Top 7 functional expense allocation errors Resources

For example, you can see whether a specific administrative function is taking up more of your expenditures than it should. If your third largest program has the highest salary level, for instance, it could indicate payroll fraud. A program that doesn’t involve travel but shows a lot of travel expenses could be a sign of reimbursement fraud.

  • Programs are the projects and activities that connect to your nonprofit’s mission.
  • If you are new to nonprofit accounting, your first step is to understand the basic principles and needs of statements of functional expenses.
  • This is because your company’s industry, years in business and unemployment history can all determine the percentage used to calculate the amount due.
  • All expenses should be included, and this includes costs that are being netted against revenues on the statement of activities.
  • Such expenses don’t apply to the non-profit mission, which typically includes costs such as administration, bookkeeping, and governance.
  • Finally, software, unlike spreadsheets, can create a federally-compliant audit trail.

The organization then divides the number of hours spent in different programs, management, and fundraising. At the end of the year, this amount is totaled to find the allocation of the money by nonprofit. This category uses space as the criteria to determine the expenses a nonprofit organization is making.

If a specific methodology is not in place and underlying calculations to support allocations are not maintained, implementation of these processes should be considered. Functional expenses are simply an allocation of expenses based upon the purpose of the underlying expenditure. While the definition is straightforward, actual allocation methods are vague and can vary greatly across different organizations. Looking at the number of people working on each program at the nonprofit business and the expenses they accrue, one can determine each individual employee’s and program’s expenses. This allocation method is only effective for nonprofits with a small number of employees, often that does not exceed more than a thousand employees.

Statement of Activities

Because nonprofit accounting is all that we do, we have established policies for handling nonprofit-specific tasks– like functional expense reporting, fund accounting, grant tracking and more. All not-for-profits are required to file a Form 990, which is an informational return that is made publicly available. Form 990s include a breakout of allocation between functional expense categories.

And depending on your mission, you could have whole months that look different for your nonprofit. But for both funders and the IRS, lower overhead costs (typically not exceeding 35%) also show that your nonprofit is a responsible steward of its funding. Excessive overhead costs could indicate organizational bloat, misallocations of funding, and even fraud.

How should you allocate functional expenses?

When allocating expenses to a program, there needs to be direct conduct or direct supervision of the program to be able to charge the expense to the program. Still, you can use an estimate of employee time or an internal memo for how you allocate salaries if it is reasonable. Regarding occupancy, you can use office space by department or program as reasonable.

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The Financial Statement lists all the debt’s values and valuation due to all the company’s properties. It also contains non-profit net assets, which display the organization’s total worth, equivalent to the business’s equity. And to use timesheet data effectively, you’ll want to invest in dedicated time tracking software.

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However, they now subsidize home office setups with the regular purchase and distribution of standard office supplies. For example, if you run an afterschool program and need to purchase 10 workbooks for it, you could allocate the costs of the workbooks directly to that program. Fundraising expenses are incurred through the solicitation of contributions, gifts, and grants. These expenses include the efforts to collect both cash and non-cash contributions.

The Statement of Functional Expenses that nonprofits issue is referred to as a matrix, because it requires organizations to report their expenses by both functional and natural classification. Because you’re required to report functional expenses to complete your IRS 990 and maintain nonprofit status. For example, a fraternal organization may choose to break out its program service activities between categories such as chapter services, conferences and conventions, housing programs, etc. Doing so provides greater insight to prospective donors and other readers of the financial statements as to how the organization is using its resources. Natural expenses are categorized by their natural classifications– for instance, employee salaries, rent, utilities, maintenance, and the cost of supplies are all examples of natural expenses.

Nonprofit organizations are required to report functional expenses either in footnotes, the Statement of Activities (SOA), or a separate Statement of Functional Expenses (SOFE). The goal of this functional expense allocation is to illustrate the relationship between program expenses and supporting expenses to better understand how those supporting expenses further the organization’s mission. And while this sounds easy enough in concept, some expenses can be difficult to classify.