statements of functional expenses for...
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Statements of Functional Expenses for Non-Profits Best Practices for Categorizing and Reporting Expenses Under Accounting Standards
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WEDNESDAY, AUGUST 21, 2013
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Michael Sack Elmaleh, Independent CPA and CVA, Boca Raton, Fla.
Catherine Bendall, CPA, PSA, CGMA, Partner, WithumSmith + Brown, New Brunswick, N.J.
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Statements of Functional Expenses for Non-Profits
August 21, 2013
Catherine Bendall, WithumSmith+Brown
Michael Sack Elmaleh, Independent CPA and CVA
Notice
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The information contained herein is of a general nature and based on authorities that are
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Today’s Program
Statement of Function Expenses: Driven by Expectations or
Reality?
[Catherine Bendall]
The Statement of Functional Expenses (SFE)
[Michael Sack Elmaleh]
Slide 8 – Slide 27
Slide 28 – Slide 47
STATEMENT OF FUNCTIONAL EXPENSES: DRIVEN BY EXPECTATIONS OR REALITY
Catherine Bendall, WithumSmith+Brown
Use of Related Entities for Fundraising
American Lebanese Syrian
Associated Charities, Inc.
AKA St. Jude Children’s Research Hospital
Total Revenue $739,593,856
Total Expenses $635,021,101
Total Program $606,848,861
Total M&G $28,172,240
Total Fundraising ZERO
“.81 of every dollar supports research…”
Television ads, print ads, telethons, billboards…
Grant from affiliate $441,990,544
Total Revenue $870,140,691
Total Expenses $703,304,449
Total Program $505,987,395
Total M&G $58,297,844
Total Fundraising $139,019,210
Grant paid to affiliate $441,990,544
9
Nonprofit Starvation Cycle
The Overhead Myth
Focus on Overhead over the Past Decade
Form 990 Statement of Functional Expenses
Issues related to NFP Reporting and GAAP Guidance
10
2012 FORM 990
Program Services
90.8%
G&A 4.1%
Fundraising
5.2%
Functional Expense Comparisons
Source: Guidestar.org
Program Services
97.9%
G&A 0.5%
Fundraising
1.6%
Total expenses $3,329,153,707
Total income $3,452,960,387
Total expenses $1,559,486,335
Total income $1,554,156,485
11
Noncash donations
, $1,510,62
2,608
Donated services & facilities , $1,454,38
2
Grants & assistanc
e , $1,479,41
4,370
Noncash donations
, $27,036,2
78
Donated services
& facilities , $10,387,9
80 Grants & assistanc
e , $212,460,
308
Percentages May Not Tell the Whole Story
Noncash Donations $27,036,278
Donated Services &
Facilities
$10,387,980
Grants & Assistance $212,460,308
Employees 31,024
Noncash Donations $1,510,622,608
Donated Services &
Facilities
$1,454,382
Grants & Assistance $1,479,414,370
Employees 295
12
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NFP
Starvation
Cycle 14
Overhead Ratios – Industry Focus
2004 2006 2009 2013
15
Urban Institute, Nonprofit Overhead Cost Project, August 2004
Misreporting of
Expenses by
NFPs
16
Study and Extent of Misreporting
Facts noted from the Urban Institute, Nonprofit Overhead Cost Study, February 2004
9 In-depth Case Studies
250K IRS Form 990s
1,500 Questionnaires
17
The CPA Journal, August 2006
Inconsistencies
in
NFP Reporting
18
Stanford Social Innovation, Fall 2009
Unrealistic
Expectations by
Funders
19
Nonprofit Quarterly, April 2011
Focus on
Transparency
20
“The Overhead Myth”
“It’s time to move beyond Overhead”
June 17,
2013
21
Letter
22
Form 990
Statement of
Functional
Expenses
23
Form 990
Statement of Functional Expenses
Categorization defined by IRS – not US GAAP
Fundraising Management and general
Program expenses 3
Areas of
Focus
24
OT
HE
R IS
SU
ES
• Problematic allocation methods
• Affiliate legal entities
• Inadequate accounting systems
• Donors’ expectations
• Audit focus on cost allocation
• Education for all users
IMPACTING REPORTING
25
Education is the Key
Not-for-Profit Organizations
• Enhanced transparent reporting
• Robust program descriptions
• Education for all
Auditors
• Challenge allocation methodologies
• Provide assistance for allocation methods
Donors • Question unusual reporting
• Expand criteria beyond overhead
26
Slide Intentionally Left Blank
THE STATEMENT OF FUNCTIONAL EXPENSES (SFE)
Michael Sack Elmaleh, CPA, CVA
The SFE: In Search of an Efficiency Measure
The income statement of a for profit enterprise provides a basic
albeit sometime crude and approximate measure of efficiency: if
the statement shows a profit a certain degree of efficiency can be
inferred. This is not the case for most non profits where the goal
is not to earn a profit but rather to provide charitable goods or
services. The SFE was developed to provide an approximate
measure of efficiency for non profits by dividing expenses into
three major categories:
•Program
•Administrative
•Fund Raising
29
GAAP – SFAS No. 117
I. FASB as GAAP Standard Setter
II. Enforecability of GAAP Standards: The Attest Function
III. Required Financial Statement:
A. Statement of Financial Position
B. Statement of Activities
C. Statement of Cash Flow
IV. Voluntary Health and Welfare entities required to report
expenses by function as well as by natural classification. This
requirement gives rise to the SFE.
V. Natural versus Functional Expense
30
Basic GAAP Definitions
• Program Services: Activities that result in goods and services
distributed to beneficiaries, customers, or members that
fulfill the organizations mission.
• Management and General: Activities included oversight,
management, record keeping, budgeting, financing, and
related admin.
• Fund Raising: Activities include publicizing and conducting
fund raising campaigns.
31
IRS Form 990
• Form 990: Open to the Public.
• SFE incorporated into the Form
• Basic Categories Consistent with FAS 117 with clarifications
• Published magazine with advertising are program expenses
• Costs to secure grants are deemed program expenses
• Management Expenses include board of director costs, legal and
accounting, liability insurance, office management, auditing,
human resources
• Fund Raising Expenses: employees working in program and fund
raising must reasonably allocate compensation related expenses.
• Instructions provide detailed natural classification account
descriptions.
32
Joint Fund Raising Costs SOP 98-2
• Joint Activity involves a multiple purpose expense usually combining a
program and fund raising purpose. Example: issuing a mailer with a
petition and a fund raising appeal.
• The SOP is designed to determine guidelines as to when it is
appropriate to allocate the costs of such activities to other than fund
raising.
• The “default” assumption is that if an activity involves fund raising all
the expenses should be allocated to fund raising.
• To overcome this default assumption three tests have to bet met:
Purpose, audience and content.
• The purpose test states that the activity is seeking to accomplish
something other than fund raising. Three test must be met to pass the
purpose criterion. The compensation test states that if any of the
compensation paid on that activity is tied to the amount of fund
raised then the entire activity is deemed fund raising.
33
Joint Costs SOP 98-2 (Cont.)
• A second test in applying the purpose criterion is the similar-
function/similar-scale/same medium test. This test states that the
organization must have been willing to use essentially the same
medium at the same scale without a fundraising component. As this
test involves a counterfactual analysis of management intent it is
functionally useless.
• A third test involves other evidence which again is of little help.
• A second criterion is the audience test. The question to be answered:
was the target audience chosen primarily for their potential as donors
or because they were needed for some program purpose. Again
because applying this criterion entails having to consider management
judgment or intent it is not a barrier to abuse.
• The third criterion is the content test. The activity meets this
criterion if the content supports program functions. The key element
that must be present is a call to action such as signing a petition or
calling for volunteers.
34
Joint Costs SOP 98-2 (Cont.)
• It should be apparent that these criteria are difficult to apply
and the only sure way to disqualify an activity is to hire
professional fund raisers who get paid on commission. Short of
that it is very easy for an organization to add a petition or call
for some other action to what is essentially a fund raising
campaign and qualify to classify some of the costs as program
and not fund raising.
• The SOP does not specify any particular method of allocating
joint costs other than indicating that they should be rational
and systematic.
35
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Allocating Administrative Costs
• Most smaller local non profits do not engage in the kinds of
large scale fund raising activities that SOP 98-2 addresses.
Nonetheless even these smaller non profits face allocation
questions due to the fact that staff perform multiple functions.
For example, executive directors are likely to perform
management, fund raising and program tasks. Even lower
level program staff will engage in a mix of functional
activities.
• Clearly the most rational way to allocate compensation cost of
staff performing multiple functions is based on time. Accurate
allocation will therefore depend on accurate time tracking.
Obviously the accuracy and sophistication of time tracking will
vary considerably from organization to organization.
37
Allocation Example
Onandon is a charitable group devoted to assisting
traumatized victims of over talking. There is an executive
director, two trauma counselors and one administrative
assistant. The two trauma counselors spend 90% of their time
providing individual and group counseling, the balance in
administrative functions. The executive director spends 30% of
her time on supervisory duties, 50% of her time in providing
counseling and outreach to clients and 20% of her time on the
organizations main fund raising event: a gala silent auction.
The administrative assistant spends 90% of his time in support
activities and 10% on fund raising activities.
38
Allocation Example
Program Support Fund Raising
Job Function
Executive Director 50% 30% 20%
Counselors 90% 10% 0%
Adminitrative Assistant 0% 90% 10%
39
Allocation Example
Total
Job Function Wages, Benefits. Taxes Program Support Fund Raising
Executive Director 75,000 37,500 22,500 15,000
Counselors 100,000 90,000 10,000 -
Adminitrative Assistant 35,000 - 31,500 3,500
Totals 210,000 127,500 64,000 18,500
Apply the previous percentages to the wage benefit, tax total for each job title
40
Allocation Example (Cont.)
Onandon rents office space for $12,000 plus utilities of $1,200 per
year. These costs are also subject to functional allocation. This is
a square footage analysis of the rental space:
41
Allocation Example (Cont.)
Allocation Based on Use Weighted Average Allocation
Fund Fund
Program Support Raising Program Support Raising
Total Square Footage 1,500 %
Reception Area 225 15% 0% 100% 0% 0% 15% 0%
Exec. Director Office 435 29% 50% 30% 20% 15% 9% 6%
Counselor One 435 24% 90% 10% 0% 22% 2% 0%
Counselor Two 435 24% 90% 10% 0% 22% 2% 0%
Conference Room 435 8% 80% 20% 0% 6% 2% 0%
100% 64% 30% 6%
42
Allocation Example
Applying these percentages yields the following functional
allocation of rent and utilities:
64% 30% 6%
Total Program Support Fund Raising
12,000 7,680 3,600 720
1,200 768 360 72
13,200 8,448 3,960 792
43
Key Ratios Based on SFE
• Program Efficiency Ratio: Program Expenses/Total Expenses
• Fund Raising Efficiency Ratio: Contributions/Fund Raising
Expenses
• GIGO applies. The ratios are meaningful only to the extent
that the SFE reflects accurate allocations between the
functional categories
44
Accurate SFE Allocations are Self Enforcing
• As pointed out earlier even audited SFE’s contain unreliable
allocations. Primary focus of auditing is still the Statement of
Position.
• IRS 990 audits are not a priority and on those audits that do
occur the major concern is not the accuracy of the SFE
• The guidance on allocation such as SOP 98-2 is not all that
stringent
• Conclusion: Accuracy of SFEs depends on the integrity and
competence of non profit management
45
Non SFE Indications of Too Much Fund Raising Expense
As a donor you can catch on fairly quickly as to whether your favorite charity
is spending too much on fund raising. Here are some indicators:
• Do you have a 200 year supply of address labels provided by the charity?
• Do you receive three times as many phone calls from your charity asking
for funds as you do calls from your friends and relatives?
• Does your charity request annual membership renewals two months after
you paid your annual dues?
• Has your charity sold your name and address to 100 other non profits so
now you receive 4 times as many direct mail solicitations as personal
mail?
• Do you have to increase your anti-anxiety meds every time you receive a
new “call to action” from your favorite advocacy group warning you that
if you do not give them more money civilization as we know it will come
to an end?
46
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