Functional Expense Allocation Methods Not-For-Profits Should Know (Part IV)

Welcome back to Part IV of Keiter’s series on ASU 2016-14, Not-for-Profit Entities (Topic 958), Presentation of Financial Statements of Not-for-Profit Entities.  This article focuses on the changes to expense reporting for functional expenses and disclosures of allocation methodologies.

Functional Expense Classifications

Upon the implementation of ASU 2016-14, all not-for-profit entities will be required to present an analysis of expenses by function and nature in one location. This may be in the notes to the financial statements, in the statement of activities, or as a separate statement of functional expenses. The presentation must disaggregate the functional expense classifications by their natural expense classifications.  Functional classifications denote the purpose for which resources were expended and are typically labeled as “Program”, “Fundraising”, and “Management and General” with sub classes therein being allowed (e.g., naming top programs). Natural classifications denote the type of expense for which resources were expended; this includes items like salaries, rent, scholarships and awards, insurance, utilities, office expenses, professional fees, etc.

While voluntary health and welfare organizations have historically been required to present a separate statement of functional expenses, they will now be allowed to choose which presentational scheme best tells their financial story.

Sample Statement of Functional Expenses

Below is an example of how this new requirement may be met as a separate statement or footnote. The columns represent the functional classifications and the rows represent the natural classifications:

Further, entities will be required to include a description of the methods used to allocate costs between program and support functions.  This is going to require upper management and potentially board involvement to establish or bolster written internal policies on how the allocations amongst the different functions are being apportion.  Affected entities should begin evaluating whether they are following industry best practices now that this will be a required disclosure in the financial statements.

Example of a note disclosure of the expense allocation method used:

The next article in this Keiter series on ASU 2016-14 will cover expense reporting for management and general expenses…stay tuned!

Questions on this topic? Contact our your Keiter representative or our Not-for-Profit Team | Email | 804.747.0000

Additional Not-for-Profit Accounting Resources:

Financial Statements of Not-For-Profits: Changes to Net Asset Classifications (Part I)

Financial Statements of Not-For-Profits: Changes to Net Asset Classifications (Part II)

Not-For-Profit Financial Statements: New Liquidity and Availability Disclosures Required (Part III)

Statement of Cash Flows and Investment Return Changes: Impact on Nonprofits (Part VI)

Not-for-Profit Proposal to Allow Goodwill Amortization

Excise Tax Changes Impact Tax Exempt Organizations