A statement of functional expenses is a report that nonprofit organizations use to account for how they spend the money they receive whether by donation, government grant, fee, or service/program revenue.
When designing the functional expense statement, the first step for an organization is to define its functions. The three most common functions include programs, management, and general and fundraising. An organization can have many programs, but it is important to bucket them into core programs. The organization can elaborate on the programs and their details in the footnotes to the financial statements. When “bucketing” programs for the statement, an organization should consider some of the following factors: Program objectives, nature of services, market served (and their geographic region), size of program compared to overall activities, and any oversight (regulatory, grant, compliance, etc.). Management and general and fundraising functions are considered supporting services. While management and general focus on the operations of the organization as a whole, fundraising focuses on donor cultivation, special events, etc. Once defined, an organization is ready to start evaluating the natural classification of expenses. These are the expenses that are disbursed to the main functions:
- Payroll taxes
- Occupancy (rent, utilities, etc.)
Because classification can be time consuming, the organization should always consider combining like costs or reviewing the IRS Form 990, Page 10 which outlines the natural classifications.
Direct cost and joint costs are two ways that nonprofits can spread the natural classification of expenses
When I prepared this statement when I was working as a nonprofit controller and when assisting some smaller organizations, I always looked at the direct costs first. These are the costs that are attributable to only one function. As such, these are often the easiest to identify, whether it be a team member who works in a program full time or costs related to a donor mailing. The more complex, but not overly tricky way, to allocate costs is by a joint costing method. The joint costing allocation methodology needs be rational and systematic (i.e. time records, square footage, etc.) An organization should review the joint costing method at least annually. If the organization evolves or roles within the organization change, so should the allocation.
There are multiple ways to do this
Each natural classification of expense does not need to have the same allocation basis. Joint cost salaries, payroll taxes and related benefits may be allocated on a time study or full-time equivalent allocation whereas occupancy and depreciation might be a square footage allocation. It is acceptable to take a few passes at this statement, and, in fact, it will most likely be necessary. This ensures that the statement will be as accurate and reasonable as possible. After all, preparing a statement of functional expenses is how an organization keeps its readers informed as to how much a function costs, along with confirming that the organization is operating efficiently. If you have any questions on allocation methods or just need to brainstorm, please feel free to reach out to me. I can be reached at Kristen.Crouchelli@SobelCoLLC.com