Joint Costs: Avoid This Popular Charity Accounting Trick!
Dec 09, 2022
In nonprofit financial reporting, the funds spent on telemarketing, direct mail, or other solicitation activities that also include an "action step" or "call to action" are referred to as "Joint Costs." For example, a charity may spend millions to hire a for-profit, direct mail company to send out fundraising letters that include 5 or 6 requests for a donation. As long as the letter also includes an action step such as “get your annual breast exam,” or “don’t forget to buckle your seatbelt,” the charity can claim that a primary purpose of these letters is to educate you. On this basis, the charity is allowed to claim that a significant portion of what it spent to design, print, and mail these letters to you and other potential donors is a program expense, not a fundraising expense.
Charities often use joint costs as a way of inflating their reported charitable program spending and deflating their reported fundraising costs. Although the use of this accounting "trick" is often perfectly in line with the accounting rules for the reporting of joint solicitation costs (AICPA SOP 98-2 / ASC 958-720), these rules allow for many interpretations and judgments that can produce questionable results.
CharityWatch has long warned donors to not rely on the pie charts and other metrics on charity websites and marketing materials claiming that a very high percentage of your donation is spent on programs since these figures often include joint costs. Such percentages are often repeated at face value in the online databases of charity raters and nonprofit trade associations that republish these percentages for thousands and thousands of charities.
The California Attorney General’s office has echoed CharityWatch’s concerns, saying that this accounting treatment “can be abused to reduce reported fundraising expenses. If a charity spends most of its money to fundraise, you probably would not donate to that charity…The improper use of Joint Cost Allocation results in a false report of a charity’s finances and misleads potential donors and others into believing that the charity operates more efficiently than other charities.”
Joint cost accounting rules require that certain criteria related to "purpose," "audience," and "content" be met before joint costs are allocated to charitable program functions. The criteria, however, are subjective in nature and therefore, leave room for biased interpretation by the charity. More specifically, while a charity may contend that portions of its solicitation materials qualify as a call to action with a purpose that promotes the charity's mission to an appropriately targeted audience, another interpretation of the purpose, audience, or content may result in a different conclusion.
For instance, if a fundraising letter from a genetic disorder charity includes educational information for the potential donor about healthy eating and exercise, the charity likely is applying joint costs. This means that the charity is reporting a portion of the cost to prepare and send that fundraising letter as a charitable program expense because the solicitation includes an educational component about healthy eating and exercise. When most donors think about how their contributions are used for the programs of a genetic disorder charity, they probably hope that this includes areas such as patient care or research—not educating potential donors on diet and exercise, which seemingly would have very little, if any, influence over whether one actually becomes afflicted with the genetic disorder.
Another example is an alcohol abuse charity applying joint costs because of a "don't drink and drive" call to action that is included with a direct mail campaign received by individuals who rarely consume alcohol and/or usually rely on public transportation. Is such a joint solicitation truly an effective promotion of an alcohol abuse charity's mission to the extent that a portion of the expenses should apply to program activities? Or as a potential donor, would you rather see your contribution being spent towards bona fide program efforts such as increasing the law enforcement of drinking and driving offenders, or even towards sending such a call to action to a targeted group of recipients with a history of driving under the influence?
These examples show that the interpretation of the purpose, audience, and content criteria for joint costs makes it relatively simple for charities to disguise the costs of fundraising as program services that most donors would not think of as the types of charitable programs they hope their contributions are being used to fund.
The accounting rules for joint solicitation costs also do not prescribe or mandate a specific method for allocating the expenses between fundraising and charitable program services, nor are any allocation methods prohibited. Rather, the guidance given describes that the chosen allocation method "should be rational and systematic," the result should be "reasonable," and the method should be "applied consistently given similar facts and circumstances." This creates variation in how joint costs are applied by different nonprofits based on auditor judgment and determination, which can make it difficult to objectively compare the fundraising and program efficiencies of different charities.
Further, although auditors may be determining the joint cost allocation methodology, it is not in their scope of work to judge the legitimacy or substance of the charitable program(s) that the charity contends are benefiting from the solicitation activities. This decision is made by the charity, which again raises the question of objectivity discussed above. In some circumstances it may even be an independent contractor, not the charity itself, that oversees the selection of the solicitation materials that are supposed to be promoting the charity's mission and program services.
The next time you receive a fundraising solicitation from a charity with a "call to action," use your own discretion and ask yourself if it really seems like the most effective way to educate the recipients and assist the charity in achieving its program goals. If the joint solicitation material truly is related to a charity's program goals, it should be easy to conclude that the program elements of the campaign material are so effective on their own that they would be delivered by the charity even if they were not accompanied by a donation request. This would justify the application of joint costs. Otherwise, the odds are that joint costs are merely being used to improve the charity's reported program and fundraising efficiency ratios, and if that is the case, your donation can be put to better use elsewhere.