What Is Statement Of Functional Expenses For Nonprofits

functional expense allocation

Identify the types of expenses that will need to be allocated to various functional categories. Program Service Expensesare expenses incurred to further the organization’s exempt purpose as outlined in the organization’s articles of incorporation. Therefore, activities that represent direct conduct or direct supervision of program or other supporting activities will require allocation from management and general activities. Program services – activities that result in goods and services being distributed to beneficiaries, customers, or members that fulfill the purposes or mission for which the not-for-profit organization exists. Expenses of all kinds should be proportionately allocated to the programs they support in order to show true total program costs. For example, a program with high costs may be worthwhile if the mission impact is also high, but you may need to generate additional revenue to cover it. With proper allocation, you can make better financial decisions and more effectively assess the cost-benefit of individual programs and fundraising efforts.

  • Again, maintain your documentation of the square footage calculations in case questions arise.
  • The post just prior to this series, Demystifying Nonprofit Overhead, made the case for why you should care about overhead and introduced the broader topic of functional expenses.
  • If your organization has low turnover, the allocation by headcount can be easily calculated at the beginning of the year.
  • NFP A mails informational materials to the parents of all junior high school students explaining the prevalence and dangers of drug abuse.
  • You can think of these types of expenses as back office expenses that contribute to keeping your nonprofit up and running so you can execute on your programs.

Previously, voluntary health and welfare organizations were required to include the statement of functional expenses as part of a complete set of financial statements. Voluntary health and welfare organizations will have the same three options to present expenses by function and nature. While a separate statement of functional expenses is not required, it may be the most effective presentation option for nonprofit organizations with more than one program. Organizations typically have expenses that relate to more than one functional expense classification.

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These details should also include the nature of the activities being held in each program and the major programs. Obtain the organization’s chart of accounts, which can be used to facilitate the allocation process in an efficient manner. With fundraising expenses now covered, we can move on to management and general expenses. Let’s start with the ways proper allocation and categorization of expenses helps your nonprofit run more efficiently.

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What is the main reason of cost allocation?

A cost allocation is a good tool to use on an annual basis to track changes in costs. Allocating costs serves three main purposes. These are to: 1) make decisions, 2) reduce waste, and 3) determine pricing.

Budgeting is also complicated when sources of support are not secured at the time the budget is prepared for the upcoming year. This could lead to the use of an account entitled Resource Development in order to balance the budget. The financing activities section of the SCF reports the amounts received from borrowings and also any repayments. Get articles like this delivered straight to your inbox by subscribing to our nonprofit blog. Courtney is a Senior Manager in Keiter’s Business Assurance and Advisory Services practice. She delivers high quality client service by assisting firms with accounting and regulatory compliance.

Statement Of Functional Expenses

In addition, there have been some highly publicized examples of nonprofit organizations that have had to endure media criticism of both their executive compensation and their cost allocation methodologies. When deciding where to make donations, potential donors rely on the information in a nonprofit’s tax return. When making their decision, many donors heavily weight the information included in the statement of functional expenses. Because of this, it is important for organizations to be aware of how to correctly classify expenses between program expenses, management & general expenses, and fundraising expenses.

  • Fundraising expenses are typically the easiest to classify because they are expenses that are directly incurred as part of obtaining donations.
  • While you can allocate expenses as needed, the following allocation methods are the ones most frequently used by nonprofit organizations.
  • Together, scrutiny by NFPs and their auditors can help increase confidence in applying this standard.
  • Any accounting software can be used to maintain program-based financials, but they each have their own structure and terminology.
  • Since this CEO didn’t document her time spent working directly with Program A, there would have been no easy way to prove to an auditor that 10% of her time was actually spent on programmatic activities.

That $12,000 difference is also important when it comes to allocating different types of funding. It happens every year — on the fifteenth day of the fifth month after functional expense allocation the close of your nonprofit’s fiscal year, to be exact. We would then add the additional $29.16 to that total to have the complete allocation for the month.

Best Practices For Establishing A Functional Expense Allocation Policy

All the facts in Example 1 remain the same; however, the audience was selected from a list composed of prior donors. In this case, the purpose and content criteria are met; however, the audience criterion is not met because the audience includes prior donors. Although the audience has a need to use or reasonable potential for use of the program component, that was an insignificant factor in its selection. All costs, including those that might otherwise be considered program or management and general costs if they had been incurred in a different activity, should be charged to fundraising. Recent media reports have questioned the efficacy and subjective nature of NFPs’ reporting of joint costs. Indeed, the risk of improper allocation makes accounting for costs of activities that include joint costs a complex area for NFPs and their auditors.

functional expense allocation

Software can also alert approvers to any errors, showing you where you’re missing data or where an employee has made a mistake. Finally, without a record of how our imaginary CEO spent her time, it’s unlikely that an auditor would have believed our allocations. However, they now subsidize home office setups with the regular purchase and distribution of standard office supplies. 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 statement of activities is close to the dilemma of the company’s income statement. The Statement of Activities encompasses the company as a whole and focuses on non-profit revenues and expenditures over a given accounting period.

Understanding Functional Expenses

Line 16, occupancy costs, includes rent, utilities, property insurance, real estate taxes, mortgage interest; and other similar occupancy-related expenses. 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. 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.

The most common functional expense classifications within not-for-profit financial statements are program activities and supporting services. Program activities are those expenses that directly support the mission of the organization. Supporting services, which cannot be directly linked to one program, are further broken out into fundraising costs and management and general expenses. Users of the financial statements generally prefer to see a not-for-profit organization with the largest allocation of expenses as program activities. While fundraising costs and management and general expenses are important to the operations of the organization, an efficient organization will be able to minimize these costs.

And while I’d love to write more about that, this month you get to learn about a different kind of nature and function. Major programs in an organization can be determined by how many people were able to benefit from it or how many activities were conducted. Costs incurred are not just the only way of telling what is labeled as a major program. An organization could be, for example, running a very effective and efficient program and many low-cost services could have been employed for that.

The formulas should be revisited if there are major changes in the way expenses are used, such as staff reassignments or growth of a program. At this point you will have a subtotal of the direct costs of each program, administration, and fundraising. 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. Interest costs – Interest expense on debt is another expense we see organizations classifying as entirely management and general. Instead, the organization should allocate the cost to the benefiting program or supporting services.

Since programs directly contribute to furthering your nonprofit’s mission, most funders — and the IRS — prefer that program expenses constitute the majority of your nonprofit’s expenses. For funders, this is partially because it’s much more exciting to say that they contributed to, say, helping to feed hungry children. What you might not know, though, is the best way to fill out Form 990’s statement of functional expense to accurately reflect your nonprofit’s spending throughout the fiscal year. Management and general expenses support spending related to the financing of the organization’s daily operations. Such expenses don’t apply to the non-profit mission, which typically includes costs such as administration, bookkeeping, and governance. Next, we need to divide that amount by all three functional expense categories.

functional expense allocation

They include costs of preparing and distributing fundraising materials to solicit contributions. Overhead, referring to the expense of management and general activities, is indispensable to the conduct of an organization’s programs and, indeed, to an organization’s very existence.

  • Users of the financial statements generally prefer to see a not-for-profit organization with the largest allocation of expenses as program activities.
  • Management and general expenses relate to the overall operations of the organization and are not identifiable with a specific program, fund raising activity or membership development activity.
  • Using this estimate, you can allocate half of your CEO’s square footage to fundraising, and the other half to management and general.
  • For example, salaries and wages may be allocated based on an estimate of time spent on each purpose and rent may be allocated based on the square-footage of the building used for each purpose.
  • These are defined by GAAP standards and include oversight, day-to-day management, record-keeping, etc.
  • Understanding the true, full cost of delivering various programs and services in the community is a critical piece of the management puzzle.
  • Program services – activities that result in goods and services being distributed to beneficiaries, customers, or members that fulfill the purposes or mission for which the not-for-profit organization exists.

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. Administrative costs apply to the organization as a whole, so they are categorized as management and general.

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Head Count – Smaller organizations, or those that operate virtually, are typically the easiest to allocate costs based on a headcount. This is because the number of people working in each program, or supporting services, can be calculated as a percentage of total employees to allocate the underlying cost.