How to Implement Functional Expense Requirements?

By Nicole Loux, CPA

There have been many questions about implementing Accounting Standards Update 2016-14 Preparation of Financial Statement of Not-for-Profit Entities (ASU 2016-14). One question that has come up is the new requirement for functional expenses. Under old guidance only voluntary health and welfare organizations were require to provide information on their functional expenses. Now, all not-for-profit entities are required to provide information about their operating expenses.

ASU 2016-14 requires a not-for-profit entity to report information about expenses in one location, either on the face of the statement of activities, as a separate statement (statement of functional expenses) or in the notes to the financial statements. ASU 2016-14 also requires enhanced disclosures about the methods used to allocate cost among activities and to disaggregate their expenses by nature and by major class services.

What does that exactly mean? It means not-for-profits are required to break down expenses by their type, such as salaries and benefits, utilities, insurance, depreciation, etc. and by major class, program, fundraising and/or management and general. Some of the natural classes of expenses will be driven 100% by either program activities, fundraising activities and/or management and general activities. Other expenses, such as salaries and depreciation expense, will need to be allocated to the various activities. Here are some examples of how the expense can be allocated.

Depreciation Expense:

Depreciation expense could be allocated to the various activities by determining what portion of the building is used for each activity. A way to determine what portion of the building is used by each activity is to determine what space each activity uses and allocate it based on square feet. Another way depreciation expense can be allocated is if there is specific equipment that is used only for one activity, the depreciation for that equipment can be 100% allocated to that specific program.


In salary expense, most likely there will be individuals who are 100% dedicated to one type of activity and then have several individuals who are dedicated to several different activities. To allocate the salary of individuals who work on different activities, estimate the percentage of time the individual spends on the different activities. If a time recording system is used, those records could be reviewed to determine what percentage should be allocated to each activity. Time studies could also be performed for a period to time to determine the allocation. If neither of those options are available, management should work with the employee to develop an estimate of time they spend on the different activities.

The important thing to remember is that these allocations are managements estimates and that means they do not need to be 100% accurate. Remember to document how you came up with your allocations as that information will be used to develop the enhanced footnote disclosure that is required under ASU 2016-14.

ASU 2016-14 requires that the changes be applied on a retrospective basis in the year of adoption, however, if presenting comparative financial statements, the not-for-profit has the option to omit the functional expense information for any periods presented before the period of application. Which means in the year ASU 2016-14 is adopted you only need to determine and disclose the functional expense information for that year (example you adopt ASU 2016-14 for the year-ended December 31, 2018 you are only required to report on functional expenses for 2018). You will need to disclose that you elected not to present the prior year information as allowed under ASU 2016-14.

ASU 2016-14 is effective for annual financial statements issued for fiscal years beginning after December 15, 2017 (calendar year 2018 and fiscal year 2019).

Please feel free to contact us if you have any questions, thoughts, or comments.

Nicole Loux, CPA
| Manager