Telling Your Story with Functional Expense Schedules

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Not-for-ProfitTHOUGHTWARE®

Telling Your Story with Functional Expense Schedules

January 14, 2020

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TO RECEIVE CPE CREDIT

• Individuals Participate in entire webinar

Answer polls when they are provided

• Groups Group leader is the person who registered & logged on to the webinar Answer polls when they are provided Complete group attendance form Group leader sign bottom of form Submit group attendance form to [email protected] within 24 hours of webinar

• If all eligibility requirements are met, each participant will be emailed their CPE certificate within 15 business days of webinar

Presenters

Emily George, CPASenior Managing [email protected]

Stephanie Whitacre, [email protected]

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Today’s Topics

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Program services analysis

Management & general clarification

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Indirect cost

5 IRS Form 990Functional analysis

6 Substantiating allocations

Common errors in functional reporting

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Statement of Functional Expenses

• Presents an organization’s expenses by both natural & functional categories

• Functional categories

Program

Administrative

Fundraising

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Reporting of Expenses by Nature & Function

• Functional analysis requirement for all organizations (in one location) either on

The face of the statement of activities,

As a separate financial statement, or

As a schedule in the notes to the financial statements

• Must show by function & natural classification

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What Is Functional Analysis?


• The relationship between functional classification & natural classification for all expenses shall be presented in an analysis that disaggregates functional expense classifications, such as

Major classes of program services &

Supporting activities• Management & general

• Fundraising

• Membership development

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Reporting of Expenses by Nature & Function• Required to provide qualitative disclosures about methods used to allocate costs

among program & support functions

• Examples, per the standard, of natural expenses Salaries & wages

Employee benefits

Professional services

Supplies

Interest expense

Rent

Utilities

Depreciation

Expenses vs. Losses

• No requirement to report losses by functional category

• Examples of losses Bad debt – can be either expense or loss

Impairment of long-lived assets

Change in market value of investments

Foreign exchange rates

Natural catastrophes

Sell of building & equipment

Winning/losing a lawsuit

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Functional Classification Defined

• Method of grouping expenses according to the purpose for which the costs are incurred

• The primary functional classifications are program services & supporting activities


Program Services –Top Three Programs

Supporting Services

Fundraising Management & General

Membership Development

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Functional Classifications –Management & General

• Management & general

Activities that are not identifiable with a program, fundraising activity or membership-development activity, but are indispensable to the organization

Functional Classifications –Management & General

• Management & general

May include accounting, general management & oversight, audit, budgeting, financing, communications with the public, human resources, insurance, occupancy, legal & risk management

What are some other types of G&A expenses?

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Functional Classifications – Fundraising

• Fundraising Activities that involve inducing potential donors to

contribute money, securities, services, materials, facilities, other assets or time

Includes publicizing & conducting fundraising campaigns, maintaining donor lists, conducting special events, preparing & distributing fundraising materials, etc.

Financial statements should disclose total fundraising expense

Direct Identification vs. Allocation

• Direct identification of specific expenses is the preferred method for charging expenses to various functions as it is viewed as the most accurate

• If an expense can be specifically identified with a program or supporting service, it should be assigned to that function

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Program Services Analysis

Program Services

• Activities that result in goods & services being distributed to beneficiaries, customers or members that fulfill the purposes or mission for which the NFP exists

• Major purpose for & the major output of the NFP & often relate to several major programs

• Interrelationships of program expenses & program revenues can help determine major program services

Segments

Cost center/projects/funds

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Program Services – Factors to Consider from the Audit & Accounting Guide (13.57)• Program objectives

• Nature of services

• Constituents served

Disaggregated by geographic demographics

Disaggregated by other demographics

• Magnitude of the program to the NFP’s overall activities

• Budgetary categories

• Oversight, regulatory, grant or other compliance requirements that separate the program from others

Program Services – Correlates To …

• Fundraising materials

• Programmatic promotional materials

• Website descriptions

• 990

• Annual reports

• Other public information

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Program Services – Examples

• University: student instruction, research, patient care, other

• Health & welfare entity: health or family services, research, disaster relief, public education, other

• Federated fundraising entity: making contributions to NFPs

• American Cancer Society: patient support, research, prevention, detection/treatment

• Homeless shelter: feed the homeless, housing for homeless

• Religious: worship services, youth instruction, adult instruction, family counseling, fellowship

Financial Reporting Requirements –Joint Activity

• FASB ASC Master Glossary defines a joint activity as “an activity that is part of the fundraising function & has elements of one or more other functions, such as program, management & general, membership development or any other functional category used by the entity”

• Membership development activities of not-for-profit entities often may be conducted in conjunction with other activities. In circumstances in which membership development is in part soliciting membership dues & in part soliciting contributions, the activity is a joint activity

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Financial Reporting – Joint Costs

• Joint costs are the costs of conducting joint activities that are not identifiable with a particular component of the activity

Joint costs may include, but are not limited to, the following

Salaries, contract labor

Consultants, professional fees, legal fees, accounting fees

Paper, supplies, printing, postage

Event advertising

Telephones, utilities

Depreciation

Airtime, websites, print advertising, brochures

Facility rentals


• To the extent that expenses are reported by other than their natural classification (such as salaries included in cost of goods sold or facility rental costs of special events reported as direct benefits to donors), they shall be reported by their natural classification in the functional expense analysis

• For example, salaries, wages & fringe benefits that are included as part of the cost of goods sold on the statement of activities shall be included with other salaries, wages & fringe benefits in the functional expense analysis

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• External & direct internal investment expenses that have been netted against investment return shall not be included in the functional expense analysis

• Certain items that are typically reported in other comprehensive income of for-profit entities, are considered gains or losses &, like other gains & losses, shall not be included in the functional expense analysis

Functional Analysis Qualitative Disclosure Example

• The financial statements report certain categories of expenses that are attributable to more than one program or supporting function. Therefore, these expenses require allocation on a reasonable basis that is consistently applied. The expenses that are allocated include depreciation, supplies & travel, services & professional fees, office & occupancy, insurance, recruitment of volunteers & other (which includes staff & volunteer training, development & children’s sustenance), which are allocated on a square-foot basis, as well as salaries & benefits, which are allocated on the basis of estimates of time & effort

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Functional Analysis Footnote Example –Clarification Guidance from New Standard

• Note – methods used for allocation of expenses from management & general activities

The financial statements report certain categories of expenses that are attributable to one or more program or supporting functions of the organization

Those expenses include depreciation & amortization, the president’s office, communications department & information technology department

Depreciation is allocated based on square footage, the president’s office is allocated based on estimates of time & effort, certain costs of the communications department are allocated based on estimates of time & effort, & the information technology department is allocated based on estimates of time & costs of specific technology used

What Is an Indirect Cost?

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Indirect Cost

• Indirect costs are those for activities or services that benefit more than one project or activity

• They’re not readily identified with a particular grant, contract, project function or activity, but are necessary for the general operation of the organization

Indirect Allocation Methods

• There is no one right way or required method. We as auditors look to see if the allocation is

Reasonable

Accurately calculated

Consistently applied methodology

Reviewed by management

Methodology is reasonable

Document in an allocation plan/memo

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• Examples

Time study

Square footage

Actual usage – telephone allocated based on extensions, supplies/postage based on a study of their use, depreciation or rental of equipment based on asset usage …

% of direct costs

Indirect Allocation Methods• Illustration 1

Assume a direct mail campaign is used to conduct programs of the entity & to solicit contributions to support the entity & its programs. Further, assume that the appeal meets the criteria for allocation of costs to more than one function

The letter & reply card include a total of one hundred lines. Forty-five lines pertain to program because they include a call for action by the recipient that will help accomplish the entity's mission, while fifty-five lines pertain to the fundraising appeal. Accordingly, 45% of the costs could be allocated to program & 55% to fundraising

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• Illustration 2

Assume costs associated with a direct mail campaign including both program & fundraising components are costs of stationery, postage & envelopes, at a total of $100,000

Costs of stationery, postage & envelopes to produce & distribute each component separately would have been $90,000 for the program component & $70,000 for the fundraising component


• Illustration 2

Under one cost allocation method, $100,000 in indirect costs could be allocated as follows

$90,000/$160,000 × $100,000 = $56,250 to program services &

$70,000/$160,000 × $100,000 = $43,750 to fundraising

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• Illustration 3

Assume an organization is a school & rents their one building in which all activities of the school take place. Total square footage of the building is 100,000 square feet

Management has physically determined the classrooms make up 50,000 square feet of the space, while the development department takes up 25,000 square feet & administration staff take up the remaining 25,000 square feet


• Illustration 3 The organization has then determined that certain

overhead costs such as rent expense, utilities & repairs & maintenance could be allocated on a functional basis as

50% – program services

50% – supporting services – broken down further as• 25% – fundraising

• 25% – management & general

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Management & General Clarification

Functional Analysis – Illustrative Cases for Allocation of Expenses from Management & General

• In accordance with the cases presented in the next few slides, a not-for-profit would be required to assess which activities constitute direct conduct or direct supervision of a program or support function &, therefore, would require allocation of costs

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• Case A – CEO allocation

The broad responsibilities of a CEO generally include administrative & programmatic oversight

At Not-for-Profit Entity A (NFP-A), the CEO spends a portion of time directly overseeing the research program

In addition, a portion of time is spent with current & potential donors on fundraising cultivation activities


• Case A – CEO allocation

A portion of the CEO’s compensation & benefits & other expenses would be allocated to the research program & to the fundraising function representing the portion of time spent on those activities because they reflect direct conduct or direct supervision

If the remainder of the CEO’s time is spent indirectly supervising the other areas of NFP-A, including the administrative areas, those activities would not constitute direct conduct or direct supervision, & the ratable portion of compensation & benefits would remain in management & general activities


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• Case B – CFO allocation

The CFO at Not-for-Profit Entity B (NFP-B) has primary responsibility for (a) accounting & reporting, (b) short-term budgeting & long-term financial planning, (c) cash management & (d) direct oversight of NFP-B’s endowment

A portion of the CFO’s compensation & benefits & other expenses would be allocated to management & general activities for the accounting & reporting, the short-term budgeting & long-term financial planning & cash management functions because they benefit the overall organization


• Case B – CFO allocation

A portion also would be allocated to investment expenses for management of the investment strategy of the endowment & would be netted against investment return

However, any portion of time spent supervising the accounting for investments or other fiduciary oversight would not be allocated to investment expenses because that time is related to an accounting & general management activity that benefits the overall organization & should be allocated to management & general activities


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• Case C – human resources department allocation

The human resources department at Not-for-Profit Entity C (NFP-C) generally is involved in the benefits administration for all personnel of NFP-C

The human resources department’s related costs would not be allocated to any specific program

Rather, those costs would remain a component of management & general activities because the benefits administration is a supporting activity for the entire entity


• Case D – grant accounting & reporting allocation

Not-for-Profit Entity D (NFP-D) receives federal grants & employs an accountant who is responsible for grant accounting & reporting

In some cases, under the terms of the grant agreement, a fiscal report is required to be filed that details expenses incurred & charged against the grant

• The fiscal report is not part of the direct conduct or direct supervision of the grant, but rather is an accounting function

• Therefore, the grant accountant’s compensation & benefits would not be allocated to the programmatic area


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• Case D – grant accounting & reporting allocation

However, a scientific report prepared by a principal investigator who is responsible for the research activity would be indicative of direct conduct &/or direct supervision of the grant activity, & the principal investigator’s compensation & benefits would be allocated to the grant


IRS Form 990 Is Different (Keep in Mind)

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990 Expense Categories (Line per Form 990, Part IX)

• Grants & other assistance (1–3)

Domestic organizations & governments

Domestic individuals

Foreign organizations, governments & individuals

• Benefits paid to or for members (4)

• Salaries & wages, various forms (5–7)

• Employee benefits, various forms (8–9)

• Payroll taxes (10)

• Fee for services (nonemployees) (11)

Management

Legal

Accounting

Lobbying

Professional fundraising services

Investment management fees

• Advertising & promotion (12)

990 Expense Categories(Line per Form 990, Part IX)• Office expenses (13)

• Information technology (14)

• Royalties (15)

• Occupancy (16)

• Travel (17–18)

• Conferences, conventions & meetings (19)

• Interest (20)

• Payments to affiliates (21)

• Depreciation, depletion & amortization (22)

• Insurance (23)

• Other expenditures (24)

• Joint costs (26)

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Tax Reporting

• Only 501(c)(3) & (4) or nonexempt charitable trust must categorize as

Program service expense

Management & general expense

Fundraising expense

• Use a reasonable method of allocation

• Do not include the following expenses

Rental expenses that should be netted with rental income

Cost of inventory sold

Special events or gaming expenses

New line items

Substantiating Allocations

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• Organizations should maintain documentation supporting

Allocation methodology

Calculations used to do the actual allocation & to support disclosures in the financial statements

Basis of calculations, e.g., time studies with signed timecards, head count of FTEs by department/function, square footage of a shared facility & each functional area within the facility, etc.


• Organization should maintain documentation supporting

Reasonableness of the allocations: may include industry information/comparables, trend information for prior years & analysis of this information with respect to current-year allocations

Support for the original transactions that make up the expenses that are allocated

Use of consistent methodology during the period & from year to year

Internal controls surrounding expense allocation process

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Common Errors in Functional Reporting

Common Errors in Functional Reporting on Form 990 • 37% of not-for-profits reporting more than $50,000 in contributions

report zero fundraising or special event costs to the IRS

Program-spending ratio

Fundraising-efficiency ratio

• 13% of not-for-profits report zero management & general expenses

• 7% charged all accounting fees to program & another 20% split them across more than one category

Source: “Nonprofit Overhead Cost Project,” Kennard Wing, Teresa Gordon, Mark Hagar, Thomas Pollak & Patrick Rooney

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Common Issues in Functional Reporting in Financial Statement

• Most common errors in allocating costs include the following

Not properly allocating management/general expenses

Reporting no fundraising expenses when the organization has substantial contribution income

Not reporting all of the major programs separately or reporting a grantor as a program

Not allocating insurance, occupancy & depreciation


• Difficulty maintaining general ledger on a functional basis, particularly overhead costs

• Establish a means of tracking separately & then allocating management & general costs to various cost centers based on a percentage of staff time charged to a particular cost center or some other reasonable method

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• Use of a fixed percentage to allocate costs rather than a basis more accurately representing true cost allocations

• Financial reports that are not truly representative of the related functions

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Continuing Professional Education (CPE) Credit

BKD, LLP is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be submitted to the National Registry of CPE Sponsors through its website: www.nasbaregistry.org

The information contained in these slides is presented by professionals for your information only & is not to be considered as legal advice. Applying specific information to your situation requires careful consideration of facts & circumstances. Consult your BKD advisor or legal counsel before acting on any matters covered

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• For questions, concerns or comments regarding CPE credit, please email the BKD Learning & Development Department at [email protected]

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Telling Your Story with Functional Expense Schedules

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