In August 2016, the Financial Accounting Standards Board (FASB) announced some major changes to accounting rules for nonprofit financial statements. Among other things, the new accounting standard – known as ASU 2016-14 – requires nonprofit organizations to report expenses according to the purpose for which they are incurred. This process, referred to as functional expense allocation, can be especially perplexing for nonprofits that don’t have experience reporting expenses in this manner.
All nonprofit organizations must now categorize their expenses by “function” or purpose. The most common functional classifications used by nonprofits are: Program Services, General and Administrative, and Fundraising. These are also the classifications used on the IRS Form 990.
Program Services
Program Services are the costs related to providing programs in accordance with your organization’s mission. Ideally, the majority of your nonprofit’s expenses would be allocated to programs. Donors generally prefer to support organizations that spend more of their money on programs. However, there are exceptions. If your organization is still in its formative years, you may not have as many expenses allocated towards programs. But for a well-established nonprofit, it could cause concern if programs do not make up the majority of your expenses.
General and Administrative
General and Administrative expenses are those related to administering the everyday activities of your organization. This typically includes expenses such as insurance, accounting, and governance. Although these expenses are certainly essential in running your organization, they are not directly related to the purpose for which your nonprofit was formed. Most donors prefer to see organizations reduce these expenses when possible.
Fundraising
Fundraising costs include all activities that relate to an appeal for financial support or for a contribution to your organization. Fundraising expenses can include your development director’s salary, postage for mailing out an appeal, and printing costs for donor acknowledgement letters. As with General and Administrative costs, many donors prefer to support organizations with relatively low fundraising expenses.
Allocating expenses among these functional categories is easier said than done. To decide how to allocate your organization’s expenses, keep these best practices and important elements in mind:
Develop a functional allocation plan and document it in writing. Make sure that the methodology for allocating expenses can be easily communicated to your auditors, board of directors, and anyone who is reviewing your financial statements.
Establish a chart of accounts that can facilitate the allocation process in an efficient manner. The chart of accounts is the foundation for your financial accounting, so it’s important to put a lot of thought into designing one that is simple, flexible, and makes sense on many different levels.
Identify expenses that can be directly allocated to one of the functional categories, versus those that need to be allocated amongst several categories. Additionally, if your organization offers multiple programs, you must identify expenses for each specific program. Accurately reporting allocations between programs is essential for grant reporting and for determining the success of a particular program.
Document and retain timesheets for individuals whose responsibilities include tasks that fall into more than one functional category or program.
Be consistent. Once the functional allocation plan is established, make sure everyone follows it carefully to avoid confusion or inconsistencies in your reporting.
Review the allocation methodology as needed. If there are major changes to your funding a change in the responsibilities of personnel, you may need to revisit your functional allocation plan to incorporate these new realities.
It is always important to remember who is reading your financial statements and what they might glean from these allocations. Typical readers include donors, grantors, organizational leaders, rating agencies, and the press. Each group is looking at these allocations for potentially different reasons, but in general, they are all trying to determine how successfully your organization is fulfilling its mission and if you are being a good steward of your resources. Take these allocations seriously, and don’t be afraid to reach out to your financial advisors for assistance.
