Classifying Functional Expenses for Nonprofits

by Mary Varano
Businesswoman Calculating Invoices

Implementing the financial accounting standards board (FASB) Accounting Standards Update (ASU) 2016-14, Presentation of Financial Statements for Not-for-Profit entities can be confusing. The updated standard states nonprofits must present an analysis of expenses by their function and natural expense classifications in one location, such as in a statement of functional expenses. While this was effective beginning in calendar 2018 years, we still see our nonprofit clients struggle with full GAAP adoption of this topic.

The ASU requires expenses for nonprofits to be classified under three categories:

  • Program
  • Management & General
  • Fundraising

These classifications are the purpose for which the costs are incurred. The functional expenses are further classified by nature, so the final financial presentation is a clear picture of a nonprofit’s overall expenses. The goal of the updated nonprofit reporting standard is, as always, transparency for donors.

There are three different functional expense categories nonprofits can classify their expenses under:

  1. Program – The activities that result in goods and services being distributed to beneficiaries, customers, or members that fulfill the purpose of the mission for which the NFP exists.
  2. Management & General – Supporting activities that are not directly identifiable with one or more program, fundraising, or membership development activities. These must include :
    • Oversight
    • Business management
    • General record keeping and payroll
    • Budgeting
    • Certain financing costs
    • Soliciting funds other than contributions and membership dues
    • Administrating government, foundation, and similar customer-sponsored contracts.
    • Advertising for exchange transactions (covered in ASU 2018-08)
  3. Fundraising – Activities undertaken to induce potential donors to contribute money, securities, services, materials, facilities, or other assets or time.

Expenses attributable to only one function are direct costs and are usually easily identifiable. Indirect costs can be more challenging to identify as they are attributable to more than one program or supporting function. These expenses require allocation on a reasonable basis, for example square footage, actual usage, number of hours, etc.

Once you’ve determined which functional expense category your cost belongs under, it’s time to classify the cost further by defining the nature of the cost. By making each classified functional expense its own line item, such as salaries, payroll taxes, employee benefits, depreciation, etc., nonprofits can meet the requirements of the new standard.

The Nonprofit team at Corrigan Krause recommends evaluating costs annually and considering only changes to programming or allocations, and otherwise choosing a method that is consistent for generally accepted accounting principles and presentation.

While you are required to present by nature and function, we also recommend keeping allocations logical and simple, and natural classifications minimal. Natural categories, such as office expenses, are acceptable and recommended to capture major categories. Separating each cost into a highly specific category, like paper, supplies, printing, etc. isn’t necessary, unless any of those categories are meaningful on their own to your nonprofits mission.

We are here to help

The nonprofit team at Corrigan Krause is ready to help you navigate the updated functional expense standards. Email for more information.

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*Additional updates in ASU 2016-14 to liquidity disclosures, net asset classification, and cash flows with restricted cash are not covered in this article.