By: Shannon Johnson, CPA
Management of nonprofit organizations face their own unique challenges in serving their missions. One of the challenges is presenting financial statement information in a way that best communicates operations to their users – donors, grantors, government agencies, their Board of Directors, lenders, and other users of the financial statements. In the Accounting Standards Codification put forth by the Financial Accounting Standards Board, Topic 958 Not-for-Profit Entities requires the reporting of an analysis of expenses on either the Statement of Activities, as a schedule in the notes to the financial statements, or in a separate financial statement called the Statement of Functional Expenses. We most commonly see a presentation of the functional allocation of expenses via the Statement of Functional Expenses.
This statement is presented as a table, whereby the applicable natural expense categories are delineated by row and these respective expenses are allocated across columns via functional allocations.
Natural expenses are things like:
- Salaries, wages
- Payroll taxes
- Employee benefits
- Awards and grants to others
- Utilities
- Rent
- Insurance
- Legal and professional fees
- Promotion and printing
- Information technology
- Supplies
- Bad debt
- Depreciation
- Amortization
- Interest
There is no limit to the natural categories you might want to display on your Statement of Functional Expenses. Consider what aspects of operation are most prominent and important to your organization. If you are required to file a Form 990, consider the natural expenses outlined on Part IX and how your current accounts fit into those categories.
The two primary functional allocation buckets are: Program Services and Supporting Activities.
Program Services consist of costs incurred that directly relate to the execution and delivery of your mission. If your organization has more than one primary program, you may choose to show separate columns for each major program. This can give the users of your financial statements a better visualization of which programs require more resources and funding.
Supporting Activities consist of costs incurred that do not directly relate to programs provided, essentially supporting all programs and operations. The two most common subcategories of Supporting Activities are Management and General and Fundraising. If your organization is required to file a Form 990, Part IX Statement of Functional Expenses has columns for: Total Expenses, Program Service Expenses, Management and General Expenses, and Fundraising Expenses. By presenting your financial statements using these functional categories, you can easily report your expense activity in Part IX.
Once you have decided on the natural and functional categories, you need to consider each natural category of expense for allocation. Some expenses are very clearly 100% Program Services, such as the purchase of educational materials given to program participants, or awards and grants made to others. Other expenses are clearly Supporting Activities, such as legal expenses, payroll administrative costs, or special event costs for a fundraising event.
However, most expenses are allocated across more than one function, either directly or indirectly. Direct allocation would be identifying specific expenditures and classifying them to the appropriate function. Another option is for management to make its best estimate on a percentage basis of how each natural expense is allocated.
Below are natural expenses commonly allocated via percentage basis:
- Salaries, payroll tax, and benefits: management can prepare an analysis by employee and/or department of how each employee spends their time. Timesheets, input from supervisors, and job descriptions can help you determine how employees are spending their time. Employee roles may be allocated across multiple functions. For example, 70% of an employee’s time is spent executing program services and the other 30% is spent conducting management and general activities.
- Utilities, rent, depreciation, and similar occupancy expenses: a suggestion for estimating the functional allocation of items like rent, utilities, depreciation, and even interest expense can be estimated based on understanding the utilization of the space, considering the square footage, and identifying how portions are used for program functions, administrative, or other activities.
The methodology used for allocating expenses across functions should be disclosed in the notes to your financial statements.
Finally, there are a few items to note as you prepare your Statement of Functional Expenses:
- ASC 958-205-45-6 identifies: “To the extent that expenses are reported by other than their natural classification (such as salaries included in cost of goods sold or facility rental costs of special events reported as direct benefits to donors), they shall be reported by their natural classification in the functional expense analysis. For example, salaries, wages, and fringe benefits that are included as part of the cost of goods sold on the statement of activities shall be included with other salaries, wages, and fringe benefits in the functional expense analysis.”
- ASC 958-205-45-6 also states the following items should be excluded from the expense analysis:
- External and direct internal investment expenses that have been netted against investment return
- Certain items that are typically reported in other comprehensive income of for-profit entities, such as unrealized holding gains and losses, foreign currency translation adjustments, gains and losses on derivative instruments, among others
We understand allocating expenses can sometimes be challenging but remember these are best estimates. Gathering information from management can help you more easily prepare the Statement of Functional Expenses and report operations to your financial statement users in a more transparent and informative manner. BRC has several professionals with extensive experience working with nonprofits, so please reach out to us as you have questions on preparing your Statement of Functional Expenses.
The information contained in this article is for informative purposes only and should not be relied on when making any business, legal, or other decisions. This information may be updated without notice and/or may not contain the most current information that is available related to this topic.