You’ll be familiar with the statement of functional expenses if you file audited financial statements or if you’ve been following the new financial statement guidance from FASB. The main purpose is to report your expenses in 3 pools – program services, management and general, and fundraising. If you already track your expenses in these categories in your accounting system, then use the same allocation method for your Form 990. If not, you can use any reasonable allocation method, but need to document your allocation method in your records.
The line items on the Form 990 should map pretty closely to the expense types in your accounting system. If you have expense types that aren’t included here, you can list them on line 24. The main trick is assigning expenses to the right functional classification.
Program service expenses are those that keep your programs running, that further your exempt purposes. Management and general covers general management of the organization (not program or fundraising management), accounting and finance functions, preparing an annual report, etc. Fundraising includes any costs of soliciting donations, such as fundraising campaigns, preparing and distributing materials, maintaining donor lists, etc.
One difference between the Form 990 and your regular financial statements is that, if you hosted fundraising events, the direct expenses of the events will not be listed on the Form 990 version of this statement, but rather on line 8b of the statement of revenue (Section VIII, immediately prior to the current statement).
Some expenses don’t fall entirely into one category and will need to be allocated based on a reasonable, documented method. Common bases for allocation include:
- Actual usage of the expense in question, e.g. a phone bill with several lines, some of which are used for fundraising staff and some are for program staff, would be allocated based on how many lines are used by each type of staff.
- Proportional to where staff spend their time (full-time equivalents, or FTEs), e.g. printing, office supplies, sometimes rent. You can also allocate an individual staff member’s salary and benefits based on where he or she spends their time. For non-payroll expenses, whatever percentage of staff members work in each function, multiply allocated expenses by that percentage.
- Square footage of each department, e.g. utilities or rent paid for an office used by multiple functions. If half the office is used by program staff, a quarter for management, and a quarter for fundraising staff, that portion of the rent would be charged to those functions.
Your Form 990 is a publicly available document, and the statement of functional expenses is commonly referenced by the public, often to evaluate the efficiency of an organization’s work. If a high percentage of your expenses are spent on fundraising or management, some people may question why you aren’t investing more in your programs. In recent years, more criticism has come up about relying too heavily in efficiency metrics, since it doesn’t tell the full story of your organization’s work and what you’re achieving. In some cases, financially similar organizations may allocate expenses differently, which would skew their efficiency metrics. In other cases, an organization might invest heavily in staff salaries in order to attract highly experienced people, and professional development to make staff more effective. Investing a lot of money in fundraising may be a result of going through a capital campaign, or may be a very active department that brings in more than enough grants, donations, and program revenue to justify the cost, and improves the organization’s finances overall. This doesn’t give carte blanche to spend unwisely in these areas, but efficiency isn’t the only criteria you should use in evaluating your organization. Your organization exists to improve the lives of your constituents, and you should always be prepared to show what you have accomplished and how that is supported and enhanced by what you’re investing in.