Nonprofits must be on their toes nowadays. New regulatory changes are being introduced constantly, many in just the last two years, including:
- an updated accounting standard that requires a complete overhaul of the reporting process;
- a tax law that threatens future donations revenue; and,
- new state-wide audit requirements.
It can be a lot to keep track of. The updated accounting standard, ASU 2016-14, Presentation of Financial Statements of Not-for-Profit Entities, is well under way now that 2018 is coming to a close, but there is still so much to learn about its intricacies. The reporting process changes are far-reaching across the financial statements, so it’s helpful to break it down and digest it in sections. Today, we wanted to focus on one section in this updated guidance: expense reporting.
What’s Changing – An Overview of ASU 2016-14
Under prior reporting requirements, nonprofits had flexibility in presenting their expenses and even in how much information they reported. Some nonprofits simply grouped their expenses by expense type and not by function, and if they did report them by function, they were not required to disclose their method for making the allocations. ASU 2016-14 changes that. Under the new accounting standard, expenses must be grouped by both their natural classification and their functional classification. Additionally, the footnotes must disclose how expenses are allocated to each function.
Classifying expenses based on their natural properties is what most businesses do intrinsically. Simply put, grouping by natural classification is grouping like expenses together – an employee’s paycheck would be a “wage expense,” or an interest charge would be “interest expense,” regardless of where those fees were generated in your business. The reporting standard describes this method as, “grouping expenses according to the kinds of economic benefits received in incurring those expenses.”
Classifying expenses based on their function is a step beyond that. It’s when you look to their purpose. The wages you pay to workers who run your essential programs will be classified differently than the wages you pay to workers who keep your workspace clean and tidy. There are two main functional classifications: program, and support services.
- Program payments are the expenses that help you run one or more of your main programs. Ask yourself: “Do these expenses directly relate to our mission?”
- Support Services payments are all other expenses that are not directly related to your entity’s purpose, and they are often further subcategorized into (1) management and general activities, (2) fundraising activities and (3) membership development.
- Management and General Activities include oversight, management, human resources, recordkeeping, budgeting, payroll, financing and soliciting funds other than contributions, like through advertising.
- Fundraising Activities include maintaining donor lists, meeting with donors and grant writing.
- Membership Development Activities include soliciting new members or member outreach.
Allocation Methods for Expenses
It’s common for many of your expenses to belong to multiple different functions simultaneously. Your rent, for instance, may be attributed both to fundraising activities and to management activities. Knowing how to allocate these expenses is key. There is no one-size-fits-all rule for how to allocate your functional expenses, but you should be able to support your decision with sound reasoning – and in fact, you are required to do so in the footnotes to your financials. A few common allocation methods are:
- By square footage
Rent, utilities and depreciation are often allocated based on square footage. If your fundraising department operates out of 200ft2 in your 2,000ft2 office, you can allocate 10% of your rent/utilities/building depreciation to the fundraising department.
- By head count
If your workers dedicate themselves solely to one organizational function, you can allocate your expenses based on each department’s head count.
- By time card
If you are like most nonprofits, your employees wear multiple hats, which means that their wage and benefits expenses will need to be allocated among multiple functions. If you have a robust time reporting software, you can ask your workers to code their time based on what they’re working on. At the end of the year, you can run a report to know how to allocate your employees’ wages among the various functions.
The new standard must be reflected on the annual reports for fiscal years that began on or after December 15, 2017. It must also be reflected on the interim reports for fiscal years that begin on or after December 15, 2018. You should apply these changes retrospectively to your financial statements, and when you do, make sure that all reporting periods are using the same methods so that they are comparable.
We know that the functional expense reporting and other aspects of the new standards may be new to you, which is why we are hosting an upcoming seminar on ASU 2016-14 on November 1, 2018. Click here to register for the event. If you are unable to make the seminar or if you have a private question to ask one of our accountants, contact us directly. We would love to help you perfect your reporting process now so that it’ll be smooth sailing for you in the future. We look forward to speaking with you soon.
ABOUT THE AUTHOR
Scott A. Henry, CPA
Scott is a Supervisor at Brown Schultz Sheridan & Fritz with over five years of public accounting experience. He specializes in providing audit and review services to government and nonprofit entities.