Linda J. Kramer, CPA, MBA
Accounting & Auditing Director

Nonprofit organizations were challenged a few years ago when they had to adapt to the significant changes in financial reporting standards that became effective with ASU No. 2016-17 – Presentation of Financial Statements of Not-for-Profit Entities. But with a few years under their belts, many nonprofits have learned how to gain insights into their operations from the Statement of Functional Expenses. 

Among other changes, the new requirements include the presentation of expenses by both natural and functional classifications in the financial statements. There are multiple reporting and presentation options available to accomplish this, including reporting expenses by nature and function in the Statement of Activities, in a separate Statement of Functional Expenses or in a footnote disclosure.

At the time of implementation, this was new to most nonprofits and a review of the internal chart of accounts and various departments was recommended to ensure expenses were being captured properly to facilitate reporting expenses by nature and function. Nonprofit organizations also had to establish a method to allocate indirect or shared expenses by function, including such expenses as depreciation, interest, occupancy costs, etc.

If you have not already done so, it would be a good time to revisit the disclosure to see if improvements can be made in either the natural classification or allocations to functional classifications to better depict your organization’s story. Things to consider:

• Aggregation of natural categories should be as simple as possible with a focus on those that provide the most significant return for the program. Do you have too many natural categories or not enough? Have those categories changed over the past years with changes in the programs?
• Do you have too many programs? Can some be combined as the mission of those programs may be similar?
• Are direct costs being captured for the correct programs?
• Allocation methods should be reconsidered to see if other methods would present a more accurate picture. As an example, should employees maintain time sheets or is a management estimate fine?
• Should depreciation be allocated based on the use of specific assets related to certain programs?
• Is square footage the best method for allocating costs such as rent, insurance, utilities and building depreciation or is space used for more than one program, making a percentage of time a more accurate method?

Be sure to involve the right people in the cost allocation process. This may include program managers who are close to the operations of their programs. Proper allocations can also tell you which programs may require more fundraising focus and which may need to be considered for re-evaluation.

Contact your GT Reilly advisor for a discussion about how your Statement of Functional Expenses can help you improve your nonprofit’s operations.