Cost Allocation in Nonprofits: Who Gets It

• Chapter 0 - Overview
  • Course Objectives
  • Introduction
  • What Is Covered
• Chapter 1 - Cost Reporting by Not-for-Profit Organizations
  • Learning Objectives
  • Introduction
  • Types of Not-for-Profit Organizations
    • External Financial Reporting Definitions
    • Internal Revenue Service (IRS) Definitions
    • Office of Management and Budget (OMB) Definitions
  • Nature of Not-for-Profit Organizations
  • Financial Statement Users and Needs
  • Financial Reporting Requirements
    • External Financial Reporting Requirements
    • Major Requirements for a Statement of Financial Position
    • Major Requirements for a Statement of Activity
    • The Contributions Standard
    • Internal Revenue Service (IRS) Requirements
    • Office of Management and Budget (OMB) Requirements
  • Uses of Financial Information
    • Ratio Analysis
    • Evaluators of Not-for-Profit Organizations
    • Financial Statement Analysis
    • Concerns about Not-for-Profit Organization Financial Reports
    • Comparisons with Other Organizations
    • Impact of Sarbanes-Oxley Act
  • Conclusions
  • Questions
• Chapter 2 - Costs in Not-for-Profit Organizations
  • Learning Objectives
  • Introduction
  • Costs and Cost Concepts
    • Cost Accounting Terms
  • Service Efforts and Accomplishments
  • Cost Objects
    • Natural Expense
    • Costs of Activities
    • Costs of Outputs
    • Functional Expense Reporting
  • Conclusions
  • Questions
• Chapter 3 - Cost Assignment and Allocation
  • Learning Objectives
  • Introduction
  • Cost Assignment and Allocation Purposes
    • Economic Decisions
    • Motivation of Managers and Employees
    • External Financial Reporting
    • Cost Justification and Reimbursement
  • Cost Assignment
  • Cost Allocation Criteria
    • Cause and Effect
    • Benefits Received
    • Equity
    • Ability to Bear
  • Cost Allocation Guidance
    • SFAS No. 117
    • AICPA Audit and Accounting Guide for Not-for-Profit Organizations
  • Allocation Methods
    • Stand-Alone Method
    • Relative Sales Value (Direct Cost) Method
    • The Physical Units Method
  • Cost Determination
    • Step 1 - Determine Reasons for Cost Determination
    • Step 2 - Identify Cost Objects (Purposes)
    • Step 3 - Identify Relevant Types of Costs
    • Step 4 - Assign Direct Costs
    • Step 5 - Select the Allocation Base(s)
    • Step 6 - Allocate Indirect Costs
    • Step 7 - Assign and Allocate All Appropriate Costs
  • A Cost Determination Illustration
    • Step 1 - Determine Reasons for Cost Determination
    • Step 2 - Identify Cost Objects (Purposes)
    • Step 3 - Identify Relevant Types of Costs
    • Step 4 - Assign Direct Costs
    • Step 5 - Select the Allocation Base
    • Step 6 - Allocate Indirect Costs
    • Step 7 - Assign and Allocate All Appropriate Costs
  • Comparative Analysis
  • Activity-Based Costing
    • Step 1 - Determine the Reasons for Using ABC
    • Step 2 - Identify Costs Relevant to Cost Objects
    • Step 3 - Analyze Activities
    • Step 4 - Create Activity Cost Pools
    • Step 5 - Relate Costs to Activities
    • Step 6 - Relate Activity Costs to Cost Objects
    • Step 7 - Account for All Costs
  • An ABC Output Costing Illustration
    • Selected BES Organization Costs
  • Cost-Benefit Considerations
  • Conclusions
  • Questions
• Chapter 4 - Functional Expense Reporting
  • Learning Objectives
  • Introduction
  • Functional Expense Reporting Requirements
  • Functional Expense Statement
    • Step 1 - Determine Reasons for Cost Determination
    • Step 2 - Identify Cost Objects (Purpose)
    • Step 3 - Identify Relevant Types of Costs
    • Step 4 - Assign Direct Costs
    • Step 5 - Select the Allocation Base
    • Step 6 - Allocate Indirect Costs
  • Reporting Certain Costs
    • Sales of Goods and Services
    • Special Events
    • Support to Affiliated Organizations
  • A Functional Expense Implementation Case Study
    • Mission and Programs
    • Supporting Services
    • Direct Mail Operations
    • Sanity! Magazine
    • Organizational Structure
    • Functional Expense Classification
    • Implementation Considerations
  • Conclusions
  • Case 4-1
  • The SEC Organization - Part I
• Chapter 5 - Cost Allocation for Activities That Include Fundraising
  • Learning Objectives
  • Introduction
  • Accounting for Activities That Include Fundraising
    • Background
  • When to Allocate Joint Costs
    • Statement of Position (SOP) 98-2 (FASB ASC 958-720, Other Expenses)
    • Key Terms
    • Major Provisions
    • Purpose Criterion
    • Audience Criterion
    • Content Criterion
  • How to Allocate Joint Costs
    • Stand-Alone Method
    • Relative Direct Cost Method
    • The Physical Units Method
    • An Illustration
    • Other Physical Units
    • Applications to Other Media
  • Footnote Disclosure
  • Conclusions
  • Cases
    • Case 5-1
    • Case 5-2
    • Case 5-3
    • Case 5-4
    • Case 5-5
    • Case 5-6
    • Case 5-7
• Chapter 6 - Cost Allocation for IRS Reporting
  • Learning Objectives
  • Introduction
  • Cost Allocation in the 990 Return
    • Internal Revenue Service Reporting Requirements
    • Form 990 - Part VIII - Statement of Revenue
    • Form 990 - Part IX - Statement of Functional Expenses
    • Allocating Indirect Expenses
    • Form 990 - Part III - Statement of Program Service Accomplishments
  • Unrelated Business Income Tax (UBIT)
    • Elements of an Unrelated Trade or Business
    • Cost Allocation
    • Acceptable Cost Allocation Methods
  • Lobbying
    • Lobbying and Related Definitions
    • Who Can Make the Safe Harbor Election?
    • Allocating Expenditures under the Safe Harbor Election
    • Lobbying Expenditures
    • Allocation of Mixed-Purpose Expenditures
    • Allocation of Costs to Lobbying Activities
    • The Ratio Method
    • Gross-up Method
    • Section 263A Cost Allocation Methods
  • Lobby Tax Provisions
    • Background
    • Determining Non-Deductibility of Dues
  • Conclusions
  • Questions
• Chapter 7 - OMB Requirements for Cost Allocation
  • Learning Objectives
  • Introduction
  • OMB Guidance
  • Guidance for Not-for-Profit Organizations
    • General Principles
    • Cost Determination
    • Allowable Costs and Allocation Illustration
    • Cost Allocation and Determination of Indirect Cost Rates
  • Circular A-110
  • Conclusions
  • Appendix - OMB Circular A-122
• Chapter 8 - Latest Developments
• Appendix A
• Bibliography

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Chapter 0 - Overview

The Hardship of Accounting
Never ask of money spent
Where the spender thinks it went.
Nobody was ever meant
To remember or invent
What he did with every cent.
- Robert Frost

The wry observations of Robert Frost notwithstanding, all organizations are required to report "where the money went." This is becoming ever more important in the nonprofit world. The purpose of this course is to provide cost accounting techniques tailored to nonprofit organizations to make it easier deal with "the Hardship of Accounting."

Course Objectives

At the conclusion of this course you should be able to

• Understand how costs incurred in a not-for-profit organization relate to activities and programs and services through cost assignment and allocation.

• Identify situations when cost allocation is required in not-for-profit organizations.

• Find appropriate cost drivers as the key to assigning and allocating costs incurred in a cost-effective manner to programs and services.

• Develop a Functional Expense Statement when required by SFAS No. 117 (FASB Accounting Standards Codification (ASC) 958-205 and 720) through appropriate assignment and allocation of costs to programs and supporting services.

• Apply special requirements of AICPA guidance for costs of activities that include fundraising.

• Avoid key pitfalls in the guidance for costs of joint activities that include fundraising.

• Determine appropriate financial statement presentation and disclosure of cost information for special situations involving not-for-profit organizations.

• Deal with cost allocation issues related to determination of Unrelated Business Income Tax (UBIT).

• Apply cost allocation techniques for lobbying activities.

• Interpret Office of Management and Budget (OMB) guidance concerning cost principles and basic allocation issues for not-for-profit organizations.

• Employ the most acceptable and cost-effective allocation methods in situations encountered by not-for-profit organizations.

• Analyze cost allocation results for performance measurement of organizations.

Introduction

What Is Cost Allocation?

Broadly speaking, cost allocation is a process to relate the money spent by an organization to its functions and related outputs such as products and services. The results of using this process are reflected in a not-for-profit organization's financial statements and IRS Form 990.

Who Should Get It?

Managers at all levels and governing boards of nonprofits should be knowledgeable about the cost allocation process and the impact on financial reports for several reasons:

• A systematic cost determination process, of which cost allocation is a part, can produce information to help the organization make better decisions;

• A well documented cost allocation process will provide the basis for reliable financial reports required by external parties; and

• The financial ratios and other indicators drawn from financial reports based on a sound cost allocation process will provide the organization a basis to better deal with growing interest and scrutiny by donors and oversight organizations.

What Are the Challenges?

The key challenge for nonprofit organizations is that cost allocation is a complex process. Its effects are not always understood by users of financial reports. A related challenge is that there is no clear or consistent guidance for implementing a cost allocation process. Thus this course proceeds from the fundamentals of cost accounting and moves to complex issues and questions about cost allocation. The techniques discussed in this course, when properly applied, can help organizations deal with three major concerns faced by not-for-profit organizations.

The first concern is the effects of allocation on the financial evaluation of not-for-profit organizations. There are no measures comparable to net income or return on investment to assess the efficiency and effectiveness of not-for-profit accomplishments. Instead, evaluation is often based on analysis of the costs reported by not-for-profit organizations. These evaluations are often spotty and, in many cases, reflect a basic misunderstanding of the nature and purposes of cost allocation. Frequently, evaluations focus only on "what was spent" rather than "where it went," i.e., how the resources were used by the organization.

A second concern is the use of cost allocation to determine the cost of fundraising efforts by notfor- profit organizations. Situations may arise where costs are incurred for multiple purposes that relate to an organization's programs, its overall management, and its fundraising activities. A major issue is whether these types of costs should be allocated among programs of the organization and its supporting functions of management and fundraising to reflect the multiple purposes for which the costs are incurred. Parties interested in not-for-profit organizations are concerned with the amounts spent on fundraising, as well as on program and management activities. Misapplication or misinterpretation of cost allocation can create major difficulties.

A third concern is external reporting requirements that involve cost assignment and allocation. Statement of Financial Accounting Standards (SFAS) No. 117, Financial Statements of Not-for- Profit Organizations, requires functional expense reporting. In most cases, this requirement will involve cost allocation. Other cost allocation issues may involve unrelated business income taxreporting, lobbying, and reimbursement for costs related to federal government awards. Addressing these concerns is critical for not-for-profit organizations. The effective use of cost allocation can improve the financial information provided to

• Management and governing boards.

• Resource providers such as donors and creditors.

• Oversight organizations such as the Better Business Bureau Wise Giving Alliance and others.

• State regulatory agencies.

• Internal Revenue Service and other Federal Agencies.

This course describes and illustrates the cost allocation process to benefit all parties interested in credible financial reporting by not-for-profit organizations. These parties include

• Not-for-profit organizations, their management, governing boards, members, and contributors.

• State regulatory agencies and private agencies serving the public interest. The public accounting profession.

• Financial and other media reporting on not-for-profit organizations.

What Is Covered

This course focuses on not-for-profit organizations that are described in section 501(c) of the Internal Revenue Code and depend on voluntary contributions, membership dues, or grants for their primary financial support. Other types of not-for-profit organizations are also considered.

Chapter 1, Cost Reporting by Not-for-Profit Organizations, provides an overview of the reporting process as a basis to consider the role of cost allocation in external financial statements. The principal users of external financial reports and their needs for financial information to evaluate the efforts and accomplishments of the organization are discussed. Financial Accounting Standards Board (FASB), American Institute of Certified Public Accountants (AICPA), Internal Revenue Service (IRS), and Office of Management and Budget (OMB) requirements involving cost allocation are introduced. Also discussed is a brief review of the conceptual basis underlying allocation. This chapter concludes with a review of oversight organization standards concerning not-for-profit organizations and their expenses. This background provides the basis for examining cost determination and allocation in not-for-profit organizations.

Chapter 2, Costs in Not-for-Profit Organizations, uses the service efforts and accomplishments framework to look at costs. The reasons for which costs are incurred usually determine the basis for classifying costs and whether costs are considered direct or indirect. Direct costs can be practicably traced to a single so-called cost objective. Indirect costs cannot. Allocations of indirect costs are often made for purposes such as financial reporting, performance evaluation, and control.

In not-for-profit organizations, programs, management and general functions, and fundraising are cost objectives for external financial reporting. SFAS No. 117 requires reporting of costs by major categories of programs and supporting services. Consequently, this chapter discusses considerations for determining appropriate cost objects for external financial reporting.

Chapter 3, Cost Assignment and Allocation, examines the various purposes for cost allocation and criteria to determine how to select a cost allocation approach by an organization. Cost allocations serve multiple purposes both internal and external to the organization. A variety of cost allocation methods exist, which result in organizations allocating costs differently. Although, ideally, one cost allocation method could serve all purposes simultaneously, the many influences that shape internal and external financial reporting make this unlikely. Consequently, appropriate cost allocation methods for external financial reports are those that meet the financial information needs of external users and are consistent with generally accepted accounting principles. Current allocation guidance is discussed, and a general approach to cost assignment and allocation is outlined. Some of the more common allocation approaches are also described.

Chapter 4, Functional Expense Reporting, provides an extended illustration of the more common cost allocation approaches for determination of program and supporting service costs. This illustration shows how the external reporting requirements for voluntary health and welfare organizations will require more complex allocation methods than for other not-for-profit organizations.

Chapter 5, Cost Allocation for Activities that Include Fundraising, discusses the guidance for accounting for costs incurred for materials and activities that include fundraising. AICPA Statement of Position (SOP) 98-2 calls for allocation when certain criteria are met. This statement requires significant analysis and effort to determine whether it is allowable to allocate costs of activities that include fundraising to programs and supporting services.

Chapter 6, Cost Allocation for IRS Reporting, discusses the role of cost allocation in the IRS Form 990 information return and in the determination of unrelated business income subject to tax (UBIT). Also explored are some allocation issues associated with lobbying activities.

Chapter 7, OMB Requirements for Cost Allocation, outlines considerations for determining direct and indirect costs in not-for-profit organizations and acceptable allocation methods under current OMB guidance. Upon completion of this course you will have attained key insights concerning principles and methods of cost allocation in not-for-profit organizations for

• Preparing external financial statements.

• Filing IRS information and unrelated business income tax returns and dealing with lobbying expense issues.

• Ensuring compliance with OMB guidance concerning cost allocation by not-for-profit organizations.

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