Functional Expense Classification
Functional expense classification refers to the method of grouping expenses according to the purpose for which the costs were incurred in an organization. It provides information about the costs of the organization’s main activities—program services, administration, and fundraising—rather than providing detailed information about the nature of the expenses, such as salaries, rent, and supplies.
For a non-profit organization, functional expense classification is typically divided into three main categories:
- Program Services: These are the costs associated with carrying out the programs or services that form the core mission of the organization. For example, for a non-profit that provides educational services, program services expenses might include the cost of instructional materials, teacher salaries, etc.
- Administration or Management and General Expenses: These are the costs associated with the overall administration and management of the organization. This could include salaries of administrative staff, office rent, office supplies, etc.
- Fundraising Expenses: These are the costs associated with activities to raise funds for the organization’s programs. This could include costs of fundraising events, marketing materials, hiring fundraising consultants, etc.
This classification is required by Generally Accepted Accounting Principles (GAAP) in the United States and is typically reported on the Statement of Functional Expenses, a part of the organization’s financial statements.
Functional expense classification helps provide transparency about how a non-profit organization is using its resources and allows stakeholders to see how much of the organization’s expenses are going towards its mission versus overhead or fundraising costs. This can be useful information for donors, grant makers, regulators, and others in assessing the organization’s efficiency and effectiveness.
Example of Functional Expense Classification
Let’s consider an example of a hypothetical non-profit organization called “Books for All” that works to promote literacy and provide books to underserved communities.
Here is how they might classify their functional expenses:
1. Program Services:
- Purchase of books: $100,000
- Cost of literacy classes (teacher salaries, classroom supplies, etc.): $200,000
- Outreach programs: $50,000
Total Program Services Expenses: $350,000
2. Administration or Management and General Expenses:
- Salaries for administrative staff: $80,000
- Office rent and utilities: $20,000
- Office supplies: $10,000
Total Administration Expenses: $110,000
3. Fundraising Expenses:
- Fundraising events: $30,000
- Marketing and promotional materials: $20,000
- Consultant fees: $10,000
Total Fundraising Expenses: $60,000
In this case, the total expenses for the year would be $520,000. The breakdown shows that 67.3% ($350,000/$520,000) of the total expenses were used directly for program services, while 21.2% ($110,000/$520,000) were used for administration, and 11.5% ($60,000/$520,000) were used for fundraising. This can help stakeholders understand how the organization’s funds are being used and how much is going towards the mission versus other costs.
It’s worth noting that the ratio of program services expenses to total expenses is often used as a measure of a non-profit’s efficiency, with a higher ratio generally seen as better. However, it’s also important to remember that administration and fundraising are necessary functions that support the organization’s mission, and so some level of expenditure in these areas is expected and necessary.
