KEY ACCOUNTING ISSUES FOR NONPROFITS—EXPENSE ACCOUNTING
By Larry L. Perry, CPA
CPA Firm Support Services, LLC
LEARNING OBJECTIVES
 Properly account for expenses of nonprofit organizations
 Understand and explain principles of accounting and reporting for accounts
presented on the statement of activities
 Describe internal controls over cash disbursements that enable their proper
recognition in financial statements
 Discuss the features of the statement of functional expenses
 Allocate joint costs
NONPROFIT ORGANIZATION FINANCIAL STATEMENTS
Basic nonprofit organization financial statements include:
Statement of Financial Position
This statement reports total assets, liabilities, and net assets of an organization and any
consolidated subsidiaries. SAS No. 117 requires net assets to be reported as permanently
restricted net assets, temporarily restricted net assets, and unrestricted net assets.
Unrestricted net assets may include designations made by an entity’s board of directors or
trustees.
Statement of Activities
This statement reports the changes in permanently restricted net assets, temporarily
restricted net assets, unrestricted net assets, and the total change in net assets. Revenues
are reported in the classes to which they apply. Temporarily restricted revenues are
reclassified as unrestricted when time and purpose designations have been accomplished.
Revenues from permanently restricted net assets will be accounted for as specified in the
related agreements or, if not specified, as unrestricted. All expenses will be recorded as
unrestricted in functional categories, program services, management and general,
fundraising and, if applicable, member development.
Statement of Cash Flows
This statement follows the requirements of SFAS No. 95. The statement of cash flows
reports cash flows in total rather than by the three classes of net assets. One significant
difference is that certain restricted donations (usually permanently restricted) are
classified as cash flows from financing activities and not included in income from
operations.
1
Statement of Functional Expenses
Voluntary health and welfare organizations must present this statement in a matrix format
that identifies major categories of expense and their allocation among major categories of
program services, management and general and fundraising expenses. Other nonprofit
organizations may voluntarily present this Statement to provide financial statement users
a better understanding of the entity’s use of resources.
ILLUSTRATIVE FINANCIAL STATEMENTS AND FOOTNOTES
The following illustration is designed for a small, hypothetical nonprofit organization and
includes only common presentation and disclosures. FASB ASC paragraphs 958-205-05
through 55 include numerous illustrations of financial statements presentations and
footnotes disclosures for nonprofit organizations. The ASC should be consulted for
issues that are not presented in these materials.
ILLUSTRATIVE FINANCIAL STATEMENTS AND FOOTNOTES
2
DISASTER RELIEF, INC.
STATEMENT OF FINANCIAL POSITION
December 31, 2014
ASSETS
CURRENT ASSETS
Cash:
Unrestricted
Restricted
Inventories of merchandise and supplies
Prepaid expenses and deposits
Total Current Assets
$192,712
87,896
33,214
9,188
323,010
INVESTMENTS
215,632
PROPERTY AND EQUIPMENT
167,946
TOTAL ASSETS
$706,588
LIABILITIES AND NET ASSETS
CURRENT LIABILITIES
Current portion of long-term debt
Accounts payable
Payroll tax liabilities
$ 32,259
15,333
3,115
Total Current Liabilities
50,707
LONG-TERM DEBT
113,839
NET ASSETS
Unrestricted (Board designated—$29,672)
Temporarily restricted
454,146
87,896
Total Net Assets
542,042
TOTAL LIABILITIES AND NET ASSETS
See Accompanying Notes to Financial Statements.
3
$706,588
DISASTER RELIEF, INC.
STATEMENT OF ACTIVITIES
Year Ended December 31, 2014
Unrestricted
Temporarily
Restricted
Total .
SUPPORT AND REVENUES
Contributions:
Unrestricted
Restricted
In-kind
Unrealized gain on investments
Interest
Net assets released from restrictions
$3,676,820
205,000
863
1,101
153,064
Total Support and Revenues
4,036,848
$3,676,820
$ 240,960
240,960
205,000
863
1,101
(153,064)
-087,896
4,124,744
EXPENSES
Program services
Supporting services
Management and general
Fundraising
Total Expenses
2,593, 401
2,593,401
751,923
563,710
751,923
563,710
3,909,034
3,909,034
INCREASE IN NET ASSETS
127,814
87,896
215,710
NET ASSETS AT BEGINNING OF YEAR
326,332
-0-
326,332
$ 454,146
$ 87,896
$ 542,042
NET ASSETS AT END OF YEAR
See Accompanying Notes to Financial Statements.
4
DISASTER RELIEF, INC.
STATEMENT OF CASH FLOWS
Year Ended December 31, 2014
CASH FLOWS FROM OPERATING ACTIVITIES
Increase in net assets
Adjustments to reconcile increase in net assets to net cash
provided by operating activities
In-kind contributions
Depreciation
Increase in unrealized gains and losses on investments
Increase in accounts payable
Increase in payroll tax liabilities
$ 215,710
(205,000)
18,738
(863)
6,886
1,175
NET CASH PROVIDED BY OPERATING ACTIVITIES
36,646
CASH FLOWS USED IN INVESTING ACTIVITIES
Purchase of tractor/trailer
(64,031)
CASH FLOWS USED BY FINANCING ACTIVITIES
Payments on debt obligations
__ (54,229)
NET DECREASE IN CASH
(81,614)
CASH AT BEGINNING OF YEAR
362,222
CASH AT END OF YEAR
$
See Notes to Accompanying Financial Statements.
5
280,608
DISASTER RELIEF, INC.
NOTES TO FINANCIAL STATEMENTS
Year Ended December 31, 2014
NOTE A—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Disaster Relief, Inc. was organized in 1983 and is a nonprofit organization, exempt from income
taxes under Section 501 (c) (3) of the Internal Revenue Code. It’s purpose if to distribute lifesustaining supplies and services to residents of areas of the United States that have suffered
natural or man-made disasters. The Organization receives a majority of its support and revenues
from contributions made by the general public.
The Organization maintains operating relationships with several affiliated entities but has no
monetary investment in, or substantial influence or control over, these entities. These financial
statements, therefore, include only the accounts of Disaster Relief, Inc.
Summary of Significant Accounting Policies
Method of Accounting:
The financial statements of Disaster Relief, Inc. have been prepared on the accrual basis of
accounting and in accordance with the American Institute of Accountants’ Audit and Accounting
Guide, Not-for-Profit Organizations. The significant accounting policies followed are described
below to enhance the usefulness of the financial statements to the reader.
Basis of Presentation
Financial statement presentation follows the recommendations of the Financial Accounting
Standards Board in its Statement of Financial Accounting Standards (SFAS) No. 117 (ASC 958),
Financial Statements of Not-for-Profit Organizations. Under SFAS No. 117, the Organization is
required to report information regarding its financial position and activities according to three
classes of net assets: unrestricted net assets, temporarily restricted net assets, and permanently
restricted net assets.
Unrestricted Net Assets:
Unrestricted net assets are resources over which the Board of Directors has discretionary control
and are available for the various programs and administration of the Organization.
6
Temporarily Restricted Net Assets:
Temporarily restricted net assets are resources subject to donor imposed restrictions which will
be satisfied by actions of the Organization or the passage of time. Donor restricted contributions
for which restrictions are met in the same reporting period are reported as unrestricted support.
Permanently Restricted Net Assets:
Permanently restricted net assets are resources subject to donor imposed restrictions that neither
expire by the passage of time nor can be fulfilled or otherwise removed by actions of the
Organization. There currently are no permanently restricted net assets.
Inventory of Merchandise and Supplies
The inventory consists of merchandise and supplies used in the Organization’s program services.
The purchased inventory is valued at average cost, which is less than market value. Donated
merchandise and supplies are recorded at their fair value at the date of donation.
Property and Equipment
Property and equipment expenditures of $1,000 or more are capitalized at cost and depreciated
over the estimated useful lives of the respective assets on a straight-line basis. Donated fixed
assets are capitalized at fair market value and depreciated on a straight-line basis. Routine
repairs and maintenance are expensed as incurred.
Revenue Recognition
All contributions are considered to be available for unrestricted use unless specifically restricted
by the donor. Amounts received that are designated for future periods or restricted by the donor
for specific purposes are reported as temporarily restricted support, which increases that category
of net assets. When a donor restriction expires, that is, when a stipulated time restriction ends or
the purpose of the restriction is accomplished, temporarily restricted net assets are reclassified to
unrestricted net assets and reported in the statement of activities as net assets released from
restrictions.
Income Taxes
Disaster Relief, Inc. is a nonprofit organization that is exempt from income taxes under Section
501 (c) (3) of the Internal Revenue Code. Management has reviewed all open tax years for all
tax jurisdictions and there are no uncertain tax positions or other provision for income taxes that
should be recognized in these financial statements. The Organization has also been classified as
an entity that is not a private foundation within the meaning of IRC Section 509(a) and qualifies
for deductible contributions as provided in IRC Section 170(b)(1)(A)(vi).
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Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
Concentrations Risk
Concentrations risk consists of cash deposits. The Organization maintains its cash in various
bank deposit accounts that, at times, may exceed federally insured and other insured limits. The
Organization has not experienced any losses in such accounts nor does it expect to incur any
such losses in the future.
Cash
Cash consists of funds on deposit at financial institutions. The Organization has no cash
equivalents.
NOTE B—INVESTMENTS
The Organization has invested in various marketable equity securities. All of the investments are
accounted for using fair value accounting in accordance with SFAS Nos. 124 (ASC 958 and 157
(ASC 820). All securities were valued based on quoted market prices on the New York Stock
Exchange as of December 31, 2014.
Unrealized
Description
Shares
Input Level Gains and Losses Fair Value
Dorcus, Intl.
Pork Belly Feeds
Shovels, Inc.
Bean Bagger Co.
U.S. Motors
100
390
510
10,105
215
Level 1
Level 1
Level 1
Level 1
Level 1
$
298
1,398
5,135
1.133
(7,101)
$
863
$
8,432
43,315
88,999
50,250
24,636
$215,632
NOTE C—PROPERTY AND EQUIPMENT
Property and equipment, at cost, consists of the following at December 31, 2014:
Office furniture and equipment
Delivery trucks
$
87,789
124,664
212,453
44,507
$ 167,946
Less accumulated depreciation
8
Depreciation expense was $18,738 for the year ended December 31, 2014.
NOTE D—RELATED PARTY TRANSACTIONS
The Organization purchases merchandise and supplies from affiliated organizations dedicated to
disaster relief. The Organization has no monetary investment in any of the affiliates or the
power to control their operating activites. These organizations and the volume of transactions
during the year ended December 31, 2014 are:
 Pure Water, Inc.—Purchased bottled water--$ 39,548
 Surplus Supplies—Purchased canned rations --$ 71,598
 Tents and Poles—Purchased tents--$ 149,713
All purchase prices in these transactions were at arms-length and approximated fair market
value.
NOTE E—DEBT OBLIGATIONS
Debt obligations as of December 31, 2014 consist of:
Note payable to bank, payable in monthly installments of
$ 1,252 including interest at 1.75%, collateralized
by 2010 Gruman van
$ 15,768
Installment contract payable to GMAC, payable in
monthly installments of $ 1,250 including
interest at 3.5%, collateralized by 2011 GMC
tractor/trailer
64,765
Installment contract payable to Easy Credit Company,
payable in monthly installments of $ 668 including
interest at 5.99%, collateralized by 2012 Ford F350
flatbed
22,646
Installment contract payable to Legal Lenders, payable in
monthly installments of $ 497 including interest at
10.25%, collateralized by 2008 Strato-Liner
42,919
146,098
Less current portion
(32,259)
$ 113,839
9
Principal maturities on these obligations are:
Year Ending December 31,
2015
2016
2017
2018
2019
2020 and thereafter
$ 32,259
19,288
20,999
19,132
16,257
38,163
$146,098
Interest paid during the year ended December 31, 2014 amounted to $ 12,196.
NOTE F—RESTRICTED NET ASSETS
Unexpended temporarily restricted net assets as of December 31, 2014 result from gifts
containing donor restrictions requiring use of the funds in the following locations:
New Orleans
Balance, January 1, 2014
$
Contributions
Change in net assets
Transfer to unrestricted funds
upon satisfaction of
purpose restrictions
Increase in temporarily restricted
net assets
Balance, December 31, 2014
$
-0-
Galveston
$
-0-
Total
$ -0-
210,980
29,980
240,960
210,980
29,980
240,960
(135,255)
(17,809)
(153,064)
85,725
2,171
$ 87,896
85,725
$ 2,171
$ 87,896
One individual contributed $ 100,000 of these designated funds during the year ended December
31, 2014.
NOTE G—OPERATING LEASE
The Organization leases office facilities under an operating lease. As of December 31, 2014, the
lease payments are as follows:
10
Year Ended December 31,
2015
2016
2017
2018
$ 62,112
63,729
65,670
10,999
$202,510
Rental expense for the year ended December 31, 2014 amounted to $ 64,887.
NOTE H—DONATED SERVICES
A number of volunteers have donated significant amounts of their time to the organization’s
program services and administrative operations. These donated services are not reflected in the
financial statements since none are specialized and, therefore, these services do not meet the
criteria for recognition as contributed services.
NOTE I—NON-CASH TRANSACTIONS
Non-cash transactions during the year ended December 31, 2010, not included in the Statement
of Cash Flows, consist of the following:
1. Purchase of 2006 GMC tractor/trailer on an installment contract for $ 69,399.
2. Donations of bedding and linens recorded at fair market value of $ 205,000.
NOTE J—JOINT COST ALLOCATION
In 2014, the Organization conducted activities that were multi-functional, i.e., they
contained program, management and general and fundraising components. Such
activities were special events, conferences, workshops and direct mail campaigns. Joint
activity costs not directly attributable to these activities are $31,000. Joint costs for each
activity were $5,000, $10,000, $9,000 and $7, 000, respectively. These costs were
allocated to functional components as follows:




New Orleans relief
Galveston relief
Management and general
Fundraising
Total
$ 8,000
4,000
10,000
9,000
$31,000
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NONPROFIT GAAP FOR EXPENSES
Types of Expenses—Accounting and Presentation
Nonprofit organizations’ expenses are classified as follows:



Functional expenses
Naturally classified expenses
Classification of particular costs
The statement of activities and footnotes contain information about the costs associated
with an NPO’s services and how it uses its resources. Expenses are reported according to
their functional classification and include:


Program services
Supporting activities:
o Management and general activities
o Fundraising activities
o Membership development activities
Program services include the activities that result in the fulfillment of the organization’s
mission or purposes by distributions of goods or services to the appropriate recipients.
Providing food and clothing, educational activities, counseling and child care are
examples of such services. A statement of functional expenses is required for health
and welfare organizations, or may voluntarily be presented by other NPOs, which
allocates the natural classifications of expenses to individual major programs.
Management and General activities include:










Oversight
Business management
General recordkeeping
Budgeting
Financing
Soliciting funds other than contributions (exchange transactions, government
contracts, etc.)
Distributing information to the public regarding stewardship
Announcements concerning appointments
Preparation and distribution of annual reports
All management and administration except that which is directly related to
program services or fundraising activities
Fundraising activities include:
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




Publicizing and conducting fundraising campaigns
Maintaining donor mailing lists
Conducting special fundraising events
Preparing and distributing fundraising manuals, instructions and other materials
Conducting other activities involved with soliciting contributions
Membership Development activities include:



Soliciting for prospective members and membership dues
Membership relations
Similar activities
When there are no significant benefits or duties connected with membership in an NPO,
the membership development costs may be classified with fundraising. When
membership development activities are conducted jointly with other activities, costs
should be allocated to both (discussed further below).
Classification of Particular Costs
Certain costs should be classified as follows:






Premiums given to potential donors—fundraising expense.
Costs of sales—separately deducted from related sales amount unless it is a
program (museum bookstore) or supporting service (not a program but major
activity) or a peripheral activity (such as a church selling a cookbook) for which
costs are presented separately.
Interest costs—allocated to program and supporting services; un-allocable
amounts should be reported as management and general expenses.
Costs of occupancy and maintenance—allocated to program and supporting
services but it is not a separate supporting service.
Payments to related local and national organizations—allocated to functional
classifications to the extent possible; un-allocable amounts are presented as a
separate supporting service.
Expenses of Federated Fundraising Entities (such as United Way)—fundraising
expenses.
COST ALLOCATIONS IN THE STATEMENT OF ACTIVITIES
Introduction
An evaluation of the results of operations of a nonprofit organization is often based on
analysis of the costs reported in financial statements and Forms 990 Information Returns.
The problem is these evaluations focus only on what was spent rather than how the
resources were used by the organization. Cost allocations in financial statements and
footnotes should present information about how an NPO used its resources.
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Expenses are incurred for joint activities among an organization’s program services, its
management and general, and its fundraising activities. These expenses should be
allocated among program and supporting services to reflect the purposes for which the
expenses are incurred.
SFAS No. 117 (ASC 958), Financial Statements of Not-for-Profit Organizations,
requires functional expense reporting which usually includes cost allocation. Cost
allocation may also be necessary for unrelated business income tax calculations, lobbying
and government awards expense reimbursement.
Accounting for Costs of Joint Activities that Include Fundraising
The ASC Glossary for nonprofit GAAP defines a joint activity as one that is part of the
fundraising function and that has elements of program and supporting services functions.
Joint costs are those connected with joint activities that can’t be identified with a
component of the activity. Joint costs may include:











Salaries
Contract labor
Consultants
Professional fees
Paper
Printing
Postage
Event advertising
Telephones
Airtime
Facility rentals
The Fundraising Presumption:
FASB ASC, paragraph 958-720-45-37 states, “In circumstances in which joint activities
are conducted, a presumption exists that expenses shall be reported as fundraising rather
than as program or management and general. The following circumstances are
insufficient to overcome that presumption:
a. The purpose of the activity includes educating the public about causes.
b. The audience has a need or reasonable potential for use of any educational
component of the activity pertaining to causes.
c. The audience has the ability to assist the NFP in meeting the goals of the
program component of the activity by becoming educated about causes.”
The ASC provides guidance for overcoming the fundraising presumption by meeting
these criterions:

Purpose
14


Audience
Content
When these criterions are met, direct costs are charged to the applicable function and
joint costs are allocated among the applicable functions. If any of the criterions are not
met, the costs are required to be reported as fundraising activities.
A joint activity is one that combines fundraising activities with program, management
and general or other activities, such as newsletters, websites, special events, or direct mail
and door-to-door solicitations. Two common examples are the use of websites and
newsletters for multi-functional purposes.
A website is commonly used by NPOs to present organizational, financial, and
educational information. Most websites also solicit contributions from visitors. The
contributions solicitation qualifies the website as a joint activity. If the purpose, audience
and content criteria are not met, all website related expenses must be classified as
fundraising.
Newsletters are also used by NPOs to present organizational, financial and educational
information. The newsletters may contain a contributions solicitation section or an
accompanying solicitation device or reply envelope. Even if the newsletter contains no
solicitation, and it includes a device or reply envelope, it would usually be considered a
joint activity including fundraising. Again, if the purpose, audience and content criteria
are not met, all newsletter related expenses must be classified as fundraising.
Overcoming the Fundraising Presumption:
Purpose Criterion
The purpose criterion is met when the costs of the joint activity are related to
accomplishing program or management and general functions. To accomplish program
functions, the activity must call for specific action by the audience that helps accomplish
the organization’s exempt purpose by benefiting recipients or society in general.
When program services and/or management and general functions are combined with
fundraising, these factors must be considered in order to determine if the purpose
criterion is met:
1. The Compensations or Fees Test. The purpose criterion is not met when any
individual is compensated for performance based on the funds raised in an activity
(such as a church building program with a compensated fundraiser).
2. The Separate and Similar Activities Test. The purpose criterion is met if a
similar activity is conducted separately on a similar or greater scale.
3. The Other Evidence Test. If the first two tests cannot be completed because of
inadequate information, other evidence such as verbal appeals or previous
operations of the organization may be considered.
15
Audience Criterion
A rebuttable presumption exists that the audience criterion is not met if the audience is
selected from a database of prior donors or the ability or likelihood of recipients to
contribute. In making such determinations, the organization must consider the extent to
which the selection was made for these reasons. If the audience’s ability and likelihood
to donate is a significant factor in its selection, and its need is an insignificant factor, the
presumption would not be overcome.
When the audience is not selected as described in the previous paragraph, the audience
criterion is met if the audience is selected for any of these reasons:



The audience’s need for the action called for.
The audience’s ability to take the action.
The organization is required to direct the management and general component to a
particular audience or one that can be reasonably expected to use the component.
Content Criterion
If the joint activity supports program or management and general functions, the content
criterion will be met if:


The program component of the joint activity calls for a specific action that will
help accomplish the organization’s exempt purpose.
The management and general component of the joint activity fulfills a
management and general responsibility of the organization.
A Chronology of the Application of Criteria to Overcome the Fundraising
Presumption:
1. Determine if the activity includes a contribution solicitation. If not, the cost
should be charged or allocated to the applicable program or supporting
service.
2. If the activity includes a solicitation, apply the Purpose Criterion by
determining if the activity calls for a specific action.
3. Determine if a majority of compensation of anyone performing the joint
activity is based on the funds raised. If so, all the costs are fundraising.
4. If not, determine if the activity is conducted on a similar scale using the same
medium without the solicitation. If it is not, determine if there is other
evidence. If no other evidence, all the costs are fundraising.
5. If the program is conducted on a similar scale using the same medium, go to
the Audience Criterion.
6. Determine if the audience is selected from prior donors or the ability or
likelihood to contribute. If so, determine if the presumption the audience
16
criterion is not met can be overcome based on its selection of management
and general reasons. If so, go to the Content Criterion.
7. Determine if the activity motivates the audience to take action in support of
program goals or if it fulfills management and general responsibilities. If it
does not, all costs are fundraising.
8. If the action called for supports these goals or responsibilities, joint costs can
be charged or allocated to a particular function.
A detailed flowchart and explanations of the application of the purpose, audience and
content criterion is included in the FASB ASC, paragraphs 958-720-55-1 through 24.
An Example of Application of the Purpose, Audience and Content Criterion
A nonprofit organization was created for the purpose of educating and serving clients that
have been diagnosed with a debilitating and potentially terminal disease. The NPO
presents three types of conferences or events in carrying out its exempt purposes:
1. Conferences for its clients that only include workshops on how to improve the
quality of client’s lives. The brochure challenges clients to take action and make
changes in their lifestyles (the mission of the NPO). A small admission fee is
charged to the clients. Conference organizers are salaried staff members of the
organization.
2. A conference for past and possible future donors and clients that also includes
quality of life workshops and, in addition, main sessions featuring well-known
actors and sports heroes that suffer from the disease.
3. Events such a bike rides, fun runs and walks are held to create public awareness
of the disease and to raise funds to support the work of the NPO.
The first type of conference is carrying out the educational purposes of the NPO. Only
clients are invited and there is no fundraising activity conducted at the conferences. The
purpose, audience, and content criterion are met and costs of this conference can be
charged to program services.
While the second type of conference also includes workshops for clients, another purpose
is the motivation of potential donors. The call to action for clients may also be to change
their lifestyles but other individuals are invited because of their ability or likelihood to
contribute to the organization. Because the organization is also holding the first type of
conference, and because it is publicized in the same way, a general mailing that doesn’t
concentrate on potential donors may satisfy the audience criterion. This mailing
concentrated on potential donors and, therefore, the audience criterion is not met and all
costs must be recorded as fundraising.
The third type of event does create awareness of the disease, which is part of the NPO’s
mission, but the events are clearly held for the purpose of raising funds and, therefore, the
purpose, audience and content criterion need not be considered. All costs of these events
must be recorded as fundraising expenses.
17
From this example and the text above, we can extract some tips for planning direct mail
campaigns to maximize the costs that can be allocated to program services:
 Always include a strong call to action that helps accomplish the organization’s
mission.
 Avoid paying organizers or fundraisers based on a percentage of funds raised.
 Use staff persons skilled in the program services as opposed to fundraisers to
organize the event.
 Hold similar events using the same medium that are clearly program services.
 When the audience includes potential donors, but was not selected primarily for
motivating contributions, the program services should be clearly documented in a
brochure or other literature.
 When special events are held for fundraising purposes, or when the event will fail
one of the three criterions for overcoming the fundraising presumption, program
services should be minimized since all costs will be accounted for as fundraising.
COST ALLOCATION METHODS
Cost allocation methods for joint costs must be rational and systematic and result in a
reasonable allocation of costs. The allocation methods must be applied consistently.
Three allocation methods are described in the ASC:
1. Physical units method
2. Relative direct cost method
3. Stand-alone joint-cost-allocation method
Physical Units Method
Joint costs are allocated to materials and activities based on the proportion of the number
of units of output that can be attributed to each of the materials or activities. Number of
lines, square inches, and other physical content measures are examples of units of output.
This method assumes benefits from the joint costs are proportional to the units of output.
Use of the physical units method can result in a reasonable allocation of costs if the l
units of output can be easily identified with each component of the joint activity. If the
benefits received for each of the functional components of the joint activity are directly
proportional to the units of output that includes that component, the resulting allocation
will be reasonable. If the units of output cannot be clearly assigned to a component
function, the method can result in an unreasonable allocation of costs.
For example, assume the joint costs for a direct mail campaign are used to conduct
programs and to solicit contributions. 75 % of the lines in the device pertain to programs
and 25% are used for contributions solicitations. If the purpose, audience and content
criterion can be satisfied, joint costs would be allocated in this ratio.
Relative Direct Cost Method
18
Joint costs are allocated to each of the components on the basis of their relative direct
costs. Direct costs are those costs specifically identifiable with a function. This method
may result in an unreasonable allocation if the joint costs are not incurred in similar
proportions and for the sane reasons as the direct costs.
For example, assume that the costs of a direct mail campaign that can be specifically
identified with program services are the costs of separate program materials and a
postcard which calls for specific action by the recipient that will help accomplish the
organization’s exempt purpose. These costs total $2,000. The direct costs of the
fundraising component consist of the costs to develop and produce the fundraising letter,
which total $8,000. Joint costs are $4,000 and would be allocated as follows:
Program expenses
$2,000 / $10,000 x $4,000 = $800
Fund raising expenses $8,000 / $10,000 x $4,000 = $3,200
Stand-Alone Joint-Cost-Allocation Method
Joint costs are allocated to each component based on a ratio that uses estimates of the cost
of each component if the activity was conducted independently. This method may result
in an unreasonable allocation because it doesn’t take into account the positive or negative
effect of each component on the other components conducted in a joint activity. For
example, the programmatic impact of a brochure on school safety procedures may be
lessened if it is distributed in a direct mail campaign that includes also includes a
solicitation for contributions instead of a school safety brochure being distributed
independently.
FASB ASC paragraphs 958-720-55-35 to 165 contain numerous examples of application
of the purpose, audience and content criterion and the related allocations of costs for joint
activities.
BASES FOR COST ALLOCATIONS
The identification of direct costs, and the allocation of joint activity direct and indirect
costs, is required to present a statement of activities on a functional basis and to present a
statement or supplementary schedule of functional expenses. Examples of direct costs
for a specific program are salaries of individuals assigned exclusively to the program or
the cost of materials and supplies purchased solely for use in the program. Other costs
described as joint activity costs above should be allocated among the various functions.
Here are some considerations for effectively allocating costs:
 Each year’s planning should include an evaluation of the preceding year’s time
records or activity reports of key personnel, the use of space, the consumption of
supplies and postage, and other costs of activities. Reconsideration of allocation
methods could result in more accurate cost allocations.
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 Periodic time and expense records should be kept by employees that are assigned
to multiple functions. If time expenditures of these employees are relatively
consistent from period to period, one or two month tests may be appropriate to
support allocations.
 Expense or time reports may be used to allocate automobile and travel costs.
 Telephone expense includes direct costs for use and calls attributable to a specific
function, or it may be allocated to multiple functions based on the allocation of
the salaries of individuals performing the functions.
 Stationery, supplies, and postage costs may be allocated based on records
supporting their use.
 The square footage of space used for specific programs or functions, or the
salaries of persons assigned to those functions, normally will be used to allocate
occupancy costs.
 Asset usage may form the basis for allocation of depreciation expense and
equipment rental expense.
STATEMENT OF FUNCTIONAL EXPENSES
Here is an illustrative statement of functional expenses:
DISASTER RELIEF, INC.
STATEMENT OF FUNCTIONAL EXPENSES
Year Ended December 31, 2010
Salaries and benefits
Occupancy costs
Relief supplies
Travel expenses
Conference and events
Postage and printing
Office expenses
Merchandise purchases
Publications costs
Total
New
Orleans
$ 321,880
52,863
506,412
412,080
41,187
8,778
$1, 343,200
Galvaston
$
195,218
35,242
706,368
262,919
41,187
9,267
$1,250,201
Management
and General
$
423,168
79,295
69,949
179,511
$ 751,923
Fundraising
$ 49,488
8,811
Total
118,766
90,165
$ 989,754
176,211
1,212,780
674,999
323,014
125,789
197,556
118,766
90,165
$563,710
$3,909,034
240,640
55,840
ILLUSTRATIVE FOOTNOTES DISCLOSURE FOR ALLOCATION OF COSTS
Here is an illustration of a footnote disclosure for cost allocations:
Note Y. Joint Cost Allocation
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In 20XX, the Organization conducted activities that were multi-functional, i.e., they
contained program, management and general and fundraising components. Such
activities were special events, conferences, workshops and direct mail campaigns. Joint
activity costs not specifically attributable to these activities are $31,000. Joint costs for
each activity were $5,000, $10,000, $9,000 and $7, 000, respectively. These costs were
allocated to functional components as follows:

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
Program A
Program B
Management and general
Fundraising
Total
$ 8,000
4,000
10,000
18,000
$31,000
INTERNAL CONTROLS AND EXPENSE RECOGNITION
Management is responsible for designing internal controls over financial reporting to
provide reasonable assurance their financial statements are fairly presented. Fair
presentation includes the accuracy of management’s representations in financial
statements, otherwise known as financial statement assertions. Control activities include
entity-level controls and activity-level controls. Entity-level controls have the most
pervasive effect on preventing errors or fraud from occurring and going undetected and,
in small NPOs, are generally operated by management personnel. Activity-level controls
may, in some cases, prevent errors from occurring and going undetected when key
controls are not properly designed or operating. Key controls may exist at the entity level
or the activity level; however, for small entities key controls are almost always operated
at the entity level. Here are some examples of entity-level and activity-level controls
over expenses for a small NPO.
Entity-Level Controls
 The director receives bank and credit card statements directly either by mail or
electronically.
 The director reviews contents of bank and credit card statements and investigates
unusual items.
 The director signs vendor checks and payroll checks.
 The director reviews and approves vendor invoices, receiving reports and/or
purchase orders when signing checks.
 The director determines account classifications are proper.
 The director reviews documentation of payroll calculations when signing checks.
 The director makes or approves all online bank transfers or payments.
 The director approves reconciliations of bank statements.
 The director reads monthly financial statements and investigates unusual items.
Activity-Level Controls
 Checks are signed only when disbursement is made.
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Only pre-numbered checks are used.
Journal entries are approved by the director.
All W-4s, I-9s and other payroll documents are maintained.
Payroll checks are distributed by supervisors.
Supervisors approve hires, fires, wage rates, time off.
A detailed, descriptive chart of accounts is used.
Checks are prepared only when supporting documents have been received.
The person recording and posting transactions cannot sign checks.
Vendor invoices are cancelled by the check signer.
Both the entity-level and the activity-level controls help ensure that all transactions are
recorded, only valid transactions are recorded, that transactions amounts are accurate and
valued properly, that transactions are recorded in the proper period and that they are
classified properly. These are management’s representations in financial statements
(assertions) that ensure an entity’s financial statements are presented fairly.
SUMMARY OF DIFFERENT PRESENTATION AND DISCLOSURE
REQUIREMENTS FOR NPOs
Nonprofit organizations generally follow U.S. GAAP for presentation of financial
statements and footnotes. GAAP for nonprofit organizations, however, contains some
differences. A summary of some common, significant differences in nonprofit GAAP for
financial statements and footnotes presentation follow.
Statement of Financial Position
 The statement can be classified or non-classified if the order of assets and
liabilities discloses liquidity.
 Assets subject to donor-imposed restrictions must be disclosed.
 Net assets must be reported as unrestricted, temporarily restricted or permanently
restricted.
 Requirements to hold cash in separate accounts must be disclosed.
 Cash designated or restricted for long-term purposes must be reported as noncurrent.
 Unconditional promises to give must be presented separately (according to their
characteristics) and amounts due in one year, one to five years and in more than
five years must be disclosed.
 The amount of the uncollectible promises to give must be disclosed and netted
against the promises.
 Unamortized discounts of long-term promises, effective interest rates and the total
related contribution amounts should be disclosed. Amortization of discounts
should be recorded as contributions.
 Major classes of inventories and their method of valuations should be disclosed.
Reasonable estimates of value are acceptable.
 Investment disclosures are similar except:
o Fair values must be used for all marketable equity and debt securities
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o Endowments and other donor restricted assets reported at fair values less
than donor requirements must disclose deficiencies.
o Information about investment returns by category of net assets must be
disclosed.
The basis of valuation of depreciation for purchased (cost) and contributed (fair
value) fixed assets.
Property and equipment used in operations with title held by a grantor must be
disclosed.
Collections capitalization policy must be disclosed.
Separate disclosure must be made of any works of art, treasures, etc. that don’t
meet the definition of collections that are capitalized.
Policies regarding agency transactions must be disclosed.
Liabilities for unconditional promises to give to other organizations require
disclosures similar to receivable promises.
The organization’s income tax status, including any uncertainties and excise
taxes, must be disclosed.
Statement of Activities
 The statement must present the change in net assets for unrestricted, temporarily
restricted and permanently restricted net assets, separately and in total.
 Revenues are recorded when received based on the presence or absence of donorimposed restrictions.
 Reclassifications of contributions due to the satisfaction of time and purpose
restrictions should be presented as a separate line item.
 All expenses are presented as decreases in unrestricted net assets.
 In-kind contributions of materials, services, free use of space and assets must be
recorded on a separate line with special disclosures regarding the methods of
valuation.
 Contributed services disclosures of their nature, use and the amounts of recorded
and unrecorded contributions.
 The total of all fundraising costs must be disclosed.
 The types and methods of joint cost allocations and the amounts allocated to
functional expense categories.
 Expenses must be reported by major functional category.
 A statement of functional expenses is required for voluntary health and welfare
organizations and optional for other NPOs.
 Costs of major programs reconciled to total program costs must be disclosed.
Statement of Cash Flows
 Certain long-term contributions with donor restrictions, usually endowments,
should be presented as financing activities.
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The disclosure requirements listed above are not all-inclusive. Complete Disclosure
Checklists can be obtained from Practitioners Publishing Company, the AICPA and other
providers of quality control materials.
NONPROFIT GAAP VS. FORM 990 ACCOUNTING METHODS
The instructions for Form 990, under Accounting Methods, states:
“Unless instructed otherwise, the organization should generally use the same
accounting method on the return to report revenue and expenses that it regularly
uses to keep its books and records. To be acceptable for Form 990 reporting
purposes, however, the method of accounting must clearly reflect income.”
Some nonprofit organizations are using other comprehensive basis of accounting, such as
the income tax basis, to prepare their financial statements. Most NPOs are using U.S.
GAAP because it is required by oversight or grantor agencies. The reporting framework
used by an organization for accounting purposes should also be used to prepare the Form
990 and all related schedules unless otherwise specified.
Part IX of Form 990, Statement of Functional Expenses, must be completed by all
501(c)(3) and 501(c)(4) organizations. The allocation of joint-activity costs and the
reporting of functional expenses in Part IX should use the same methods and reporting
framework used by the NPO in its financial accounting and reporting, with the exception
of recording expenses related to certain in-kind contributions.
Contributions of services and the free use of space cannot be recorded in the Form 990.
Because contributors and grantors may request copies of the Form 990, or view the return
on www.guidestar.org, disclosure of the amounts of these contributions used in program
services in the left column, line 24, of Part IX may be beneficial.
Cost allocations for unrelated business income tax calculations (UBIT) must be done
reasonably and consistently. All expenses deductible against unrelated business income
must be “directly connected” with the source of the revenue and have a “proximate and
primary” relationship to the revenue. Allocation methods similar to those used for
financial reporting will be the easiest to defend.
Deductible expenses must be “ordinary and necessary” and special UBIT rules in the
Internal Revenue Code and Regulations must be followed. Differences between financial
accounting and tax reporting, such as reporting bad debts, meals and entertainment
expenses, fines and penalties and excise taxes must be taken into account.
Cost allocation methods must include all expenses, i.e., direct and indirect. While certain
functional expenses like fundraising and membership development are allocable only to
nonprofit activities, all other applicable direct and indirect costs should be charged or
allocated to unrelated business income.
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CONCLUSION
Nonprofit organizations’ financial statements and footnotes are designed to report the
management and use of an entity’s resources. Funds available for carrying out the
Organization’s mission in the future are reported in its financial statements and footnotes.
Management is responsible for internal control over the financial reporting process and
has primary responsibility for representations (assertions) in the financial statements and
their presentation in accordance with the applicable reporting framework. Knowledge of
the basic accounting and reporting requirements described in these materials will enable
management and/or their auditors to prepare accurate and complete financial statements
and footnotes.
Disclosure checklists for nonprofit organizations are available from the AICPA and other
major publishers. Obtaining and using such checklists will ensure the preparation of
accurate and complete financial statements and footnotes.
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