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Expenses are outflows or other using up of assets associated with delivering or producing goods, rendering services, or carrying out the NFP’s other activities. In a statement of activities or statement of operations, expenses must be reflected as changes in net assets without donor restrictions, except for external and direct internal investment expenses that must be netted against investment returns (see NP 9).
As discussed in AAG-NFP 12.11, expenses that are directly related to specific revenues may be displayed adjacent to those revenues, similar to the manner in which costs of goods sold are reported.

Excerpt from AAG-NFP 12.11

Expenses that are directly related to specific gross revenues may be displayed sequentially with [the related] revenues. For example, gross revenues from special events less the direct costs related to those events, followed by a subtotal, may be reported in a statement of activities.

NFPs are required to provide information about expenses disaggregated by both function and nature, as those terms are defined in the ASC Master Glossary.

ASC Master Glossary

Functional expense classification: A method of grouping expenses according to the purpose for which costs are incurred. The primary functional classifications of a not-for-profit entity are program services and supporting activities.
Natural expense classification: A method of grouping expenses according to the kinds of economic benefits received in incurring those expenses. Examples of natural expense classifications include salaries and wages, employee benefits, professional services, supplies, interest expense, rent, utilities, and depreciation

Figure NP 3-7 illustrates the functional versus natural classification presentations.
Figure NP 3-7
Expense classification formats
Expenses by natural classification
Expenses by functional classification
Expenses:
Expenses:
Salaries and benefits
$ 15,115
Program A
$ 13,296
Grants to other organizations
4,750
Program B
8,649
Supplies and travel
3,155
Program C
5,837
Services and professional fees
2,840
Management and general
2,038
Office and occupancy
2,528
Fundraising
2,150
Depreciation
3,200
Interest
382
Total expenses
$ 31,970
Total expenses
$ 31,970

An NFP has free choice regarding which classification to use for displaying expenses on the face of the statement of activities or statement of operations. Information regarding the other expense classification may be satisfied by the required analysis of program expenses by function and nature, discussed at NP 3.5.2. Some entities with a single program might be able to display both classifications on the face of the statement. Figure NP 3-9 illustrates such an approach.
For NFP HCOs, industry convention is to use natural expense classifications on the face of the statement of operations, consistent with business entity reporting practices. Among other NFPs, practice is mixed.

3.5.1 Reporting expenses by functional classification

The presentation and disclosure requirements for NFPs regarding expenses are more extensive than they are for business entities. Because most NFPs have no single indicator of performance comparable to a business entity’s profit, the FASB determined that other indicators of performance (such as information regarding service efforts) were needed in financial statements. Consequently, ASC 958-720-05-4 established a requirement to provide information about expenses by functional classifications, which focus on how an NFP’s resources (cash, personnel, materials, etc.) are used in providing its programs or services.

ASC 958-720-05-4

To help donors, creditors, and others in assessing an NFP's service efforts, including the costs of its services and how it uses resources, a statement of activities or notes to financial statements shall provide information about expenses reported by their functional classification such as major classes of program services and supporting activities.

Functional reporting involves grouping expenses according to the purposes for which they were incurred. The primary categories used are program services and supporting activities.

3.5.1.1 Program services

Program services involve distribution of the NFP’s goods or services to beneficiaries, customers, or members—in other words, carrying out the purpose for which the NFP exists. Some entities will report multiple programs—for example, an academic medical center might report information about programs for student instruction, research, and patient care, among others. Others may have a single program. For financial reporting purposes, NFPs have latitude to define the programs to be displayed and to determine the degree of aggregation used when reporting expenses of programs.
The components of program expenses must be evident from the details provided either on the face of the statement of activities or in the notes.

Excerpt from ASC 958-720-50-1

The financial statements of an not-for-profit entity (NFP) shall disclose the following information:
b. Total program expenses and information about why total program expenses disclosed in the notes do not articulate with the statement of activities. Pursuant to paragraph 958-720-45-5, this disclosure is only required if the components of total program expenses are not evident from the details provided on the face of the statement of activities (for example, if cost of sales is not identified as either program or supporting services).

3.5.1.2 Supporting activities

Expenses that are not associated with programs are considered to be supporting activities. Supporting activities generally include:
  • Fundraising

    Fundraising activities are undertaken to induce potential donors to contribute. They include publicizing and conducting fund-raising campaigns; maintaining donor mailing lists; conducting special fund-raising events; preparing and distributing fund-raising manuals, instructions, and other materials; and conducting other activities involved with soliciting contributions from individuals, foundations, government agencies, and others.
  • Membership development

    Membership development expenses include costs associated with member dues, member relations, and soliciting new members. As discussed at NP 12, some NFPs have "members" whose "dues” are tantamount to contributions, because the member receives no significant benefits in exchange for the resources they provide. In those situations, membership development activities might more appropriately be considered fundraising activities. If member dues paid are part-exchange and part-contribution, membership development activities would be “joint activities,” the costs of which must be allocated according to a specific framework (see NP 3.5.1.3).
  • Management and general

    This is the residual classification used for activities that are not directly identifiable with program, fundraising, or membership development functions. Typically, it includes the salaries and expenses of the NFP’s executive management and supporting staff, expenses of the governing board, and costs of activities or departments that benefit the overall organization (for example, human resources or accounting). See ASC 958-720-45-2A for types of activities that are considered management and general.

3.5.1.3 Allocation of costs among functions

Some expenses relate directly to a single program or supporting service. Whenever possible, direct identification of specific expenses (also referred to as “assigning” expenses) is the preferable method of charging expenses to functions.
When that is not possible, expenses must be allocated among the functions to which they relate. Situations requiring allocation include:
  • Specific activities that directly benefit more than one function

    Costs of certain supporting activities carried within management and general should be allocated among the functions that receive direct benefit, while others should remain entirely within the management and general function. Costs of departments that benefit the overall organization should remain entirely within management and general. ASC 958-720-45-2A cites accounting, financial reporting, and human resources as examples of supporting activities for the entire entity that benefit the overall organization. Information technology is cited as an example of costs that are shared by and identifiable with more than one function that should be allocated. Illustrative guidance that clarifies the types of costs that should (and should not) be allocated are provided in paragraphs ASC 958-720-55-171 through ASC 958-720-55-176.

Excerpt from ASC 958-720-45-2A

Certain costs benefit more than one function and, therefore, shall be allocated. For example, information technology generally can be identified as benefitting various functions, such as management and general (for example, accounting and financial reporting and human resources), fundraising, and program delivery. Therefore, information technology costs generally would be allocated among the functions receiving direct benefit.

  • Joint activities

    If activities that are part of the fundraising function have elements of one or more other functions, they are considered “joint activities” that must be allocated in a particular manner. Guidance on the allocation of costs of joint activities is provided in the Accounting for Costs of Activities That Include Fundraising subsections of ASC 958-720 (beginning with ASC 958-720-45-28). ASC 958-720-55-2 includes a flowchart that is useful in determining how to account for joint activities.
  • General management personnel are involved in conducting or supervising program, fundraising, or membership development activities

    If individuals whose compensation and benefits are classified as management and general costs spend a portion of their time directly conducting or supervising program, fundraising, or membership development activities, allocation of a ratable portion of their compensation to those other functions is required by ASC 958-720-45-2A.

Excerpt from ASC 958-720-45-2A

Activities that represent direct conduct or direct supervision of program or other supporting activities require allocation from management and general activities.

Example NP 3-1 illustrates the allocation of the costs of supervisory personnel to various functions.
EXAMPLE NP 3-1
Allocating compensation of the chief financial officer among functions
The CFO at Charitable.org has primary responsibility for (a) accounting and reporting, (b) short-term budgeting and long-term financial planning, (c) information technology, and (d) managing the investment strategy of the endowment. The CFO spends 40% of her time on accounting and reporting (including supervising the accounting for investments); 30% on budgeting and financial reporting; 20% on information technology; and 10% managing the investment strategy.
How should Charitable.org allocate the CFO’s salary and benefits among its functions?
Analysis
In this situation, 70% of the CFO’s compensation and benefits would relate to conduct or supervision of management and general activities that benefit the overall organization (i.e., accounting and reporting, and budgeting and financial planning). That portion of compensation and benefits would remain within the management and general function. The 20% of time spent directly supervising the information technology department means that 20% of the CFO’s compensation and benefit costs should be included in the IT costs that are allocated among the functions that benefit from them. The time spent directly supervising and managing the investment strategy for the endowment qualifies as direct investment expense, so 10% of her compensation and benefit costs would be netted against investment return and thus, would not be displayed as part of expenses (see NP 9 for guidance on direct internal investment expenses netted against investment return). The time spent supervising the accounting for investments is not allocated to investment return; instead, it is part of the accounting function within management and general activities.

Other examples can be found in ASC 958-720-55-171 through ASC 958-720-55-175. ASC 958‑720‑50‑1(d) requires disclosure of the allocation methods used. AAG-NFP 13.67 through AAG-NFP 13.73 provide additional commentary on allocations and allocation methods.

3.5.2 Analysis of expenses by nature and function

NFPs are required by ASC 958-720-45-15 to provide a statement or schedule detailing how the entity’s natural expenses were allocated among its program and support functions in order to demonstrate more clearly how an NFP uses its resources to achieve its mission or objectives.

Excerpt from ASC 958-720-45-15

The relationship between functional classification and natural classification for all expenses shall be presented in an analysis that disaggregates functional expense classifications, such as major classes of program services and supporting activities, by their natural expense classifications, such as salaries, rent, electricity, interest expense, supplies, depreciation, awards and grants to others, and professional fees.

NFPs have flexibility in where they present this information. It can be provided on the face of the financial statements, in the notes, or as a separate basic financial statement. The analysis must include all expenses reported in the statement of activities or statement of operations and is required for all periods presented. If an entity reports expenses on the face of the statement using functional classifications, and those amounts do not reconcile to this analysis, the differences must be explained. This might occur if, for example, cost of sales is displayed apart from other expenses on the face of the statement, in order to present those costs together with the related program revenue.
Figure NP 3-8 illustrates the reporting of expenses by nature and function as a separate schedule.
Figure NP 3-8
Schedule of expenses by nature and function
Program activities
Supporting activities
A
B
C
Subtotal
Manage-ment and general
Fund-raising
Subtotal
Total expenses
Expenses and losses:
Salaries and benefits
$ 7,400
$3,900
$1,725
$13,025
$1,130
$960
$2,090
$ 15,115
Grants to other organizations
2,075
750
1,925
4,750
4,750
Supplies and travel
890
1,013
499
2,402
213
540
753
3,155
Services and professional fees
160
1,490
600
2,250
200
390
590
2,840
Office and occupancy
1,160
600
450
2,210
218
100
318
2,528
Depreciation
1,440
800
570
2,810
250
140
390
3,200
Interest
171
96
68
335
27
20
47
382
Total expenses (Note F)
$13,296
$8,649
$5,837
$27,782
$2,038
$2,150
$4,188
$ 31,970

Figure NP 3-9 illustrates how the requirements of ASC 958-720-45-15 might be accomplished on the face of a statement of activities.
Figure NP 3-9
Expenses by function and nature on face of statement of activities
Expenses:
Program:
Salaries and benefits
$3,900
Supplies
1,013
Services and professional fees
1,490
Office and occupancy
600
Depreciation
800
Total program
7,803
Management and general:
Salaries and benefits
1,130
Supplies
213
Services and professional fees
200
Office and occupancy
218
Depreciation
250
Total supporting
2,011
Total expenses
$ 9,814

Figure NP 3-10 provides a summary of items that frequently raise questions as to whether they should be included or excluded from the analysis.
Figure NP 3-10
Items included in or excluded from the analysis by nature and function (ASC 958-205-45-6)
Included in analysis
Excluded from analysis
Salaries included in cost of goods sold on face of statement
Facility rental costs of special events reported as direct benefits to donors on face of statement
Any other expenses shown apart from functional expenses on the face of a statement that displays expenses by functional classifications
Non-service component of net periodic benefit cost
Expenses shown as nonoperating activity
External and direct internal investment expenses netted against investment return (see NP 9)
Losses (in general)
Losses reported in OCI of business entities (see NP 3.4.1)

Question NP 3-2 and Question NP 3-3 address common questions related to the analysis.
Question NP 3-2
Can an NFP consider materiality in determining whether to present the analysis of expenses by nature and function?
PwC response
Yes. ASC 105-10-05-6 states that “the provisions of the Codification need not be applied to immaterial items.” This applies to all provisions of the Codification, including disclosure requirements.
Question NP 3-3
An NFP’s statement of activities presents an intermediate measure of operations. Should the components of net periodic benefit cost other than service cost be excluded from the analysis of expenses by nature and function?
PwC response
No. Net periodic benefit cost represents a period expense of the entity, regardless of whether it is displayed as a single amount or subdivided into its various components. The requirement to segregate net periodic benefit costs between operating and nonoperating categories would have no impact on the amounts to be included in the analysis. All expenses reported in the financial statements—including those classified as nonoperating—must be included in the analysis of expense by nature and function.
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