Functional Expense Allocation for Nonprofits

Nonprofits following U.S. GAAP must present expenses by both natural classification and function in one location—on the face of the statement of activities, in a separate statement, or in the notes—and disclose the methods used to allocate costs among program and support functions. Form 990 filers also complete functional expense reporting under the form's instructions. The exact presentation and categories depend on the organization and applicable framework.

Why Functional Allocation Matters

Financial Statement Requirements

Under FASB ASC 958 as amended by ASU 2016-14, nonprofits present an analysis of expenses by nature and function in one location and disclose allocation methods. A separate Statement of Functional Expenses is permitted, but is not universally required.

IRS Requirements

Organizations required to file Form 990 generally report expenses in Part IX by:

• Program services (Part IX, Column B)
• Management and general (Part IX, Column C)
• Fundraising (Part IX, Column D)

Donor and Funder Interest

Stakeholders want to know:

• How much goes to programs vs. overhead?
• Is the organization efficient?
• How do they compare to peers?

The Three Functional Categories

Program Services

Activities that fulfill the organization's mission.

Examples:

• Direct service delivery
• Educational programs
• Research activities
• Advocacy that directly furthers an exempt program (including lobbying where applicable; separately report lobbying information when the form requires it)
• Publications advancing mission

There is no GAAP or IRS “healthy” program-spending percentage. Ratios need organizational context and should not drive misclassification.

Management and General (M&G)

Activities supporting the organization overall, not specific to programs or fundraising.

Examples:

• Executive oversight
• Board activities
• Accounting and finance
• HR and payroll
• General legal services
• General insurance

No universal percentage is prescribed.

Fundraising

Activities related to soliciting contributions.

Examples:

• Grant writing
• Donor cultivation
• Fundraising events
• Donor communications
• Planned giving programs
• Donor database management

No universal percentage is prescribed.

Direct vs. Allocated Expenses

Direct Expenses

Expenses that can be assigned to a single function without allocation.

Examples:

• Program supplies used only by one program
• Fundraising event costs
• A staff member's time that is wholly attributable to one function

Treatment: Assign 100% to the appropriate function.

Allocated Expenses

Expenses benefiting multiple functions that must be split.

Examples:

• Shared office space
• Utilities
• Accounting staff serving all functions
• Phone and internet

Treatment: Allocate using reasonable methodology.

Allocation Methods

Method 1: Time-Based

Allocate based on time spent on each function.

Best for: Personnel costs

How it works:

1. Staff track time by function
2. Calculate percentage for each function
3. Allocate salary/benefits proportionally

Illustrative example: Accountant salary: $60,000

• Time spent: 20% program, 70% M&G, 10% fundraising
• Allocation: $12,000 program, $42,000 M&G, $6,000 fundraising

Method 2: Square Footage

Allocate based on space used.

Best for: Rent, utilities, maintenance

How it works:

1. Measure space used by each function
2. Calculate percentage
3. Allocate costs proportionally

Illustrative example: Rent: $50,000/year

• Space: 60% program, 30% M&G, 10% fundraising
• Allocation: $30,000 program, $15,000 M&G, $5,000 fundraising

Method 3: Headcount

Allocate based on number of employees.

Best for: General office expenses, HR costs

How it works:

1. Count employees by primary function
2. Calculate percentage
3. Allocate costs proportionally

Illustrative example: Office supplies: $5,000

• Staff: 10 program, 3 M&G, 2 fundraising (15 total)
• Allocation: $3,333 program, $1,000 M&G, $667 fundraising

Method 4: Direct Costs

Allocate based on other direct costs.

Best for: Some indirect costs

How it works:

1. Sum direct costs by function
2. Calculate percentage
3. Allocate proportionally

Method 5: Specific Identification

Allocate based on actual use documentation.

Best for: Expenses with clear usage patterns

How it works:

1. Track actual usage by function
2. Allocate based on documented use

Example: Phone system charges based on call logs by department.

Building an Allocation Plan

Step 1: Identify What Needs Allocation

List all expenses that benefit multiple functions:

• Shared personnel
• Shared space
• Utilities
• Insurance
• Professional fees
• Technology costs

Step 2: Choose Allocation Bases

Expense Type	Recommended Basis
Shared personnel	Time study
Occupancy	Square footage
Office supplies	Headcount
Phone/internet	Headcount or usage
Insurance	Direct costs or square footage
Depreciation	Square footage or direct costs

Step 3: Document Methodology

Write a formal allocation methodology including:

• What expenses are allocated
• What basis is used for each
• How basis is determined (annual time study, etc.)
• When allocations are updated

Step 4: Apply Consistently

Apply each documented methodology consistently within its governing framework and across periods. Reconcile differences among GAAP financial statements, Form 990, federal cost allocation, and award reports rather than forcing one method to fit every purpose. Document and support changes when facts or requirements change.

A possible internal time-study process

Conducting a Time Study

1. Define activities for each function
2. Select and document a period that represents actual activity
3. Have staff track time by function category
4. Calculate averages by position or person
5. Document results and rationale
6. Reassess when activities or staffing change and on the organization's documented cadence

Time Study Template

Activity	Function	Example Tasks
Program delivery	Program	Teaching, counseling, service provision
Program management	Program	Program planning, oversight
Grant writing	Fundraising	Research, writing, submission
Donor relations	Fundraising	Cultivation, stewardship
Accounting	M&G	Bookkeeping, reporting, audit
HR activities	M&G	Hiring, benefits, payroll
Board support	M&G	Meeting prep, minutes
General admin	M&G	Office management, filing

Do not assign “typical” percentages by job title. Classify the activities actually performed. For federal payroll charges, also satisfy 2 CFR 200.430; a periodic study used for GAAP presentation does not automatically support a federal award charge.

Special Situations

Joint Costs

Some activities accomplish multiple purposes (e.g., a newsletter that provides program information AND solicits donations).

Under ASC 958-720, joint activities that include fundraising are evaluated using purpose, audience, and content criteria. The detailed accounting analysis is fact-specific; if the criteria are not met, the joint costs are reported as fundraising rather than allocated to program or management and general.

If criteria are met: Allocate joint costs using a rational and systematic basis appropriate to the components If criteria are not met: Report all costs of the joint activity as fundraising

New Programs

When starting a new program:

• Update allocation methodology
• Consider pilot period time tracking
• Document basis for estimates

Significant Changes

When functions change significantly:

• Conduct new time study
• Document reason for change
• Evaluate with the accountant whether the change requires disclosure

Common Allocation Mistakes

Mistake 1: Outdated Allocations

Using percentages from years ago that no longer reflect reality.

Fix: Reassess when staffing, space, or activities change, and on the cadence in the documented policy. GAAP does not prescribe an annual time study.

Mistake 2: All to Program

Allocating everything possible to program to look efficient.

Fix: Be honest; auditors will scrutinize unrealistic allocations.

Mistake 3: No Documentation

Can't explain how allocations were determined.

Fix: Document methodology and support.

Mistake 4: Inconsistency

Using different methods for financial statements vs. Form 990.

Fix: Reconcile differences. GAAP, Form 990, federal cost allocation, and award reporting can have different rules; consistency does not justify an otherwise incorrect method.

Mistake 5: Ignoring Joint Costs

Not properly analyzing activities with multiple purposes.

Fix: Apply joint cost criteria honestly.

Reporting Requirements

Statement of Functional Expenses

Present expenses by:

• Rows: Natural classification (salaries, benefits, etc.)
• Columns: Function (Program, M&G, Fundraising)

Notes to Financial Statements

Disclose:

• Methods used to allocate costs
• How joint costs were allocated
• Any significant changes in methodology

Form 990

Report functional expenses on:

• Part IX, Statement of Functional Expenses
• Supporting schedules as required

Tools for Functional Allocation

In QuickBooks

QuickBooks Online Locations can support a flat, whole-transaction functional dimension when that matches the accounting design:

1. Create: Program, M&G, Fundraising
2. Tag applicable transactions consistently; a Location applies to the entire transaction, not individual rows
3. Use Location-based reports as inputs to the natural-by-function analysis

For allocations, either:

• Enter split transactions
• Run month-end allocation journal entries

A Location report is not automatically a GAAP functional-expense statement. Reconcile natural classifications, shared-cost allocations, and any transactions requiring more than one function under the accountant-approved process.

In Spreadsheets

Create allocation workbook:

• Track direct costs by function
• Apply percentages to shared costs
• Generate functional expense matrix

In Grant Management Software

Some tools can preserve more than one reporting dimension, such as:

• Grant scope from a Customer, Project, Class, or other explicit link
• Function from a Location or another documented process

Verify the exact data and reporting behavior rather than assuming a tool produces a compliant functional-expense presentation.

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How GrantLink supports this today

QuickBooks Online remains the accounting source of truth. GrantLink's per-grant Expenses link can backfill and auto-allocate eligible linked QuickBooks Online activity; Ledger, Todos, and manual allocation are exception paths. GrantLink allocations do not inherently rewrite QuickBooks Online, and they do not replace the organization's GAAP functional-expense analysis.

Sources

• FASB ASU 2016-14 — natural-by-function analysis and allocation-method disclosure
• IRS Instructions for Form 990 (2025), Part IX — functional columns, line instructions, and allocation rules