Can the Royal Academy paint itself out of debtors' corner?

The head of the Royal Academy of Arts admitted last night that the 228-year-old institution had a "serious financial problem" after the leak of an auditor's report which revealed a pounds 3m debt and the failure to pay money into the staff pension fund.

But David Gordon, secretary of the Royal Academy, while promising a radical modernisation of the institution, ruled out selling off any of its treasures, which include Michelangelo's sculpture Madonna and Child, estimated to be worth pounds 50m.

The Royal Academy, the heart of Britain's art establishment since Sir Joshua Reynolds established it in the 18th century, has an accumulated deficit of pounds 3m; its auditors Ernst & Young have not yet signed accounts for the past two years; and, most damagingly of all, the auditors have discovered that pounds 200,000 of staff pension contributions and pounds 1m from trust funds intended for capital expenditure have been spent on running the institution.

The auditors also found that the RA spent pounds 237,000 on investigating an alleged fraud during 1995 and 1996 - far more than the pounds 181,000 losses from the fraud. And pounds 200,000 was wasted on exhibitions "which are not going to take place".

Ironically, the RA has long been hailed as an example to the rest of the art world. Lacking any public funding, it has to raise its own money from private sponsorship of exhibitions and entry fees paid by the public, sales of merchandise, and the subscriptions of its 70,000-strong Friends organisation.

But it has been some years now since it has been able to boast a genuine blockbuster exhibition such as the Monet show of 1990. And private business sponsorship has proved harder to obtain.

The RA accounts reveal that it is costing more than pounds 7m a year to run. In the year to 30 September 1996 it spent pounds 14,718,006, more than half on administration. But it earned only pounds 13,206,918, with almost pounds 4.5m from exhibitions and a further pounds 2.4m from subscriptions. The shop earned pounds 2.27m and the restaurant more than pounds 1m. Other sources of income were pounds 147,380 from its schools, pounds 313,030 from its magazine and pounds 311,199 from framing. Evening viewings raised pounds 236,483.

Among the liabilities listed by the auditors are pounds 191,078 in 1996 "due to pension fund".

Earlier this year the secretary of the RA, Piers Rodgers, was suddenly moved sideways and put in charge of the planned takeover of the Museum of Mankind. The academy did not advertise for a replacement, but instead head-hunted David Gordon, former chief executive of Independent Television News.

Speaking to The Independent yesterday, Mr Gordon said: "It is a serious financial problem that we are facing and we have been running deficits. But we won't sell works. We are primarily an arts institution here to promote understanding of the arts."

Mr Gordon stressed: "The pension fund is inviolate and there's no question of money being taken out of the pension fund. As a result of inadequate procedures in one of our departments - nothing criminal - payments have not been made."

Mr Gordon and his president, the architect Sir Philip Dowson, are determined to modernise the institution. They want to wrest control from the RA's elected council - chosen from academicians on rotation - and give it to a "review board" appointed by them. In a damning private paper sent to the council, they say the financial situation "indicates a lack not only of necessary financial control but of adequate governance".