December 2020

FASB makes clear that its model disclosures and statement mock-ups are meant to provide guidance and should not be seen as the only proper way to display information. That means that we’ll have to allocate an additional $29.16 in utility expenses to each of the three functional expense categories.

While these reports are critical to the success of the grant, they are not part of the direct conduct/supervision of the grant. Calculating and analyzing the true cost of programs and activities can be completed as a one-time project or implemented as an ongoing management practice, as we recommend. If that is the goal, it’s worthwhile to make sure that the program and cost definitions match the setup of your accounting system. Any accounting software can be used to maintain program-based financials, but they each have their own structure and terminology. One benefit of structuring accounting this way is that you can control your chart of accounts – the list of income and expense categories. These two cost centers are important components of understanding true costs and are created in parallel with the programs. By organizing your budget and allocations this way, you’re also setting up the accounting system to track and report the three functional expense categories required on audits and the IRS Form 990.

Understanding Nonprofit Functional Expense Allocation

The push for more transparency from nonprofits has placed a greater emphasis on how an organization’s expenses break down — in other words, how it uses its resources. In 2016, the Financial Accounting Standards Board released a new rule that reflects this priority. While the rule has been in effect for almost two years, some nonprofits still struggle with properly allocating their costs. We have occasionally seen that some charities are joint cost allocating this content as a programmatic expense.

The costs that are allocated should only be for the direct benefit of the activity they are being allocated to. For example, occupancy costs can be allocated to programs if the programs utilize space to conduct their activities. In this case, the cost of the space is related to the direct conduct of the program and should be allocated to this functional classification to show the direct benefit the program receives from the use of the space. As organizations have undertaken implementation efforts, we have seen one area is causing more issues than anticipated—the presentation of the analysis of expenses by function and natural classifications.

Asu 2016

Next, we need to divide that amount by all three functional expense categories. This can be done by the area used by each category or by the number of people in each department, whichever is easier. The easiest costs to allocate are those that can only be allocated to a single category. For example, a grant that Sam receives allows him to purchase a variety of canned and non-perishable foods for his community food pantry. This cost can be directly allocated to programs since the grant and resulting expense both directly relate to the cost of the community food pantry program.

We highlighted the column headings for learning purposes, showing expenses by function. In the first column, we have highlighted the words as they reflect the essence or expenses. Once the functional allocation plan is established, make sure everyone follows it carefully to avoid confusion or inconsistencies in your reporting. Get the latest information from ClickTime on timesheet and expenses directly to your inbox. Finally, without a record of how our imaginary CEO spent her time, it’s unlikely that an auditor would have believed our allocations. For example, if you run an afterschool program and need to purchase 10 workbooks for it, you could allocate the costs of the workbooks directly to that program.

The costs of providing various programs and other activities have been summarized on a functional basis in the statements of activities and in the statements of functional expenses. Accordingly, certain costs have been allocated among the programs and supporting services benefited. Such allocations are determined by management on a reasonable basis that is consistently applied.

What Are Functional Expenses And How Do You Allocate Them?

But first another intermission break for vocabulary building – direct vs. indirect costs. We’ll continue to provide insight and implementation suggestions through a series of articles on this new standard. To learn more about the new standard, or to gain a better understanding of the specific changes coming for not-for-profit financial statement requirements in general, contact your Moss Adams not-for-profit professional. Consideration should also be given to the methodology used to allocate the expenses by function and whether enhancements or changes need to be made to the methodology to comply with the new standard. Additional disclosures will be required relating to methods used to allocate costs among functions. In this article, we’ll examine expense reporting and give an overview of how the new requirements change current practices and some related best practices.

• At first glance, the direct method of allocation seems like the most straightforward one.
• For instance, information technology costs can benefit management and general, fundraising and program delivery.
• Supporting activities are all activities of a nonprofit organization other than program services.
• The allocation of all expenses within the statement should be well reasoned and the final decision to how expenses were allocated should be properly documented.
• Donors generally prefer to support organizations that spend more of their money on programs.
• This is a powerful tool for measuring the actual program performance and is more in line with the reality of nonprofit business models.

And while this sounds easy enough in concept, some expenses can be difficult to classify. Like many other businesses, not-for-profits incur costs such as salaries, rent and utilities. Unique to NFPs is the requirement that those expenses be classified in the financial statements according to purpose, or function, for which they were used. The statement of functional expenses assists readers of the NFP’s financial statements in associating expenses with the service efforts and accomplishments of the organization. This CPE course offers you detail-rich examples and case studies that will help you allocate costs and accurately prepare the statement of functional expenses.

Bottom Line For Nonprofit Functional Expenses

If you use time tracking software to help automate the process, you can easily pull timesheet data from the system. But you can also use it to communicate transparently about spending with donors or to hand over to independent auditors who are evaluating your financial stewardship. But employees can plug their hours into a timesheet — and maybe even include a short description of the task they worked on — to help you make smarter decisions about where your organization’s money should go. If you want to experience https://accounting-services.net/ the full benefits of time study allocation — reduced overhead, maximized funding, and audit-ready records — you have to track employee time every day. However, they now subsidize home office setups with the regular purchase and distribution of standard office supplies. Allocating expenses by headcount is another option for nonprofits, especially those without a dedicated office space. One works on Program A and another on Program B. You also have a donor outreach manager, an accountant, and a CEO.

Knowing the real costs of each program allows us to make informed decisions and choices that will lead to mission and financial success. With nonprofit functional accounting you can easily identify each transaction coming in or going out with an amount that corresponds to the who, what and why of each transaction.

The primary functional classifications of a not-for-profit entity are program services and supporting services. Similarly, the cost of fundraising is valuable to programs and the final step is to allocate fundraising expenses to each.

• And without the full picture, you’ll be unable to take advantage of several benefits of the more accurate method of time study allocation.
• Looking at the CEO’s calendar, for example, we saw that in a given week, half her meetings were related to fundraising and half to general and administrative issues.
• As a nonprofit accountant, you can’t follow everyone around all day trying to understand what they’re really doing to get a better sense of how to allocate your functional expenses.
• Management and general expenses support spending related to the financing of the organization’s daily operations.

If your current accounting methods cannot accomplish this then you might want to consider a nonprofit accounting software package that incorporates functional accounting methods. This is part of the framework of knowing the answers to nonprofit organization accounting questions. Shared direct costs are expenses that relate to operating the organization itself and accomplishing the work at hand. These are resources that are shared by multiple programs but whose costs are not directly identifiable. Accounting standards define them more specifically, but they usually include things such as office space, payroll for staff who work on more than one program, utilities, technology and other equipment or office supplies.

Using Trec’s Shared Allocation Resource

For instance, information technology costs can benefit management and general, fundraising and program delivery. Insurance could cover property that houses multiple functions or a single program.

However, this process also provides management with key information for decision making. More specifically, it allows management to understand the true costs of providing services and operating programs. Determine the allocation methods – Once the costs have been clearly identified, management must then select an appropriate method to use to allocate the costs. Commonly used methods include allocating costs on the basis of time and effort, full-time equivalents , square footage, and key indicators. After determining the allocation bases for the costs, the documentation to support each allocation basis should be collected.

This resource is an overview of the concepts and management decisions needed to calculate the true costs of activities for a nonprofit and also a how-to guide for the accompanying spreadsheet template. You can find a glossary of terms in our resource library and below, a list of articles and resources for more in-depth discussion or technical guidance on this topic. The accompanying spreadsheet template may be used for a functional expense allocation one-time analysis project or to implement ongoing program-based budgeting and financial management practices. While a calculation can be completed for a single program or activity, we highly recommend that these concepts and practices be used throughout a nonprofit. Program-based financial information will be most useful for planning, management, and communications if it is comprehensive, accurate, and used consistently.

Allocate Direct Costs By An Appropriate Method

Why is the presentation of Functional Expenses so important to your organization? Our 990 series continues with an overview of the statement of functional expenses. The Statement of Functional Expenses is where you must report the details of your organization’s expenses and indicate whether those expenses were used for program services, management and general or fundraising purposes. Following the steps above to accurately and consistently allocate costs across an organization’s programs and supporting activities ensures the organization is in compliance with both GAAP and IRS reporting requirements.

Read: What Mn Nonprofits Need To Know About Unemployment Claims Right Now

The most common basis for allocating fundraising costs is based on percentage of total support received by each program. This method matches the percentage of fundraising expense charged to a program to the percentage of contributed income that program receives. We leave this step until last because some funders, including many government funders, will not allow fundraising expenses to be charged to their grants or contracts.

At this point you will have a subtotal of the direct costs of each program, administration, and fundraising. Square footage allocation is typically used for items such as building depreciation, rent, and utilities. To use this methodology, the organization will need to know the square footage of their physical locations and determine which areas relate to the corresponding function. Employee time can be based on employee headcount or time study to determine the amount of time each employee spends on a certain function. After salaries has been allocated, this same allocation can be applied to other natural expenses such as payroll tax and employee benefits. These allocation methodologies should be evaluated each year to make sure that they are still applicable and have been updated for any organizational changes. When possible, automate the allocation process – After the costs have been identified and appropriate allocation methods have been selected, management should consider automating the cost allocation process.

Review the chart of accounts for expenses and identify which expenses are directly linked to a single functional expense category. Evaluate the remaining expense types and brainstorm reasonable allocation methodologies. You would only need to add revenue totals for the month to have a complete statement of functional expenses. If we take the salary portion of the statement of functional expenses above and combine it with the other expenses, you’ll have a complete accounting of expenses for October. If employees split their time between several programs or organizational areas, their time must be tracked and allocated properly. For example, Ann runs an agricultural nonprofit called Back to the Land that offers several different programs ranging from onsite farm training to financial planning seminars for farm and ranch owners. Aside from accounting regulations that require a SOFE in some form, it’s a useful tool for the organization to visualize how their resources are being used.

Or, if a director of fundraising is also providing programming, there would need to be a change in allocation of the director’s salary and benefits. One of the best practices and critical elements of a functional allocation methodology is documenting your allocation plan in writing. This written plan helps your governance board, auditors and any other users of the financial statements understand your allocations. It is important that you know the type of expenses that are directly allocated, as cost allocation can be important in terms of grant reporting and determining the success of a program. Some entities may report expenses in classifications other than their natural classification—salaries expense is included as part of cost of goods sold and rent expense is allocated among programs, for example. Such expenses are to be reported by their natural classification in the functional expense analysis. The process begins with the decision of which activities at your organization comprise a program for the purpose of budgets and financial reports.

What if the program our imaginary CEO spent 10% of her time on was a summer program, but you decided to conduct a time study in the fall? Or what if you track time during the month before your huge annual fundraising gala? Much more staff time would be devoted to fundraising activities — and, therefore, allocated to fundraising expenses — during that time.

For similar reasons, savvy donors will evaluate the organization’s overall breakdown between program expenses and those that serve as supporting services before making large gifts. Propel Nonprofits strengthens the community by investing capital and expertise in nonprofits. Propel Nonprofits is also a leader in the nonprofit sector, with research and reports on issues and topics that impact that sustainability and effectiveness of nonprofit organizations. According to the Charities Review Council, program costs in a well-run nonprofit organization should account for 70 to 90 percent of total expenses.