Functional Expense Allocation for Nonprofits

Nonprofits that follow U.S. GAAP must present an analysis of expenses by both nature and function in one place. That place can be the statement of activities, a separate statement, or the notes. They must also disclose the methods they use to allocate costs among program and support functions. Many Form 990 filers also report expenses by function in Part IX. The exact presentation depends on your organization and the reporting framework.

Why functional allocation matters

Financial statement requirements

FASB Accounting Standards Update (ASU) 2016-14 amended ASC 958, the accounting standard for nonprofits. Under ASC 958-720-45-15, every nonprofit presents an analysis of expenses by function and nature in one location, e.g., on the face of the statement of activities, in a separate statement, or in a schedule in the notes. Under ASC 958-720-50-1, the notes must describe the methods used to allocate costs among program and support functions. A separate statement of functional expenses is allowed but not required.

IRS requirements

Form 990 reports expenses in Part IX, the statement of functional expenses. The Form 990 instructions say that section 501(c)(3) and 501(c)(4) organizations must complete all four columns:

Column (A), total expenses
Column (B), program services
Column (C), management and general
Column (D), fundraising

Other organizations must complete column (A) and may complete columns (B) to (D). Organizations that file Form 990-EZ or Form 990-N don't complete Part IX.

Donor and funder interest

Donors, funders, and others often want to see how much goes to programs compared with support costs. They may also compare your results with similar organizations.

The three functional categories

Program services

Program services are the activities that carry out your mission. Examples include direct services, educational programs, research, and publications that advance the mission. Advocacy that directly furthers an exempt program can also count, but report lobbying separately where the form requires it.

GAAP and the IRS don't set a healthy percentage for program spending. Ratios need context, and they should never lead you to misclassify costs.

Management and general

Management and general activities support the whole organization rather than a specific program or fundraising. Examples include executive oversight, board activities, accounting and finance, HR and payroll, general legal services, and general insurance. No rule sets a standard percentage.

Fundraising

Fundraising activities ask for contributions. Examples include grant writing, donor cultivation, fundraising events, donor communications, planned giving, and donor database management. No rule sets a standard percentage.

Direct and allocated expenses

Direct expenses

A direct expense belongs to a single function, so you don't need to allocate it. Examples include supplies used only by one program, the costs of a fundraising event, and the pay of a staff member who works only on one function. Assign the whole expense to that function.

Allocated expenses

An allocated expense benefits more than one function, so you split it. Examples include shared office space, utilities, accounting staff who serve all functions, and phone and internet service. Split these costs with a reasonable method.

Allocation methods

Method 1: Time spent

The time method allocates costs by the time staff spend on each function. It works best for personnel costs. First, staff record their time by function. Second, you calculate each function's share. Third, you allocate salary and benefits in the same proportion.

For example, an accountant earns $60,000 and spends 20% of their time on programs, 70% on management and general, and 10% on fundraising. The allocation is $12,000 to programs, $42,000 to management and general, and $6,000 to fundraising.

Method 2: Square footage

The square footage method allocates costs by the space each function uses. It works best for rent, utilities, and maintenance. Measure the space each function uses, calculate the shares, and allocate the cost.

For example, rent is $50,000 a year, and the space is 60% program, 30% management and general, and 10% fundraising. The allocation is $30,000, $15,000, and $5,000.

Method 3: Headcount

The headcount method allocates costs by the number of employees in each function. It works best for general office costs and HR costs. Count employees by their main function, calculate the shares, and allocate the cost.

For example, office supplies cost $5,000, and the staff includes 10 program, 3 management and general, and 2 fundraising employees, for 15 in total. The allocation is $3,333 to programs, $1,000 to management and general, and $667 to fundraising.

Method 4: Direct costs

The direct cost method allocates a shared cost by each function's share of direct costs. It can work for some indirect costs. Add up the direct costs by function, calculate the shares, and allocate the shared cost.

Method 5: Measured use

The measured use method allocates a cost by documented actual use. It works best for costs with clear usage records. For example, you can allocate phone system charges by call logs for each department.

Building an allocation plan

Step 1: List what needs allocation

List every expense that benefits more than one function, e.g., shared personnel, shared space, utilities, insurance, professional fees, and technology.

Step 2: Choose a base for each expense

Expense type	Suggested base
Shared personnel	Time study
Occupancy	Square footage
Office supplies	Headcount
Phone and internet	Headcount or usage
Insurance	Direct costs or square footage
Depreciation	Square footage or direct costs

Step 3: Write down the method

Your written allocation method should list the expenses you allocate and the base for each one. It should also explain how you determine each base, e.g., an annual time study, and when you update the allocations.

Step 4: Apply it consistently

Apply each method the same way over time and within its reporting framework. GAAP financial statements, Form 990, federal cost allocation, and award reports can follow different rules. Reconcile the differences instead of forcing one method to fit every purpose. Document and support any change when the facts or requirements change.

One way to run an internal time study

Running the study

Define the activities that belong to each function.
Choose a study period that reflects normal activity, and document why you chose it.
Have staff record their time by function.
Calculate averages by position or by person.
Document the results and your reasoning.
Repeat the study when activities or staffing change, and on the schedule in your policy.

Time study categories

Activity	Function	Example tasks
Program delivery	Program	Teaching, counseling, providing services
Program management	Program	Program planning and oversight
Grant writing	Fundraising	Research, writing, submission
Donor relations	Fundraising	Cultivation and stewardship
Accounting	Management and general	Bookkeeping, reporting, audit
HR activities	Management and general	Hiring, benefits, payroll
Board support	Management and general	Meeting preparation and minutes
General administration	Management and general	Office management and filing

Don't assign standard percentages by job title. Classify the activities each person actually performs. For salary charged to federal awards, you must also meet 2 CFR 200.430(g). A periodic study you use for GAAP reporting doesn't automatically support a federal award charge.

Special situations

Joint costs

Some activities serve more than one purpose, e.g., a newsletter that shares program information and also asks for donations. ASC 958-720 evaluates joint activities that include fundraising with three criteria, which are purpose, audience, and content. The analysis depends on the facts, so work through it with your accountant.

If the activity meets all the criteria, you allocate the joint costs among the functions using a rational and systematic method. If it doesn't meet them, you generally report all the costs of the joint activity as fundraising.

New programs

When you start a new program, update your allocation method and consider tracking time during a pilot period. Document the basis for your estimates.

Major changes

When your functions change a lot, run a new time study and document the reason for the change. Ask your accountant whether the change needs disclosure.

Common allocation mistakes

Out-of-date percentages

The mistake is using percentages from years ago that no longer reflect how people work. To fix it, reassess when staffing, space, or activities change, and on the schedule in your written policy. GAAP doesn't require an annual time study.

Charging everything possible to programs

The mistake is pushing costs into programs to look efficient. To fix it, allocate honestly, because auditors look closely at unrealistic allocations.

No documentation

The mistake is not being able to explain how you set the allocations. To fix it, document the method and its support.

Unexplained differences between reports

The mistake is using different methods for the financial statements and Form 990 without explaining why. To fix it, reconcile the differences. GAAP, Form 990, federal cost allocation, and award reports can follow different rules, and consistency doesn't justify a method that is wrong for a given purpose.

Ignoring joint costs

The mistake is not analyzing activities that serve more than one purpose. To fix it, apply the joint cost criteria to each such activity.

Reporting requirements

Analysis of expenses by function and nature

Whether you present it as a statement or a schedule in the notes, the analysis usually shows natural classes, e.g., salaries and benefits, in rows. It shows functions, i.e., program, management and general, and fundraising, in columns.

Notes to the financial statements

Disclose the methods you use to allocate costs among functions. If you allocate joint costs, also make the joint cost disclosures that ASC 958-720 requires.

Form 990

Report functional expenses in Part IX, the statement of functional expenses, and complete any supporting schedules the form requires.

Tools for functional allocation

In QuickBooks Online

QuickBooks Online Classes and Locations are available on the Plus and Advanced plans. Either one can hold a function, i.e., program, management and general, or fundraising. A Location applies to the whole transaction, while Classes can be set on each line when your settings allow it. One setup uses Locations:

Create Locations for program, management and general, and fundraising.
Tag each transaction consistently. A Location applies to the entire transaction, not to individual lines.
Use reports by Location as inputs to your analysis by function and nature.

For shared costs, enter split transactions or record allocation journal entries at month end.

A report by Location is not automatically a GAAP analysis of functional expenses. Reconcile the natural classes, shared cost allocations, and any transactions that span more than one function, using a process your accountant approves.

In spreadsheets

Build an allocation workbook that tracks direct costs by function, applies percentages to shared costs, and produces a matrix of expenses by function and nature.

In grant management software

Some tools can track more than one reporting dimension, e.g., the grant from a Customer, Project, or Class, and the function from a Location or another documented process. Check exactly what data and reports a tool produces. Don't assume it produces a compliant functional expense presentation.

How GrantLink supports this today

QuickBooks Online remains your accounting system. In GrantLink, the QuickBooks records chosen under Expenses in each grant's QuickBooks section decide which activity GrantLink automatically allocates to that grant. You can classify or split other transactions on the Ledger page. In Settings > QuickBooks > Mapping, under Advanced, the Functional expense tracking setting records whether your program, administration, and fundraising dimension is a QuickBooks Class or a Department/Location.

GrantLink is read-only toward QuickBooks by default, so allocations in GrantLink don't change your QuickBooks transactions. GrantLink doesn't replace your organization's GAAP functional expense analysis.

Sources

FASB ASU 2016-14, which requires the analysis of expenses by function and nature and the disclosure of allocation methods
IRS Instructions for Form 990, Part IX, which explain the functional columns, the line instructions, and the allocation rules