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4 steps to improve nonprofit functional expense reporting

Expense reportingCongress, the media, watchdog agencies and funders — almost everyone wants to know how nonprofits are using their scarce resources. They look at functional expenses to make that determination, so it’s important to present the most useful and transparent information possible.

To that end, FASB Accounting Standards Update (ASU) 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, requires not-for-profit entities to disclose their expenses by both functional and natural classification in one location. This ASU gives you good reason and opportunity to review your current classifications to determine if any changes need to be made as you prepare for implementation. ASU 2016-14 is effective for fiscal years beginning after Dec. 15, 2017.

How often does your nonprofit review its functional expense classifications? For most, it’s been a while. The following will walk nonprofit professionals through that process.

  1. Start by looking at the functional classifications you currently use. Are they the ones that best tell your story? How many functions do you have? If there are too many, valuable information may get lost in the detail. If there are too few, financial statement users may not understand how you’re using resources. It’s a fine balance. Although not required by ASU 2016-14, not-for-profits may wish to consider whether a brief narrative describing the types of expenses included in the various functions — if not obvious from their titles — would be helpful to financial statement users.
  1. Ensure expenses in your system are being coded to the correct functional category. Sometimes an account is set up in the system and assigned to a functional category. Over time, the nature of activities charged to that account change, but the functional expense category is never revised. If this scenario rings a bell, a thorough scrub of your current classifications may be warranted. Break it down into manageable pieces and work systematically.
  1. Consider how you want to present the analysis in your financial statements. Under current GAAP, Voluntary Health and Welfare Organizations are required to present a separate statement of functional expenses. ASU 2016-14 eliminates that requirement but still requires the analysis to be presented somewhere within the financial statements. If your not-for-profit is currently preparing a statement of functional expenses, consider whether you wish to continue doing so. If you don’t currently present such a statement, consider whether you’d like to add one or whether including the analysis in the notes makes more sense. For very simple organizations, a description on the face of the statement of activities might be sufficient.
  1. Choose whether to show expenses by function or nature on the face of the statement of activities. Today, most not-for-profit entities show functional expenses on the face of the statements. Under current GAAP, there’s no requirement for those entities to show expenses by natural classification. Since both functional and natural classifications will be required under ASU 2016-14, now is a good time to consider whether changing the way expenses are presented on the statement of activities would be beneficial to your financial statement users. For example, many nonprofit board members are more familiar with for-profit entities that report expenses by natural classification and don’t really understand the functional expense categories. If that’s the case for your entity, you might want to consider presenting natural classifications on the face of the statements.

Functional expenses generate frequent questions among not-for-profit professionals. For additional information on functional expense allocation and reporting, among many other aspects of not-for-profit accounting and financial reporting, visit the AICPA Not-for-Profit Section’s Audit and Accounting FAQs. Stay tuned for the next part in this series, when we’ll discuss functional expense reporting from an auditor’s perspective.

Karen Craig, CPA, is a consultant providing technical accounting, reporting, finance, and analytical expertise to not-for-profits with a focus on higher education. She volunteers on the AICPA Not-for-Profit Advisory Council and is an ex-officio member of the AICPA Not-for-Profit Industry Expert Panel. Karen also is a technical advisor to the Accounting Principles Council of the National Association or College and University Business Officers (NACUBO).

Expense reporting courtesy of Shutterstock.

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