Expense Allocation Basis

Both generally accepted accounting principles (GAAP) and the IRS require nonprofit organizations to allocate expenses by function.  Each expense must be allocated into one or more functions.  The three main types of functional expenses are program, management and general and fundraising. 

Program services expenses are those costs that are directly and indirectly related to providing program services.

Management and general expenses relate to the overall operations of the organization and are not identifiable with a specific program, fundraising activity or membership development activity.

Fundraising expenses are those costs related to inducing potential donors to contribute to the organization.

With the implementation of FASB ASU 2016-14, Not-for-Profit Entities (Topic 958) Presentation of Financial Statements of Not-for-Profit Entities all nonprofit organizations are not only required to report expenses by function but also to disclose the basis for the allocation.  Expenses that are direct in nature are the easiest to identify.  This is when a single invoice relates to one specific program or an employee only works with one program.  Indirect expenses are those expenses that relate to more than one function.  For example, the executive director’s salary who spends time working with programs, managing the organization and raising funds or utilities expense that is used for both the programming part of the building and admin offices.  In order to allocate indirect expenses by function, the organization must have a reasonable basis to allocate the expenses. 

Salaries.  Salaries are normally allocated by function based on the amount of time spent in each function.  The organization may have program personnel that work 100% of their time with a specific program; however, other employees may split their time between all three functions.  To determine how much of salary expense to allocate to program, management and general, and fund raising, a time study should be done to determine the average amount of time spent in each area.

Employee benefits and payroll taxes.  Since employee benefits and payroll taxes relate to specific employees, the allocation of these expenses should normally follow the same allocation method as payroll.

Occupancy.  Expenses related to occupancy, such as rent, utilities, maintenance, and insurance, are normally allocated based on square footage.  How much of the organization’s building is used for programming activities versus general admin or fundraising duties?

Other expenses.  Other expenses can be allocated using the salary or occupancy allocation or another reasonable method such as full-time equivalents. 

As your organization determines the basis for allocating expenses, remember the basis needs to be reasonable and should be reviewed each year to determine if any changes should be made.   It is also important to understand that the allocation of expenses by function required for financial statements and Form 990 is not the same as the allocations used for grants.

Posted by: Carrie Minnich, CPA