Nonprofit organizations are subject to unique accounting and reporting requirements where expenses must be reported by functional areas.
Nonprofit Functional Accounting is an accounting method of separating accounting for expenses related to major activities in operating your nonprofit organization. These consist of (1) Support Services such as administration and fundraising; (2) Program Services which are mission-based.
Nonprofit Functional Areas
Nonprofit functional areas consist of Support Services and Program Services.
- Support Services
- Management and General – Day to day administrative activities such as management, accounting, human resources and governance.
- Fundraising – Activities related to appeals for support through donations and fundraising events.
- Activities related to providing the services for your mission.
What Do Functional Expenses Tell You
Nonprofit functional accounting easily allows your organization to identify three key elements that identify every dollar that comes into and goes out of your organization, answering the Who, What and Why of nonprofit reporting requirements.
- Income: Who is providing the dollar – funder
- Expense: Who is paying for an expense – funder
- Income: What type of income is it – grant, contract, earned revenue
- Expense: What will dollars be spent on – payroll, supplies, etc.
- Income: Why they are providing the dollar – which program or purpose
- Expense: Why the dollar is being spent – which program or purpose
Readers of your financial statements, such as donors are interested in understanding the relationship between an organization’s program expenses and its supporting expenses. This helps answer the “what” and “why” questions regarding an organization’s expenses. It is also required for the IRS Form 990 which asks nonprofits to divide expenses by Support Services and Program Services.
Keeping track of functional expenses also facilitates the preparation of a statement of functional expenses, which is required as part of an annual audit. Tracking functional expenses is also an excellent tool for decision-making and transparency. It gives you a bird’s eye view of exactly what each activity is costing, helps to determine what is working, and what is sustainable.
Benefits of Functional Accounting
Functional Areas place the “who” and the “what” of each dollar in the “why”, which is either support services or programs designated for that dollar. If you use functional accounting, you can easily monitor each dollar coming in and going out. To get started, begin with your mission. Study your goals and value statements and determine how your nonprofit is organized. Identify the larger purposes for which you spend the most time and money.
With nonprofit functional accounting you can easily identify each transaction coming in or going out with an amount that corresponds to the who, what and why of each transaction. This will help you generate higher quality and accurate reports. If your current accounting methods cannot accomplish this then you might want to consider a nonprofit accounting software package that incorporates functional accounting methods. This is part of the framework of knowing the answers to nonprofit organization accounting questions.
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