Expense Reporting by Function and Nature for Nonprofits

Running financial reports can be daunting even for traditional businesses. As a growing nonprofit organization evolves, the process becomes even more complex. With such a unique set of financial requirements, nonprofit organizations need simplified accounting processes for grant management, budget forecasting, and expense reporting.

Unfortunately, the “doing more with less” resilience for which nonprofits are known can lead to an organization holding onto outdated financial management and business solutions when in reality, these ineffective legacy systems can cost significant time and money as a nonprofit outgrows off-the-shelf accounting systems.

More and more nonprofits are making the switch to cloud accounting software for their grant management and expense reporting requirements. Sage Intacct gives nonprofits a cloud-based financial management solution with functionality and accessibility that manual processes or onsite systems simply can’t provide.

Let’s take a look at some of the complexities of nonprofit expense reporting to illustrate the need for modern cloud accounting with Sage Intacct.

(ASU) 2016-14 Presentation of Financial Statements of Not-for-Profit Entities

The government mandates that nonprofits must use the functional expense classification method to report relevant financial information. This method clusters organizational expenses by their effect and function within the nonprofit, such as fundraising activities and support services. By comparison, the natural expense classification method clusters expenses according to type which includes operational supplies, employee compensation plans, utilities among others.

Nonprofits prepare financial statements for a variety of interested parties which include regulatory bodies, financial institutions, charitable backers, watchdog organizations, public interests, and their own board of directors. Each has different financial priorities and interests and thus benefit from functional vs. natural expense groupings.

As a result, the FASB Accounting Standards Update (ASU) 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, requires that nonprofits disclose both functional and natural expenses because of the unique utility offered by each classification. These different expense groupings can be reported in note disclosures, on their own individual statements, or on the activities statement.

Methods of Determination

Donors and backers of nonprofits often use reported financial information and functional expense reporting to make decisions about their contributions and continued support. For instance, many donors focus primarily on the ratio of dollars raised in fundraising efforts to dollars spent on program activities. Other donors may be more concerned with the organization’s in-kind service sharing with other nonprofits. These different donor priorities benefit from different functional expense classifications in reporting.

How functional expenses are classified is not rigidly defined. Certain operating expenses could be direct expenses that are also functional, such as educational materials for an adult education nonprofit. Other expenses, including administrative supplies and building lease costs, serve a functional role but do not directly fulfill the organization’s charitable mission.

Nonprofits can use direct or indirect allocation to determine the nature of expenses along natural and functional lines.

The method revolves around determining the function of expenses as they relate to their direct utility to the organization. For instance, a nonprofit may spend $500 on mailing costs, of which $400 is spent on mailing materials aimed directly at soliciting donor contributions while $100 is spent on mailing professional materials to employees such as payroll, onboarding materials, tax documents, etc. The total cost of mailing expenses would thus be broken down as follows:

  • Fundraising: $400
  • Program Expenses: $100

The method can be useful for organizations when the direct allocation of their expenses would be too complicated and time-consuming to be viable. This method focuses on both financial and non-financial organizational information to group expenses by some available objective or quantifiable criteria. For example, nonprofits may use the square footage area of their headquarters to determine whether they should designate their lease expenses as part of either their core program activity costs or their program support costs.

Functional Expense Classification for Your Organization

Sage Intacct can help you sort through the different criteria used to classify expenses to meet your different reporting statement goals. As the preferred fund accounting solution for nonprofit organizations, Sage Intacct can help you simplify processes like expense reporting while showcasing the ways in which contributions further your mission.
Contact us at e2b to learn more about Sage Intacct. There’s a Reason Sage Intacct is the AICPA’s Preferred Provider of Financial Applications.

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