Guide #3 from the series "Nonprofit Overhead Cost Project"
The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.
Note: This report is available in its entirety in the Portable Document Format (PDF).
Nonprofit managers and their donors rely on functional expense reporting for both management and giving decisions. However, many nonprofit organizations misreport these expenses.
Research findings fall into four areas:
- Functional expenses
- Capital gifts
- In-kind donations
- IRS Form 990
Nonprofit Overhead Cost Project
This guide is based on information collected by the Nonprofit Overhead Cost Project. The goal of the project is to understand how nonprofits raise, spend, measure, and report funds for fundraising and administration, and to work with practitioners, policymakers, and the accounting profession to improve standards and practice in these areas. The project is a collaboration between the Center on Philanthropy at Indiana University and the Center on Nonprofits and Philanthropy at the Urban Institute. For more information on the project, see http://www.coststudy.org.
The Nonprofit Overhead Cost Project was supported by the Atlantic Philanthropies, the Ford Foundation, the Charles Stewart Mott Foundation, The David and Lucille Packard Foundation, and the Rockefeller Brothers Fund. Project researchers who contributed to the content of this guide are Kennard Wing, Mark A. Hager, Patrick M. Rooney, and Thomas Pollak.
Functional Expenses
Absent good, comparable information about the relative mission effectiveness of various nonprofit organizations, donors, funders, and charity watchdog organizations have placed undue
reliance on financial indicators, many of which are based on expenses by functional classification (program, management and general, and fundraising).
Two common financial indicators are the program-spending ratio and the fundraising-efficiency ratio. The program-spending ratio is calculated by dividing total program expenses by total expenses. The fundraising-efficiency ratio is calculated by dividing fundraising costs by total contributions.
Such ratios are only as good as the numbers used to calculate them. Unfortunately, research shows that in many cases the numbers are not good at all, and that practices vary so widely that comparisons among organizations may lead to flawed conclusions.
A national survey of a representative sample of nonprofit organizations, for example, found that only 25 percent of nonprofits that get grants from foundations properly classify those
proposal-writing costs as fundraising. Only 17 percent of nonprofits that get grants from government properly report those proposal-writing costs as fundraising.
In-depth case studies of nine nonprofits turned up gross errors in audited financial statements.
One organization had a part-time employee who worked exclusively on fundraising. The executive director was involved in fundraising as well, and the organization also did some direct-mail fundraising. The Statement of Activities reported zero fundraising costs. Another organization's audited financials placed the Statement of Functional Expenses in with the supplemental information, despite the clear guidance of Statement of Financial Accounting Standards (SFAS) 117,
Financial Statements of Not-for-Profit Organizations, that it is a required part of the core financial statements for this type of organization.
Personnel costs form the largest expense at many nonprofits, and how those costs are allocated across the categories of program, management and general, and fundraising can make a huge difference in their program-spending and fundraisingefficiency ratios. In our national survey, barely one-third of nonprofits said they track staff time by functional expense category for each payroll period. Similarly, in our case studies, three of nine organizations had a paper or automated time-tracking system that was capable of serving as the basis for functional expense tracking. Unfortunately, only one of those three used it for that purpose, and in that one case, the fundraising person charged proposal-writing time to the program the grant was for rather than
properly accounting for it as fundraising cost. Interestingly, this one site had only adopted its timesheet system at the urging of its auditor.
At the other eight sites, the vast majority of employees were classified as falling wholly within one of the three functional expense categories. For the handful of remaining employees, one or two staff members made a retrospective judgment at year-end about how they had spent their time,
and this was used to allocate their personnel costs across the functional categories. The accuracy of such judgments is open to question, and given the emphasis that users place on low overhead, and low fundraising costs, it is not surprising that such judgments tended to result in low percentages
for management and general, and especially fundraising.
All nonprofit organizations are required by SFAS 117 to report expenses by functional classification. The many users that emphasize program-spending and fundraising-efficiency ratios are relying on the attestation of the auditor that these numbers fairly reflect the activities of the organization. Research suggests that in too many cases they do not, and in at least a few cases the errors are egregious.
Because users of nonprofits financials rely so heavily on reported expenses by functional classification, public accountants must begin to bring the same standards of practice to auditing
these expense classifications that they currently apply to auditing assets, liabilities, revenues, and total expenses.
Note: This report is available in its entirety in the Portable Document Format (PDF).
Latest Research
Browse by Topic:
PDF
Printer-friendly summary
