Learning objectives

• Identify how to report an analysis of expenses by function and nature.
• Identify the criteria used to determine whether joint costs can be allocated.
• Identify how to report reclassifications.

Introduction

Prior to the implementation of Accounting Standards Update (ASU) No. 2016-14, Presentation of Financial Statements of Not-for-Profit Entities, there were inconsistencies in the types of information provided about expenses — for example, some, but not all, not-for-profits (NFPs) provided information about expenses by both nature and function. Also, only certain types of NFPs (voluntary health and welfare organizations) were required to include a statement of functional expenses. Now, all NFPs are to report amounts of expenses by both their natural classification and their functional classifications in one location, on the face of the statement of activities, as a separate statement, or in the notes to financial statements.

Expenses versus losses

An important determination in financial reporting for NFPs is whether an item is an expense or a loss. Consider the differences between expenses and losses:

• Expenses are outflows of or other ways of using up assets or incurrences of liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity’s ongoing major or central operations.
• Losses are different from expenses. Losses result from activities that are peripheral or incidental to the organization. Activities that are reported as expenses by some entities may be reported as losses by others. It will depend on whether the activity is part of the organization’s ongoing major or central operations.

The determination is important because of the following:

• There are differences in how expenses and losses are reported. Expenses are reported gross, except investment expenses, where losses may be reported net.
• Expenses are always reported as decreases in net assets without donor restrictions.
• NFP entities are required to report information about the functional and natural classification of expenses, such as major classes of program services and supporting activities. This information can be done on the face of the statement of activities, as a separate statement or in the notes to the financial statements. Losses need not be reported by a functional classification or in the matrix that presents information about expenses according to both their functional and natural classifications.

Again, activities that are reported as expenses by some entities may be reported as losses by others. For example, a Girl Scouts council could have an annual cookie sale that is its main fund-raising event each year (a major and central activity), whereas a Boy Scouts council could hold a special fund-raising cookie sale for new camping equipment that may be considered a peripheral or incidental activity. Both groups are selling cookies but their reporting of the activity is potentially different.

Special events and other fund-raising activities

Many entities have fund-raising or other special events in which the attendee receives some type of direct benefit. For example, an entity may hold a $100 per plate special dinner as a fund-raising event. An entity may also hold special social or educational events where the attendee receives a direct benefit. Often, these activities are considered part of the organization’s ongoing and major activities and therefore revenues and expenses from such events must be reported separately.

Entities have several ways they can report the revenues and expenses from these types of activities. The following is an example of the different ways entities can report a special fund-raising dinner in the statement of activities. Assume the following:

• The price of the dinner is $100.
• The cost of the dinner is $25.
• The fair value of the dinner is $30.
• Additional costs incurred with promoting the dinner are $10.

Now, let us review the possible reporting of this in exhibit 3-1.

Knowledge check

1. Which is accurate of the functional reporting of expenses?
   1. Program services are not activities that result in goods and services being distributed to beneficiaries, customers, or members that fulfill the purposes or mission of the organization.
   2. Supporting services may not include, as one or more separate categories, cost of sales and costs of other revenue-generating activities that are not program-related.
   3. Supporting services are activities other than program services and include management and general, fund-raising, and membership-development activities.
   4. Classification of supporting services other than management and general and fund-raising cannot be used by entities.
2. Which is accurate of the functional reporting of expenses?
   1. The proper classification of expenses between program services and supporting services is often important to NFP entities.
   2. An entity cannot report expense information about program services that it provides.
   3. Resource providers rarely compare the percentage of expenses that go to providing program services to the percentage of expenses that go to supporting services.
   4. Functional reporting of expenses must be reported in the statement of activities.

Program services

An entity must report expense information about program services that it provides. The relationship between functional classification and natural classification for all expenses shall be presented in an analysis that disaggregates functional expense classifications, such as major classes of program services and supporting activities by their natural expense classifications. The financial statements shall provide a description of the nature of the NFP’s activities, including a description of each of its major classes of programs. If not provided in the notes to the financial statements, the description can be presented on the statement of activities (for example, using column headings).

For example, a college may report student instruction, research, public service, and other program areas. An entity should report information for each of its major classes of program services and supporting activities. The number of classes to use requires professional judgment. Entities may consider guidance in FASB Accounting Standards Codification (ASC) 280-10-50 in determining the number of major classes to use.

Knowledge check

3. Which is accurate of reporting expense information about program services?
   1. All entities may only report a single classification of program expenses.
   2. Entities cannot consider guidance in FASB ASC 280 in determining the number of major classes to use.
   3. Professional judgment is required when determining the number of classes of major programs.
   4. Entities may not report more than five program service classifications.

Supporting services

Supporting services are often classified as management and general, fund-raising, and membership development. However, some NFP industries use other classifications of supporting services. For example, most colleges report institutional support and institutional development activities. Entities may also report more detailed classifications for each type of supporting services.

Management and general activities typically include all items not reported as program services, fund-raising, or membership development. Examples of management and general activities are illustrated as follows:

• Oversight
• Business management
• General record keeping and payroll
• Budgeting
• Financing
• Soliciting revenue from exchange transactions
• Administering government, foundation, and similar customer-sponsored contracts, including billing and collecting fees and grant and contract financial reporting
• Disseminating information to inform the public of the NFP’s stewardship of contributed funds
• Making announcements concerning appointments
• Producing and disseminating the annual report
• All management and administration except for direct conduct of program services or fund-raising activities

The cost of oversight and management usually includes the salaries and expenses of the governing board, the chief executive officer, and the supporting staff. If such staff spend a portion of their time directly conducting or supervising program services or categories of other supporting services, however, their salaries and expenses should be allocated among those functions.

Fund-raising activities are connected with inducing potential donors to contribute. The contribution can be money, other assets of value, services, facilities, or time. The activities include

• publicizing and conducting fund-raising events;
• maintaining donor mailing lists;
• conducting special fund-raising events;
• preparing and distributing fund-raising manuals, instructions, and other materials; and
• other activities connected with soliciting contributions from individuals, foundations, governments, and others.

The financial statements should disclose total fund-raising expenses. It should also be noted that fund-raising costs should be expensed as incurred. However, the costs of tangible fund-raising assets, such as brochures and promotional items, may be recorded as assets upon purchase and expensed when used.

In some cases, fund-raising activities are conducted by professional fundraisers or federated fund-raising entities on behalf of an NFP organization. For example, the professional fundraiser may charge a 20% fee for conducting a fund-raising activity, or a federated fund-raising entity may charge a 5% administrative fee for gifts that will be transferred to the NFP organization. In such cases, the NFP should report the gross amount of the contributions raised and a fund-raising expense for any fee.

Membership-development activities include soliciting for prospective members and membership dues, membership relations, and similar activities. To the extent that member benefits are received, membership is an exchange (reciprocal) transaction. If there are no significant benefits or duties connected with membership, however, the substance of membership-development activities may, in fact, be fund-raising, and the related costs should be reported as fund-raising costs.

Membership-development activities may be conducted in conjunction with other activities. In circumstances in which membership development is in part soliciting revenues from exchange (reciprocal) transactions and in part soliciting contributions, the activity is a joint activity. If membership development is a joint activity and the purpose, audience, and content of the activity are appropriate for achieving membership development, joint costs should be allocated between fund-raising and the exchange transaction. In circumstances in which membership development is conducted in conjunction with other activities but does not include soliciting contributions, the activity is not a joint activity, and the costs should be allocated to membership development and one or more other functions. For example, membership may entitle the members to group life and other insurance at reduced costs because of the organization’s negotiated rates and to a subscription to the organization’s magazine or newsletter. Under these circumstances, an appropriate part of the costs of soliciting members should be allocated to the membership-development function and a part to program services.

Costs related to sales of goods and services that are related to major or central activity of an entity should be reported separately. Cost of sales and services is permitted to be reported immediately after revenue from the sale of merchandise. If the sale of merchandise is related to the organization’s mission, the cost of sales could be reported as a program expense. For example, if a museum has a store that sells merchandise related to the museum’s program, the cost of the store’s sales could be reported as a program expense. If the sale of merchandise is not related to the organization’s mission, cost of sales would be reported as supporting services.

Knowledge check

4. Which is accurate of management and general activities?
   1. They exclude budgeting activities.
   2. They exclude oversight activities.
   3. They include financing activities.
   4. They include fund-raising activities.

Analysis of expense by nature and function

All NFPs shall report information about all expenses by function and nature in one location — on the face of the statement of activities, as a schedule in the notes to financial statements, or in a separate financial statement.

All expenses shall be presented in an analysis that disaggregates functional expense classifications, such as major classes of program services and supporting activities by their natural expense classifications, such as salaries, rent, electricity, supplies, interest expense, depreciation, awards and grants to others, and professional fees. Expenses reported in cost of goods sold or services provided (or costs related to special events) should be reported by their natural classification in the functional expense analysis. For example, salaries, wages, and 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, and fringe benefits in the functional expense analysis.

Exhibit 3-2 is a simple example using a statement of functional expenses:

Knowledge check

5. Which is accurate of analysis expenses by function and nature?
   1. The analysis is required for all NFP entities.
   2. The analysis reports expenses by natural classification only.
   3. It is only required for voluntary health and welfare entities.
   4. The analysis is optional for all NFP entities.

Classification of expenses related to more than one function

As stated earlier, the proper classification of expenses between program services and supporting activities is often important to NFP entities. Some expenses are easily assigned to a single program or supporting activity. However, some expenses relate to more than one program or supporting activity and must be allocated to the appropriate functions. For example, rent on a building may need to be allocated among program services and supporting activities.

Where possible, direct identification of specific expense is the preferable method of charging expenses to various functions. For example, travel costs incurred in connection with a program activity should be assigned to that program.

Often, it may not be possible or practical to use direct identification to assign costs to various functions. In such cases, an allocation method would be used. Allocating costs is a common practice for both NFP entities and business enterprises. A reasonable allocation of expenses can be made in a variety of ways and should be based on an objective method.

Allocation methods may be based on financial or nonfinancial data. For example, building costs (rent and utilities) may be allocated based on square footage of space occupied by the various programs and support activities. Time records or activity reports may be used to allocate salary of certain personnel. Entities should review their allocation methods periodically to ensure they reflect the most current activity. A description of the methods used to allocate costs among program and support functions would need to be disclosed in the notes to the financial statements.

There is special guidance on allocating costs related to an activity that combines fund-raising activities and also elements of another function. These types of costs are referred to as joint activities and are discussed in the next section.

Expenses of materials and activities that combine fund-raising activities with activities that have elements of another function (joint activities)

NFP entities may solicit support through a variety of fund-raising activities, including the following:

• Direct mail
• Telephone solicitation
• Door-to-door canvassing
• Telethons
• Special events
• Other similar activities

Sometimes fund-raising activities are conducted with activities related to other functions, such as program activities or supporting services, such as management and general activities. Sometimes fund-raising activities include components that would otherwise be associated with program or supporting services, but in fact support fund-raising.

If any of the criteria are not met, all costs of the joint activity should be reported as fund-raising costs, including costs that otherwise might be considered program or management and general costs if they had been incurred in a different activity, subject to the following exception. Costs of goods or services provided in exchange transactions that are part of joint activities, such as costs of direct donor benefits of a special event (for example, a meal), should not be reported as fund-raising.