FASB recently issued its new accounting standard update for nonprofits (ASU 2016-14), which will apply to fiscal years beginning after December 15, 2017.
As part of the new standard, there is significant updated guidance concerning the accounting for functional expenses.
Right now is a good opportunity for nonprofits to take a closer look at their functional expense accounting and make course corrections, so that there are no surprises down the road (e.g. during audit time).
This updated guidance can be found in sections 958-720-45 and 958-720-55 of the FASB Accounting Standards Codification (available at asc.fasb.org).
To make things a little clearer, the key provisions of the updated guidance are detailed below.
All nonprofit organizations will be required to present information on their expenses:
- By function (e.g. program activities, management & general, fundraising, and membership development); and
- By natural classification (e.g. salaries, rent, consultants, etc.)
This must be provided in one location in your financial statements. Many nonprofits already do this.
It will typically be accomplished with the Statement of Functional Expenses, which uses a matrix format that separates expenses into functional columns as well as traditional line item categories.
Coding day-to-day expense transactions
The most immediate impact of the new functional expense accounting guidance is that it will change how your bookkeeper codes expense transactions in your accounting system.
This is broken down below.
These are “the activities that result in goods and services being distributed to beneficiaries, customers, or members that fulfil the purposes or mission for which the NFP exists.”
Expenses that should be classified as program expenses include the direct conduct and/or direct supervision of program activities.
IMPORTANT: If an activity simply benefits a program, this alone cannot be used as a reason to record it as a program expense. See additional information below under “Shared” Costs.
Management & General (M&G), a.k.a. Administrative
This includes some activities that appear straightforward and others that, intuitively, may not have seemed like M&G expenses in the past:
- General oversight;
- Corporate governance;
- Disclosing information to the general public (e.g. annual report);
- Program advertising;
- Soliciting funds other than contributions and membership dues (i.e. encouraging customers/clients to purchase goods or services from you, negotiating program service contracts, etc.);
- Billing and collecting fees relating to program service contracts;
- Administration of benefits/human resources; and
- Miscellaneous – expenses other than “direct conduct of program services, fundraising activities, or membership development activities.” If something doesn’t easily fit into another functional category, there is a good chance that it belongs in M&G.
This includes the cost of activities relating to soliciting contributions of “money, securities, services, materials, facilities, other assets, or time”.
It is a pretty straightforward category. However, when you are attempting to secure funding, the cost of the solicitation may be a fundraising expense or it may be an M&G expense, and it may not always seem clear.
The determining factor should be the type of funding you’re trying to secure (earned or contributed).
For example, for a contribution from a government agency, the solicitation cost is a fundraising expense. But, for a fee contract from the same government agency, the solicitation cost is an M&G expense.
So, in determining how to classify expenses associated with the solicitation of funding, you may also need to consult the ASC section on revenue recognition (ASC 958-605).
If associated expenses are significant, membership organizations present a category entitled “Membership Development”.
This includes the cost of soliciting membership dues from prospective members, as well as serving the existing membership base.
The ASC discusses the concept of “direct conduct and direct supervision” when determining whether certain “shared” expenses can be allocated to functions other than M&G.
For many organizations, the updated guidance may significantly increase expenses classified as M&G.
The ASC describes several examples that help clarify what types of expenses may or may not be allocated to non-M&G functions.
Examples of expenses that would be allocated to non-M&G functions
- CEO’s time (i.e. compensation) spent directly supervising a research program (program)
- CEO’s time spent cultivating donor relationships (fundraising)
Examples of expenses that should remain in M&G (even if they were previously allocated to non-M&G functions)
- CEO’s time spent on indirect supervision/management (time that cannot be identified with a specific program, fundraising, or membership development activity).
- Human resources staff
- Grant accounting
When a nonprofit determines that certain expenses may be allocated across functions in accordance with GAAP, they will disclose in their financial statement notes:
a. Which specific expenses are allocated, and
b. The method used to determine the allocation.
For a more thorough discussion of accounting for functional expenses, please visit the ASC, which is the only official/authoritative source for GAAP.
Additional helpful references include the AICPA Accounting and Audit Guide for Not-for-Profit Entities and Wiley’s Not-for-Profit GAAP Guide, both of which are updated annually.