Coming Soon! Changes to Not-for-Profit Expense Reporting (Part 1)

by Kara Jungbluth, CPA, Audit Manager

Posted on July 11, 2017

For the first time in 20 years, FASB has made some major updates to the not-for-profit financial reporting and disclosure model. Accounting Standards Update (ASU) No. 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities was created to improve the usefulness, relevance, and clarity of information in financial statements for donors, grantors, creditors, and other users, as well as preparers. The amendment covers several areas including updates to net asset classifications, disclosures, and cash flows.

One major change highlighted in ASU No. 2016-14 is the new requirement for all not-for-profit (NFP) entities to classify expenses by both functional and natural classification.

Prior to the FASB update in August 2016, only volunteer health and welfare entities were required to present information about expenses by natural class in addition to their functional class. All other NFP’s were encouraged to provide both classifications of expenses, but they were only required to present the functional classification.

What is the difference between functional and natural classifications? While functional expenses are grouped by the purpose of the expense (program, management & general, or fundraising), natural expense classification is a method to group expenses by the kinds of economic benefits received or what the money was spent on. 

Some examples of natural expense classifications are:

  • Salaries and wages
  • Employee benefits
  • Professional services
  • Supplies
  • Interest expense
  • Rent
  • Utilities
  • Depreciation

Most NFP entities should already be tracking expenses by both functional and natural expenses as both are required to be reported on the Internal Revenue Service Form 990.

There are three main parts of the new expense classification requirement.


NFP entities will have to provide an analysis that shows the relationship between functional and natural classifications in one location. The analysis is intended to help donors and grantors to better assess how specific resources (salaries, rent, supplies, etc.) are used in the entity’s programs and supporting activities.

According to the Codification, NFP entities have three options on where to provide this information:

  1. On the face of the statement of activities;
  2. As a schedule in the notes to the financial statements; or
  3. In a separate financial statement

Although NFP entities were given flexibility on the location of this analysis, entities with more than one program will likely find it most effective to present a table (like the one below) in the notes or as a separate financial statement.


Allocation Methods

The update will also require NFP entities to provide a qualitative description of the methods that were used to allocate functional expenses. When expenses benefit multiple purposes and are not directly identifiable to one function, the expense must be allocated. Some ways to allocate expenses include:

  • Square footage
  • Time records and time cost studies
  • Asset usage
  • Benefit received
  • Cost study of specific technology utilized

Most NFP entities are already using these methods to allocate functional expenses; the new update will now require each method used to be disclosed in the notes.

Improved Guidance

ASU 2016-14 simplifies the definition of management and general activities. Per the Codification, management and general activities are “supporting activities that are not directly identifiable with one or more program, fundraising, or membership development activities.”

The update also provides illustrative cases that will help NFP entities decide how to allocate certain expenses between program and supporting activities. For example, human resource department expenses generally do not relate to a specific program activity and are almost always categorized to management and general. More examples can be found directly in the Codification.

ASU 2016-14 is effective for annual financial statements issued for fiscal years beginning after December 15, 2017. This means if your entity has a June 30 year end, the updates must be adopted for fiscal year 2019 or the year ending June 30, 2019. If your entity has a December 31 fiscal year end, the updates should be adopted in fiscal year 2018 or the year ending December 31, 2018. For interim periods within fiscal years, the changes must be applied for fiscal years beginning after December 15, 2018.

Upon adoption, all updates are retroactive for entities that present comparative information. However, the analysis of expenses by both natural and functional classifications will not be required for the prior period in the year of adoption.

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Also, check out the second part of this article for more guidance on the allocation of expenses!