Cost allocation probably isn’t your favorite task — particularly if your not-for-profit has many activities. Yet the process is critical because donors and funders want to know how your organization uses its financial resources. In addition, you likely need to comply with Generally Accepted Accounting Principles (GAAP), which are determined by the Financial Accounting Standards Board (FASB). Let’s look at some FASB standards that might apply to your cost allocation.
Nature and function
FASB standards require not-for-profits to include in their financial statements an analysis of expenses by nature (such as salaries, rent, and utilities) and function (program services and supporting activities). Your organization must present information about expenses in one location on its statement of activities, either in the financial statement notes or a separate financial statement.
Properly allocating costs between program services and supporting activities is critical. According to FASB standards, program services are activities that result in goods and services being distributed to beneficiaries, customers, or members that fulfill your not-for-profit’s purpose or mission. They’re your not-for-profit’s major priority.
3 categories
Activities that don’t qualify as program services are considered supporting activities. These should be broken down into three categories:
- Management and general services. These items aren’t identifiable with a single program, fundraising activity, or membership activity but are indispensable to your not-for-profit’s existence. They generally include oversight and administration, budgeting, human resources, and obtaining fee-based revenues.
- Fundraising. This includes activities involved in soliciting donations from individuals, foundations, government agencies, and others.
- Membership development. This refers to recruiting prospective members, collecting membership dues, and managing member relationships. Membership development should be stated separately in your financial statements if significant benefits or duties are associated with membership.
Not-for-profits often engage in fundraising activities that also have elements of another function. For example, a special event or direct mail campaign might include both fundraising and program components. In such cases, you should allocate these costs between fundraising and the other functions if specific criteria related to purpose, audience, and content are met. If those criteria aren’t met, you’re required to report all costs of the joint activity as fundraising.
When it comes to the management and general category, don’t treat it as a catchall. Some expenses that might seem like overhead — such as mortgage interest on a building — should be allocated to specific programs or supporting services whenever possible. Additionally, certain costs that appear to relate to management and general functions might belong to more than one function. For instance, insurance could cover property that houses multiple functions or a single program. Moreover, recording too much expense to management and general can result in under-allocation to other functions.
A complicated process simplified
FASB standards require not-for-profits to disclose the method they use to allocate expenses. However, guessing and estimates aren’t allowed. That’s why it’s essential to work with knowledgeable accounting professionals. Contact us. We can help you simplify the process with an effective cost-allocation plan.
