Preparing a Statement of Functional Expenses for Faith-based Nonprofits

Understanding Expense Classifications and Allocation Methodologies

Introduction

Faith-based nonprofits, like other nonprofit organizations, are required to present their expenses in a manner that provides meaningful information to their stakeholders. This involves creating a statement of functional expenses which categorizes costs according to their nature and function. Understanding the distinction between these classifications and employing appropriate allocation methodologies is essential for accurate and transparent financial reporting.

Natural vs. Functional Classification

Natural Classification

Natural classification groups expenses according to their inherent nature. Examples of natural expenses include salaries, rent, utilities, supplies, and travel. This classification provides a straightforward view of what types of costs the organization incurs. Avoid using broad categories such as “program expense” when creating natural classifications. That’s a functional label and is too vague to meet the definition of natural classification.

Functional Classification

Functional classification, on the other hand, groups expenses according to their purpose within the organization. Typically, these purposes are divided into program services and supporting services. Supporting services can be further broken down into management and general expenses, fundraising, and membership development activities, if applicable. Functional classification helps stakeholders understand how resources are being utilized to achieve the organization’s mission.

Importance of Expense Classification

Properly classifying expenses is crucial for several reasons. It ensures that donors, grantors, creditors, and organizational leaders have a clear understanding of how funds are being used, which in turn supports transparency and accountability. Moreover, it enables better financial planning and decision-making by providing insights into cost structures and resource allocation.

Tracking Costs and Avoiding Double Charging

Accurate tracking of costs is imperative to avoid charging the same costs to multiple grants or programs, which can lead to compliance issues and potential loss of funding. Each cost should be allocated to the appropriate program or supporting service and documented to ensure accuracy.

Allocation Methodologies for Common Expense Items

Allocating expenses involves determining a rational and systematic basis for distributing costs among various functional classifications. Below are common expense items and suggested allocation methodologies:

• Salaries: Use timesheets or time studies to allocate salaries based on the actual time employees spend on different activities.
• Employee Benefits: Allocate benefits in proportion to salaries or through time studies.
• Payroll Taxes: Allocate based on salary dollars or use studies.
• Supplies: Allocate based on headcount or specific uses.
• Telephone: Use the number of extensions, use studies, or salary dollars to allocate telephone expenses.
• Postage and Shipping: Allocate through use studies.
• Interest Expense: Allocate based on asset use or loan use.
• Rental and Maintenance of Equipment: Allocate based on equipment use.
• Printing and Publications: Use studies or specific uses.
• Travel and Transportation: Allocate based on employee use or salary dollars for those traveling.
• Insurance: Allocate using square footage, asset use, and/or salary dollars.
• Depreciation and Amortization: Use asset use and/or square footage for allocation.
• Website Hosting and Maintenance: Allocate through use studies.
• Other Expenses: Allocate using other reasonable bases.

Reviewing and Updating Allocation Bases

It is essential to review and update allocation bases regularly, especially when significant changes occur, such as acquiring new office space, incurring new debt, starting or discontinuing programs, or changing staff positions. Regular reviews ensure that the allocation methods remain reasonable and consistent over time.

Documentation and Policy Development

Having a documented policy for expense allocation is critical. It should outline the methodologies used, the rationale behind them, and how they are reviewed. This documentation should be shared with organizational leaders, auditors, and users of the financial statements to ensure transparency and compliance.

Conclusion

Preparing a statement of functional expenses is a crucial task for churches and synagogues, and it’s required for compliance with US accounting standards. By understanding the difference between natural and functional classifications, accurately tracking costs, and employing appropriate allocation methodologies, these organizations can ensure transparent and meaningful financial reporting. Regular reviews and well-documented policies further support the accurate allocation of expenses, helping to maintain trust and accountability with stakeholders.

This article was featured in our Religious Organization Guide. View the guide and more related topics here!