Demystifying Allocation of Expenses in Nonprofit Organizations

When contemplating the primary objectives of their finance department, numerous nonprofits recognize the necessity of a modernized cost allocation blueprint. A well-crafted strategy for allocating costs is pivotal for these organizations to gain a comprehensive understanding of how their resources are utilized. It plays an essential role in conducting cost analyses, encompassing assessments of funding requirements and comparisons between actual expenditures and budgeted amounts.

Cost allocations provide an efficient and effective means of distributing expenses across diverse activities, such as programmatic endeavors, administrative functions, and fundraising initiatives. However, the practical application of allocation concepts can present challenges. While certain costs can be directly linked to specific activities without further distribution, there are particular expenses that necessitate proportional allocation across different activities and the organization as a whole. This complexity amplifies the potential for errors and adds intricacy to the process.

Methods of Allocation

Simplifying the allocation strategy by employing a limited number of methods can help circumvent unnecessary complexity, although most organizations utilize at least two distinct allocation methods based on the nature of the costs involved.

Payroll and related expenses often constitute the largest financial outlay for nonprofits. Different organizations employ various approaches to track and document employee work time. Nonetheless, the ultimate objective remains consistent: reporting these costs in a manner that accurately reflects how employees allocate their time and resources. For costs unrelated to payroll or personnel service (OTPS) expenses, allocation can be accomplished through different methods, including:

• Full-time equivalent (FTE): The FTE method apportions OTPS costs in proportion to the time employees spend on different activities.
• Percent of salary dollars: The salary dollars method assigns OTPS costs proportionally based on the payroll dollars allocated to each activity.
• Square footage (SF): The SF method, commonly used for occupancy costs, allocates expenses based on the portion of facility space attributed to each activity.
• Per participant: The participant-based method, often utilized to allocate OTPS costs across programs, distributes expenses proportionally to the number of participants in each activity.

Allocation of Grant Costs

Managing cost allocation within the context of grant agreements adds complexity for nonprofit organizations. Grants typically necessitate cost alignment with approved budgets and compliance with specific terms and conditions, regardless of the funding source. Establishing and implementing consistent methodologies for both organizational and grant-specific cost allocation is crucial. Paying special attention to grant allocations assists organizations in the following ways:

• Tracking progress against each grant's budget.
• Mitigating the risk of double charging, where the same cost is charged to two different grants.
• Avoiding potential consequences for violating grant agreements.

To illustrate how organizational cost allocation interacts with grant allocations, let's consider the allocation of program supplies expense for a nonprofit with two supporting grants for a specific program. The organization has chosen to employ the FTE approach for allocating OTPS costs. Using this approach:

1. The program accounts for 20% of personnel time and effort, resulting in an allocation of 20% of shared supply costs to the program.
2. The program's supply expense can be further distributed across the two grants, subject to any limitations outlined in the grant budgets and the allowable costs specified in the contracts.

Maintaining consistency in the methodology applied when allocating costs to grants is essential. Nonprofit financial systems should have the capacity to accommodate multi-dimensional expense tracking. Automating allocation calculations, as opposed to relying on spreadsheets, offers significant efficiency gains. Generating financial reports at various levels of detail, based on activities and grants, directly from the financial system is crucial.

By effectively applying these principles, organizations can obtain an equitable representation of the costs incurred in each program area and supportive service. This information proves invaluable for making informed decisions regarding funding opportunities, operational planning, and ongoing activity monitoring.