It is a very common report in the financial world and you may want to add it to your in-house reporting schedule. Your auditor will expect to see an explanation of your functional expenses (although the required format may vary). Tracking and allocating functional expenses is a major bookkeeping challenge for small nonprofits. However, nonprofit-friendly accounting software can help you make creating your Statement of Functional Expenses fairly easy. Because you’re required to report functional expenses to complete your IRS 990 and maintain nonprofit status.

A simple example of functional expense allocation:

Not to mention, failure to accurately report functional expenses on your Form 990 could put your organization’s nonprofit status in jeopardy. The statement of functional expenses stands as an essential instrument in the financial toolkit of nonprofit organizations. Beyond its primary function of detailing expenses, it plays an instrumental role in cultivating trust and establishing open communication with stakeholders. When crafted meticulously and transparently, this statement becomes a testament to an organization’s commitment to its mission and its accountability to those it serves.

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The categories represented by the rows are often referred to as natural expenses, which organize expenditures based on the nature of the payment rather than its end goal. Additionally, this is often how transactions are recorded in your accounting system as they occur. As we have discussed above, a nonprofit has to record all its expenses in classifications.

Reporting Expenses by Their Nature

It also promotes analysis and discussion about the mission relevance of each activity in an organization’s program portfolio. These discussions can lead to renewed commitment for those program activities requiring subsidy and to exploration of different fundraising strategies to support them. Your reports can then tell you how close you are to your plan for each activity and whether you need to make any course corrections. A key component of this accountability-focused approach to accounting is compiling financial statements, which are documents that summarize your nonprofit’s use of funds. The Statement of Functional Expenses is a key financial report for non-profit organizations. This detailed document offers a comprehensive view of an organization’s expenses, grouped by both function and nature.

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A nonprofit organization incurs fundraising expenses specifically for activities they undertake to solicit and manage donations. Consequently, the Statement of Functional Expenses typically reports these expenses separately. While these costs might not directly contribute to the mission, they are vital for efficient long-term survival. Therefore, nonprofits must maintain a reasonable ratio between program service expenses and management and general expenses. This approach is more fine-grained, and so results in more line items on the income statement. Examples of reporting by nature are repairs and maintenance expense, salaries expense, and utilities expense.

What is a Statement of Financial Position in a Nonprofit?

It provides a detailed breakdown of expenses according to their functional categories, such as program services, management and general administration, and fundraising. This statement offers transparency into how resources are utilized to achieve the organization’s mission, fostering trust among donors, stakeholders, and the public. Your nonprofit’s statement of functional expenses is vital to an effective financial management strategy.

These 3 expense categories are mandatory for the IRS, but you may choose to track others internally. Reporting noncash investing and financing activities requires separate disclosures. Examples of these activities may include receiving contributions of fixed assets or securities, purchasing a building by incurring a mortgage, or obtaining an asset by entering into a capital lease.

This line includes, office supplies, telephone expenses, postage and delivery expenses, shipping, equipment rentals, bank fees, and other similar costs. Going back to Coats 4 Kidz, let’s say the nonprofit is currently housed in a 1,000-square-foot office space. Twenty-five percent of the space is used equally https://accounting-services.net/ by all employees, while 30% is occupied by program staff, fundraising occupies 25%, and management takes up 20%. Nonprofit accounting differs from business accounting, because nonprofits don’t exist to make profits. They instead fulfill missions aimed at addressing specific needs in our society.

In some cases, the cost spent for fundraising has to be counted under the program account. The costs of salaries of employees working on raising funds go into this account. Most of the expenses counted here are for bookkeeping, governance, and management.

1. This provides transparency and shows how much of your funding is used on your mission-related activities vs. how much is used for the organization.
2. If you have any questions about joint costs, check out our blog “Is My Nonprofit Allocating Joint Costs Properly?
3. Operating expenses distribution involves the system by which an accountant or bookkeeper of a non-profit entity classifies each cost according to its functional classification.
4. Non-profit accounting is separate from corporate accounting, as no non-profits work to make a profit.

The statement of functional expenses is described as a matrix since it reports expenses by their function (programs, management and general, fundraising) and by the nature or type of expense (salaries, rent). For instructional purposes we highlighted the column headings to indicate the expenses by function. We also highlighted the words in the first column as they indicate the nature or type of expenses.

Good accounting software will also allow directors to compare budgeted amounts to actual amounts and make the necessary adjustments. Budgeting is also complicated when sources of support are not secured at the time the budget is prepared for the upcoming year. This could lead to the use of an account entitled Resource Development in order to balance the budget. We would then add the additional $29.16 to that total to have the complete allocation for the month. Take our 2-minute survey to find out if outsourced accounting and bookkeeping is a good fit for your organization. So if you’re ready to modernize your finances and finally find the time to focus on your mission, click the button below to find out how we can help you.

Organizations can create a custom export of all expenses grouped by both natural and functional expense types. All of these expense details are also automatically exported to your accounting system so that you can build your financial statements with clean and organized data. The nonprofit statement of functional expenses is a table- or matrix-style report that breaks down your organization’s expenditures into categories based on what purpose the money was used to accomplish. Typically, the three categories of functional expenses are program, administrative, and fundraising expenses (which will be covered in more detail later). Additionally, all nonprofits must file an informational tax return, Form 990, made publicly available by the IRS.

In fact, nonprofit financial statements are so important that many nonprofit organizations will make their annual reports publicly available by sharing them on their website. Following the Financial Accounting Standards Board requirements, all non-profit organizations in the US now have to declare their expenditures according to their practical classification refm certification and their natural classification. An organization must, at minimum, allocate expenses among program, management, and fundraising for purposes of the IRS 990 report and the organization’s audit (if applicable). Activity-based budgeting and reporting also benefits the organization as it allows an organization to see its business model.

For nonprofit organizations and 501(c)(3) and 501(c)(4) not-for-profit organizations, a statement of functional expenses (often abbreviated to an SOFE) requires the classification and reporting of functional expenses. Understanding functional expenses, how to report them, and how to differentiate them from natural expenses can be tough for busy nonprofits. But tax and accounting concerns don’t have to be a headache that detracts from time and efforts spent accomplishing your organization’s mission. In the below article, the nonprofit tax accounting experts at Flynn & Company simplify the concept of functional expenses for you. The final report that nonprofit organizations are required to run is the statement of functional expenses, which reports expenses based on functional classifications. Each organization’s statement of functional expenses will look slightly different depending on what natural expenses they incur and how resources are allocated.

This provides transparency and shows how much of your funding is used on your mission-related activities vs. how much is used for the organization. That means that we’ll have to allocate an additional $29.16 in utility expenses to each of the three functional expense categories. If employees split their time between several programs or organizational areas, their time must be tracked and allocated properly. For example, Ann runs an agricultural nonprofit called Back to the Land that offers several different programs ranging from onsite farm training to financial planning seminars for farm and ranch owners. Nonprofit reporting is different from that of a for-profit business, with nonprofits issuing the following financial statements.