Article by: Anna Baumgardner, CPA, Senior Client Advisor for Nonprofits
Overhead Expenses: to allocate, or not to allocate?
Not only should expenses be carefully categorized according to the type of expense, or account, but most not-for-profits also categorize expenses according to the activity, or class, that the expense supports. Outside of standard financial statement preparation, these activities, or classes, are separated on the annual Form 990. One of the most challenging aspects of accounting for not-for-profits is determining whether the overhead expenses incurred are allocable to the various functional areas of your organization. The functional expenses can be classified as either programmatic, management & general, or fundraising. Let’s walk through what overhead expenses should be allocated.
Management and General Overhead Expenses
Let’s start by examining the management & general (M&G) expense class. M&G is also sometimes known as the Administrative class, and is generally defined as “overhead.” The IRS Information Form 990 instructions describe M&G as “expenses that relate to the organization’s overall operations and management, rather than to fundraising activities or program services.” Sometimes this is construed as anything that’s not a fundraising or program expense. The Form 990 instructions list examples of M&G expenses, including the salaries and wages of the chief officers and staff – unless those officers and staff also spend time directly supervising program and fundraising activities, in which case those salaries/wages should be allocated. Other examples include the costs associated with holding meetings (unless a meeting is specific to a program or fundraising activity), and general legal services, accounting and audit services, general liability insurance, office management, HR, investment expenses, and other centralized, for-the-good-of-all services.
Allocating Overhead Expenses
The Allocation class is a “part 1 of 2” phase of preparing the financial statements. Some expenses provide benefit to multiple activities, so they should be allocated to more than one class, but are not quite overhead or entirely Management & General. Instead of breaking out each individual expense to the applicable classes manually, we use the allocation class as a bucket to proportionally distribute those expenses over multiple classes using a consistent basis of allocation and cost allocation plan.
The Cost Allocation Plan
Developing a cost allocation plan requires some critical thinking. What basis most accurately captures how multi-benefit expenses are distributed? For personnel, this is most accurately captured by tracking timesheets or using a percentage allocation based on their job description. For the utilities of a building, square feet occupied by each program might provide the most ratable allocation. Avoid overcomplicating things by using more than one allocation plan. Choose the most applicable method and use it for the entire bucket. In our experience, timesheets are often the most accurate basis of allocation for service-providing non-profits and will be used as the basis for the following examples.
See the table below identifying common expenses, and how they could be classified. Remember, the allocation pool gets distributed over other classes, including M&G if appropriate. If an expense has an M&G element to it, but is also decidedly not just M&G the allocation pool is probably the place to drop it.
The non-salary and wage expenses that apply to more than one class tend to apply to all classes. These are the expenses that should be allocated. Be aware that some expenses – like accounting fees – could be allocable to various functions depending on the reporting required. When these expenses are recorded, the entire amount is pooled in an allocated class. At the end of the month – or whatever period you choose to use – the allocated pool is distributed over the other classes using the selected basis of allocation. . The salaries and wages of personnel who work on only one Program (or other class) should be coded 100% to that program, and the salaries and wages of personnel who work on more than one program or activity should be allocated across those classes.
By carefully selecting the correct class for your overhead expenses, you ensure that your financials are presented in a way that accurately represents how your overhead supports the organization. Although some expenses are legitimately management and general support only, and should be classified as such, it’s important to allocate overhead that’s applicable to other activities across those classes appropriately. This prevents unnecessarily bloating your M&G activity expenses, which may make your organization looks too administration-heavy. If you’d like more detailed advice regarding how to classify specific expenses, or if your books would benefit from having a CPA review your allocations, reach out to us!