The Statement of Functional Expenses (SFE) is a cornerstone of not-for-profit accounting, providing transparency and accountability to donors, stakeholders, and regulatory bodies. However, many organizations face challenges when preparing this critical document. In this article, we’ll explore the importance of the SFE, common challenges, and best practices for ensuring accurate and compliant financial reporting. 

What is the Statement of Functional Expenses? 

The SFE breaks down a not-for-profit’s expenses into functional categories, helping stakeholders understand how resources are used. According to the AICPA, the primary classifications are: 

• Program Services: Expenses related to the purpose or mission for which the not-for-profit exists. 

• Supporting Activities: Activities of a not-for-profit other than program services, including management and general activities, fundraising activities, and membership development activities. 

Why is the SFE Important? 

A well-prepared SFE benefits not-for-profits in several ways: 

• Transparency and Accountability: Helps tell the story of the organization and how funds are used. 

• Compliance: Meets GAAP and IRS requirements, ensuring tax-exempt status. 

• Informed Decision-Making: Helps management evaluate program efficiency and allocate resources effectively. 

• Stronger Fundraising: Demonstrates to donors that funds are used effectively, enhancing trust and potentially increasing contributions. 

Common Challenges in Preparing the SFE 

Not-for-profits often encounter difficulties when creating their SFE, such as: 

• Allocation of Expenses: Difficulty in accurately dividing expenses between functional categories. 

• Consistency: Maintaining consistency in expense classification over time. 

• Regulatory Requirements: Keeping up with changes in accounting standards and regulations. 

• Multi-Program NFPs: Allocating expenses in organizations with multiple, diverse programs. 

• Software Limitations: Using systems not designed for nonprofit accounting. 

• Staff Training: Lack of training or expertise among staff responsible for preparing the SFE. 

Solutions and Best Practices 

Overcoming these challenges requires a strategic approach. Here are some practical tips: 

1. Develop Clear Allocation Policies and Methodology 

• Use methodologies such as time and effort tracking or square footage for shared costs. 

• Regularly review and adjust allocation methods to reflect changes in operations or activities. 

2. Standardize Procedures 

• Implement standardized procedures and templates for expense classification. 

3. Stay Informed 

• Keep abreast of updates to accounting standards and regulations through continuous professional education and industry publications. 

4. Address Multi-Program Complexities 

• Detail program codes and allocate indirect costs systematically to ensure fairness. 

5. Invest in Nonprofit-Specific Accounting Software 

• Use accounting software tailored to nonprofits and integrate it with donor and payroll systems. 

6. Focus on Staff Training 

• Provide ongoing professional development and cross-training to ensure that knowledge is not siloed and to offer coverage during absences. 

Preparing an accurate Statement of Functional Expenses is vital for maintaining transparency, compliance, and donor trust. By addressing common challenges and following best practices, not-for-profits can confidently manage this essential aspect of their financial reporting. 

This article is a summary of a webinar previously presented by our not-for-profit experts, Claire Manspile and Allison Shrader. Visit our Engagement Hub to watch the full webinar and access additional resources.