Nonprofit organizations are required to present expenses by their functional classification, such as major classes of program services and supporting activities, but some organizations wait to allocate their expenses functionally until they are required to for financial statement purposes.
Below, you will find some of the reasons that it is important to allocate expenses throughout the year, as well as the four major steps to allocating expenses.
Why do you need to allocate expenses?
Each program has an associated cost, but without allocating expenses throughout the year it is difficult to determine the total costs that should be associated with each program. Often, indirect expenses such as occupancy or personnel costs are not accounted for within their program, which can mislead management about the actual financial results of a specific program and of the organization as a whole. When you consider the total costs you can use this information to analyze the program and make more accurate management decisions for each program – maybe you are spending a lot of time and resources on a program that isn’t as effective when you can be devoting more time and resources to another program that has a great return on investment.
How do you allocate expenses?
There are four major steps to allocating expenses:
- Determine program services and supporting activities. Program expenses are the costs associated with an organization’s mission, while supporting activity expenses are those costs not directly related to the organization’s mission (for example, management and general, membership development, and fundraising activities).
- Determine direct and indirect expenses. Direct expenses can be identified as being related to a specific program service or supporting activity and are preferable over allocating indirect expenses. Direct expenses can be split between more than one program or supporting activity. Indirect expenses relate to more than one program service or supporting activity and should be allocated among the applicable programs and/or activities.
- Determine proper allocation methods for indirect expenses. Objective methods of allocating expenses are preferable over subjective methods. The allocation method can be based on financial or non-financial data, such as: employee time records or activity reports, square footage, or the consumption of supplies and postage. It is likely that multiple allocation methods should be used.
- Apply allocation methods to indirect expenses.
Have a process in place
Although nonprofit organizations have been required to present expenses by their functional classification for several years, with the issuance of ASU 2016-14, New Financial Reporting Model, which is effective starting for fiscal years beginning after December 15, 2017, the FASB has added additional guidance for allocating costs. Having a process in place to allocate expenses in a timely manner not only gives you access to more accurate information for management decisions, but it will also save you time at the end of the year when preparing your financial statements to be in accordance with the new accounting standard.