Effective Strategies for Allocating Costs in Nonprofits

Allocating costs might not be the most thrilling task, especially if your nonprofit has numerous activities. However, it is essential because donors and funders want to understand how your organization uses its financial resources. Additionally, you need to comply with Generally Accepted Accounting Principles (GAAP) set by the Financial Accounting Standards Board (FASB). Let's review relevant FASB standards for cost allocation.

Expense Analysis by Nature and Function

FASB standards require nonprofits to include an analysis of expenses by nature (such as salaries, rent, and utilities) and function (program services and supporting activities) in their financial statements. Your organization must present this information in one location on its statement of activities, either in the financial statement notes or a separate financial statement.

Properly allocating costs between program services and supporting activities is crucial. According to FASB standards, program services are activities that result in goods and services being distributed to beneficiaries, customers, or members that fulfill your nonprofit's purpose or mission. These are your nonprofit's primary focus.

Categorizing Supporting Activities

Activities that do not qualify as program services are considered supporting activities. These need to be broken down into three categories:

1. Administrative and General Services: These items are not identifiable with a single program, fundraising activity, or membership activity but are essential to your nonprofit's existence. They generally include oversight and administration, budgeting, human resources, and obtaining fee-based revenues.
2. Fundraising Efforts: This includes activities involved in soliciting donations from individuals, foundations, government agencies, and others.
3. Membership Development: This involves recruiting prospective members, collecting membership dues, and managing member relationships. Membership development should be stated separately in your financial statements if significant benefits or duties are associated with membership.

Nonprofits often engage in fundraising activities that also have elements of another function. For example, a special event or direct mail campaign might include both fundraising and program components. In such cases, you would allocate costs between fundraising and the other functions if certain criteria related to purpose, audience, and content are met. If those criteria are not met, you must report all costs of the joint activity as fundraising.

When it comes to the administrative and general category, do not treat it as a catchall. Some expenses that might seem like overhead, such as mortgage interest on a building, should be allocated to specific programs or supporting services whenever possible. Additionally, certain costs that appear to relate to administrative and general functions might belong to more than one function. For instance, insurance could cover property that houses multiple functions or a single program. Recording too much expense to administrative and general can result in under-allocation to other functions.

Simplifying the Allocation Process

FASB standards require nonprofits to disclose the method they use to allocate expenses. However, guessing and estimates are not allowed. Therefore, it is important to work with knowledgeable accounting professionals. Contact us, and we can help you simplify the process with an effective cost-allocation plan.