NFP Functional Expense Allocation: Program, Management, and Fundraising

Functional Expense Reporting for NFPs

Not-for-profit organizations (NFPs) must present expenses by both their nature (salaries, rent, depreciation) and their function (program services, management and general, fundraising). Under ASU 2016-14, all NFPs must provide this analysis either on the face of the statement of activities, as a separate statement, or in the notes. Health care organizations and voluntary health and welfare organizations were previously the only NFPs required to present a matrix-style statement of functional expenses; now the requirement extends to all NFPs. This is a frequently tested topic on the CPA FAR exam.

Functional Categories

Program Services

Program services are activities that fulfill the organization's mission. A homeless shelter's programs might include housing, meals, and job training. Each significant program should be reported separately. The ratio of program expenses to total expenses (the program spending ratio) is closely watched by donors, watchdog groups, and the IRS.

Management and General (M&G)

Management and general expenses include oversight, business management, general recordkeeping, budgeting, financing, and other administrative activities that are not identifiable with a single program or fundraising activity. Examples include the executive director's salary (to the extent not allocable to programs), accounting and auditing fees, board meeting costs, and human resources department costs.

Fundraising

Fundraising expenses are costs incurred to induce potential donors to contribute money, securities, services, materials, or other assets. Examples include direct mail campaigns, special event costs, salaries of fundraising staff, and costs of maintaining donor databases.

Allocation Methods

Many costs benefit multiple functions and must be allocated using a reasonable and consistent methodology. Common allocation bases include:

Square footage: allocates occupancy costs (rent, utilities, maintenance) based on space used by each function
Headcount or FTE: allocates HR, payroll processing, and general administrative costs based on staff assigned to each function
Time and effort: allocates salaries of employees who work across functions based on time records or reasonable estimates
Direct identification: costs that can be traced directly to a function are assigned without allocation

Allocation Example

An NFP has total facility costs of $300,000. The building is used as follows: program services occupy 60% of space, management uses 25%, and fundraising uses 15%.

Program services: $300,000 x 60% = $180,000
Management and general: $300,000 x 25% = $75,000
Fundraising: $300,000 x 15% = $45,000

The executive director earns $200,000. Time records indicate 40% of time on program oversight, 45% on management, and 15% on fundraising:

Program services: $200,000 x 40% = $80,000
Management and general: $200,000 x 45% = $90,000
Fundraising: $200,000 x 15% = $30,000

Joint Costs and ASC 958-720

Joint costs arise when a single activity fulfills both program and fundraising (or other) purposes. The classic example is a direct mail piece that both educates recipients about a social issue (program) and solicits donations (fundraising). Under ASC 958-720-25, joint costs may be allocated between functions only if all three of the following criteria are met:

Purpose: The activity has a bona fide program or management purpose beyond fundraising. This is evidenced by whether a similar activity would be conducted without the fundraising component.
Audience: The audience includes people who could take the desired program action, not just potential donors.
Content: The materials include a call to action for the program purpose (such as urging recipients to vote, seek medical screening, or change behavior).

If any criterion is not met, all joint costs are classified as fundraising. If all three are met, the costs are allocated between functions using a reasonable method.

Joint Cost Allocation Example

An environmental NFP sends a mailing costing $120,000 that educates recipients about recycling and asks for donations. All three criteria are met. The NFP determines that 55% of the content and effort relates to the program message and 45% to the fundraising appeal.

Program services: $120,000 x 55% = $66,000
Fundraising: $120,000 x 45% = $54,000

The methodology and amounts must be disclosed in the notes to the financial statements.

Statement of Functional Expenses

The statement (or note) presents a matrix showing natural expense categories in rows and functional categories in columns. A simplified example:

Salaries: Program $400,000, M&G $150,000, Fundraising $100,000, Total $650,000
Rent: Program $180,000, M&G $75,000, Fundraising $45,000, Total $300,000
Supplies: Program $50,000, M&G $10,000, Fundraising $15,000, Total $75,000
Depreciation: Program $30,000, M&G $10,000, Fundraising $5,000, Total $45,000
Total: Program $660,000, M&G $245,000, Fundraising $165,000, Total $1,070,000

Required Disclosures

NFPs must disclose the methods used to allocate costs among program and supporting functions, including the allocation of joint costs. If joint costs exist, the notes must describe the nature of the activities, the total costs, and the amounts allocated to each function.

Key Exam Tips

All NFPs must present expenses by both nature and function under ASU 2016-14.
Joint costs may be allocated to program services only if the purpose, audience, and content criteria are all met; otherwise, all joint costs go to fundraising.
Common allocation bases are square footage for occupancy and time/effort for salaries.
The program spending ratio (program expenses / total expenses) is a key metric but is not a GAAP requirement.
Practice building the matrix from natural expenses and allocation percentages, as this is a common simulation format.