{"id":4231,"date":"2023-08-28T19:13:01","date_gmt":"2023-08-28T19:13:01","guid":{"rendered":"https:\/\/duganlopatka.com\/?p=4231"},"modified":"2023-09-13T16:26:18","modified_gmt":"2023-09-13T16:26:18","slug":"nonprofit-gaap-guide-reporting-expenses-by-function-vs-nature","status":"publish","type":"post","link":"https:\/\/www.duganlopatka.com\/nonprofit-gaap-guide-reporting-expenses-by-function-vs-nature\/","title":{"rendered":"Nonprofit GAAP Guide: Reporting Expenses by Function vs. Nature"},"content":{"rendered":"

If you were to make a personal budget, you\u2019d probably divide your expenses based on what they are<\/em>: car payments, groceries, Netflix subscription, etc.<\/p>\n

But what if you had to divide your expenses based on what they do<\/em>?<\/p>\n

For the past few years, the IRS has required nonprofits to do just that. While for-profit companies report costs based on their nature alone (what they are), nonprofits must report expenses on IRS Form 990 based on their nature and function: what they are and <\/em>what they do.<\/p>\n

In this article, we compare natural vs. functional expenses, explain how to allocate costs \u2013 and hopefully make filing your next 990 a little easier.<\/p>\n

Hold On. Why Should I Care?<\/h2>\n

Creditors, grantors, donors, watchdog groups \u2013 they all rely on the information on your Form 990 to understand how your nonprofit spends its money. If you want to build trust, you need to give them an accurate, complete, and clear picture of your expenses.<\/p>\n

It\u2019s also important because, well, it\u2019s the law. The IRS requires that you report both functional and natural expenses on your Form 990. (Most organizations file their Statement of Functional Expenses as a separate document within their 990, but you can also include it within the Statement of Activities or in the Notes to the Financial Statements.) Failure to file can jeopardize your tax-exempt status.<\/p>\n

Finally, the Generally Accepted Accounting Principles (GAAP) require a statement of functional expenses, so you\u2019ll need one to pass an audit.<\/p>\n

The bottom line? Completely and accurately reporting your expenses is essential. And it starts with understanding how to categorize them.<\/p>\n

Natural vs. Functional Expenses<\/h2>\n

There are two main ways to categorize your expenses: naturally and functionally. To file a proper 990, you\u2019ll need to understand both.<\/p>\n

Reporting Natural Expenses<\/strong><\/span> is the most, well, natural<\/em> way of looking at your costs. This method categorizes expenses based on what they are<\/em>: rent, utilities, salaries, marketing, etc. Your rent is one line item. So is your recent marketing campaign. It\u2019s pretty intuitive.<\/p>\n

You can also categorize those very same costs as Functional Expenses<\/span><\/strong>.<\/p>\n

This method requires a bit more calculation. When reporting functional expenses, you\u2019ll categorize each line item according to its purpose, whether that\u2019s directly supporting your mission, raising funds, or covering the management and administration of your organization.<\/p>\n

Let\u2019s dig deeper into those three categories.<\/p>\n

The 3 Types of Functional Expenses<\/h2>\n

Every functional expense falls into one (or more) of three categories:<\/p>\n

    \n
  1. Program Services
    \n<\/strong>This covers any costs associated with executing your mission. That could include program administrator salaries, as well as certain supplies, portions of your rent, and other expenses.While smaller organizations may have a single, clearly defined program service, larger organizations often have multiple classes of services. They will need to create sub-categories within their Program Services and organize their expenses accordingly.For example, if my autism services organization provides clinical support for children and at-home care for adults, I will need to divide my program expenses into two groups \u2013 one for clinical services, another for adult care \u2013 and label them accordingly.<\/li>\n<\/ol>\n
      \n
    1. Fundraising and Membership Development
      \n<\/strong>This includes expenses related to raising money and developing members, ranging from marketing and staff salaries to fundraising event costs, expenses related to creating grant proposals, etc.<\/li>\n<\/ol>\n
        \n
      1. Management and Administration
        \n<\/strong>This third category is a catch-all, encompassing overhead costs that aren\u2019t directly related to executing your mission or raising funds. Portions of office rent, executive salaries, and certain supplies may all be covered here.<\/li>\n<\/ol>\n

        Pictured below is a sample analysis. Designing your analysis along these lines is a good place to start.<\/strong><\/em><\/span><\/p>\n

        \"\"
        \nIt may sound straightforward. But what happens when an expense doesn\u2019t neatly fall into one of these three categories?<\/p>\n

        Allocating Functional Expenses<\/h2>\n

        While certain functional expenses may belong in a single category, many will serve multiple purposes.<\/p>\n

        For the latter, the bookkeeper must divide the item\u2019s total cost across multiple categories according to their relative weight.<\/p>\n

        For example, let\u2019s say one of your staff members performs several functions. You calculate that they spend 70% of their time on mission-related work, 20% on non-mission administrative services, and 10% on writing grant proposals and participating in other fundraising activities.<\/p>\n

        In that case, you would divide the cost of their salary based on how they spend their time: 70% on programming, 20% on administration, and 10% on fundraising.<\/p>\n

        Determining how to properly allocate funds can be difficult and ambiguous. That\u2019s why it\u2019s so important to have clear, detailed reporting procedures \u2013 and to follow them consistently.<\/p>\n

        Why Good Reporting Procedures Matter<\/h2>\n

        Good reporting procedures are important because they help bookkeepers allocate functional expenses appropriately, accurately, and consistently.<\/p>\n

        They\u2019re also required by regulators. The Financial Accounting Standards Board (FASB) requires that organizations establish clear processes and procedures for allocating expenses and apply them consistently. Generally Accepted Accounting Principles (GAAP) also state that organizations must disclose these processes and procedures in their Form 990.<\/p>\n

        Another good way to ensure complete and accurate reporting? Outsource it to a team you trust.<\/p>\n

        \n

        Outsource Your Accounting for Consistency, Clarity and Confidence<\/h3>\n

        Want to spend less time worrying about bookkeeping and compliance and more time focused on your mission?<\/p>\n

        Dugan + Lopatka, CPAs can modernize, streamline and augment your financial management. Our experienced CPAs deliver everything from accurate bookkeeping and timely reports to in-depth guidance and strategic planning.<\/p>\n

        And with Outsourced Accounting from D+L<\/a>, you get all the services you need in a flexible, affordable solution that scales with your organization.<\/p>\n

        Learn more about our decades of experience<\/a> with nonprofit clients or connect with D+L here.<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"

        For the past few years, the IRS has required nonprofits to report expenses in two ways: naturally and functionally. We compare these two categories, explain how to allocate costs, and hopefully make filing your next 990 a little easier.<\/p>\n","protected":false},"author":7,"featured_media":4242,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"inline_featured_image":false,"footnotes":""},"categories":[18],"tags":[],"acf":[],"yoast_head":"\nNonprofit GAAP Guide: Reporting Expenses by Function vs. Nature<\/title>\n<meta name=\"description\" content=\"For the past few years, the IRS has required nonprofits to report expenses in two ways: naturally and functionally.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/www.duganlopatka.com\/nonprofit-gaap-guide-reporting-expenses-by-function-vs-nature\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta 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