Most of us are familiar with the statement “100% of nonprofit donations should go directly towards those in need.” From a donor’s perspective, that is an enviable goal. However, from an accounting perspective, we know 100% is not reasonable. Almost all nonprofits have overhead and all are required to classify how they spend their resources. So what is the best practice for a nonprofit to present an accurate measure?
To help clarify, in August 2016 the Financial Accounting Standards Board, (FASB) released guidance known as ASU 2016-14 – Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities. Within this update, nonprofits are required to present an analysis of operating expenses based on nature and function in one location. In other words, organizations must disclose how resources were spent and for what purpose. It is important to understand the difference between nature and function:
Although this analysis can be presented on the statement of activities, a separate statement, or in the notes to financial statements, nonprofits with multiple programs benefit from presenting a separate statement for effectiveness. Nonprofits required to file the annual Form 990 can also use this to fill out the statement of functional expenses section required by the IRS (keep in mind tax requirements can be different from financial reporting discussed in this post).
The tricky part about completing the statement of functional expenses can arise from functional classifications and allocations. Not-for-profit accounting should always be considerate of the following:
An efficient statement of functional expenses should be concise and clear, so aim for consolidating appropriately. As a tip, include percentages at the bottom of the statement. This will allow readers to quickly review allocation of functional expenses as a percent of total expense.
So, does 100% of a nonprofit donation go directly towards those in need? It’s very unlikely that 100% is allocated to program services, but there are cases where a small portion is necessarily allocated to supporting services. Either way, providing donors with transparency to drill down on the impact of their donation helps them make an informed decision.