What is the Statement of Functional Expenses?

The Statement of Functional Expenses (SFE) is a financial report used by not-for-profit organizations to present the functional classification of expenses in addition to the natural classifications of expenses. Natural expense classifications are what constitutes an organization’s chart of accounts and what is featured on its statement of activities. Examples of these include salaries and wages, rent, utilities, insurance, repairs and maintenance, and supplies. Functional expense classification further classifies natural expenses into three areas: program, management and general, and fundraising.

Program expenses are costs incurred to aid the organization’s fulfillment of its mission. Natural expenses in this category vary greatly based on the organization and industry.

Management and general expenses are considered supporting expenses and are associated with running an organization, regardless of its mission. Common natural expenses in this category are accounting, legal, financing fees, license and filing fees.

Fundraising expenses are also supporting expenses and consist of costs incurred in raising funds for the organization. Natural expenses in this category could be related to fundraising events, mailers, and employees’ time spent fundraising.

Why is the SFE important?

FASB issued ASU 2016-14, Presentation of Financial Statements for Not-for-Profit Entities (effective for fiscal years beginning after December 15, 2017), which requires all nonprofit organizations to present expenses by natural classification and functional classification. This can be done on the face of the statement of activities in the notes to the financials or as a separate statement (SFE). In addition to this, not-for-profit organizations exempt under 501(c)(3) and 501(c)(4) need to report expenses by natural and functional expense classification on IRS Form 990.

Aside from accounting regulations that require a SOFE in some form, it’s a useful tool for the organization to visualize how its resources are being used. Most of an organization’s expenses should be programmatic since programs are what drive an organization’s mission. Taking program expenses as a percentage of total expenses is known as program efficiency, and it’s a metric that should be monitored. The program efficiency target will vary based on the organization and industry, but a generalized benchmark is 75%.

Functional Expense Allocation

For natural expenses that can’t be directly tied to one or multiple programs or to one of the support services categories (management and general, and fundraising), a functional expense allocation needs to be done. It will spread the natural expense among the programs and supporting services it indirectly relates to. Examples of natural expenses that are often allocated are personnel costs, rent, utilities, insurance, and supplies.

There are various allocation methods acceptable by auditors and the IRS, which include but are not limited to time-based, square footage, usage, and headcount. An organization can use one or multiple allocation methods, but the most important considerations are outlined below:

• Document the method(s) in an allocation policy. This should include the reasoning for using said method(s).
• The methods should be applied consistently.
• Allocation methodology should be evaluated annually.

At its core, the Statement of Functional Expenses helps connect your spending to your mission. Reviewing it each year can help you make informed decisions about where your dollars go.