Nonprofit organizations have their own accounting and reporting methods and requirements that make them report expenses in accordance with how they are incurred.
This is called functional expense allocation and is very important in preparing financial statements for a nonprofit organization.
Nonprofits have to file the IRS Form 990 and according to that they must allocate their yearly expenses into these three categories:
- Program Expenses
- Administrative Expenses
- Fundraising Expenses
What are the program expenses?
Program expenses are the expenses incurred when nonprofit entities carry out their mission and in accordance with that provide goods and services. These are delivered through programs like providing health care or providing food and clothing to the needy.
These expenses are easily distinguished from other main expenses of a nonprofit organization, for example, fundraising, management, and administration.
The public and donors really appreciate when the nonprofit’s major expenses are program expenses, as it is an indicator of how well the entity is carrying out its mission. Program expenses generally are in a higher proportion.
Though there exist exceptions. If a nonprofit organization is in its early years and hasn’t really established itself, it may not have as many expenses that have been incurred because of programs.
But for an organization in its later established stage, it should have more program expenses, and it is not concerning if it doesn’t.
There are two types of program expenses- direct and indirect. Direct expenses are the expenses specific to a particular program and are incurred for it only.
Administrative or Indirect Expenses are program expenses which are not easily traced to one program and are so allocated by either allocating to one single program or by using a percentage or formula, which can be based upon:
- The area in square foot occupied by the program, administrative, and management staff
- Staff employed in a particular program or department
- Machine or labor hours d) the percentage of salary paid to the staff in a specific program or department. The methods used should be reasonable, based on the nature of the expense being allocated, and should be applied on a consistent basis across all programs.
Examples of Programs:
Here are a few examples of some typical programs that exist within types of nonprofit organizations:
- Higher Education Programs: academic support for students, library and research center facilities, publicly available education materials
- Health and Welfare Programs: health services for families and individuals, research and development, prevention, detection and treatment, patient services and support, public awareness campaigns/education, general and disaster relief
- Cultural and Social Programs: exhibits and performances, productions for different groups, community outreach, library, education and awareness campaigns, artifacts collections
- Association Programs: membership activities, education, and awareness, public programs
- Religious Programs: worship services, community outreach, missionary activities, music, education for all age groups
- Federated Fundraising Programs: grants and contributions to other organizations
Presentation of Program Expenses
Nonprofit organizations should be able to provide detailed information about their programs and the nature of the programs, in the financial statements.
These details should also include the nature of the activities being held in each program and the major programs.
If the total expenditure incurred in one program is not highlighted in the financial statements, it should be disclosed in the notes to the financial statements.
The number of programs and their details reported by nonprofit entities will depend on the nature of activities held in these programs.
In some cases, organizations could report multiple programs as one single program. In other cases, each activity and the expense incurred in each program are reported, along with any other details.
FASB ASC 958 has specified that all expenses should be reported according to the major categories of programs.
Costs incurred are not just the only way of telling what is labeled as a major program. An organization could be, for example, running a very effective and efficient program and many low-cost services could have been employed for that.
Major programs in an organization can be determined by how many people were able to benefit from it or how many activities were conducted.
Different nonprofit organizations have different programs that can be of the same type as other organizations but still differ.
For example, a women’s shelter home and a type of food bank both come under the health and welfare organizations category, but their programs would differ.
The women’s shelter may offer career counseling, ways to earn and learn different skills, etc., while a food bank would just be providing consumables to those who need them.