The Function of Functional Expense Allocation

For example, the salary of a teacher would be allocated to “Program Services” in an educational nonprofit. Allocating your costs in detail on your financial statements showcases how much of your funds go to program costs vs. administrative and other areas. This transparency isn’t lost on generous stakeholders looking for a cause to support, as they understandably want to see how their donated funds make a direct impact.

If your third largest program has the highest salary level, for instance, it could indicate payroll fraud. A program that doesn’t involve travel but shows a lot of travel expenses could be a sign of reimbursement fraud. We’ve had the pleasure of drafting indirect cost proposals related to Federal awards. While the Feds have a variety of acceptable approaches, one method they honor follows very closely the work you are doing already to carve out management and general expenses for Form 990 and audit purposes.

1. Looking at the number of people working on each program at the nonprofit business and the expenses they accrue, one can determine each individual employee’s and program’s expenses.
2. If your expenses are broken down more explicitly, it’s easier for an outside party to assess your statements.
3. 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.
4. As with General and Administrative costs, many donors prefer to support organizations with relatively low fundraising expenses.
5. The utility costs for that building might be allocated based on the square footage occupied by each.
6. Topic 958 not only requires disclosure of expenses by natural and functional classification, but also requires disclosure of the allocation methods in the notes to the financial statements.

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. Your statement of functional expenses must be submitted as part of your IRS Form 990. Additionally, your financial statements won’t be compliant with generally accepted accounting principles (GAAP) if you don’t present a functional expense allocation. So a clean audit opinion can’t be obtained without clearly stating this information.

Functional Expenses Statement

Ultimately, it is both the not-for-profit’s requirement and benefit to accurately report its functional expenses. Another way to assess whether or not functional expenses are being accurately reported is to compare the functional expense allocations to other organizations within the same industry. This information can be easily accessed via a lookup of similar organizations’ Form 990s on GuideStar or other similar sites. If the allocations are far out of line from the organization’s peers, it could be an indication that the method for allocating functional expenses should be revisited.

Nonprofit reporting is different from that of a for-profit business, with nonprofits issuing the following financial statements. If you use time tracking software to help automate the process, you can easily pull timesheet data from the system. You can — and should — use that data for your annual return form, of course. 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.

This is known as a cost allocation plan — and not only does it save time later, it’s also a requirement for most grants. Auditors will also review this plan to make sure you’re following necessary procedures. Allocating expenses is dividing overhead costs between all of the functions that are indirectly related to that cost.

Choose the Disclosure Method

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. Take these allocations seriously, and don’t be afraid to reach out to your financial advisors for assistance. While nonprofit organizations exist to fulfill societal needs instead of generating profits, they still have complex financial needs. In fact, because nonprofit accounting differs so significantly from regular accounting practices, NPOs are in even greater need of strong financial leadership. If you need a nonprofit CFO or nonprofit controller to provide accounting oversight and help lead your organization, contact us to get started.

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As we have discussed above, a nonprofit has to record all its expenses in classifications. The functional expenses account is the record where accountants or bookkeepers classify and store all the functional expenses. 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 an easier process, https://accounting-services.net/ while consulting with a CPA who specializes in nonprofit accounting can also help. All nonprofit organizations in the US are now required to report their expenses based on their functional classification and by the natural classification, as per Financial Accounting Standards Board guidelines. Further, entities will be required to include a description of the methods used to allocate costs between program and support functions.

You allocate each expense to a functional category based on how the money was used. However, a quick examination shows that direct allocation isn’t always possible. 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.

Offset Long-Term Care Costs With Possible Tax Breaks

“The devil is in the details.” It’s an old saying about hidden, mysterious aspects of a situation that could cause problems later. Because not only is this practice required for compliance, it provides a more detailed picture of exactly where your nonprofit’s money is going. This article takes you through the entire process of building, classifying, and recording all the functional expenses a nonprofit needs to record. Here are some of the most important points from the article you cannot overlook. A nonprofit organization primarily runs on money raised by donors and funding groups. Naturally to raise this money a nonprofit has to carry out fundraising campaigns.

The Statement of Functional Expenses

So allocating more payroll costs than necessary to fundraising and management and general classifications can add up to thousands of dollars more in overhead than you’re actually spending. This is especially true for comparatively highly-paid employees, like nonprofit CEOs. While our example CEO was the only employee floating between functions, in most nonprofits it’s common for all employees to perform multiple roles and pitch in where they’re needed. So not understanding where your employees’ time goes means you could potentially miss out on allocating less money to overhead expenses and more to programs.

Auditors will be able to see timestamped entries and alterations, as well as hours worked to justify your functional expense allocations. Using time tracking software, you can create an audit trail for every nonprofit staff member to help auditors understand your allocation methods. With your better understanding of how your CEO spends her time, you’re able to allocate $1,000 more dollars of your rent costs to program expenses, which amounts to a 2% decrease in overhead rent costs.

Topic 958 not only requires disclosure of expenses by natural and functional classification, but also requires disclosure of the allocation methods in the notes to the financial statements. The final report that nonprofit organizations are required to run is the statement of functional expenses, which reports expenses based on functional classifications. Natural expense classifications are a grouping of expenses according to type. Examples include salaries and wages, rent, professional fees, and depreciation. Functional expense classifications are a grouping of expenses according to purpose. The most common functional expense classifications within not-for-profit financial statements are program activities and supporting services.