Reporting Requirements for Charities and Not For Profit

Organizations

Roland Love, CA

The current reporting requirements for Charities & Non-Profit Organizations have left a
lot of our clients wondering what exactly they are required to file. This article is intended
to act as a general guideline for the reporting requirements of Charities & Non-Profit
Organizations.

Charities

Under the Income Tax Act, every registered charity has to file an Information Return
each year. The return must be filed no later than six months after the end of the
registered charity’s fiscal period.

The Information Return includes:

• Registered Charity Information Return, Form T3010A

• Registered Charity Basic Information Sheet, Form TF725
• List of directors/trustees or like officials, Form T1235
• List of qualified donees, Form T2136
• Copy of the registered charity’s own financial statements

CRA will send a Registered Charity Information Return Summary to acknowledge that
they have received and processed your return. A charity that does not file its return can
lose its registered status and may be liable for a $500 penalty.

A registered charity must spend a specific amount each year on charitable programs or as
gifts to qualified donees. This amount varies according to the registered charity’s
designation and is called its “disbursement quota”. The purpose of the disbursement
quota is:

• To ensure that most of the registered charity’s funds are used to further its
charitable purposes and activities;
• To encourage registered charities not to accumulate excessive funds; and
• To keep other expenses at a reasonable level.

Essentially the disbursement quota is in place to ensure that registered charities actively
use their tax-assisted donations to help others according to their charitable purposes. To
help registered charities plan their expenditures, the quota is largely based on what
happened in the previous years. Consequently, at the end of one year, a registered charity
should have a fair estimate of how much it will need to spend on its charitable programs
the following year.
A disbursement excess is created when a charity spends more on charitable activities or
by way of gifts to qualified donees than it is required to by its disbursement quota for that
year. A charity can apply a disbursement excess from one year against a disbursement
shortfall occurring in the immediately preceding fiscal period. If necessary, a charity can
also draw on a disbursement excess for up to five of its following fiscal periods to help it
meet its disbursement quota.

If a charity spends less on charitable activities or by way of gifts to qualified donees than
its disbursement quota for that year, it has a disbursement shortfall. A charity can draw
on previous years’ disbursement excesses to cover a shortfall. If no excesses are
available to draw on, the charity can try to spend enough the following year to create an
excess that will make up for the shortfall. Continuous shortfalls can lead to revocation of
the charity’s registration.

Non-Profit Organizations (NPO’s)

A non-profit organization must file a Non-Profit Organization Information Return (Form

T1044) if:

• It received or was entitled to receive taxable dividends, interest, rentals or

royalties totaling more than $10,000 in the fiscal period,
• The total assets of the organization were more than $200,000 at the end of the
immediately preceding fiscal period (the amount of the organization’s total assets
is the book value of these assets calculated using generally accepted accounting
principles); or
• An NPO information return had to be filed for a previous fiscal period

Once an organization has filed an NPO information return for a fiscal period, it must file
an information return for all subsequent fiscal periods, as long as it remains an NPO and
regardless of the dollar value of its revenues or the book value of its assets in those later
years.

An organization has to file its NPO information return no later than six months after the
end of its fiscal period. If the organization fails to do so on time, the basic penalty is $25
a day. There is a minimum penalty of $100 and a maximum of $2,500 for each failure to
file. An NPO is not required to include financial statements with the NPO information
return.

Unlike charities, there is currently no disbursement quota that regulates where an NPO
must spend their revenues.

Federal Reporting Requirements – Corporations Canada

Corporations Canada, using its powers under the Canada Corporations Act, requires that
Form IC3151-A be submitted annually. This return does not require the provision of any
financial information, audited or otherwise.
Provincial Reporting Requirements – Ontario Ministry of Finance

The Ontario Ministry of Finance requires an annual return and an Exempt From Filing
(EFF) Declaration Form to be filed within six months of the taxation year end for every
taxation year in which the EFF criteria are met. These criteria are listed on page 2 of
form and include that they have “filed a Federal Income Tax Return (T2) with the Canada
Revenue Agency for the taxation year:”

And “Has no Ontario taxable income for the taxation year”

This return does not require the provision of any financial information, audited or
otherwise.

United States Internal Revenue Service

The IRS requires form i990 be submitted by all “Organization Exempt From Income
Tax”.

This return requires the provision of the significant amounts of financial information (see
the form i990, attached). This information includes detailed, line by line, statements of
Income and Expenditures (an income statement), together with Assets and Liabilities (A
Balance Sheet), ‘Reconciliation of Revenue per Audited Financial Statements With
Revenue per Return’, ‘Reconciliation of Expenses per Audited Financial Statements
With Expenses per Return’, a list of ‘Current Officers, Directors, Trustees, and Key
Employees (showing title and average hours per week worked, contributions to benefit
plans & deferred compensation plans, and expense accounts and other allowances) and
‘Former Officers, Directors, Trustees, and Key Employees That Received Compensation
or Other Benefits’ that shows Loans and Advances, Compensation, Contributions to
employee benefit plans & deferred compensation plans Expense account and other
allowances. There are several additional sections of detailed questions.

The information on this form is open to public inspection.

Charities Commission: England and Wales

The Charity Commission for England and Wales is established by law as the regulator
and registrar of charities in England and Wales. They are responsible for maintaining the
Register of Charities, which you can view on their website.

Charities with yearly incomes over £10,000 must by law send their accounts and report
every year within 10 months of the end of their year-end. These returns are publicly
available through a web site.

The CC requires an information return and a complete set of audited financial accounts,
prepared to the relevant Statements Of Required Practice (SORP) and the Generally
Accepted Accounting Principles (GAAP).
International Research Evidence

Renée A. Irvin, in “State Regulation of Nonprofit Organizations: Accountability

Regardless of Outcome” (Nonprofit and Voluntary Sector Quarterly, Vol. 34, No. 2, 161-178 (2005))
examines the motivations that regulators have in promulgating registration and reporting
requirements for nonprofit organizations and professional fund-raisers. Examination of
six states with no annual requirements for nonprofit organizations or professional fund-
raiser registration and financial reporting revealed no obvious accountability
pathologies such as unusually high fraudulent activity or abnormally low donations to
nonprofit organizations. Because nonprofit accountability in states without annual
registration appears as robust as that in other states, the author proposes removal of
state regulations requiring nonprofit annual registration and financial reporting. At the
very least, the author urges caution in the face of increasing calls form ore stringent state
regulation of nonprofit organizations.

On the other hand, a fascinating piece of academic research was conducted by Ranjani
Krishnan, Michelle H. Yetman, Robert J. Yetman, entitled “Financial Disclosure
Management by Nonprofit Organizations.” Their analyses suggest that nonprofit
organizations over-report expenses in the program services category and under report
their fund raising expenses, which have the effect of improving the ratios used by donors
when making their resource allocation decisions. This despite the risk of comparison
between the two different publicly reported financial statements.

Michelle H. Yetman and Robert J. Yetman of The University of California at Davis

argued on September 24, 2004 in “The Effects of Governance on the Financial Reporting
Quality of Nonprofit Organizations” that “Various stakeholders use nonprofit financial
information for investing, contracting, and regulating decisions, and these decisions can
be affected by the quality of the underlying financial information. Using multiple
measures of financial reporting governance and reporting quality, we find that higher
reporting quality is associated with increased governance. We find that our market-
based governance measures have a more consistent effect on nonprofit reporting quality
than do our regulatory-based measures. Our findings suggest that attempts to enhance
the monitoring and oversight of nonprofits can lead to higher quality financial reports,
particularly if those efforts involve market participants such as lenders or donors.“

One interesting response to the challenge of reporting to the variety of American

regulators has been the development of the Unified Chart of Accounts (UCOA) for Non
Profits organizations. It is sponsored by a number of major nonprofit support
organizations, including:

• The California Association of Nonprofits (CAN)

• The National Center for Charitable Statistics
• The California Society of CPAs
The system is designed so that nonprofits can can quickly and reliably translate their
financial statements into the categories required by the IRS Form 990, the federal Office
of Management and Budget, and into other standard reporting formats. UCOA also seeks
to promote uniform accounting practices throughout the nonprofit sector.

This approach to accounting was first adopted by France who, under Napoleon, sought to
impose a Uniform Accounting System upon Europe in the first part of the 19th Century.
The French are now harmonizing their accounting system with the rest of the world in the
use of flexible accounting system governed by GAAP and SORP.

Carolyn J. Cordery, of the Victoria University of Wellingto, published “Charity financial

reporting regulation: a comparative study of the UK and New Zealand” in Accounting
History, Vol. 12, No. 1, 7-27 (2007). She noted that Charities are becoming more highly
regulated worldwide and yet they are subject to diverse, country-specific, financial
reporting standards. New Zealand is a jurisdiction that has treated all sectors alike in its
approach to the financial regulation of charities, while the UK has, for some time,
separated the regulation of charities from other entities. This article provides a
comparison of the histories of the evolution of regulation for charity reporting in the UK
and New Zealand. The current process of international harmonization in both
jurisdictions is premised on the principle that accounting conceptual frameworks should
not be jurisdiction-specific, but charities have proved to be an exception. She suggests in
this study that this exception is attributed to different drivers resulting in regulatory
distinctions in two otherwise similar jurisdictions. Without persisting in the maintenance
of sector-neutrality, the inevitable divergence increases the load on preparers, attesters,
and users and may lead to lower levels of accountability and transparency.

Rowena Sinclair and Keith Hooper, of the School of Business, AUT University, New
Zealand, published “Financial reporting by New Zealand Charities: Finding a way
forward” on June 2007 (copy available on request). In New Zealand they noted a move
towards providing public access to the financial accounts of charities to assist
stakeholders in their decision making and to enhance transparency in charities.
However, this assumes that these financial accounts are understandable by all
stakeholders.

Their paper identifies four problems that limit the way forward of the financial reports of
charities. The first problem is fund accounting where different titles are used to describe
similar funds and specific funds are utilized to remove items from performance
measurements. The second problem involves the practice of recording fixed assets as an
expense rather than capitalization and depreciation. Third, the accounting basis is a
problem for charities where several pledges are made and not received. The final
problem surrounds the issue of the allocation of fund raising expenses and the
subsequent variable proportion of donations that reach beneficiaries as a result of
differing accounting treatments. They provide some suggestions top deal with these
problems.
Gareth G Morgan Center for Voluntary Sector Research, Sheffield Hallam University,
Faculty of Organization and Management wrote a Paper for presentation at BAA
Auditing SIG conference 2005entitled “Auditing Financial Statements
without a True and Fair Opinion: Assessing the Effectiveness of Charity
Independent Examiners”.

The Charities Acts 1992 and 1993 introduced for the first time in the UK a general statutory
regime for scrutiny of charity accounts (Morgan 1999; Picarda 2001). The legislation
requires charities over 250,000 Pounds Sterling income to have their accounts audited by a
registered auditor, but this only applies to around 7% of registered charities (Charity
Commission 2004b). Below this a charity may opt for an independent examination of its
accounts.
The independent examiner (IE) is undertaking an “audit role”, but is not required to express
and opinion as to whether or not the charity’s accounts give a true and fair view. This
regime means that many charities can opt for scrutiny of their accounts by individuals drawn
from within the charity sector, frequently volunteers, rather than engaging external
accountants – it can be seen as a lay audit role function. But although the IE does not give a
true and fair opinion, by law the IE must follow a 12 stage process and the IE’s report must
address a range of issues, including opinions in up to seven areas.

A decade after its introduction, the paper reports on the operation of independent
examination, and discusses planned policy developments. A new Charities Bill which is now
before Parliament (House of Lords 2004) proposes an increase to £500,000 in the upper
income limit for independent examination, but with a requirement that for larger charities
within the independent examination range, the IE must hold a relevant professional
qualification. So what began as a “lay” role is arguably becoming a semi-professional role.
The paper seeks to investigate the effectiveness of the independent examination regime,
drawing both on theory and fieldwork, and seeks to consider how it will develop in the light
of these proposed changes.

The fieldwork spans a seven year period, beginning with a series of qualitative studies of
independent examiners, and leading on to a study of 700 registered charities: where these
charities met the criteria for independent examination, their accounts were individually
inspected and assessed in terms of a range of variables.

The main conclusion is that the UK independent examination regime offers a potentially
rigorous approach to scrutiny of charity accounts, and even though the IE does not express a
true and fair view, the process is much closer to an audit than might be supposed. Based on
the limited measures used in this study, the regime appears to be working, and standards
have improved considerably since an earlier, smaller study (Morgan 2000). It therefore
appears that the case for increasing the threshold is well justified, provide the professional
qualification requirement is broad enough to include individuals with a voluntary sector
background.

Elizabeth K. Keating and Peter Frumkin, of the The Hauser Center for Nonprofit
Organizations and The Kennedy School of Government, Harvard University
presented “Reengineering Nonprofit Financial Accountability: Toward a More
Reliable Foundation for Regulation “as a working paper dated August 2000

In it they noted that “Right now there is considerable uncertainty in the accuracy of the
information reported in the 990 forms. Stakeholders need assurance that the financial
data, particularly as it relates to executive compensation, administrative overhead, and
other nonprogram expenditures are reported consistently and accurately. Moving to a
system that requires GAAP accounting and the use of audited financial statements would
be a first step in improving reliability and relevance. Their analysis led to the following
five recommendations:

First, the Internal Revenue Service should revise the 990 forms to conform with generally
accepted accounting standards (GAAP) and encourage dissemination of audited
financial statements. In the meantime, active stakeholders can follow the lead of
government agencies and institutional funders by requiring nonprofits to provide audited
financial statements, whenever possible, in addition to 990s.

Second, information technology now makes it possible for this information to be shared
much sooner and more broadly. There is no compelling reason that tax filings could not
be filed electronically by nonprofit organizations and quickly posted on the web.

Third, education and public information could improve stakeholders' understanding of

the importance of financial reporting to sensible performance assessments. A public
information campaign could raise awareness of differences in nonprofit operating
practices and impress on donors, clients and communities the importance of being
informed about nonprofit organizations they support directly or indirectly.

Fourth, more relevant disclosures should be provided to stakeholders. In particular,

management discussion and analysis (MD&A) and indicators of program activity could
be included in the financial reports.

Encouraging more extensive disclosure of program rationale, inputs (e.g. names of

donors and number of employees and volunteers), and outputs (e.g. number of clients
served and hours of service delivered) would be a useful first step.

Our fifth recommendation recognizes that providing more extensive and reliable
information more quickly may be insufficient. The amount of financial reporting by
publicly traded firms and extensive SEC enforcement activities demonstrate an important
point: Even the best financial reporting system alone can not prevent fraud and
fraudulent reporting.

Whenever substantial amounts of money are involved, abuses are likely to occur. The
nonprofit sector now constitutes 12% of the US economy and 10% of the workforce and
continues to grow. For this reason, greater coordination the nonprofit financial
reporting system is necessary and may require a new organization. A range of
organizational structures and powers are possible. This body could be a independent,
self-regulating organization, like the FASB, New York Stock Exchange, or NASDAQ. It
could be a quasi-independent government agency, like the Federal Reserve system.
Alternatively, it could be an intergovernmental agency, such as the Federal Financial
Institutions Examination Council that oversees regulatory filings and examinations of
financial institutions. Finally, it could be a federal agency, such as the NCUA or SEC
that could either work cooperatively with the IRS or subsume the responsibilities of the
Exempt Organizations Division.

Once established, the new agency could be funded in one or more ways: The system
could be funded with annual filing fees that are based on a sliding scale. This scale could
range from $50 to 250 per year, and perhaps an initial application fee of $100. With
600,000 nonprofit filers with an average filing fee of $100, such a system would generate
$60-65 million to launch a top quality information dissemination system. Alternatively,
the system could be funded by a range of parties, including government agencies,
foundations, corporations, and federated funders, which use this data in their decision
making and evaluation of nonprofits regularly. While this approach would remove the
costs from the nonprofit agencies, it would be difficult to support and sustain in the long
run given the ever changing priorities of many funders. Another option would be to
create an endowment to support this initiative, which could be funded by a combination
of fees from the nonprofits and contributions from funders. A final option would be to
attempt to finance the system by charging users who access the data a fee. This is the
least workable of the options given the scale of the initiative and the fact that demand for
the data must be stimulated and cultivated.

Sixth, we suggest that an independent commission be created to study the nonprofit

reporting system and make recommendations for the new agency and its funding. While
we are not recommending a specific organizational structure or duties for the new
agency, the process by which this organization is formed is important. The present
financial reporting system does not provide the reliable and relevant information that the
stakeholders should demand, and nonprofit organizations are not held accountable for
providing this type of information. These commissions have been successfully in the
business setting. The Wheat Commission led to the redesign of the standard setting
process and the creation of FASB.

More recently, the Jenkins Committee re-evaluated the business reporting model, leading
to a greater emphasis on reporting of non-financial outcomes by businesses. The goal of
the commission would be to develop a blueprint for an effectively operating nonprofit
reporting system and new agency based on input from the stakeholder, regulator and
nonprofit communities. The commission would design an implementation plan complete
with recommended funding proposals. It would then work to develop a consensus behind
its recommended plan and achieve implementation.

In constructing any new system for collecting and disseminating information on

nonprofits, it will be critical to have nonprofit organizations actively involved in all
aspects of the system’s design. The experience of the credit unions is instructive in this
regard. Their oversight system is popular among participants precisely because there is
ample opportunity for input and control. Any new nonprofit accountability system must
therefore be supported by the nonprofits themselves. This will entail convincing the
sector that better information and more informed donors will strengthen support for
nonprofits and generate greater levels of support in the long run.

By working simultaneously to improve the supply of nonprofit financial information and

to stimulate demand for this information, a new nonprofit reporting agency – conveying
data based on audited financial statements – could lay a strong foundation for the
sector’s continued growth. Improving the sector’s accountability system will go a long
way toward building the trust that nonprofits need to thrive in the growing space left
open between the state and the market.”

John Trussel at the Pennsylvania State University at Harrisburg wrote Assessing Potential
Accounting Manipulation: the Financial Characteristics of Charitable Organizations with
Higher than Expected Program-Spending Ratios in Nonprofit and Voluntary Sector
Quarterly, Vol. 32, No. 4, 616-634 (2003).

He wrote that “Accounting manipulation is defined as when the managers of an

organization intentionally misstate their financial information to favorably represent the
entity’s financial performance. Managers of nonprofit organizations may have incentives
to manipulate their reported program-spending ratios because donors use them in
determining contribution decisions. The program-spending ratio is the percentage of
expenses that is allocated to programs rather than to administrative or fundraising
functions. In this study, I analyze the financial characteristics of potential accounting
manipulators: those organizations that have program-spending ratios significantly
higher than expected. I limit the study to relatively large nonprofit charitable
organizations (charities) and use six financial indicators of accounting manipulation to
develop a predictive model. The model is significant, with most of the financial
indicators significantly contributing to the overall model. Also, within certain
parameters, the model can predict with reasonable accuracy whether or not a charity is a
potential accounting manipulator”

Lourdes Torres11University of Zaragoza, Spain and Vicente Pina22University of

Zaragoza, Spain
Accounting for Accountability and Management in NPOs. A
Comparative Study of Four Countries: Canada, the United
Kingdom, the USA and Spain

Financial Accountability & Management

Volume 19 Issue 3 Page 265-285, August 2003
Financial and non–financial information are developing issues in the NPO field.
Countries such as Canada, the UK, the USA and Spain have recently updated their
accounting systems for NPOs through the implementation of full accrual basis to
enhance their accountability and the usefulness of accounting information for decision–
making purposes. The information provided by accrual accounting will be incomplete
until performance indicators are developed. The performance indicators are essential for
making budgets, for planning and forecasting, for evaluating the financial needs, for
carrying out benchmarking with other NPOs or governmental entities, and for explaining
the welfare activities realised to donors.

Analysis of Charity Financial Accounts

Management Capacity – Capacity Development

Capacity Development: Definitions,

Issues and Implications for
Planning, Monitoring and
Evaluation
Charles Lusthaus, Marie-Hélène Adrien, Mark Perstinger
Universalia Occasional Paper No. 35, September 1999

Background
In the field of development the term capacity development is relatively new, emerging in
the 1980s. Despite its newness, CD has become the central purpose of technical
cooperation in the 1990s (UNDP 1996). CD is seen as complementary to other ideas
that dominated development thinking (and still play an important role) over the past four
decades. These concepts include institution building, institutional development, human
resource development, development, management/administration and institutional
strengthening.

These and other concepts related to development work – organizational development,

community development, integrated rural development and sustainable development –
have been subsumed under the wider concept of CD which can be seen as an umbrella
concept (Morgan, 1998) that links previously isolated approaches to a coherent strategy
with a long-term perspective and vision of social change. In part, the theme of CD has
emerged in reaction to the lack of results produced by initiatives based on technical
cooperation (Morgan and Baser, 1993; UNDP, 1993). However, using CD as an
umbrella concept, has both positive and negative consequences. On the positive side,
many people see the idea as an integrating force that brings together a large number of
stakeholders who believe that CD is an important part of the overall development puzzle.
On the negative side, CD has taken on many meanings and has been used as a slogan
rather than as a term for rigorous development work.

Definitions of Capacity Development

1 “Capacity building is the ability of individuals, groups, institutions and organizations to

identify and solve development problems over time.”(Peter Morgan, 1996)
2 Capacity development is a concept which is broader the organizational development since it
includes an emphasis on the overall system, environment or context within which individuals,
organizations and societies operate and interact (and not simply a single organization). (UNDP,
1998)
3 Capacity development is ”… any system, effort or process… which includes among it’s major
objectives strengthening the capability of elected chief executive officers, chief administrative
officers, department and agency heads and programme managers in general purpose
government to plan, implement, manage or evaluate policies, strategies or programs designed
to impact on social conditions in the community.” (Cohen, 1993)
4 "...capacity is the combination of people, institutions and practices that permits countries to
reach their development goals … Capacity building is... investment in human capital,
institutions and practices" (World Bank, 1998)
5 Capacity building is any support that strengthens an institution's ability to effectively and
efficiently design, implement and evaluate development activities according to its mission
(UNICEF Namibia, 1996).
6 “Capacity building is a process by which individuals, groups, institutions, organizations and
societies enhance their abilities to identify and meet development challenges in a sustainable
manner,. (CIDA, 1996)
7 Capacity development: "The process by which individuals groups, organizations, institutions
and societies increase their abilities: to perform functions solve problems and achieve
objectives; to understand and deal with their development need in a broader context and in a
sustainable manner" (UNDP, 1997)
8 Capacity strengthening is an ongoing process by which people and systems, operating within
dynamic contexts, enhance their abilities to develop and implement strategies in pursuit of
their objectives for increased performance in a sustainable way" (Lusthaus et al. for IDRC,
1995).

The following sections are our attempt to categorize the literature into four approaches
to capacity development.

Approaches to CD
1 The Organizational Approach
According to Hilderbrand and Grindle (1996) CD “refers to the improvements in the
ability of public sector organizations, either singly or in cooperation with other
organizations, to perform their tasks.” The organizational approach sees an entity,
organization or even set of organizations as the key to development. Organizational
development (OD) approaches focus on the capacities of organizations, looking from the
inside out (G. Morgan, 1989). OD approaches apply to work with governments, non-
governmental organizations, as well as other civil society and community organizations
(Lusthaus et al., 1999). The approach focuses on identifying the elements or
components of capacity within an organization. Labels for these elements of capacity
and prioritization may vary from author to author, although there is some consensus on
the core groupings (UNICEF, 1999). The OD literature is a mixture of closed and open
systems approaches. From a closed system perspective it focuses on the internal
workings of the organization – the bureaucratic machinery – to improve capacity.
However, the literature also stresses the importance of an organization’s relationship to
influences from its external environment: institutions, social values, and the political and
economic contexts.
In this view, organizations are seen as processing systems that change individual and
system capacities into organizational results (Lusthaus et al., 1999; Eele, 1994; Van
Diesen, 1996). In the literature, the process of CD can be prescriptive, with clear steps
or stages of development marked by output and capacity for change (Anderson and
Winal,1997; PACT,1996). When CD is viewed primarily as organizational development,
analysis and intervention function at a practical, micro-level and useful sets of
assessment tools are generated (Lusthaus et. al., 1999). When CD extends outwards
from OD to encompass institutions and systems, it can become more difficult to plan,
monitor, and evaluate an intervention.

What are the merits that distinguish CD and incorporate organizational development?
The advantage of the organizational approach is that it has much in common with the
well established field of organizational theory and change. Consequently, it is relatively
focused and the unit of change is clear. Although the concept of an organization is well
defined, a great deal remains to be learned about how to change organizations in the
developing world

On the other hand, the organizational approach has a narrow focus – seeing the system
through the eyes of an organization – and organizations are only part of the vast
development picture. In striving for development results, the organizational component
is necessary but not sufficient.

2 Institutional Approach
The institutional approach is related to but not synonymous with institutional
development and has been an emerging field (Scott, 1995). Early development literature
did not distinguish between institutions and organizations, and even today the terms
often are used interchangeably (Brinkeroff, 1986; Lusthaus et al., 1996).

In the past decade, inspired by institutional economists, ideas associated with

institutions and institutional change have been applied more rigorously, and clearer
distinctions have been made between institutions and organizations. For example, North
(1994), in his Nobel prize acceptance speech, defined institutions as the formal and
informal “rules of the game.” Institutional approaches build the capacity to create,
change, enforce and learn from the processes and rules that govern society. The
definition of CD that most closely parallels this approach was put forward by Cohen
(1994) who cites specific actors and identifies which “rules” are to be changed. The
importance of globalization and democratization may explain the persuasiveness of this
definition.

How is CD an addition to the ideas generated by institutional development? Clearly,

much of the work of CD requires knowledge of and access to “the rules of the game”.
Laws need to be changed to ensure equity amongst groups, policies that support
poverty reduction need to be developed, ways need to be developed to help groups
oppressed through informal cultural arrangements engage in the process of changing
those arrangements. The definition of CD has not evolved to the point where it can be
used to determine exactly where institutional change ends and CD begins. That
boundary is still vague, yet it is possible to make some key distinctions between the
concepts. Institutional change is often expert-driven, does not include a stage of-
development approach, and fails to consider
how it could link to other approaches. We
must be careful to avoid a kind of chauvinism
by judging some institutions “right” and
others “wrong”.
By adopting a macro perspective, the
institutional approach is better able to deal
with the issues which underlie most
development problems. These issues include
such ideas as norms, cultural values, incentive
systems and beliefs.

3 Systems Approach
The systems approach to capacity development is a multidimensional idea. At one level,
both institutional and organizational approaches take on a systems perspective (Beer,
1986). Organizations are systems. However, the systems approach refers to a global
concept that is multilevel, holistic and interrelated, in which each system and part is
linked to another. CD is a complex intervention that encompasses multiple levels and
actors, power relationships and linkages. The systems approach suggests that CD
should build on what exists in order to improve it, rather than to build new systems.

Systems extend beyond the individual and organizational levels to systems of

organizations, their interfaces, and the institutions that guide them. The approach
requires consideration of all contextual elements as well as the linkages between them.
Here, CD is an all-inclusive strategy involving national, regional and municipal levels,
local organizations and institutions, as well as people organized by the state, by private
or public organizations, and in their civil roles (Morgan, 1996; UNDP,1999).

From this perspective CD is seen as a dynamic process whereby intricate networks of

actors (individuals, communities/groups and organizations) seek to enhance their
abilities to perform what they do, both by their own initiatives and through the support of
outsiders. According to the Task Force on Capacity Development in the Environment set
up by the Development Assistance Committee of the OECD (1996,a), "capacity systems
are seen as dynamic, interconnected patterns that develop over time along certain
dimensions toward greater complexity, co-ordination, flexibility, pluralism,
interdependence and holism.” Developing such systems in an effective way requires a
systems approach, including important elements of the institutional approach. Often the
institutional framework dictates how the different elements of the system interact. This
multilevel system perspective is set out in the UNDP approach to capacity development
(UNDP,1999).

One difficulty with the systems approach to CD is that it is sometimes unclear whether
CD is occurring any time someone engages in any aspect of a systems intervention, or
whether it is necessary for CD specifically to be seen and planned from a national,
sector or regional perspective (holistic). Individual actors play prominent roles in system
development. However, at what time does an intervention that builds the capacity of
individuals become a CD intervention? For example, is a training program for individuals
within the civil service a CD program? Does it become one when linkages to other
systems are explicit? The biggest difficulty is identifying what is and what is not a CD
activity.

The advantages of the systems approach are that it is comprehensive, flexible, and
emphasizes linkages between elements. It offers a broad conceptual and theoretical
framework within which development theory can place itself, and is a concept useful to
those interested in national and sectoral change. What it sometimes lacks is focus. The
vastness of the elements under consideration sometimes makes this approach unwieldy
while the high level of abstraction can result in vague language. Since the concept itself
is broad and encompasses everything, it is unclear where one starts in a system change
effort.

4 Participatory Process Approach

Embedded in the above approaches to CD are particular ideologies about the process of
development. Within the CD theme, an ideology is emerging that identifies how CD
occurs. While not ignoring the goals of development, this “participatory-process”
approach to CD emphasizes the importance o
the means used to achieve them. Those who view development as people-centered and
non-hierarchical believe that unless CD is a participatory, empowering partnership for
which those involved feel a high degree of ownership, intended results cannot be
achieved (Fowler, 1997). The goal to develop an institution should not result in the
imposition of a foreign model but instead attempts should be made to identify and use
local expertise, and develop a grassroots, domestic model (Upoff, 1986).

CD is consistently linked to empowerment in formal UN documents and in much NGO

literature, with some objectives incorporated from other approaches. In fact, the
participatory-process approach may not be a discrete approach, but may overlap the
organizational, institutional and systems approaches. However, linkages between CD,
empowerment and participation are not clear. Although definitions vary, a few key
considerations emerge. The notion of empowerment implies a particular vision of
development. Wallerstein (1992:198) refers to "a social process that promotes
participation of people, organizations and communities towards the goals of increased
individual and community control, political efficacy, improved quality of community life
and social justice." Linking CD to empowerment shapes the substantive development
goals of CD, specifically introducing the notion of equity and distinguishing CD from
private sector concepts that may be blind to social justice issues (Alley & Negretto,
1998). Fundamentally this is a process approach that embraces change and learning as
core values.

What makes CD different from other process approaches (i.e., people-centered

development)? The advantages of this approach to CD are that it has a narrowly defined
scope that clarifies what is included and excluded: i.e., development activity should be
participatory. This is congruent with general concepts of development because it shares
some of the same basic assumptions, emphasizing participation, ownership, power
sharing. Although capacity building for participatory development would necessarily
involve a range of entry points and approaches, little consideration is given in the
general CD literature to the stages of development people go through as they learn how
to be more participatory or empowered. Perhaps because of the importance of people in
this approach, the focus of change is often the individual. And although individual
change is important, it is also important to determine when the qualitative and
quantitative changes in individuals add up to capacity development.

By making participation the defining characteristic of this approach, due consideration is

not given to both change outcomes and unit of change. As a result there is a danger that
interventions with a narrow development outcome (i.e. individual training) could be
labeled CD, in as much as they were carried out in a participative way, and at the same
time not contribute to the building of capacity.
Absorbtive Capacity