The Statement of Functional Expenses is the table in your financial statements that shows two things side by side: what you spent money on (salaries, rent, supplies) and what that spending was for (your programs, running the organization, or raising money). It may be the most-read page in your financial statements. Donors look at how much goes to programs. Funders compare it across applicants. Your auditor tests it. And Form 990 publishes a version of it for anyone to see.
Yet in many organizations, the split behind it is a spreadsheet built once a year, from memory, a few weeks before the audit. Here is how to split your costs in a way that holds up, and keeps working all year.
What the accounting rules require
The accounting rules for nonprofits (FASB ASC 958-720, updated by ASU 2016-14) require every nonprofit to show its expenses two ways at once: by type (salaries, rent, supplies) and by purpose (what the spending was for). Accountants call these “nature” and “function.” This breakdown has to appear in one place in your financial statements, and the notes must explain how you split any costs that were shared.
There are three purposes:
- Program services: the activities that carry out your mission.
- Management and general, often called administration or overhead: leadership and oversight, accounting, budgeting, HR and other work that keeps the organization running but isn’t tied to a specific program or to fundraising.
- Fundraising: asking for donations, grants and donated goods or services, including the staff time spent on it.
Administration is not a catch-all. A cost belongs there only when it truly supports the organization as a whole.
Where the same numbers show up
- Your audit. Your auditor checks how expenses were sorted, whether your method for splitting shared costs is reasonable, and whether you have records to back it up. Without that support, the auditor may change your numbers or raise it in the letter they send to your board.
- Form 990, Part IX. 501(c)(3) and 501(c)(4) organizations must split their expenses into the same three purposes on their tax return, and that return is public. The IRS rules differ slightly from accounting rules, so the return includes a reconciliation (Schedule D) that explains the differences. Every difference should have a clear reason, not be an accident.
- Federal grants. Federal grants let you recover part of your shared overhead, either through a rate negotiated with the government or a simple flat rate of up to 15% (2 CFR 200.414). The overhead you claim on grants should match the story your functional expenses tell.
Charge directly first, then split what’s shared
The cleanest split is the one you don’t have to make. Record every cost you can directly to a program, to administration or to fundraising when you enter it. Program-specific staff, supplies and grant-funded purchases usually fall here.
What’s left are shared costs: people who wear several hats, and the building, technology and insurance everyone uses. For each shared cost, choose a fair way to split it, based on how it is actually used, and apply it the same way every time:
| Shared cost | A fair way to split it |
|---|---|
| Salaries and benefits | Timesheets showing how each person spends their time |
| Rent, utilities, cleaning | Share of office space used for each purpose |
| IT, software, phones | Number of staff working on each purpose |
| Insurance | What the policy covers, or number of staff |
| Depreciation | How the equipment or building is used |
Write these methods down, have the finance committee approve them, and revisit them when something changes, such as a new program, a move or a reorganization.
Salaries drive the answer
Personnel is usually the largest expense, so it decides most of your result. An executive director who spends a quarter of the week with donors is doing fundraising for that time, whatever the job title says. A finance manager who tracks grant spending is supporting programs for part of the day.
Base the split on evidence: ongoing timesheets, or tracking time for a couple of typical weeks each quarter. If any salaries are paid from federal grants, the federal rules (2 CFR 200.430(i)) require records of the work people actually did. Budget estimates alone are not enough.
Mistakes we see most often
- Putting all leadership and finance salaries in administration, or all of them in programs to look better. Neither reflects how people really spend their time.
- Allocating once a year. Splitting shared costs every month keeps board reports, grant reports and the year-end numbers in line, with no surprises in the audit.
- Using different methods for the audit, Form 990 and grant reports with no reconciliation between them.
- Hiding fundraising costs inside programs. When a mailing or event mixes a donation ask with education or outreach, part of the cost can count as program only if it passes specific accounting tests. If it doesn’t, the whole cost counts as fundraising. Form 990 asks about these mixed costs separately.
- Chasing a program percentage. A flattering number that can’t be supported is a bigger risk than an honest one. Accurate numbers, clearly explained, build more trust with donors and funders.
A practical checklist
- Your accounting system set up to tag each expense as program, administration or fundraising when it is recorded (for example, “classes” in QuickBooks Online or “dimensions” in Sage Intacct)
- A written allocation policy, approved by the finance committee, listing each shared cost, how it is split, how often and who reviews it
- Timesheets for every employee whose work covers more than one purpose
- A monthly entry in the books that splits the shared costs, with the calculation saved alongside it
- A year-end check that your Statement of Functional Expenses, your Form 990 and your grant reports all agree
Get these in place and the Statement of Functional Expenses stops being a year-end scramble. It becomes a clear, defensible picture of where your resources go.
Want allocations that hold up?
Mandala CPA provides outsourced accounting to nonprofit organizations across the United States: month-end close, financial reporting, Uniform Guidance compliance and audit readiness, on a single monthly fee. We can set up your accounting system to tag expenses the right way, write a cost-sharing policy your board can approve, handle the split every month and prepare the support your auditor and your Form 990 will need.
Sources
FASB ASC 958-720, Not-for-Profit Entities: Other Expenses; FASB ASU 2016-14, Presentation of Financial Statements of Not-for-Profit Entities.
IRS, Instructions for Form 990, Part IX (Statement of Functional Expenses) and Schedule D.
2 CFR 200.414, Indirect costs; 2 CFR 200.430(i), Standards for documentation of personnel expenses.
This article is general information and is not accounting, tax or legal advice for any specific organization.
