Functional expense reporting confuses many first-time nonprofit bookkeepers and executives. Federal grants can provide essential funding for nonprofits, but managing these grants requires a thorough understanding of federal requirements and meticulous compliance. Here’s a comprehensive deep dive into what nonprofit leaders need to know to successfully…

Create your own with our Statement of Functional Expenses Template

One natural expense type will often fall under multiple functional expense classifications. Management must determine proper methodologies for allocating natural expenses over various Bookstime functional expenses. For example, salaries and wages may be allocated based on an estimate of time spent on each purpose and rent may be allocated based on the square-footage of the building used for each purpose. For example, a marketing coordinator may be hired solely for assisting with fundraising efforts and their time would be designated 100% to fundraising expenses. The allocation methods used should be reasonable, consistent, and well documented. Topic 958 not only requires disclosure of expenses by natural and functional classification, but also requires disclosure of the allocation methods in the notes to the financial statements.

What are the benefits of classifying functional accounting?

• As you can see, the column headings highlighted in green show the expenses by function.
• As with any other accounting-related matter, documentation to support the allocations is the key.
• Each category plays a critical role in the overall sustainability and success of the organization, and understanding these components is crucial for anyone involved in managing, funding, or evaluating nonprofit entities.
• The audience of an organization’s financial reporting includes funders, donors, boards of governors and regulators.

As nonprofit accountants, it’s vital to know the ways to report expenses to the IRS for your nonprofit clients, and one of the most important parts of that is understanding the role of a statement of functional expenses. The statement of functional expenses gives you insight into how well your nonprofit used the money it received from donors or grants. You can normal balance improve decision-making by reviewing the data in your non-profit accounting software and comparing it to previous years when creating your annual operating budget. It also promotes analysis and discussion about the mission relevance of each activity in an organization’s program portfolio.

Time Studies

Let’s dive in and unravel the complexities of the Statement of Functional Expenses.. Fundraising expenses are incurred through the solicitation of contributions, gifts, and grants. These expenses include the efforts to collect both cash and non-cash contributions. Common expenses that appear as a fundraising expense include the postage for appeals and letters, acknowledgment letter creation, and the wages paid to the development director. As you can see, the column headings highlighted in green show the expenses by function.

Statement of Functional Expenses Example

Tracking and allocating functional expenses is a major bookkeeping challenge for small nonprofits. However, nonprofit-friendly accounting software can help you make creating your Statement of Functional Expenses fairly easy. Allocating expenses is dividing overhead costs between all of the functions that are indirectly related to that cost. The square footage allocation example we used above is one common example of functional expense allocation.

The Statement of Functional Expenses is not just a financial reporting tool but a strategic asset that can significantly influence decision-making processes within a nonprofit organization. Program costs refer to any direct expenses related to delivering the nonprofit’s programs and services to achieve its larger mission. All costs directly related to delivering programs should be recorded in this category. Ideally, this category would be the most robust on the Statement of Functional Expenses, as donors and investors prefer that nonprofits direct most of their funds towards achieving their stated mission. Nonprofits should strive to allocate most of their expenses to programs costs, provided these expenses are allocated properly and are aligned with the nonprofit’s mission. Nonprofit accountants should have a basic understanding of nonprofit fundraising software, and how to help their clients statement of functional expenses keep up-to-date records of expenses through the use of these software solutions.

• Nonprofits should strive to allocate most of their expenses to programs costs, provided these expenses are allocated properly and are aligned with the nonprofit’s mission.
• Most importantly, the statement breaks down the expenses into categories based on their function.
• The Statement of Functional Expenses that nonprofits issue is referred to as a matrix, because it requires organizations to report their expenses by both functional and natural classification.
• Users of the financial statements generally prefer to see a not-for-profit organization with the largest allocation of expenses as program activities.
• For example, a marketing coordinator may be hired solely for assisting with fundraising efforts and their time would be designated 100% to fundraising expenses.
• Nonprofits must learn how to record functional expenses correctly to ensure compliance with federal regulations.

It also contains non-profit net assets, which display the organization’s total worth, equivalent to the business’s equity. Before the accountant goes on to allocate the expenses, they all need to classified. As per the governing board, all the expenses made are mandatory to be classified and recorded in one of these categories of expense. More specifically, your organization’s SFE plays an important role in the development of your nonprofit’s annual operating budget. It will also provide you with an easy reference guide for filling out your nonprofit’s annual tax return at the end of your nonprofit’s fiscal year. Lastly, a year-to-year comparison of functional expense allocations should be performed.

Functional Expense Allocation

This provides transparency and shows how much of your funding is used on your mission-related activities vs. how much is used for the organization. For additional guidance on accurately reporting your functional expenses, reach out to your local Blue & Co. advisor today. Functional expenses are simply an allocation of expenses based upon the purpose of the underlying expenditure.

Accurate Allocation of Functional Expenses

This detailed document offers a comprehensive view of an organization’s expenses, grouped by both function and nature. It serves as a critical tool for financial transparency and accountability, providing stakeholders with valuable insight into how an organization utilizes its resources. The Statement of Functional Expenses provides a detailed breakdown of a nonprofit organization’s financial activities. It includes components such as Program Services, Management and General Expenses, Fundraising Expenses, and Total Expenses. This statement actively provides insight into the effective use of resources to fulfill the organization’s mission.