If you are a nonprofit organization in North Carolina you may be required to prepare a statement of functional expenses. The statement of functional expenses is not required for every non-profit organization; however, it is commonly included in the financial statements.
Certain Grants may include language requiring expenses to be reported by functional classification. As a nonprofit auditor, I have seen several North Carolina nonprofits require this when they distribute pass-through funds or issue funds to a subrecipient.
Generally, management of the nonprofit is concerned with the accounting of expenses in their natural classification such as payroll, repairs and maintenance, occupancy, etc. Grantors and Donors are generally interested in the functional classifications. They want to see how much a particular program they support cost and the ratio compared to supporting expenses.
The statement of functional expenses reports expenses according to function. This is different than how the expenses are normal accounted for in the general ledger. Nonprofit organizations account for the expense disbursements on a natural classification like a for profit business. When reporting expenses on a functional basis, the basic classifications are program services and administrative and support services. There may also be a classification for fundraising. Program service expenses are the expenses directly and indirectly incurred to provide the service and fulfill the organization’s mission.
Expenses cannot always be directly matched to a specific program activity, grant, or contract. These types of expenses are considered indirect expenses and must be allocated across the programs applicable including administrative services. The allocation method chosen should consistent and reasonable producing meaningful results. It should be evaluated on a periodic basis to ensure it remains relevant and appropriate. Some examples of indirect cost allocation methods I have seen as a nonprofit auditor performing audits of nonprofits in North Carolina include allocations based on employee’s time spent on various programs, square footage of building used to fulfill programs purpose, actual usage of supplies/telephone/equipment, and percentage of direct cost.
Once an allocation methodology has been decided, the organization should maintain documentation supporting the methodology, any calculation’s used to do the allocation and the basis of the calculations (for example study of timesheets, square footage of shared building with each functional in the building, etc.), support for the original transactions that are being allocated.
Finally, consider internal controls over the allocation process. This may include documentation that describes the organizations activities by function, budgets, chart of account instructions for charging disbursements to a particular program or grant. Management would then review the budget to actual expenditures, distribution of expenses and cost allocation.