Functional Allocation of Expenses Under ASU 2016-14
As a reminder, Accounting Standards Update (ASU) 2016-14 is effective for 12/31/18 year-ends and will affect every nonprofit organization. In our last article, “Miscellaneous Provisions,” we provided information on some of the less publicized provisions of ASU 2016-14 – reporting of investment return, use of the indirect method of reporting cash flows, and release of restrictions related to donations for fixed asset purchases. Another provision of ASU 2016-14 addresses the functional allocation of expenses, with the goal of improving presentation and disclosure. This will affect every nonprofit organization, even those that already prepare a functional allocation.
Many nonprofit organizations are considered “voluntary health and welfare entities” – their purpose is to provide voluntary services for various segments of society that solve health or welfare problems. These organizations have always been required to functionally allocate their expenses in a full set of financial statements. In addition, every nonprofit organization having a Form 990 filing requirement completes a Statement of Functional Expenses. This information can be very useful to donors, and has also been known to be a point of contention in the media when a nonprofit shows a higher than usual percentage of their costs coded to administration.
With the implementation of ASU 2016-14, all nonprofit organizations will now be required to include an analysis of expenses by nature (e.g. salaries, utilities, etc.) and function (e.g. Program A, Program B, management, and fundraising) in one location. Three options are provided:
- Present a separate statement of functional expenses – this option will likely be chosen by most organizations
- Present a table in the notes to the financial statements
- Incorporate the details into the statement of activities
Whether this is a new requirement for your nonprofit, or you have always presented this information in your financial statements, you should assess which presentation you prefer. It’s also a good time to reevaluate which functions are most meaningful to financial statement readers. The requirement includes allocating between programs and supporting services, but each nonprofit must define those functions. You may have more than one program, and your supporting services could include management duties, fundraising functions, and membership development. What programs do you talk to your donors or granting agencies about? Would it make sense to show each of these programs as a separate column to provide better financial information about their cost? Once this determination is made, you may need to update your chart of accounts to help you track some of these costs more appropriately.
In addition, allocation methodologies between program and supporting services should be reviewed. If not already in place, formal allocation methodologies that follow ASU 2016-14 and make sense based on operations, should be developed. Historically, management may have “guessed” what the allocation should be – e.g., “I spend about 10% of my time doing fundraising.” With the new reporting requirements, the allocation method will need to be disclosed, and “guesses” may not make the best disclosure in your financial statements! Instead, you are going to want to specify what methodology is applied. For example, occupancy costs might be allocated based on the square footage used for each program or supporting service, while salaries might be allocated based on time and effort expended.
Finally, ASU 2016-14 provides more guidance on management expenses than previous accounting literature. This is intended to reduce diversity in practice and improve comparability of financial statements between organizations. The new definition of management and general expenses is “supporting activities that are not directly identifiable with one or more program, fundraising or membership-development activity.” Each organization is unique and needs to analyze how its expenses support its activities; however some examples of what should be included in management include:
- General recordkeeping and payroll
- Financing, including interest costs not directly related to a program
- Audit costs
- Producing and distributing an annual report
- Human resource functions, to include employee benefits management and oversight
As a “catch-all”, the standard clarifies that all other management and administration, except for the direct conduct or supervision of program activities, is considered management expense. Activities that represent direct conduct or supervision should be allocated to the functions they relate to. Examples might include:
- IT benefits various functions and generally would be allocated
- CEO salaries are likely allocated to program, fundraising, and management
- HR does not provide direct supervision, so these costs are generally assigned to management
- Grant accounting and reporting could be program (e.g. program related reports) or management (e.g. financial reports and related accounting activities)
Nonprofit organizations will want to perform this analysis prior to year-end to see how it affects the percentage of expenses charged to programs. Donors and watchdog agencies use these percentages to analyze and evaluate your nonprofit in comparison to others, so any significant fluctuations could be a red flag.
The above provisions need to be adopted for your 12/31/18 financial statements. If preparing comparative financial statements, nonprofits who weren’t previously required to show functional and natural expenses in one statement, can omit that presentation for the previous year.
Watch for future articles on additional provisions of this new standard that will apply to your organization. The nonprofit experts at Ketel Thorstenson, LLP are here to help you navigate the intricacies of ASU 2016-14. Call us at 605-342-5630 to set up a meeting now.