Non-profits are required to have a Statement of Functional Expenses that is representative of their expenses throughout the year. Here are a few of the common mistakes when preparing the Statement and how to avoid them.
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ASU 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities requires all Non-Profit entities to have a Statement of Functional Expenses present in their financial statements. Non-Profit organizations utilize this Statement to show a detailed classification of their expenses incurred. If the organization is required to file a Form 990 (if they are a tax-exempt, nonprofit organization), then the information in this Statement is included on their 990. In this Statement, functional expenses are allocated by their nature- program services or supporting activities. Program services include expenses that are directly related to a program the organization has, while supporting activities include fundraising and management and general expenses.
Some of the main mistakes that occur with this Statement include improper classification, questionable allocation methods, and the fundraising salaries not being allocated proportionately.
One of the tricky things about this Statement is deciding what should be categorized as a management and general expense. An expense should be classified as management and general if it is not directly related to a program (hence why it is a supporting expense). Some examples of these expenses include human resources, business management, budgeting, general organization oversight, and financial activities.
Who decides how to allocate the expenses on this Statement? Management of the organization uses their professional judgement to do so. Many members of management will assign a certain percentage to each expense category to show how much will be program vs. supporting. This percentage is usually an estimation based on their knowledge of the organization. Auditors need to evaluate how these expenses are allocated and confirm that the method is reasonable and representative.
If an organization gets a significant amount of their income from donations, there is probably at least one employee whose sole job is to help raise money. When organizations have fundraising personnel, they need to take this into consideration when allocating the expenses associated with their salaries. Fundraising salaries should be allocated greatly to the fundraising category, not just to the management and general group.
Overall, these points show that a lot of professional judgement should be used when preparing the Statement of Functional Expenses, on the organization’s side and also on the auditor’s side, so that it will be representative of how the expenses are spent throughout the year.