Cost allocation probably isn’t your favorite task — particularly if your nonprofit has many activities. Yet the process is critical because donors and funders want to know how your organization uses its financial resources. In addition, you likely need to comply with Generally Accepted Accounting Principles (GAAP), which are determined by the Financial Accounting Standards Board (FASB). Let’s look at some FASB standards that might apply to your cost allocation.
Nature and Function
FASB standards require nonprofits to include in their financial statements an analysis of expenses by nature (such as salaries, rent and utilities) and function (program services and supporting activities). Your organization must present information about expenses 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 critical. 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. They’re your nonprofit’s major priority.
Three categories
Activities that don’t qualify as program services are supporting activities. You need to break down these activities into three categories:
1. Management and general services. These items aren’t identifiable with a single program, fundraising activity or membership activity, but are indispensable to your nonprofit’s existence. They generally include oversight and administration, budgeting, human resources and obtaining fee-based revenues.
2. Fundraising. This encompasses activities involved in soliciting donations from individuals, foundations, government agencies and others.
3. Membership development. This refers to recruiting prospective members, collecting membership dues and managing member relationships. You should state membership development 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 this case, you would allocate such costs between fundraising and the other functions if certain criteria related to purpose, audience and content are met. If those criteria aren’t met, you’re required to report all costs of the joint activity as fundraising.
When it comes to the management and general category, don’t 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. Also, certain costs that appear to relate to management and general function might belong to more than one function. For instance, insurance could cover property that houses multiple functions or a single program. What’s more, recording too much expense to management and general can result in under-allocation to other functions.
A Complicated Process Simplified
FASB standards require nonprofits to disclose the method they use to allocate expenses. But guessing and estimates aren’t allowed. That’s why it’s important to work with knowledgeable accounting professionals. Contact us. We can help you simplify the process with an effective cost-allocation plan.
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