Functional Allocation of Expenses – How Difficult Could This Be?

By: Peggy Jennings, CPAPeggy Jennings

The allocation of expenses among program, management & general (M&G), and fundraising functions is sometimes a mysterious process, often left to chance or defaulted to SALY (same as last year), or, in certain unfortunate cases, is determined based on desired ratio outcomes. If done properly, the allocation methodologies can be as diverse as the nature of the expenses incurred.

For those wanting to “do things right,” why the confusion?

One reason is the sometimes over-generalization of the requirements, which themselves are rather sparse in the FASB Accounting Standards Codification (ASC). For example, the definition of program services found in the ASC is “The activities that result in goods and services being distributed to beneficiaries, customers, or members that fulfill the purposes or mission for which the not-for-profit entity (NFP) exists. Those services are the major purpose for and the major output of the NFP and often relate to several major programs.” Little wonder that a question often heard is, “Aren’t all of our expenses incurred in fulfilling our mission?”

A more useful reference can be found in the AICPA Audit and Accounting Guide, Not-For-Profit Entities (Guide), which provides helpful guidance in Chapter 13, Expenses, Gains and Losses.

To learn more, read the full article here.

Evaluating the Auditor Relationship

By: Peggy JenningsPeggy Jennings

Nonprofit organizations, much like public companies, rely on their external audit firm to perform a quality engagement. The audit committee plays a critical role in the governance of nonprofit organizations and one of the tasks assigned to this group is the evaluation of the audit firm.

The AICPA’s Audit Committee Toolkit for Not-for-Profit Entities (3rd Edition) contains a chapter devoted to the evaluation of the audit firm, including the following excerpts of considerations:

Quality of Resources and Services: Does the audit team identify and discuss appropriate risks in planning the audit?

Quality of Communications: Is the auditor comfortable raising issues that would reflect negatively on management?

Independence and Objectivity: Are you confident that the audit team maintains appropriate objectivity and professional skepticism?

Questions for Management: Are you satisfied with the knowledge, skills and abilities of the staff assigned to the audit engagement?

These queries, and many more, can be found in the Toolkit referenced above. If you don’t have access to this valuable document, consider joining the AICPA’s Not-for-Profit Section where you can find resources devoted to assurance, financial accounting & reporting, governance & management and tax compliance.

As always, feel free to contact Eide Bailly with any questions regarding this topic!

AICPA Guide Chapter-by-Chapter: Chapter 7 — Other Assets

As a member of the task force that drove the overhaul of the recently-released AICPA Not-for-Profit Entities Audit and Accounting Guide, I am providing weekly, chapter-by-chapter summaries to help users preview the guide.AICPA guide

Gifts of merchandise inventory for resale and other personal property

In general, donated items have no value unless they can be used internally by the NFP, or for program purposes, or be sold by the NFP.  If recognized, donated items should be measured at fair value, which, according to the Codification definition of fair value, is the estimated selling price of the items.

Sales of inventory or other assets

If part of an NFP’s ongoing major or central operations and activities, sales should be reported separately from, and therefore in addition to, the reporting of the contribution of the inventory items, with a corresponding cost of sales.  As previously noted in Chapter 5, donations of tickets, gift certificates, works of art, and other merchandise contributed for the purpose of being sold at fundraising events are originally recorded at fair value.  When sold, the original contribution amount should be adjusted to reflect the actual amount of the sale.  No gain or loss is recognized.  Other sales resulting from incidental or peripheral transactions should be reported net, similar to gains and losses.

Transactions Typically Reported Gross Less COGS:

  • Items   produced/processed in vocational workshops that are part of the NFP’s mission
  • Items   contributed to the NFP and subsequently sold in its thrift shops that are   operated as part of the NFP’s mission
  • Used cars   contributed and sold  by an NFP that has   a vehicle donation program

Transactions Typically Reported Net:

  • Excess food, medicine, clothing, office equipment, real estate, and cars (if only occasional) received but that are beyond the NFP’s current needs (and  assuming that the transaction is incidental or peripheral)

Prepaid Expenses, Deferred Costs, and Similar Items

Prepaid expenses and deferred costs are typically used up or expire within the normal operating cycle of an entity.  Deferral of costs may be appropriate regardless of whether or not the activity is expected to generate net cash inflows.


  • Production costs relating to upcoming performances or exhibits
  • Catalogues or brochures
  • Fundraising materials and certain advertising costs
  • Internal-use computer software costs

Amortization of prepaid expenses and deferred costs is based on how the economic benefit underlying the asset is used up or lost.

Most Internally Developed Intangible Assets Must Be Expensed When Incurred

Costs of internally developing, maintaining, or restoring intangible assets that are not specifically identifiable, that have indeterminate lives, or that are inherent in a continuing business or nonprofit activity and related to an entity as a whole, should be recognized as an expense when incurred.  This results in many internally developed intangible assets never being recognized as assets.

Collections and Works of Art, Historical Treasures, or Similar Assets

Treatment of collections under generally accepted accounting principles is wide-ranging.  Below are the three options:

  • Capitalize all collection items
  • Capitalize all collection items acquired after a stated date
  • Capitalize no collection items

Capitalization of selected collections or items is precluded.  Readers should refer to paragraphs 7.16 – 7.28 for further information on reporting of collection items.


An NFP recognizes goodwill only when the operations of the acquiree are not expected to be predominately supported by contributions and returns on investments. Goodwill recognized should not be amortized; instead, it should be tested annually for impairment at a level of reporting referred to as a reporting unit.

AICPA Guide Chapter-by-Chapter: 5 — Contributions Received and Agency Transactions

AICPA guideAs a member of the task force that drove the overhaul of the recently-released AICPA Not-for-Profit Entities Audit and Accounting Guide, I am providing weekly, chapter-by-chapter summaries to help users preview the guide

Chapter 5 includes new sections on measuring and reporting noncash gifts, including gifts in kind; contributions of fundraising materials, informational materials, advertising, and media time or space; below market interest rate loans and bargain purchases; and naming opportunities. Additional emphasis is given to distinguishing among contributions, exchange transactions, and agency transactions.

What’s in a Name?

Naming opportunities, an incentive benefit sometimes offered to significant contributors, may be contributions, exchange transactions, or some combination of both, depending on the value of the public recognition and other rights conveyed to the donor. Factors to consider include:

• The value to the donor
• The length of time the naming benefit is provided
• Control over the name and logo use
• Other exclusive rights and privileges. (For example, exclusive naming rights for a university football stadium for a 10-year term is likely worth more than the having one’s name on a plaque in the university library.)

Agency Transactions — Not Revenue, Not Expenses

In the aftermath of investigations by the IRS and various watchdog organizations into the distribution of certain medicines to needy populations outside the U.S., the determination of whether an apparent contribution is, in fact, an agency transaction has never been more important. In these investigations, certain international nongovernmental organizations (NGOs) were accused of misreporting agency transactions as contributions received, offset by contributions made, in situations where the NGOs arranged for the delivery of medicines directly to needy populations without clearly taking title, possession, or exercising control or discretion in using or distributing the medicines along the way. These transactions, said the IRS, were nothing more than agency transactions which, while laudable, did not constitute contributions received or made by the NGOs. The IRS further alleged that even if the transactions would have qualified as activities of the NGOs involved, the valuation methods used to determine the amounts of the contributions reported were flawed, resulting in the overvaluation of both the contributions received and made.

GIK Challenges

Gifts in kind (GIK) should be recognized if the recipient entity has discretion on using or distributing the gifts, AND also has the risks and rewards of ownership. Physical possession is not a requirement of revenue recognition. GIK that can be used or sold should be measured at fair value. GIK that can’t be used or sold are not recordable.

As was evident in the IRS investigation mentioned above, valuing GIK presents several unique challenges to the recipient entity, including the following:

• There may be a lack of an active market for the items received
• Some items received are rarely bought and sold
• Some items would not otherwise be purchased or sold by the entity
• Some items are not used at the highest and best use by the entity
• Some items may have expired
• There may be geographic or market-based diversity in pricing

While fair value estimates are just that — estimates — NFPs must carefully consider and document valuations of these gifts.

Part of an NFP’s fundraising activities may include an annual gala and/or auction. Contributions of tickets, gift certificates, works of art, and merchandise to be sold at fundraising events should be recorded as contributions at fair value. Later, when sold, the original contribution amount should be adjusted for the difference between the recorded amount and the selling price. Note: the contribution amount is adjusted, thus there is no “gain” or “loss” on the eventual sale of the contributed items.

Contributed Material or Advertising

Questions as to whether contributed fundraising and informational material, as well as advertising (including media timea and space) constitute GIK or donated professional services have long abounded. The questions are important in that the recognition criteria differ depending on the answer. The Guide clarifies that these are contributed assets, not services, and should be recognized as contributions if the NFP has active involvement in determining and managing the message and use of the materials. The involvement does not need to be absolute. Advertisements or the distribution of promotional materials produced by others without any input or participation by the NFP need not be recognized.

Unlike donated professional services, recognition of contributed fundraising materials, informational material, or advertising is unaffected by whether the NFP could afford to purchase the assets, or would typically need to purchase the assets if they had not been provided by contribution. NFPs should consider the appropriate function allocation of the expense side of the contributions to the various program and supporting services categories.

Use of Campaign Proceeds to Pay Campaign Expenses

NFPs commonly earmark a portion of capital campaign proceeds to offset the costs of conducting the campaign. FinREC has clarified that such a practice is a violation of a donor’s enforceable right to have his or her contribution expended only for the purpose stipulated by the donor. In the absence of explicit donor stipulations, campaign solicitation materials may imply those purposes. Unless those materials include campaign costs as an explicit use of campaign proceeds, NFPs are precluded from using such proceeds to pay those costs. Doing so is an act of noncompliance with donor restrictions.

To avoid this prohibition, NFPs should make their intentions known by effectively communicating to all prospective donors during the solicitation process. Disclosing the policy in the notes to the financial statements is not sufficient.

AICPA Financial Reporting White Paper

In addition to an extensive auditing section geared toward the revenue recognition issues unique to NFPs, Chapter 5 includes a section on measuring unconditional promises to give cash or other financial assets excerpted from the AICPA Financial Reporting White Paper, Measurement of Fair Value of Certain Transactions of Not-for-Profit Entities. The information included is extremely helpful, and those responsible for this area will be well served by reading it.

AICPA Guide Chapter-by-Chapter: 4 – Cash, Cash Equivalents, and Investments

As a member of the task force that drove the overhaul of the recently-released AICPA Not-for-Profit AICPA guideEntities Audit and Accounting Guide, I am providing weekly, chapter-by-chapter summaries to help users preview the guide.

Chapter 4 combines Chapters 4 (Cash and Cash Equivalents) and 8 (Investments) of the previous guide.  The Chapter does not cover:

  • investments in consolidated subsidiaries (Ch. 3),
  • investments in an entity that provides goods or services that accomplish the purpose or mission of the NFP entity or that serves an administrative purpose (Ch. 3),
  • changes in valuation and reporting investment income on split-interest agreements (Ch. 6), or
  • programmatic investments (Ch. 8).

When Cash Isn’t Cash

NFP entities may deposit funds in a related entity’s cash account under a centralized arrangement.  Common examples include deposit-and-loan, revolving fund arrangements used by many religious denominations, and local chapters of national NFP organizations. FinREC believes that the depositing entity’s cash account under such arrangement generally would not be classified as cash and cash equivalents in the depositing entity’s financial statements.  Instead, the entity would classify the deposit in the cash pool as a receivable from a related entity.

Cash held as part of an endowment fund or other investments held for long-term purposes is appropriately included in the investments line item in the Statement of Financial Position. Such treatment eliminates what can sometimes be an awkward or confusing division of investment balances between the various kinds of investments held within an investment portfolio.

Valuation of Investments in Entities Held for Investment

Chapter 4 includes expanded coverage of the valuation of investments in entities held for investment, and includes a table summarizing the guidance for 13 different relationships an NFP entity may have with investee entities, derivative arrangements, and investment pools, which is followed by several pages of discussion and examples.

Investment Expenses

FinREC has noted diversity in the types of costs that have been included as related investment expenses.  The Guide clarifies that investment expenses include, but are not limited to the costs of the following activities if conducted by the NFP (or directly on its behalf):

  • Investment advice, including advice provided by employees as well as third parties
  • Investment acquisition due diligence
  • Custodian services
  • Legal and accounting services incurred in connection with investment activities
  • Interim and year-end monitoring
  • Valuation procedures and processes

Investment expenses exclude internal fees charged by mutual funds, hedge funds, and other investment funds. Instead, those charges are considered to be a part of the investment’s return.

Fair Valuing an Interest in a Community Foundation’s Investment Pool

Some NFPs transfer funds to community foundations for investment management, seeking to benefit from the foundations’ investing expertise, size, and scale. For purposes of determining the fair value of an NFP’s interest in a community foundation’s investment pool, the appropriate unit of account is the interest in the pool itself, not the underlying investments within the pool. The pool may qualify for use of the net asset value per unit or share (NAV) as a practical expedient to measure fair value.

The Rest of It

The balance of the Chapter is devoted to an expanded discussion of endowment funds, financial statement presentation, and disclosures. It also includes expanded coverage of auditing considerations, suggested audit procedures, and incorporates AICPA Technical Practice Aid questions and answers related to determining fair values of alternative investments and the use of NAV as a practical expedient to measure fair value.

AICPA Guide Chapter-by-Chapter: Starting with 1

AICPA guideAs a member of the task force that drove the overhaul of the recently-released AICPA Not-for-Profit Entities Audit and Accounting Guide, I am providing weekly, chapter-by-chapter summaries to help users preview the guide.

Chapter 1

Establishes that the Guide covers entities that meet the definition of a Not-for-Profit entity (NFP), which is an entity that possesses the following characteristics, in varying degrees, that distinguish it from a business entity:

a. Contributions of significant amounts of resources from resource providers who do not expect commensurate or proportionate pecuniary return
b. Operating purposes other than to provide goods or services at a profit
c. Absence of ownership interests like those of business entities.

Entities that clearly fall outside this definition include the following:

a. All investor-owned entities
b. Entities that provide dividends, lower costs, or other economic benefits directly and proportionately to their owners, members, or participants, such as mutual insurance entities, credit unions, farm and rural electric cooperatives, and employee benefit plans.

The Guide specifically applies to the following nongovernmental NFPs:

• Animal protection and humane organizations
• Cemetery organizations
• Civic and community organizations
• Colleges and universities
• Elementary and secondary schools
• Federated fund-raising organizations
• Fraternal organizations
• Labor unions
• Libraries
• Museums
• Other cultural organizations
• Performing arts organizations
• Political action committees
• Political parties
• Private and community foundations
• Professional associations
• Public broadcasting stations
• Religious organizations
• Research and scientific organizations
• Social and country clubs
• Trade associations
• Voluntary health and welfare entities
• Zoological and botanical societies

Providers of health care services follow the AICPA Audit and Accounting Guide, Health Care Entities.
The Guide applies to financial statements prepared in accordance with accounting principles generally accepted in the United States of America, and does not include guidance on special purpose frameworks such as cash and tax-basis financial statements, or IFRS.

NFPs should follow the guidance in the FASB Accounting Standards Codification (ASC) unless specifically exempted, even if the application of certain provisions may be unclear because elements or items are included in the ASC without considering the net asset reporting model included in ASC 958, Not-for-Profit Entities.

NFPs are specifically exempted from ASC guidance on:

a. Earnings per share
b. Reporting comprehensive income
c. Segment disclosure
d. Variable interest entities

Certain other provisions of the ASC simply do not apply to NFPs because they do not have ownership interests similar to business entities:

a. Common stock
b. Convertible debt
c. Stock purchase warrants
d. Share-based payments
e. Certain hybrid financial instruments convertible to equity

NFPs are permitted to utilize fund accounting as long as the required aggregated amount for each of the three net asset classes of net assets and total nets assets are displayed in the statements of financial position and activities as required by the ASC.

Chapter 1 concludes by referring the reader to sources of example financial statements.

Up Next: Chapter 2 – Auditing Considerations