As nonprofits began to implement Accounting Standard Update (ASU) 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statement of Not-for-Profit Entities, for the first time they were required to present functional analysis of expenses by function and natural classification in one location. Previously this was only required by voluntary health and welfare organization but upon implementation was required by all nonprofit entities.. Although many nonprofits were already presenting this information voluntarily, many organizations were not aware that further guidance regarding functional expenses is provided in Topic 958.
The purpose of reporting expenses on a functional basis is intended to provide management, funders, and others an overview into the Organization’s use of resources to complete its mission. The relationship between functional classification and natural classification for all expenses must be presented to allow for analysis that disaggregates expenses by major class of program or service and those items considered supporting activities such as management and general or fundraising. This analysis can be presented in one of three ways: within the statement of activities (must be easy to follow), statement of functional expenses, or within a disclosure to the financial statements. With the standard it is no longer permitted to present this information as supplemental information. Losses are not included in this schedule such as impairment, change in market value of investments, and gain or loss of sale of property and equipment.
The natural classification of expenses refers to the “what” grouping of expenses in accordance with the category of costs incurred such as salaries, occupancy, and professional expenses. These classifications are considered standard across many organizations but can vary between organizations depending on the segment of the public they serve. Functional classification is the “why” method of grouping expenses in accordance with the purpose for which those same costs were incurred. The primary functional classes are program & services or supporting activities: management and general and fundraising. Organization may choose to expand upon each of these categories to provide even more detail such as having program expense broken out by all major programs they provide.
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