Reporting Expenses by Function

Successful nonprofit organizations find that reporting expenses in their financial statements by function can help with their financial man-agement. But the main reason to report expenses this way is that current accounting rules require it.

Two Reporting Functions
The rules require you to break down expenses into two reporting functions:

1. Program services: Report as program expenses all costs incurred while con-ducting activities that result in goods and services that fulfill your purpose or mis-sion. These goods and services are your organization’s major output. You should usually report program expenses sepa-rately by major program.

2. Supporting services: Report in this func-tion all expenses other than program expenses. The most important categories are: l) management and general, 2) fund-raising, and 3) membership development. Here’s a closer look at each.

Management and general. These administra-tive expenses are not necessarily identified with a specific program but are indispensable to your operation. When a management and general expense relates directly to a specific program, allocate it directly to that program.

Note, though, that expenses for management and general are just that — regardless of the funding source. Even if a program funder reimburses management and general expenses along with direct program expenses, their classification does not change to program expense. Instead, they become funded man-agement and general expenses. For example, if a grant covers the full cost of a billing clerk for a program, this is a management and gen-eral expense even though funded.

The management and general expenses cate-gory includes:

• Cost of general management and oversight of the organization, such as managing the business office,

• Salaries and related costs,

• General recordkeeping,

• Budgeting,

• Managing and operating the finance office,

• Applying for grants, contracts and similar funding, and

• Disseminating financial information.

When a portion of the management and gen-eral expenses for a particular program is funded, your financial statements should report total management and general expenses for that program regardless of the extent to which they are funded. This is important for determining whether you need additional funding for a particular program.

Fundraising. Report costs incurred when asking potential donors to contribute money or other assets as fundraising expenses. These activities include:

• Publicizing and conducting fundraising campaigns,

• Maintaining donor lists,

• Conducting special fundraising events,

• Giving premiums to prospective donors or to acknowledge contributions,

• Preparing and distributing fundraising materials, and

• Other activities that solicit contributions.

Membership development activities. These expenses include recruiting prospective mem-bers and collecting their dues. Use this cate-gory only when you give significant benefits in exchange for dues. But be sure to record dues solicitation as a fundraising expense when dues represent contributions to an organization and not the value of benefits pro-vided to members.

Assigning or Allocating Expenses
When possible and practical, assign expenses to the specific program or supporting service they benefit. Consider directly assigning major expenses such as payroll and occupancy to programs or specific sup-porting services. But expenses can be pooled that are impossi-ble or impractical to trace to a specific program or supporting service. Then you can allocate the pooled expenses to various programs and supporting services, using an appropriate formula. Allocate local phone charges in proportion to program budgets or clients served. Just don’t confuse direct expenses with program expenses. For example, payroll can be a direct charge to fundraising, which is a supporting service, not a program expense.

You can determine the proper place to assign expenses from various sources, such as:

• Actual square footage used by people and equipment for rent, utilities, building insurance and similar occupancy costs,

• Actual time worked for payroll and related taxes, benefits and other costs, and

• Actual place where equipment is used for equipment rental or depreciation costs.

When More Than One Program Benefits
Expenses will frequently benefit more than one program or supporting service or both. In that case, you should allocate them to the pro-grams and supporting services benefited. Allocate these indirect expenses on the basis of direct payroll, total program costs or another reasonable, consistently used basis.

In some cases, you can partially assign expenses to a particular function and partially allocate them to specific programs. Let’s say that a bookkeeper works half time following up on delinquent receivables in the medical program and half time in general bookkeep-ing. You should treat 100% of the cost as management and general — assigning half directly to the medical program and allocating the other half to all programs benefited.

Set up your accounting system so that you can efficiently and accurately assign and allocate expenses. Investigate current general ledger programs to find the right program for your organization.

Also, design the chart of accounts in your general ledger to allow you to easily extract information for:

• Financial reporting,

• Reporting to grantor agencies,

• Preparing annual filings, and

• Managing your organization.

Develop An Accounting Policies Manual
Many nonprofits find that an accounting poli-cies manual can help train new staff and assure that they apply procedures consistently and according to plans. If you develop an accounting policies manual for your nonprofit, you’ll want to include:

• An introduction with a description of the organization,

• Accounting policies for budgeting and cash flow forecasting, billing and accounts receivable, contributions, purchases, accounts payable, and check writing poli-cies by type of expense,

• Personnel policies, such as standards for hiring and procedures for reviews,

• Payroll and benefits policies covering overtime, vacation, holiday, educational assistance and retirement plans,

• Procedures for payroll file documentation, including salary and increases, withhold-ings authorizations, and Immigration and Naturalization Forms,

• A system of internal controls,

 • Procedures for annual audits, and

• Property management policies for capital-izing and recording fixed assets, physical inventories of equipment, and insurance on buildings and equipment.

Reporting as a Management Tool
Following this guide will allow your organi-zation to comply with the requirements for reporting functional expenses. More impor-tant, it will give you a better idea of your pro-grams’ true operating costs — so you can make better decisions about what programs to undertake and continue.

Please let us know if you have any questions about reporting your organization’s expenses. Our professionals can guide you through the maze of reporting by function. We would be glad to help you with this or any other accounting matter.