23.3 Functional Expenses and Statement Presentation

Why Functional Expenses Matter

The 2026 FAR Blueprint states candidates may need to report expenses by nature and function in the statement of activities, the notes, or a separate statement of functional expenses for a nongovernmental NFP. This requirement comes from ASU 2016-14, which mandates an analysis of expenses by both nature and function in one location for every NFP — not just voluntary health and welfare organizations as under the old rules. That breadth makes it a likely simulation topic because it combines classification, allocation, and presentation.

A natural classification describes the type of cost: salaries, rent, supplies, insurance, depreciation, professional fees, utilities. A functional classification describes the mission purpose served: program services, management and general, and fundraising (a fourth, membership development, appears for some entities).

Nature Versus Function

The total expense does not change with functional reporting; only the display changes. A $90,000 salary remains $90,000 of salary expense by nature, but it might be presented as $60,000 program, $20,000 management and general, and $10,000 fundraising by function. The rows (natural) and columns (functional) of the matrix must cross-foot to the same grand total.

Statement Presentation

The statement of activities reports revenues, gains, expenses, losses, and changes in net assets. Expenses are generally shown as decreases in net assets without donor restrictions. When donor-restricted resources fund the intended purpose, the NFP reports a release from restriction and reports the cost in the appropriate functional category. The functional/natural analysis may live in three acceptable places: the face of the statement of activities, a separate statement of functional expenses, or the notes.

Allocation and Joint Costs

Shared costs require a reasonable, rational, and consistently applied allocation method that tracks the cost driver: space by square footage, personnel by time studies, information technology by headcount or usage. ASU 2016-14 also requires disclosing the methods used to allocate costs among functions.

Fundraising deserves special care. Costs of soliciting contributions are fundraising unless a joint activity meets all three ASC 958-720 criteria — purpose, audience, and content — that support allocating part of the cost to a program or management function. A mailer that both educates the public and asks for donations only escapes pure fundraising classification if those criteria are satisfied. When the facts are thin, choose fundraising rather than inventing a program allocation.

Worked Example: Cross-Footing the Matrix

Suppose total expenses are: salaries $200,000, rent $60,000, depreciation $40,000 — $300,000 by nature. Time and space studies allocate 65% program, 25% management and general, 10% fundraising. The functional column totals are $195,000 program, $75,000 management and general, and $30,000 fundraising — also $300,000. If a candidate's functional columns do not sum to the natural total, an allocation error exists.

Simulation Workflow

When the exhibit set includes invoices, payroll data, and allocation percentages:

1. Build a natural-expense total for each cost category.
2. Identify direct expenses that clearly belong to one function.
3. Apply the stated allocation basis to shared expenses.
4. Tie functional column totals back to natural row totals (cross-foot the matrix).
5. Confirm expenses reduce net assets without donor restrictions.
6. Verify the disclosure explains the methods used to allocate costs.

Presentation Traps

• Do not treat a cash outflow as a functional expense merely because cash was paid. A capital asset purchase hits the statement of financial position first; depreciation becomes the functional expense later.
• Do not create a donor restriction just because management tracks program budgets internally.
• Do not report a release from restriction as an expense — the release moves resources between net asset classes; the expense reports the cost of the activity.
• Do not allocate fundraising costs to a program unless the purpose, audience, and content joint-cost criteria are all satisfied.

The Joint-Cost Criteria in Detail

Under ASC 958-720, all three tests must pass before any joint-activity cost leaves fundraising. The purpose criterion requires the activity to accomplish a program or management function, judged by whether compensation is tied to contributions raised, whether the same program activity is conducted separately on a similar scale, and other factors. The audience criterion is presumed unmet if the audience was selected based on its likelihood to contribute; it can be rebutted if the audience was chosen for program reasons (its need for the program, or its ability to act on a call to action).

The content criterion requires the activity to call the audience to specific action that helps the mission (program) or to provide genuine management content. If any one test fails, the entire joint cost is reported as fundraising. FAR fact patterns often plant a single failing factor — such as a mailing list chosen purely by donation propensity — that forces the whole cost into fundraising, and the correct simulation entry reflects that all-or-nothing result rather than a partial allocation.