Understanding Nonprofit Functional Expense Allocation

Understanding Nonprofit Functional Expense Allocation

Last Updated on March 12, 2024 by admin

what are functional expenses

Management and general expenses are necessary to operate an effective organization. They include expenses for such things as management, recordkeeping, finance, activities of the governing board and soliciting funds oth­er than contributions and membership dues, such as government grants. Labor is often the single biggest expense in an organization, so its accurate allocation is critical to understanding the breakdown of expenses.

what are functional expenses

One natural expense type will often fall under multiple functional expense classifications. Management bookkeeping must determine proper methodologies for allocating natural expenses over various functional expenses.

Allocating Expenses

Essentially, if the expenses are part of the nonprofit’s programs, general and administrative, or fundraising activities, then they should be allocated like any other expense. Understanding the statement of functional expenses may take a bit of time, but it is an important part of managing your nonprofit properly. Fund accounting software can make managing and allocating expenses what are functional expenses an easier process, while consulting with a CPA who specializes in nonprofit accounting can also help. You may have heard the phrase functional expenses thrown around, and now I am here to help clarify what that means. First, to understand functional expenses for nonprofit organizations it is important to understand the difference between functional expenses and natural expenses.

Examples are benefits expense, compensation expense, and depreciation expense. The expenses a non-profit organization incurs in executing its programs, in addition to fundraising and management. Functional expenses are reported on the organization’s Form 990 and are useful in ensuring that its income is reinvested in the organization and is not in fact profit. While allocation methods should generally remain consistent year over year, any major changes to the organization should be analyzed for their effect on the allocation plan. Examples include new funding streams or debt, new programs, personnel changes, changes to staffing roles and responsibilities, changes to rental space, etc.

Under the revised standard, all nonprofit organizations must disclose the relationship between functional expenses and natural expenses on the financial statements. The financial statements’ note disclosure also requires the description of the methods used to allocate costs among program and support functions.

But with a pandemic, there are concerns that not-for-profits need to take into consideration. Where possible costs should be identified as a direct impact or relation to a function but not all costs can easily be assigned to one program or one function. These costs are costs of conducting joint activities that are not identifiable with a particular component of the activity. For this reason, management must choose allocation methods that are able to be supported and reasonable based on the Organization. Some of these methods could include use of direct time for program work and support activities through time studies or square footage to allocate costs such as rent, and utilities based on use of space by staff. The key is the allocation methods used by management must be internally documented and consistently applied.

  • They include expenses for such things as management, recordkeeping, finance, activities of the governing board and soliciting funds oth­er than contributions and membership dues, such as government grants.
  • Fundraising activities also involve courting or seeking potential donors to contribute to the organization through donation of funds, in-kind support, or time.
  • 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.
  • It’s easy to spend hours — if not days — sorting through Excel spreadsheets and analyzing business costs.

If you are bringing in support revenue or contributions, it is highly unlikely you will not have some costs that should be considered part of the fundraising function of your organization. The statement of functional expense also referred to by some as a “SOFE”, provides the reader of the financial statement more detail of an entity’s expenses. This statement classifies expenses by its natural expense classification and also its functional expense classification.

Management And General:

Direct costs must be classified to the functional expense category benefit­ted. Certain costs can be identified to a specific function, such as the salary of an employee who works exclusively on a particular program. This will allow readers to quickly review allocation of functional expenses as a percent of total expense. The tricky part about completing the statement of functional expenses can arise from functional classifications and allocations. Indirect costs that indirectly benefit each function should not be allocated. These costs primarily benefit the organization as a whole and should be presented under management and general activities.

Once complete, an organization can compute a line total to calculate the final percentage of the total by both function and natural classification. Analyze and interpret these percentages as the tea leaves of your organization. Monthly or quarterly will be more beneficial than just once annually at year-end. Fundraising costs may include staff, campaigns, special events, and digital resources. In some situations, fundraising costs should be categorized under Programs rather than Fundraising.

This schedule has provided 23 lines with specific descriptions and guidance of what expenses fall within each category. Then line 24, “other expenses” is where you would report any expenses that did not fall in any of the pre-listed descriptions. Do not include expenses on line 24 that fit into any of the categories on lines 1 to 23. The only expenses which should appear on line 24 are expenses that clearly do not fit into a previous category. Regardless of the format used or the reporting location, the allocation method needs to be clearly described in the footnotes. Auditors will need to pay close attention to how the methods are described and take into consideration the risk of fraudulent reporting.

Line 16, occupancy costs, includes rent, utilities, property insurance, real estate taxes, mortgage interest; and other similar occupancy-related expenses. The most common functional classifications used are Program, Administrative, and Fundraising. The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant. We not only provide professional services to the not-for-profit industry, we provide our own time and resources. So even though all the contributions your organization receives may support your overall mission, FASB has defined how some expenses get recorded functionally. CRI is a member of PrimeGlobal, a worldwide association of independent accounting firms and business advisors.

what are functional expenses

For example, if you would classify a certain activity as a program for a grant budget request, but also report it as a major program in Form 990, keep it as a major program to simplify the process so that your data isn’t as scattered. Your organization’s management, general counsel, fundraising and development are always the main support and key pillars of the program outlined in your statement.

It is important to develop a reasonable and consistent methodology to report the allocation of expenses over time for the fair presentation of the information disclosed on their financial statements. Although this analysis can be presented on the statement of activities, a separate statement, or in the notes to financial statements, nonprofits with multiple programs benefit from presenting a separate statement for effectiveness.

Before you can use any of the allocation methods outlined below, you need to understand functional classifications. In nonprofit accounting, all expenses need to be recorded in one of these three nonprofit expense categories. The audience of a financial reporting company includes financing organizations, donors, governing boards, and regulators. These stakeholders reflect on the relationship between program expenses and their funding costs in a non-profit what are retained earnings organization. They want to know how the supporting expenses of a company influence and control its programs. Following the Financial Accounting Standards Board requirements, all non-profit organizations in the US now have to declare their expenditures according to their practical classification and their natural classification. The organization will then use that data on an annual basis to allocate costs, such as supplies, telephone, or internet costs.

For an expense to be allocated to program services, the expense must be the result of direct conduct and/or direct supervision of a program service. CPAs should do their part to help nonprofits navigate the new reporting requirement.

Business Checking Accounts

The key to remember is that not all indirect costs should be allocated, but only those that directly benefit one or more function. These costs commonly include occupancy-related expenses such as depreciation, rent, and utilities. These are costs that have been incurred in a combined educational and fundraising campaign. Many organizations publish a monthly or quarterly newsletter containing both educational material and a fundraising solicitation. (Actually, many organizations add a solicitation request to every mailing.) This type of publication is subject to the “joint cost” allocation process. If you are sending material out to the public that is partly educational and partly a solicitation for support, you must be aware of the “joint cost” rules. If you have any questions about joint costs, check out our blog “Is My Nonprofit Allocating Joint Costs Properly?

As a subsidiary report to your financial statement, the Statement of Functional Expenses is a detailed list of the nature of each expense by functional area. This report is necessary also when comparing actual expenses to budgets in each of your functional areas. An efficient statement of functional expenses should be concise and clear, so aim for consolidating appropriately. Indirect costs that directly benefit more than one function should be allocated.

Shaking Off The Stigma Of Indirect Costs

All expenses should be included, and this includes costs that are being netted against revenues on the statement of activities. This can include salaries or rental costs included in the cost of goods sold or special events costs included in special event revenue to show a net revenue. QuickBooks Salaries, employment taxes, and benefits are often the largest expense for a nonprofit and must also be allocated to the Programs, Management and General, and Fundraising categories. Ideally, employees would complete weekly timesheets to record the time spent on each category.

Compile a listing of activities taking place within the physical space maintained by the organization by square footage and use this information as a basis for future occupancy expense allocations. In the diagram, the proper way to account for $2,000 of fundraising related expenses would be to remove the fundraising row and redistribute the expenses to the rows identified by their natural classification. Fundraising related expense are recorded as a function and are broken out by natural classifications . Edited by CPAs for CPAs, it aims to provide accounting and other financial professionals with the information and analysis they need to succeed in today’s business environment. Budgeting for nonprofits can become complex when it involves several overlapping categories, such as grants, programs, function, and nature. The U.S. Internal Revenue Service requires some tax-exempt nonprofit organizations to file Form 990 or Form 990-EZ each year. However, churches and some other nonprofit organizations are not required to file.

Jitasa’s bookkeeping and accounting services are affordable and cater to every nonprofit. Line 13, office expenses, includes a few expenses that we typically see written out on line 24, but they qualify to be included in line 13. This line includes, office supplies, telephone expenses, postage and delivery expenses, shipping, equipment rentals, bank fees, and other similar costs. Courtney provides audit and review services for not-for-profit organizations as well as financial services companies. She is a member of the Not-for-Profit team and Financial Services Industry team. Get in touch to find out how we can help you with your accounting, tax and financial needs. Since Form 990 is public information, you can learn much about a nonprofit by reading the information it provided on Form 990.

Nonprofit Accounting Basics: What Are Functional Expenses?

Management and general expenses include supporting costs that do not relate directly to the organization’s mission. Fundraising would include any costs used for soliciting contributions or grants. Not reporting fundraising expense – If an organization shows more than an insignificant amount of contributions on the statement of activities, we would expect to see fundraising expense included in the functional expense statement. Even if your organization does not have a specific grant writer or development director, there is likely someone, such as the executive director, spending time cultivating these donations. Because that time is focused on fundraising activities, a portion of that person’s salary should be allocated to fundraising. However, there are some types of organizations that generally do not have fundraising expenses.

As A Nonprofit, Heres Why You Should Love The Functional Expense Statement

The functions are listed by the program, fundraising or development, management, and general/administration. If you have ever wanted to expand your knowledge of nonprofit accounting basics, learning about functional expenses is a great place to start. Nonprofits have unique reporting requirements that set them apart from for-profit businesses. Beyond compliance, there are other reasons why organizations should care about tracking functional expenses. The standard also expanded the disclosure requirement to include the description of the methods used to allocate costs among program and support functions. The added standard to include disclosure of the methods has prompted nonprofit organizations to re-think the approach to the allocation and reporting of functional expenses to capture the information needed to accurately make the allocations. It allows you to see exactly what each of your individual program expenses are costing, whether your fundraising is proportionate to the areas that need it, and whether you or not a specific program is sustainable.

However, for rent expense, a nonprofit might allocate by square footage of an area used directly for programs and services. According to GAAP, there is no right or wrong method to allocated expenses as long as it is a reasonable allocation method that is consistent over several reporting periods.

PrimeGlobal does not and cannot offer any professional services to clients. Each independent member of PrimeGlobal is a separate firm and an independent legal entity. PrimeGlobal is not a partnership and independent member firms are not acting as agents of PrimeGlobal or other independent member firms. Since resource development is often ongoing, budgets may require frequent modification. Good accounting software will also allow directors to compare budgeted amounts to actual amounts and make the necessary adjustments. Document and retain timesheets for individuals whose responsibilities include tasks that fall into more than one functional category or program. Sage 50cloud is a feature-rich accounting platform with tools for sales tracking, reporting, invoicing and payment processing and vendor, customer and employee management.

Read more: Management of a non-profit organization to establish an executive search company

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Sophia Anderson
Sophia Anderson is a finance writer and blogger with a passion for helping people improve their financial literacy. With over 5 years of experience in the finance industry, Sophia has worked with individuals, families, and small businesses to provide financial advice and guidance. Her expertise includes budgeting, saving, credit management, and debt reduction. Sophia is dedicated to breaking down complex financial concepts into easy-to-understand language and empowering her readers to make smart financial decisions. She is a frequent contributor to financial publications and has written extensively on topics such as personal finance, investing, and financial planning. Sophia's mission is to help people take control of their finances and achieve financial security and freedom. When she's not writing, Sophia enjoys hiking, practicing yoga, and reading personal finance books.