Creating a Clearer Picture of Expenses for Nonprofits
In 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standard Update (ASU) 2016-14, “Presentation of Financial Statements of Not-for-Profit Entities,” which, among other changes, mandated the creation of a statement of functional expenses for nonprofits. This ASU, effective for fiscal years beginning after Dec. 15, 2017, has had significant impact on nonprofit organizations of all sizes.
All Nonprofits Are Affected
Because the statement of functional expenses had previously been required only under certain circumstances, most nonprofits were not concerned about the details surrounding the classification of expenses. But with ASU 2016-14 came a broader approach, expanding the changes to financial statement reporting in order to include all nonprofit entities for the first time.
Under this new standard, FASB made it clear that nonprofits would be expected to answer this key question: What impact is the money that is being spent having on the organization’s essential purpose? To provide an accurate answer, nonprofits have to record expenses based on what purpose they serve in the nonprofit. Organizations have to categorize expenses, assigning the costs to the appropriate “buckets.” Thus, every organization is required to demonstrate the relationship between functional expenses and natural expenses, providing the information in a statement of activities, in the financial statement footnotes or in a separate statement of functional expenses.
The FASB’s objective in announcing this major change was to ensure that nonprofit leaders, and others with decision-making responsibilities, take into careful consideration the allocation and reporting of functional expenses when reviewing their financial situation. By doing so, the organization gains a much more accurate assessment of how their expenses are apportioned across the various departments and has a clearer picture of the true costs of achieving their mission.
The updated financial statement presentation helps nonprofit boards and staff in deciding whether to continue supporting a program, invest in a new program or eliminate one that is no longer fiscally strong. These types of crucial decisions can now be determined based on facts — and not on supposition.
Natural Classification Versus Functional Classification
In preparing a nonprofit’s financial statement, three functional areas are defined based on their purpose within the organization: general and administrative (G&A), programming and fundraising. These are the core groups of activities that form the basic foundation of any nonprofit. Collectively they ensure that the nonprofit functions effectively and efficiently, always moving towards accomplishing their mission and vision.
G&A typically is comprised of the day-to-day activities that support any organization, while programming and fundraising are self-explanatory. A good balance should ensure that investments are made in each category so that there is less likelihood of over or under spending on key areas. For example, low costs attributable to G&A, while possibly seeming to be a show of extreme efficiency, may actually be masking a lack of investment in a strong infrastructure. Similarly, too few expenses around fundraising initiatives, once carefully examined, may indicate a lackluster approach to revenue generation.
Natural expenses, on the other hand, include generic costs that all organizations incur such as rent, utilities and telephone, technology, professional fees, interest, salaries, insurance and benefits, and repairs and maintenance. These expenses can be distributed directly to a specific functional area or they may be allocated across one or more of the functional areas as determined by the leadership and their advisors.
As an example, accounting fees are typically all directly chargeable to the G&A area, whereas salaries could be distributed to G&A, programming and fundraising, depending on how much time is spent by the employees in each of these functional areas.
Whether directly assigned to one function, or divided among a combination of two or three, the calculation method applied must be reasonable, as well as consistent, from year to year. There are different approaches that can be applied when allocating natural expenses including employee head count or square footage.
Different strategies will be more or less effective depending on the attitude, culture and capabilities of the nonprofit. But based on the expectations of FASB, no matter what strategy is utilized, the allocation of natural expenses must be conducted using efficient and transparent record keeping, good judgment, discipline and a comprehensive approach that takes many different methodologies into account.
Tara E. Del Gavio
Tara E. Del Gavio, CPA, is the senior audit manager in the Nonprofit & Social Services Practice at SobelCo LLC. She is a member of the NJCPA Nonprofit Interest Group.
This article appeared in the September/October 2020 issue of New Jersey CPA magazine. Read the full issue.