Best Practices for Allocation of Functional Expenses

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Non-profit organizations are required to report on expenses by functional classification. This can be presented within the statement of activities or within a related note to the financial statements. In addition, the functional expenses are also reported in the IRS Form 990.

The functional expense classifications are as follows:

  • Program Services – costs relating to providing program services that fulfill the organization’s mission.
  • Management and General – costs relating to the essential day-to-day administration and overall direction of the organization. Examples include oversight, general recordkeeping, financing, etc.
  • Fundraising – costs relating to obtaining financial support for the organization from potential donors.

Organizations typically have expenses that relate to more than one functional expense classification. The most accurate and preferred method of allocation is by directly identifying a specific expense to a function. However, in many cases, direct identification is not feasible, and, therefore, allocating expenses based on either financial or non-financial data is appropriate. Management should have a written policy in place for its cost allocation plan in order to ensure consistency. Please keep in mind that management should review the policy at least annually and consider the organization’s current year operations in order to make revisions as necessary.

Below are some examples of allocations of expenses:

  • Salaries and Wages – allocate based on percentage of time spent in each function by the individual employee/department
  • Employee benefits and payroll taxes –  allocate based on salaries and wages
  • Occupancy costs (utilities, janitorial, building maintenance, etc.) – allocate based on square footage of the organization by function or allocate based on salaries and wages

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