Functional Classifications

Program services. Some not-for-profit organizations operate only one program, while others operate many. The number of functional reporting classifications for program services varies according to the nature of the services rendered. For some organizations, a single functional reporting classification may adequately portray what is, in effect, a single program service that the organization provides to its service recipients. (FASB ASC 958-720-45-3)

The more typical not-for-profit organization, however, has several separate and identifiable services, and in such cases the expenses for program services should be reported by the kind of service function or group of functions.

To determine which programs and activities to report separately, an organization should consider the following:

1. Identify the organization's major programs and activities;
2. Group those programs and activities by function;
3. Select the functions that are significant to the organization as a whole.

Of course, the not-for-profit organization should not report so many different program classifications that financial reporting becomes difficult and too complicated.

Supporting services. Supporting activities are all activities of a not-for-profit organization other than program services. They include the following: (FASB ASC 958-720-45-7)

1. Management and General
   1. Oversight;
   2. Business management;
   3. General recordkeeping;
   4. Budgeting;
   5. Financing;
   6. Soliciting funds other than contributions, including exchange transactions (whether program-related or not) such as government contracts, and related administrative activities;
   7. Disseminating information to inform the public about the not-for-profit organization's stewardship of contributed funds;
   8. Announcements concerning appointments;
   9. The annual report;
   10. Related administrative activities;
   11. All management and administration except for direct conduct of program services or fundraising activities.
2. Fundraising
   1. Publicizing and conducting fundraising events;
   2. Maintaining donor lists;
   3. Conducting special fundraising events;
   4. Preparing and distributing fundraising manuals, instructions, and other materials;
   5. Conducting other activities involved with solicited contributions from individuals, foundations, government agencies, and others.
3. Membership development
   1. Soliciting for prospective members and membership dues;
   2. Membership relations and similar activities.

FASB ASC 958-720-45-17 through 27 also provide information on when and how costs may be allocated when program or management and general activities include fundraising activities.

Support to affiliated organizations. Some organizations make payments or provide other support to local or national affiliates. These payments should be reported by their functional classification to the extent that it is practicable and reasonable to do so and the necessary information is available, even if it is impossible to allocate the entire amount of the payments to functions. (AICPA Guide, paragraph 13.115)

Payments to affiliates that cannot be allocated to functions should be treated as a separate supporting service, reported on a statement of activities on a separate line item entitled “unallocated payments to affiliated organizations.” (AICPA Guide, paragraph 13.115)

Classification of expenses related to more than one function. Some expenses are directly related to, and can be assigned to, a single major program or service or a single supporting activity. Other expenses cannot. They relate to more than one activity or service. In these cases, expenses should be allocated among the applicable functions.

It is important to provide objective allocation methods based on either financial or nonfinancial data when direct identification is impossible or impractical.

Some examples of techniques to allocate functional expenses include:

1. Time sheets that are kept by employees may serve as a basis to allocate salaries and expenses when employees spend time on various projects.
2. Office expenses may be allocated based upon the square footage used by the personnel that work on a particular activity.
3. Expense logs and records can be used to determine the actual expenses for various programs and activities that were worked on.
4. Supplies and postage expenses may be allocated based on estimates of their use. For example, if direct mail solicitation is used for fundraising, those costs can be specifically identified and then all other postage expenses allocated ratably.

Costs that cannot be directly related to a specific program or specific supporting activity are referred to as “indirect” costs. The examples provided above are usually components in a methodology, generally referred to as an “indirect cost allocation plan,” that attempts to assign each program or supporting activity with a reasonable allocation of indirect costs. These indirect costs are then added to a program or supporting activity's direct cost to obtain the total cost of each program and supporting activity; it's these total costs that are reported in the not-for-profit organization's statement of activities for its program and supporting activities.

There is no specific GAAP that defines acceptable methodologies for indirect cost allocation plans, although it is safe to say that GAAP, in general, would require that the indirect costs be allocated consistently from reporting period to reporting period. In addition, if the not-for-profit organization is a recipient of any federal grants or other federal awards programs, there are some specific federal requirements as to indirect cost allocation plans that would need to be considered.

Functional category of cost of sales of contributed inventory. AICPA Technical Practice Aid 6140.06 (now included in paragraph 13.37 of the AICPA Guide) specifies that the cost of sales of contributed inventory should be reported as a cost of a separate supporting service, unless the item is related to a program activity, in which case the cost of sales is reported as a cost of a program activity. Accordingly, cost of sales of contributed inventory should not be reported as a fundraising cost.

Reporting

Not-for-profit organizations report functional classification of expenses either in the statement of activities or the notes to financial statements, although financial statement presentation is more common. Voluntary health and welfare organizations are required to have a separate financial statement in a matrix format that presents expenses both by function and by natural classification. Reporting by natural classification means presenting expenses by their normal expense description, such as salaries and fringe benefits, rent, utilities, etc.

An example of a matrix format displaying functional and natural expense classifications is presented in Exhibit 1.