Functional Expense Allocation for Nonprofits

Nonprofits must report expenses by function—Program, Management & General, and Fundraising—on their financial statements. This guide explains how to allocate expenses correctly.

Why Functional Allocation Matters

Financial Statement Requirements

Under GAAP (and specifically ASU 2016-14), nonprofits must present:

• Statement of Functional Expenses — Matrix of expenses by function and nature
• Expense disclosure — Methodology for allocation

IRS Requirements

Form 990 requires expense reporting 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 (non-lobbying)
• Publications advancing mission

Typical % for healthy nonprofits: 70-85%

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

Typical % for healthy nonprofits: 10-20%

Fundraising

Activities related to soliciting contributions.

Examples:

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

Typical % for healthy nonprofits: 5-15%

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
• Executive Director salary (often M&G)

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

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

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

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

Use the same methodology:

• Across all periods
• For both financial statements and Form 990
• Year over year (or document changes)

Time Studies for Personnel

Conducting a Time Study

1. Define activities for each function
2. Select a representative period (2-4 weeks)
3. Have staff track time by function category
4. Calculate averages by position or person
5. Document results and rationale
6. Update periodically (at least annually)

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

Allocation Percentages by Position

Typical allocations (adjust for your organization):

Position	Program	M&G	Fundraising
Executive Director	40%	50%	10%
Program Manager	90%	10%	0%
Program Staff	100%	0%	0%
Accountant	10%	85%	5%
HR Manager	15%	85%	0%
Development Director	5%	5%	90%
Development Staff	0%	0%	100%
Admin Assistant	30%	60%	10%

Special Situations

Joint Costs

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

Requirements:

• Must meet purpose criterion — Would activity occur without any one purpose?
• Must meet audience criterion — Appropriate audience for each purpose?
• Must meet content criterion — Supports each purpose?

If criteria met: Allocate based on relative effort or space If not met: Generally charge to 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
• Disclose methodology change in notes

Common Allocation Mistakes

Mistake 1: Outdated Allocations

Using percentages from years ago that no longer reflect reality.

Fix: Update time studies annually.

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: Use same methodology for all purposes.

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

Use Departments (Locations) for functions:

1. Create: Program, M&G, Fundraising
2. Tag all expenses
3. Run P&L by Department

For allocations, either:

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

In Spreadsheets

Create allocation workbook:

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

In Grant Management Software

Many tools track both:

• Grant (Class dimension)
• Function (Department dimension)

This enables cross-tabulation for both grant and functional reporting.

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GrantLink tracks expenses by both grant and function, making functional expense reporting straightforward even for complex grant portfolios. See how it works.