Functional Expense Allocation

The latest view on not-for-profit accounting issues

It’s important as a not-for-profit organization to accurately allocate expenses among your program(s), management and general, and fundraising. Many donors restrict grants and contributions specifically for the entity’s programs. Therefore, it’s vital to only allocate expenses that are related (either directly or indirectly) to the purpose or mission of the not-for-profit to the program functional category, and properly allocate expenses for administrative and support or fundraising to management and general and fundraising functional categories.

There are specific expenses that are clearly stated as supporting activities that you should not allocate to program. Some of these types of expenses are:

  1. Oversight-type expenses
  2. Business management expenses
  3. General recordkeeping expenses
  4. Expenses relating to budgeting and financing
  5. Soliciting funds associated with advertising that promotes the sales of goods or services
  6. Soliciting funds for government, foundation, and other requests for proposals for customer-sponsored contracts for goods and services
  7. Producing and distributing the annual report

The above list is not all-inclusive, but it does include the most common types of supporting services expenses.

Many costs are directly allocated to each area, as they are clearly either program, management and general or fundraising expenses. However, there are several areas of expenses with every not-for-profit that are shared costs (indirect costs). For example, occupancy, salary and related costs, depreciation, communication and other expenses may be shared among the functions. Therefore, it is important to determine a clear, reasonable allocation method that accurately reflects what function the expenses should be allocated to.

It is important to keep the aforementioned list in mind when determining allocation methods as well. If your not-for-profit is conducting a time study to determine the allocation percentage of each staff person’s time among the functions, your staff should be aware of what activities are considered management and general versus program or fundraising. If your program coordinator is assisting with preparing your annual budget, his or her salary for the time spent in budget preparation should be allocated to management and general. All time spent on oversight and management of the entity’s employees and business functions are management and general costs as well. Therefore, to conduct a time study that accurately reflects what your staff is spending their time on, you should educate them prior to the time study of what activities fall within each function.

Under GAAP, all not-for-profit organizations are required to report expenses by functional classification. This also allows financial statement users the ability to evaluate where the organization is spending its resources. Therefore, it is vital as a not-for-profit to understand what expenses should be classified to each function and to properly allocate the expenses based on the day to day activities of the entity.

By Samantha E. Mahlen, CPA