administrative costs has a negative impact on ChSO programmes and projects. Research objectives The main objective of this study is to assess the actual and likely impacts of the 70/30 Guideline on the operational activities of ChSOs by undertaking an in-depth study of sample ChSOs and consortia, and by seeking a wide range of stakeholder views, in addition to drawing upon international CSO accounting standards. At the time of the study, it was unclear how far the Guideline would in fact be applied to ChSOs 2011 accounts. In the event, most ChSOs interviewed assumed that they should try to apply it as much as possible 2. Since the Guideline became official by November 2011, most ChSOs had no time to change their programmes and their operations before the end of the fiscal year in order to comply with the Guideline. In 1 The Development Assistance Group (DAG) was established in 2001 to foster information sharing, policy dialogue and harmonise donor support to Ethiopia in order to enable the country to meet the targets set in the Millennium Development Goals (MDGs). DAG also assists in the preparation, monitoring and evaluation of the country s Poverty Reduction Strategy (PRS). DAG currently comprises 26 donor agencies providing development assistance to Ethiopia within the Paris Declaration principles of aid effectiveness and harmonization. Disclaimer: This policy brief is based on research commissioned by DAG members through the Tracking Trends in Ethiopia s Civil Society (TECS) project. The research study was carried out by Atos Consulting in partnership with the Forum for Social Studies (FSS), an Ethiopian Resident Charity. The authors were Dr Berhanu Denu and Ato Getachew Zewdie. The views presented in this briefing note are those of the authors, FSS and Atos Consulting, and do not necessarily represent the views of DAG members. 2 The ChSA s Director s messages on this issue during the consultation events held in different cities in late 2011 were not always consistent TECS April

2 this respect, we were able to analyse only the early impact of the Guideline. Fuller impact is likely to be evident after the 2012 accounts are submitted and assessed. Approach and methods The research used quantitative and qualitative methods. The quantitative approach used operational and audit reports of 2011 fiscal year to determine the extent to which ChSOs have been able to comply with the 70/30 Guideline. The qualitative approach used interviews with key informants to determine the challenges faced by ChSOs in complying with the Guideline, the early impact of the Guideline on ChSO operations and recommendations of all stakeholder groups on the way forward. The sources of evidence for the research were: ChSO representatives (35 ChSOs covering all categories, and 8 consortia/networks) DAG members (5 development partners) ChSO accredited audit firms (15 firms: 5 category A and 10 category B )) ChSO Proclamation, Regulation and Directives Operational and audit reports of ChSOs for 2011 fiscal year (63 audited financial statements) Relevant government reports such as the Growth & Transformation Plan International accounting principles on NGOs and relevant international literature on administrative/operational cost ratio of ChSOs (from several countries) Government officials at the federal level and in 3 regions The research team found that many ChSOs were reluctant to participate in the study. There were also problems in obtaining copies of audited reports for the 2011 fiscal year. It was difficult to find many Ethiopian Charities or Societies to include in the sample, either because of: reluctance; or they had carried out few operations, or some had re-registered as Resident Charities or Resident Societies. Review of international literature on charity financial accounting standards There is a general consensus that charities should allocate more resources to their programs and projects. However, the review of selected literature on cost allocation practices in other countries found no rules that predetermine a specific ratio of administration to program costs. Most countries practice the classification of costs as programme, fundraising and administration/general expenses, which are reported based on charity accounting standards of their respective country. Programme (operating) costs typically include those support costs which are utilized in order to deliver the project (such as consultancy, monitoring and evaluation, transportation and others). TECS April

3 Findings Extent of compliance A significant majority of ChSOs were unable to comply with the Guideline. Of the 35 ChSOs and 8 consortia representatives who were interviewed, over two thirds (71%) believed their 2011 operations and financial reports did not comply with the Guideline. However, the researchers found an even higher level of non-compliance, with 81% of the 63 audited accounts from the 2011 year failing to conform to the Guideline. This high rate of noncompliance tallies exactly with the Agency s own statistics, which suggest a non compliance rate of 81%. 3 The Ethiopian Resident Charities had a compliance rate of about 30%, the highest level of compliance among the different categories of ChSOs. The smaller charities and societies have particular difficulties in complying due to the economies of scale in fund volume 4 and the nature of their operations. None of the consortia were able to comply as they had operating expenditures in 2011 as opposed to what was stipulated in the Guideline. See figure 1 below. Figure 1: Number of ChSOs and Level of Non-compliance by Category Number of chsos iwhich accounts analysed Foreign Charity Ethiopian Resident Charity Ethiopian Resident Society Ethiopian Society or Charity Consor5a Number of ChSOs Non- compliance On average, across all 63 ChSOs financial statements reviewed, the overall operational to administrative ratio was 52/48. This suggests that ChSOs will have to make major operational changes in order to comply in future. It is most challenging for health programmes to comply with the Guideline (only 16.7% compliance rate); and least challenging for agriculture programmes to comply 3 The ChSA s Annual Report for 2004 ( ) 4 The relative size of societies annual budgets is small and as a result the 30% of this volume of fund tends to be small relatively TECS April

4 (44.4% compliance rate) due to the emergency relief programs which are included in this sector. Opportunities and challenges in the guideline There are two types of challenges faced by ChSOs in complying with the Guideline. On the one hand, both ChSOs and auditing firms found the actual guideline is confusing in places (it is not clear how certain costs are delineated). On the other hand, 40% of the audit firms expressed the view that the classification of some costs as administrative, which were clearly program related - including monitoring and evaluation (M&E) and transport - has been the main cause of non-compliance. The majority of ChSOs also found the cluster approach confusing and difficult to apply. Government bodies at federal and regional level recognised both advantages and disadvantages in the Guideline. On the positive side, they pointed out that the Guideline creates the opportunity for target communities to benefit more from a project since more of the funds will be allocated directly to them, rather than being consumed in the form of administrative costs by the charities themselves. They stated that the Guideline would improve ChSO financial management systems, promote better use of resources, and better accountability of charities. However, they also identified some challenges in terms of the classification of certain project costs as administrative. Two federal ministries stated that the classification of transportation and capacity building as administrative were problematic, while regional bureaux felt that M&E, cost of vehicles and capacity building for stakeholders should be re-classified as operational. Additionally they believed that smaller ChSOs (in particular, those operating with annual budgets under 10 million birr) should receive special consideration, since they have greater challenges in applying the Guideline. Development partners stated that the Guideline is useful in attempting to curb the activities of ChSOs that operate with poor standards and practices. However, it may harm the activities of the majority of ChSOs, which operate with sound standards and work to support the achievement of the Growth and Transformation Plan and Millenium Development Goals. They stated that they are unlikely to support ChSO projects with reduced M&E, baseline surveys and delayed reports arising from lengthy auditing procedures. Early impact of the guideline Most ChSOs have made operational changes in order to comply, but they fear these changes will impact negatively on their efficiency, effectiveness, accountability and transparency. They gave examples of the negative consequences of cutting back on M&E, consultancies, transportation, research and training activities, which ranged from reducing or stopping projects in remote areas or emerging regions to the inability to ensure project quality. They also believe that development partners could cease funding them because core accountability systems and practices are no longer in place. TECS April

5 The Guideline affects consortia/networks in a more radical manner. This is because it is assumed consortia have no operations, because training, capacity building and fundraising engagements are considered administrative. Consortia state the Guideline puts their very existence into question. Stakeholder views on the way forward The majority of ChSOs (52%) suggested that the Guideline should be revised to make it clearer and more flexible in its application. Among the consortia, around 63% suggested that negotiation with the Government should be continued to revise the Guideline. Development partners and audit firms gave views on the suitability of different cost classifications in line with international practices and generally accepted cost allocation methods. Federal government bodies and regional government bureaux suggested that certain costs transportation, capacity building, M&E - should be re-classified as operational, and the inevitable higher administrative costs at project start-up should be taken into account during a review of the Guideline. Smaller ChSOs should receive special consideration. They also suggested that there should be a regular fora and close working relationship established between the CSA, sector bureaux and ChSOs, in which opportunities and challenges could be presented and inform any further revisions to the Guideline. Conclusions and Policy Recommendations This study concluded that while the 70/30 Guideline is meant to promote transparency in ChSOs operations, there are significant concerns that it is affecting all categories of ChSOs negatively in achieving their goals. 5 Although it is early days to gauge the full impact of the 70/30 Guideline, the analysis of information gathered from the sample of ChSOs, consortia, auditors and development partners highlights some significant areas of early impact. Endeavours to comply with the Guideline will in themselves have consequences, many of which are expected to be negative. These include a complete shift in the development intervention approach and a compromise in standard project cycle management practices. Beneficiaries are likely to have to shoulder the negative effects of the Guideline as and when, for instance, ChSOs cut back on operations in more remote areas and if they no longer carry out training, which would have helped ensure sustainability after projects come to an end. 5 These concerns have resulted in several initiatives to seek amendments, including: CCRDA research on 70/30; forthcoming recommendations for ChSOs engaged in environmental protection; and recommendations prepared by UN Humanitarian Coordinator TECS April

6 The following are the main policy recommendations arising from the findings: I. The CSA should consider revising the Guideline, especially the classification of costs, in line with generally accepted charity accounting standards. II. III. IV. The CSA should develop an operational and financial reporting framework (program and support definitions and their associated cost classification) and give the sectoral offices (health, education, agriculture, etc) more latitude to apply the Guideline so that they can ensure better services by ChSo to target beneficiaries. The CSA should create a forum to enable regular exchange of views with stakeholders, including federal and regional sectoral offices, with regard to emerging issues in the implementation of the Guideline. There should be an on-going monitoring of the Guideline and a follow up study of the actual impact of the Guideline in mid-2013, to allow all stakeholders to assess the full impact of the Guideline. Prepared by: The TECS team. For information, contact gemechu_desta@hotmail.com ;anncondy@yahoo.com; gil.long@btopenworld.com; clairefhoward@gmail.com For further information, please read TECS research report: Early Evidence of the Guideline to determine Charities and Societies Operational and Administrative Costs (70/30 Guideline), Final Report, April 2013 TECS April