Allocating Functional Expenses for Your Nonprofit

By Julissa Canas, LSWG Staff Accountant

Thursday, January 7, 2021 – Are you properly allocating your nonprofit’s functional expenses?

Before FASB’s Accounting Standards Update 2016-14*, voluntary health and welfare organizations were the only nonprofits that were required to allocate their functional expenses. Once ASU 2016-14 was issued, all not-for-profit entities are now required to present the relationship between functional expenses and natural expenses–providing financial statement users a more detailed report on how these entities spend their money toward their mission.

The most common functional classifications used are Program, Administrative, and Fundraising.

Program:  Expenses that relate directly to programs that support the organization’s mission. (Donors prefer to fund organizations that spend more money towards their mission.)

General and Administrative:  Expenses that relate to administering the day-to-day activities of the nonprofit. Examples include:  accounting fees, insurance, supplies, etc., that are not directly related tot he programs. (Generally, donors want to see less expenses in this category.)

Fundraising:  Expenses that relate directly to the purpose of soliciting contributions, grants, and donations.

Once the classifications are established, how are expenses allocated?

There are different methods that are commonly used. A good example would be salary and wage allocation. A reasonable allocation method to use for these expenses include hours spent on direct labor for programs and services. 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.  But with a pandemic, there are concerns that not-for-profits need to take into consideration.

In order for organizations to determine the impacts of COVID-19-related expenses, the entity should consider only the expenses that are attributable and incremental to COVID-19–which include expenses such as additional cleaning supplies required as part of prevention, COVID hazard pay to employees, and possibly COVID testing. Many organizations have turned to a virtual presence in order to accomplish their fundraising events or have shifted to working from home. In the long run, shifting to a virtual setting might make organizations rethink the need for expansive square footage (that could potentially reduce the cost in rental agreements and real estate). 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.

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.

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*FASB Accounting Standards Update 2016-14:  Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities

Julissa Canas is a staff accountant in LSWG’s Frederick office and a graduate of East Carolina University College of Business. You can reach Julissa at 301.662.9200, or by email at jcanas@LSWG.cpa.