Overview Nonprofit organizations are institutions that exist for the welfare of people or communities. These make nonprofit organizations different from profit-making organizations.
Nonprofit organizations are like any other business as they must occur expenses to achieve their goals and purposes.
However, when it comes to recognition and reporting of expenses, there are differences between nonprofit organizations and other types of businesses.
In nonprofit organizations, the types of expenses differ from the expenses in other typical for-profit businesses. This is mainly due to fact that nonprofit organization activities are different than the activities of other for-profit businesses.
Expenses of a nonprofit organization must be identified and reported separately in the Statement of Functional Expenses of a nonprofit organization. These expenses are then further reported alongside the revenues of the organization in the Statement of Activities.
Nonprofit organizations sometimes operate under strict budgets. The budgets specify the limits of expenses for all types of expenses that a business can occur. Moreover, some funds provided by donors might be restricted to a particular use or purpose.
If the funds are restricted, nonprofit organizations cannot use those funds for expenses that are not approved by the donating party. When a donor provides funds to the organization, they specify the purpose of the funds and make the funds restricted or they may choose to make the funds unrestricted.
Types of Nonprofit Organization Expenses
To recognize an expense, a nonprofit organization must first identify the type of the expense and categorize them. There are no standard requirements for expenses to be classified in one category or another. The categories of these expenses are decided by the purpose of expenses and by the management of the nonprofit organization.
Under the standards for recognition of expenses for nonprofit organizations, the nonprofit organizations must report their expenses under categories according to the purpose or function of the expense. This type of accounting is known as functional accounting.
There are two main categories that a nonprofit organization may classify their expenses, these are either program expenses or operating expenses. Operating expenses are then further classified into administrative expenses and fundraising expenses.
1) Program Expenses
Program expenses are any expenses borne by a nonprofit organization to achieve its goals. The goals are defined in the nonprofit organizations mission. These expenses are generally an indicator of the nonprofit organization’s performance for the period.
In established nonprofit organizations, program expenses make up the major portion of the total expenses of the organization.
For example, for a nonprofit organization that works to teach women in remote areas of developing countries, the teaching service expenses will be the majority portion of its total expenses.
On the other hand, for nonprofit organizations that provide books for children to study, the majority portion of its expenses will be book printing or buying expenses.
2) Administrative Expenses
Administrative expenses consist of different day-to-day expenses for a nonprofit organization. These are expenses that generally relate to daily running of the nonprofit organization also known as supporting activities.
For established nonprofit organizations, these expenses are very low. For nonprofit organizations that are just starting out, these expenses may be very high due to different types of startup costs such as licenses and purchasing of fixed assets, etc.
While administrative expenses may often be deemed unnecessary to the mission of the nonprofit, they must still be borne by the nonprofit organization. Keeping the administrative expenses of an organization to minimum is ideal for any nonprofit organization.
However, while cutting these expenses, nonprofit organizations must make sure the quality of their services are not affected by the cut in the administrative expenses of the organizations.
Administrative expenses include expenses such as rent payments for building or administrative staff salaries, utility expenses, printing and stationery expenses and other day to day expenses of the organization.
The administrative expenses of an organization do not relate to its activities. These expenses are borne whether the nonprofit organization is carrying out its activities or not.
4) Fundraising Expenses
The fundraising expenses of a nonprofit organization are an indicator of the efforts of the organization to raise funds for its activities.
More fundraising expenses mean that the nonprofit organization is making maximum efforts to raise funds. Fundraising expenses also dictate the number of funds a nonprofit organization receives.
Therefore, nonprofit organizations must be willing to spend more on fundraising activities to receive more funds. For example, a nonprofit organization may host different sports events to receive funds for their activities.
5) Reporting Expenses
The expenses of a nonprofit organization are categorized under one of the categories mentioned above. Once they are categorized, they are reported in the Statement of Functional Expenses and the Statement of Activities of the organization.
6) Statement of Functional Expenses
The Statement of Functional Expenses of a nonprofit organization is the main financial statement of the organization for reporting expenses.
In this statement, expenses are broken down according to the different types of functions, as explained above. As the name of the statement suggests, this statement is a dedicated statement to report only the expenses of an organization.
The Statement of Functional Expenses is the main indicator of the functions of the organization where costs have been borne.
This statement is used to monitor the types of expenses that a nonprofit organization occurs. Furthermore, the Statement of Functional Expenses is used to report the proportion of each type of expense during the period in pursuit of its goals.
7) Statement of Activities
While the Statement of Functional Expenses contains a type-wise breakup of different types of expenses under different categories, the Statement of Activities shows the total expense for each category.
This total expense for each category must match the sum of the breakup of expenses given in the Statement of Functional Expenses.
The Statement of Activities takes the total expenses of the nonprofit organization and subtracts them from any revenues or funds received.
The Statement of Activities also describes the changes in the net assets of the organization. If the net assets reported in the Statement of Activities is categorized into unrestricted, restricted or temporarily restricted funds, the expenses and revenues must also be categorized in the same categories.
Nonprofit organizations must incur expenses for the welfare of the people or communities they are trying to serve. To be recognized, these expenses must be classified into two different categories, i.e. program expenses and operating expenses.
Once these expenses are categorized, they are reported in two main statements that every nonprofit organization must produce. These are the Statement of Functional Expenses and the Statement of Activities.