Embrace The Value Of Cost Allocation
For nonprofit organizations, cost allocation is often viewed as a daunting administrative task, particularly when managing multiple programs and activities. However, this process is essential to ensure transparency for donors, comply with regulatory standards, and demonstrate effective stewardship of financial resources.
Adhering to Generally Accepted Accounting Principles (GAAP), as established by the Financial Accounting Standards Board (FASB), is a critical component of this process. Below, we explore key FASB standards and best practices to guide your nonprofit in making informed cost allocation decisions.
Read Also: What Your Nonprofit Should Know About Credit Loss Accounting Standards
Understanding FASB Standards for Expense Analysis
Under FASB standards, nonprofits are required to provide a detailed analysis of expenses in their financial statements, categorized by both nature (e.g., salaries, rent, utilities) and function (e.g., program services and supporting activities). This information must be presented in a single, consolidated location—either within the statement of activities, accompanying notes, or a separate financial statement. This requirement ensures stakeholders have a clear understanding of how funds are utilized across the organization’s operations.
Differentiating Program Services and Supporting Activities
A cornerstone of effective cost allocation is distinguishing between program services and supporting activities. According to FASB, program services are those activities directly related to delivering goods and services to beneficiaries, customers, or members in fulfillment of the nonprofit’s mission. These activities represent the core priorities of your organization and are often the primary focus of donor and funder interest.
In contrast, supporting activities encompass all functions that do not qualify as program services. These activities are essential to the organization’s operations but are not directly tied to its mission delivery. Supporting activities must be further categorized into three distinct areas:
1. Management and General Services
These activities are not specific to a single program, fundraising effort, or membership initiative but are vital to the nonprofit’s overall existence. Examples include board oversight, administrative functions, budgeting, human resources, and efforts to generate fee-based revenue. Proper allocation to this category ensures these indispensable costs are accurately represented without being misclassified.
2. Fundraising Activities
Fundraising activities involve efforts to solicit contributions from individuals, foundations, government agencies, and other entities. These costs must be tracked separately to provide transparency regarding the resources invested in generating donations.
3. Membership Development
For organizations with significant membership programs, membership development activities — such as recruiting members, collecting dues, and managing member relationships — should be reported as a distinct category. This is particularly important when membership entails notable benefits or responsibilities.
Addressing Joint Activities and Allocation Challenges
Nonprofits often undertake activities that serve multiple purposes, such as special events or direct mail campaigns that combine fundraising with program or educational components. In these cases, FASB standards permit cost allocation between fundraising and other functions, provided specific criteria related to purpose, audience, and content are met. If these criteria are not satisfied, all costs must be reported as fundraising expenses to avoid misrepresentation.
When allocating costs to the management and general category, it is critical to avoid treating it as a catchall. Certain expenses, such as mortgage interest on a building, may appear to be overhead but should be allocated to specific programs or supporting services when feasible. Similarly, costs like insurance may pertain to multiple functions or a single program, requiring careful analysis to ensure accurate distribution. Over-allocating expenses to management and general services can lead to under-reporting in other critical areas, skewing the financial picture of your organization.
Simplifying Compliance With Professional Guidance
FASB standards mandate that nonprofits disclose the methodology used for expense allocation, emphasizing that approximations or guesswork are not permissible. To navigate this complex process effectively, collaboration with experienced accounting professionals is essential. A well-designed cost-allocation plan can streamline compliance, enhance financial transparency, and strengthen stakeholder confidence.
For expert assistance in developing an effective cost-allocation strategy tailored to your nonprofit’s needs, contact GBQ’s nonprofit services team. Our service professionals are committed to helping you simplify this process while ensuring adherence to regulatory standards and best practices.
Looking for additional insight to help you manage your nonprofit? Check out these resources:
When Your Nonprofit’s Debt-Financed Income Is Subject To Tax
Fundamental Differences Between Nonprofit And For-Profit Accounting
Nonprofit Refresher Course: Excess Benefit Transactions
