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    The Causes and Consequences of Internal Control Problems in...
    research summary posted October 24, 2013 by Jennifer M Mueller-Phillips, tagged 07.0 Internal Control, 07.03 Reporting Material Weaknesses, 12.0 Accountants’ Reports and Reporting, 12.06 Consequences of Adverse 404 Opinions 
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    Title:
    The Causes and Consequences of Internal Control Problems in Nonprofit Organizations
    Practical Implications:

    This study informs the debate over whether public charities should adopt more rigorous corporate governance practices, particularly in relation to internal control. Recently, policymakers have focused attention on the perceived lack of accountability and transparency by charitable organizations. This increased scrutiny is not necessarily unwarranted due to the recent financial scandals and the size of the nonprofit sector. The evidence provided in this study suggests that the internal control information currently produced by a subset of organizations in the nonprofit sector does affect, either directly or indirectly, both donors’ and government agencies’ funding decisions. Furthermore, the results of this study should also interest nonprofit managers who make decisions about how to allocate scarce resources. Lastly, this study provides insight on how the recently adopted standards SAS No. 112 and SAS No. 115 which provide guidance regarding the communication of internal control matters may influence public perception of nonprofit organizations.

    For more information on this study, please contact Christine Petrovits.
     

    Citation:

    Petrovits, C., C. Shakespeare and A. Shih. 2011. The Causes and Consequences of Internal Control Problems in Nonprofit Organizations.  The Accounting Review 86 (1):  325-357. 

    Keywords:
    internal control; nonprofit organizations; donors; government grants; Sarbanes-Oxley.
    Purpose of the Study:

    The nonprofit sector represents a non-trivial portion of the United States economy. Nonprofit organizations had over $3.4 trillion in assets under their control and charitable giving to these organizations reached an estimated $295 billion, or 2.2 percent of gross domestic product, in 2006. Furthermore, several recent financial scandals have highlighted the significant fiduciary responsibilities of nonprofit managers as well as the relatively weak regulatory oversight of the nonprofit sector. Although internal control audits are not new to the nonprofit sector being that any nonprofit receiving federal funding is subject to review of internal control, the authors utilize this unique setting to investigate the causes of internal control deficiencies and perhaps, more interestingly, the consequences of internal control reporting for these organizations. Specifically, the authors examine the characteristics of public charities that report internal control problems and the effect of such problems on subsequent contributions and government grants received.

    Design/Method/ Approach:

    The authors first examine the probability of disclosing an internal control problem as a function of characteristics of the nonprofit organization, such as size, growth and financial distress, using a sample of 27,495 public charities from 1999 to 2007. Next, the authors consider the consequences of disclosure of an internal control problem for nonprofit organizations. Specifically, the authors examine whether the disclosure of an internal control problem is associated with lower contributions, both directly and indirectly, received subsequently from donors which captures the responsiveness of donations to various economic factors. Lastly, the authors investigate the effect of disclosing internal controls deficiencies on subsequent contributions received from local, state, and federal government agencies.

    Findings:
    • The authors find evidence that generally suggests that nonprofit organizations that are more complex, financially distressed, smaller, and/or growing rapidly are more likely to disclose an internal control problem.
    • Additionally, the findings indicate that reportable conditions over financial reporting are negatively associated with future public support. Specifically, organizations that disclose internal control problems over financial reporting receive fewer contributions, both directly and indirectly, from individuals, corporations, and foundations in the subsequent year.
    • Lastly, the authors find negative associations between reportable conditions over both financial reporting and federal program compliance and subsequent government contributions, after controlling for prior-year government contributions and political and economic determinants of governmental funding allocations.

    The authors suggest their results are generalizable to the for-profit sector because they provide long-term evidence that stakeholders do indeed use internal control information to evaluate organizations. Furthermore the authors suggest the nonprofit managers should understand these internal control risks as they estimate that, all else equal, organizations with internal control problems receive 3.8 percent less public support and 2.1 percent less government support.
       
     

    Category:
    Accountants' Reporting, Internal Control
    Sub-category:
    Consequences of Adverse 404 Opinions, Reporting Material Weaknesses