February 5, 2019
By Alison Albrecht, CPA | Nonprofit Audit Supervisor
The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-14, Presentation of Financial Statements of Not-for-Profit Entities, to enhance the presentation of financial statements and provide more meaningful information to the readers of the financial statements. One of the changes included in the ASU 2016-14 is the new requirement to present expenses by both their natural and functional classifications. While many organizations are familiar with the ASU and are planning to implement it, following a few best practices will help nonprofits easily comply with the ASU’s requirements.
Tracking and Allocating Expenses
First and foremost, nonprofit entities should be tracking their expenses based on their “natural’ expense category (i.e. salaries, rent, professional services, etc.). The tracking of these expenses can be done inside the accounting software using separate account numbers for the descriptions of the accounts. Similarly, nonprofits should also be allocating their expenses incurred based on their ‘functional’ (program benefited) expense. The main functional categories used and presented are 1) program services 2) fundraising 3) general and administrative, however, other categories are permissible based on the nature of the entity. Under ASU 2016-14, when an entity is preparing annual financial statements, an analysis of expenses by natural and functional categories must be disclosed and presented.
ASU 2016-14 Effective Dates and Requirements
ASU 2016-14 is effective for annual financial statements issued for fiscal years beginning after December 15, 2017 and for interim periods within fiscal years beginning after December 15, 2018. Early adoption of the requirements is also permitted.
A nonprofit entity will now be required to disclose the following information in their financial statements:
- Total cost of program services by their natural classification (i.e. salaries, rent, professional services, etc.)
- Total cost of fundraising (if applicable) and general and administration by their natural classification
- The method(s) used to allocate costs among program services vs fundraising vs general and administrative expenses
Presenting Expenses by Natural and Functional Classification
Nonprofit entities have the option to choose how they would like to present their expenses by natural and functional classification. The disclosure of their analysis of expenses must be presented in one of the three locations in the financial statements:
- The face of the statement of activities
- As a separate statement
- In the notes to the financial statements
Best Practices for Recording and Presenting Expenses
In an effort to ensure your organization is properly recording and allocating expenses, consider first implementing a formal functional expense policy. The purpose of a functional expense policy is to ensure that management has properly documented its definitions of all cost elements and that allocations between functional categories can be properly supported, specifically those costs which are considered to have multiple cost objectives.
Also consider setting up a “class/program” function within your accounting system to be used for all expenses. The “class/program” function would allow management to designate each expense towards one of the programs (i.e. each donor-funded program, fundraising and general and administrative). This information would then allow for the preparation and reporting by each program (including fundraising and general and administrative) and would allow management to review the results from each separate function against the current year (or donor) budgets.
Keep in mind that setting up a “class/program” function inside an accounting software is not the only way to track costs. Detailed reconciliations in Excel can also be used as an alternative and entered into the accounting software either on a monthly basis or at the end of the fiscal year to be used for presenting the functional expense statement. The detailed reconciliations should contain the full expense amount and then split out amongst the different programs benefited.
It is a good idea to periodically review your organizations’ allocation methodology as the organization may change its activities or size from time to time. Using an allocation methodology that is outdated or inadequate given the size of the organization may not accurately depict how the organization is using its resources. After all, the benefit of including a functional expense statement in the organization’s financial statements is to provide readers with a summary on how the organization is using its resources to accomplish its mission.
Consult a CPA who specializes in nonprofit audits for guidance on implementing ASU 2016-14. For more on best practices, watch our December 11, 2018 webinar, Expense Allocations & Indirect Rates — Changes in Trends & Implementation for New ASU 2016-14. If you have specific questions about the requirements of the ASU and presentation of your organization’s expenses, contact Alison Albrecht, CPA, Nonprofit Audit Supervisor at 301-951-9090 or firstname.lastname@example.org.