Functional Expenses Are Changing: FASB’s New Nonprofit Standards

FASB Accounting Standards Update (ASU) 2016-14 was issued in August 2016 after a significant amount of time deliberating the issues in not-for-profit financial reporting. The current reporting model was enacted in the mid-90s, so FASB thought it would be a good idea to revisit the core principles in our industry. As a result, there are significant changes to the standard. And, the standard is applicable now beginning with not-for-profits with fiscal years beginning after Dec. 15, 2017.

The new standards are expected to improve overall reporting in the not-for-profit industry. As many of you know, many individuals use not-for-profit financial statements, and they’re published. Therefore, donors, grantors, and others are looking at and possibly making decisions based on those financial statements. It is critical that the messaging on the financial statements is clear and transparent.

What Is Changing

One of the changes is to the functional allocation of expenses, and we expect it to impact almost all of the not-for-profits preparing audited and reviewed financial statements. Utilizing functional expenses is the current required way that not-for-profits have to report their expenses. It’s a method where all expenses are grouped into program expense — those directly for your mission and programs — or supporting services expense, which includes management and general, fundraising, and membership development.

The big change is around management and general expenses. Now, these costs have lots of names: M&G, G&A/general and administrative, indirect costs, or even referred to as overhead. For clarity, we’ll refer to it as M&G. For the audited financial statement and the Form 990 filing annually, many organizations allocate a portion of M&G expenses into one of the other buckets. So, a portion of M&G costs are allocated to program expense, fundraising, or membership development.

The New Requirements

Now, here is the challenge: FASB’s original not-for-profit standards did not define what goes into M&G. Not-for-profits have been using FASB’s descriptions of what fits into program, membership development, and fundraising; and whatever expenses are left are reported in M&G. And now, FASB added a definition of what must be reported in M&G that cannot be allocated to the other buckets. As a result, it’s anticipated that many not-for-profits will report more M&G than in the past and less expense in program. This can create issues, since many grantors and donors look at the percentage of costs that go into program expenses and want to see a higher percentage of costs spent on program activities.

The following items are required to stay in M&G:

• General record keeping & payroll — includes finance (CFO/accounting), grant accountants, billing, AR, payroll, audit costs, etc.
• Employee benefits management & oversight (Human resources)
• Budgeting departments/functions
• Oversight functions
• Business management
• Soliciting funds other than contributions & membership dues, for example, costs associated with:
• Promoting the sale of goods or services to customers, including advertising costs
• Responding to government, foundation, & other requests for proposals for customer-sponsored contracts for goods & services
• Administering government, foundation, & similar customer-sponsored contracts, including billing & collecting fees, & grant & contract financial reporting
• Disseminating information to inform the public of the not-for-profit’s stewardship of contributed funds
• Making announcements concerning appointments
• Producing & disseminating the annual report

What This Means

At smaller nonprofits, the CFO may have more responsibility than finance. All the finance objectives must remain in M&G, but any time spent directly conducting or supervising program services can be allocated to program. Any time the spent supervising program services should be well documented as the CFO role is generally thought to be 100 percent M&G. The documentation may include a job description that supports why the CFO would also be working on direct program activities. In addition, documentation must be maintained to support how much of the compensation is allocated out of M&G. FASB does not define what the documentation should be; however, it should be reasonable and auditable (timesheets, time studies, etc.)

Many nonprofits are allocating a portion of the costs for finance, HR, and budget-to-program activities now. Which means that now they will have less costs that can be allocated into program activities.

We recommend you revisit the new definition of M&G, review your allocation methodology, and discuss any significant changes with your auditor.

Katie Thornton, CPA, Partner. Katie has more than 17 years of experience serving not-for-profit and higher education clients. She is a leader in Plante Moran’s professional standards department for the not-for-profit and higher education industry groups. Katie currently serves several large private foundations, public universities, and related foundations. She is a frequent presenter at industry and state CPA associations. Katie also serves as finance committee chair to two not-for-profits in the Lansing, Michigan.