In our last thought leadership article relating to the Financial Accounting Standards Board’s ASU 2016-14’s “Presentation of Financial Statements of Not-for-Profit (NFP) Entities” we began the discussion about the new expense reporting requirement.  All NFPs will be required to present an analysis of expenses by both function and nature in one location.  That location can be either as a separate Statement of Functional Expenses within the financial statements themselves, as a table presented in the footnotes, or the information can even be incorporated into the Statement of Activities.  It is important to note that NFP organizations are now prohibited from presenting this information in a supplementary schedule (Other Financial Information) after the footnotes.  NFPs need to start considering the following:

Natural Expense Classification – A method of grouping expenses according to kinds of economic benefits received in incurring those expenses.  Examples of natural expense classifications include salaries/wages, employee benefits, professional services, supplies, rent, utilities, depreciation, travel, office expenses and property taxes.

Functional Expense Classification – A method of grouping expenses according to the purpose for which costs are incurred.  The primary functional classifications of a NFP entity are usually program services and supporting services.

·         Program Services – activities that result in goods and services being distributed to beneficiaries, customers, or members that fulfill the purposes or mission for which the organization exists.

·         Supporting Activities – all activities of a NFP other than program services:  Management and General, Fundraising, and Membership Development Activities (if applicable).

This is an opportune time for NFPs to take a fresh look at all of their expenses and determine the most appropriate and reasonable way to allocate those costs by nature and by function.  If they don’t already have them, NFPs must develop formal allocation methodologies to use in allocating expenses attributable to more than one program or supporting function.  The new guidance requires that a description of the methods used to allocate costs in this manner now be disclosed in the notes to the financial statements.  An example of such a disclosure might be:

“The financial statements report certain categories of expenses that are attributable to one or more program or supporting functions of the organization.  Therefore, these expenses require allocation on a reasonable basis that is consistently applied.  The expenses that are allocated on a square footage basis include depreciation and amortization, interest and occupancy.  Salaries. benefits, and payroll taxes are allocated on the basis of estimates of time and effort.  Information technology costs are allocated based on the functions receiving direct benefits.”

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The information reflected in this article was current at the time of publication. This information will not be modified or updated for any subsequent tax law changes, if any.