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 Torres11 University of Zaragoza, Spain and Vicente Pina22 University 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 EvaluationCharles Lusthaus, Marie-Hélène Adrien, Mark PerstingerUniversalia Occasional Paper No. 35, September 1999

BackgroundIn 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 institutionalstrengthening.

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 approachesto capacity development.

Approaches to CD1 The Organizational ApproachAccording 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 ApproachThe 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 considerhow it could link to other approaches. Wemust be careful to avoid a kind of chauvinism

by judging some institutions “right” andothers “wrong”.By adopting a macro perspective, theinstitutional approach is better able to dealwith the issues which underlie mostdevelopment problems. These issues includesuch ideas as norms, cultural values, incentivesystems and beliefs.

3 Systems ApproachThe 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 setup 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 ApproachEmbedded 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