When considering a charitable gift, prospective donors want to know how a nonprofit spends its money. While the information is accessible through publicly available financial statements, these documents can be difficult to wade through and interpret for a non-accountant. That’s why the Financial Standards Accounting Board (FASB) has established a new requirement for nonprofits to prepare expense statements in a form that helps donors easily grasp the relevant information: the schedule of functional expenses.
This change to reporting requirements is part of FASB’s sweeping Accounting Standards Update 2016-14, Presentation of Financial Statements of Not-for-Profit Entities, released in August of 2016. The new policy specifies that for fiscal years beginning after December 15, 2017 all tax-exempt organizations must create and maintain a statement of functional expenses to share financial data in a simplified manner.
The statement uses a matrix format to communicate how funds are spent in two ways: by functional area and by natural category. You can see the matrix format in the sample statement below.
One axis on the simplified statement shows functional expenses divided into program costs and supporting service costs. Program costs are those expenses incurred directly as part of the effort to advance the organization’s mission. Supporting services generally fall under fundraising expenses or management and administrative expenses.
The second axis documents expenses by natural category. Typical natural expense categories could include wages, salaries and benefits; rent and utilities; professional services; supplies; travel; interest; and other costs.
What’s the advantage to this new format for expense statements? According to the FASB, the simplified statement will enable donors to better understand and compare financial positions and relative performance between organizations. In addition, the board anticipates that functional statements of expense will make reporting less complex and costly for nonprofits.
There are limits to the utility of the functional statement of expense, however. The matrix tells nothing of revenue recognized, cash flow, debt or profitability of operations. To understand these key data points, it is still necessary to delve into the statement of financial position, statement of activities, and the statement of cash flows for the organization.
Nevertheless, the new statement provides an easy way to see total expense overviews and learn how much nonprofits spend on fundraising and management versus direct program services, which is a prime concern of donors. The functional statement of expense also allows management to compare expense rates to industry-wide averages.
Many nonprofits are just beginning to assess their responsibility under the FASB’s 2016 Accounting Standards Update. These changes are significant but should not be overwhelming to implement. We will revisit the statement of functional expense in a future blog post, examining methods of computing the functional allocation and offering guidance on how to comply with the updated FASB standards. In the meantime, if you have questions or concerns about keeping your organization in compliance please reach out to the nonprofit professionals at HBP. Accounting standards may change but you can always count on us to help you navigate them, one step at a time.
Written by Marco Fernandes, CPA; Audit Principal.