New Guidance Requires Proper Reporting With Statement Of Functional Expenses
Those who know me, know I enjoy spending time in nature – mostly hiking and camping. It helps me function better in my everyday life. And while I’d love to write more about that, this month you get to learn about a different kind of nature and function.
The new nonprofit accounting guidance (ASU 2016-14) directs nonprofit organizations to report expenses by both nature and function within their Generally Accepted Accounting Principles (GAAP) financial statements. While this information can be presented in the footnotes or directly in the statement of activities, many nonprofits are finding that including a statement of functional expenses is the most practical method for complying with this new requirement.
Since most nonprofits were previously not required to present this information or this statement, many are finding that they need to consider new factors in preparation of their 2022 financial statements.
Even if your organization presented a statement of functional expenses in the past or can prepare one based on the information included in the Form 990, now is a good time to fine-tune your understanding and decisions in this area.
Statement of Functional Expenses
A statement of functional expenses presents expenses grouped by nature and function. The natural classification of expenses involves categories such as salaries, rent, supplies, and travel. On the other hand, the functional classification groups expenses according to their purpose. These purposes are typically shown as program services and supporting services, with supporting services being broken down further into management and general, fundraising and membership development (if applicable).
So, why is this information important? These modifications to the nonprofit financial statements are intended to provide more meaningful information to the users of the financial statements. Different users desire different information regarding the breakdown of expenses. With that, management is typically more concerned with the natural classification while the users of the financial statements, such as donors and grantees, are curious about how the money is being used as a functional classification with an eye on efficiency.
How To Build A Statement of Functional Expenses
To build a statement of functional expenses, an organization must allocate costs among the different programs and supporting services categories. Also, all costs can be allocated directly or indirectly.
Direct costs are those that relate to only one classification such as meals provided for an after-school program or rent for a building that is solely used for providing a specific program. However, indirect costs are those that apply to more than one category or would be too cumbersome to allocate directly. These indirect costs can include items such as rent and utilities for general buildings or depreciation and should be allocated through an appropriate basis (such as square footage for occupancy costs or salaries for benefits).
It’s important for the organization to consider each section of expenses, and I recommend developing a written policy that exhibits the intended allocation methods. This should be applied consistently with few exceptions and variations because the new guidance requires disclosure in the footnotes of the methods used for allocating expenses for functional classification.
What To Look Out For
To ensure you’re properly adhering to the new nonprofit accounting guidance, it’s important to understand what to look out for. Take a look at the following considerations:
- Make sure you are actually allocating expenses that should be allocated. Sometimes organizations will lump depreciation, insurance, or interest costs into general and administrative. However, these often represent costs that could be partially applied to the programs that are benefiting from the use of the related property (which is depreciating, is being insured, or has debt associated with it).
- Make sure any expenses that are netted against revenues for GAAP purposes (such as event costs) are included in the statement of functional expenses.
- Consider what fundraising costs you have. If your organization receives donations or grants, it is likely to have costs associated with soliciting the contributions or writing the grant request.
- Use your accounting system to your advantage. Take advantage of ways to allocate expenses within the system to simplify the process. Do not over-complicate your processes. If you have a simple operation, keep it that way!
- Do not get caught in the “overhead myth”. While some donors and grantors compare organizations and award gifts and competitive grants based on efficiency (desiring a low ratio of supporting services to total overall costs), the true measure of an organization’s success should focus on program accomplishments. I’m all for efficiency, but sometimes a bit more administrative work can influence a much greater organizational impact without much cost to the program.
If you want to know more about the new accounting guidance for nonprofits or how to correctly build a statement of functional expenses, email Rea & Associates. Financial reporting for your nonprofit organization should not be overlooked.
After you’ve spent the time learning about and building your statement of functional expenses, go outside and enjoy some real nature (I know that’s my plan).
By Mark Beebe, CPA (Zanesville office)