Functional Expense Reporting: Have a Plan (and Stick to It)
Before you can perform functional expense reporting, you should have a written policy in place addressing cost allocation. The policy should be reviewed at least annually and revisions made as necessary.
Other critical steps for an effective allocation plan include the following:
Be consistent. Use consistent allocation methods over the reporting period and from year to year. Minimize any exceptions to the plan and document them when they do occur.
Establish reasonableness. Make sure you can establish the reasonableness of your expense allocations. For example, analyze overhead expense levels for comparable nonprofits.
Create a chart of accounts. Set up your accounting system to facilitate the allocation process so that you have the necessary data on hand at year-end.
Maintain documentation. Keep supporting documentation that can substantiate your allocations. For example, maintain time studies with signed time cards used to calculate allocation of salary and benefits.
Avoid temptation. While it’s tempting to tweak your ratios, nothing will raise suspicion faster than reporting substantial contribution income with little or no fundraising expenses.
Don’t fall for errors. A common error is failing to appropriately allocate the Executive Director’s salary into all of the activities he or she spends time on. Many organizations instead put the entire salary under Management and General. Likewise, some nonprofits charge all depreciation to administration instead of allocating it across activity centers as a common cost.
From a program director’s salary to rent and utilities, effective cost methodologies can help your nonprofit better understand the true cost of its core activities. Take steps today to ensure you have a plan in place. If you have any questions about cost allocation planning and how it can affect your organization, please contact our nonprofit team at 512.610.7200.