Expenses are reported in two different ways on the 990 return: by their natural classification (salaries, depreciation, travel, etc.) and by their functional classification (program, administrative, fundraising). Correct functional allocation of expenses is important because some donors may scrutinize the percentage of program costs vs. administrative and fundraising costs while making a decision to donate to an organization. Tracking and allocating costs can be difficult or confusing but there are some things you can do to make the process easier:
– Develop a consistent and reasonable method for cost allocation and document it so that it will be easy for you to explain to your auditors, tax preparer, etc.
– While some expenses are directly and easily allocated, others may be more ambiguous or divided among multiple functions. Depending on the particular cost there are a number of methods that can be used, such as square footage used, time spent by employees on certain activities, or the number of employees. Typically the best basis of allocation is the primary cost driver. For example to allocate the rent expense of your facility you might use the percentage of square footage that is dedicated to program activities/administrative activities. Or in order to allocate salaries expense of employees who have both program and administrative duties you might use the time they spend on each function.
– Instead of waiting until the end of your fiscal year to allocate costs, it may be much easier to apply your allocation method throughout the year, and can help to avoid delays and additional time during your audit.
– Accounting expenses will always be administrative costs.
If you are unsure of how certain expenses within your organization should be allocated or what method to use, your CPA is a great resource to provide guidance on how specific expenses are typically classified.