Before ASU 2016-14, only not-for-profit entities that were considered health and welfare entities were required to report expenses by both functional classification in addition to natural classification. After ASU 2016-14, all not-for-profit entities are required to report expenses by functional and natural classifications together.
If the entity is reporting functional expense for the first time, then multiple considerations will need to be made by management. For example, what are the various categories in which expenses fall (i.e. management and general, program, and fundraising)? Would the readers benefit from additional classifications if multiple, distinct programs exist? Should the expenses be reported by function in their own statement, a separate footnote, or included in the statement of changes in net assets? How will the expenses for each category be determined (i.e. will there be separate accounts for each or an allocation of accounts at each reporting period)? Do internal controls exist for preparation of expenses by functional classification? Management will need to prepare a footnote to describe the accounting policy for the functional allocation of expenses. This footnote should include the basis of allocation.
The basis of allocation of expenses likely will include data retrieval or discovery. Therefore, if the entity is reporting functional expense for the first time, management will need to ensure it has appropriate data for classification. This may result in a time study or evaluation of time and expense records in order to determine how employees’ activities are split up during a typical work schedule. Relevant data for occupancy costs includes square footage for rent, utilities, and maintenance expenses.
The allocation of expenses based on functional category will require management to make decisions regarding how the information will be presented in financial statements and additional effort to ensure data is accurate.
If your not-for-profit has a June 30, 2019 year-end, set aside time and resources now to prepare and comply with ASU 2016-14.
Drew McCullough is a Senior Manager in LBMC’s Audit group. He can be reached at firstname.lastname@example.org.