What Functional Expense Allocation Means
Functional expense allocation assigns every cost your organization incurs to the purpose it served: program services, management and general, or fundraising. Your chart of accounts answers a different question. Natural classification records what you bought, salaries, rent, depreciation, professional fees. Functional classification records why you spent it.
Same dollar, different question.
GAAP requires both views for every US not-for-profit, in one location. Functional expense allocation for nonprofits rests on two authorities, one from FASB and one from the IRS.
FASB’s ASU 2016-14, Not-for-Profit Entities (Topic 958), made three changes that matter here. Every nonprofit now presents an analysis of expenses by nature and by function in one location, on the face of the statement of activities, as a separate statement, or in the notes. The method used to allocate costs among program and support functions has to be disclosed, which moves your basis out of internal workpapers and into the audited statements. And management and general got a tighter definition, through the concepts of direct conduct and direct supervision, as The CPA Journal’s 2019 review of the standard explains. The update took effect for fiscal years beginning after December 15, 2017.
The three functions, as the IRS instructions for Form 990 define them:
- Program services. The cost of the work your organization exists to do.
- Management and general. Overall direction, oversight and administration, including board meetings, general legal services, accounting and auditing, office management, human resources, and management of investments.
- Fundraising. Soliciting contributions, gifts and grants, including development staff, donor communications, appeal production and postage, and professional fundraising fees.
Our introduction to nonprofit accounting walks through each statement, and net assets with and without donor restrictions covers a separate classification readers often blend into this one. One describes the strings attached to the money. The other describes the purpose it was spent on.
The split isn’t just a number for the tax return. It’s a monthly read on how your organization is actually built.
How to Allocate Expenses Under ASU 2016-14 and Form 990 Part IX
Neither FASB nor the IRS prescribes an allocation formula, so both ask for the same two things, a reasonable basis and consistent application. GAAP adds a third, which is to disclose the basis you chose. The question of how to allocate expenses nonprofit organizations genuinely share across functions comes down to four steps.
Step 1. Direct charge first, then pool what’s shared
A cost that serves exactly one function belongs entirely to that function, with no percentage involved. Allocation is the exception, not the default. Program staff compensation and participant supplies go to program services. Your donor database and appeal printing go to fundraising. The audit fee, board insurance and finance staff compensation go to management and general. A 2019 Journal of Accountancy article on adopting the reporting standard recommends coding expenses by department all year and naming accounts for natural expense types rather than for programs, so the matrix comes out of the ledger instead of being rebuilt by hand. Our guide to bookkeeping basics covers the coding habits behind that. What’s genuinely shared then gets pooled by the thing that drives it, with one basis per pool and one place the evidence lives.
| Shared cost pool | Allocation basis | What the auditor asks to see |
|---|---|---|
| Compensation and benefits for people working across functions | Time records, or a periodic time study over a representative period | Signed timesheets or activity logs, the study period and sample, and who approved it |
| Occupancy: rent, utilities, janitorial, property insurance | Square footage by functional use | A floor plan with square footage by room and its use |
| Technology: devices, software licenses, IT support | Full-time-equivalent headcount, or license or device count | An FTE roster by function and the license inventory |
| Depreciation | Square footage, or the asset’s own functional use | The fixed asset schedule with a function tagged per asset |
| Communications carrying program content and an ask | The joint cost rules in Step 3 | The piece, the mailing list criteria, and the three-criteria assessment |
A time study is the most defensible basis for compensation, because it measures the driver directly. Benefits and payroll taxes follow the same percentages as the salary they attach to.
Step 2. Keep oversight in management and general
This is where organizations get corrected most often. ASU 2016-14 permits moving a management cost into program only where the person or activity is directly conducting or directly supervising that program. Overall oversight, general recordkeeping, budgeting, financing activities and the governance work of the board stay in management and general, even when the person doing them also runs the program. The Form 990 instruction for column (C) runs parallel. Overall management usually includes the compensation and expenses of top management and their staff, and where part of that time goes to program services or fundraising, it should be allocated among those functions. Two rules, one answer.
Step 3. Run joint activities through three criteria
Joint activities are the one place GAAP replaces judgment with a gate. ASC 958-720-45, carried forward from SOP 98-2, allows part of a joint activity’s cost to be reported as program only when all three criteria are met, and failing any one sends the entire cost to fundraising, as a 2014 Journal of Accountancy analysis of allocating joint costs sets out. Purpose asks whether the activity accomplishes a program function, tested partly through whether you run a comparable standalone activity in the same medium at a similar scale. Audience fails where the list includes prior donors or is picked for its likelihood to give, which creates a rebuttable presumption. Content asks whether the piece calls for a specific action other than giving. Where all three hold, charge identifiable costs to their function first, then allocate the joint remainder by physical units, relative direct cost or stand-alone cost.
Step 4. Carry the same numbers into Part IX
Part IX is the IRS version of the statement of functional expenses, and the 2025 instructions require 501(c)(3) and 501(c)(4) organizations to complete columns (A) total, (B) program services, (C) management and general, and (D) fundraising. An organization whose system does not allocate expenses may use any reasonable method, and its records have to support the amounts reported. Line 26 is the joint costs line, completed only where you reported joint costs from a combined educational campaign and fundraising solicitation in column (B). Our walkthrough of Form 990 and the public support tests covers how the schedules connect. Your Form 990 Part IX functional expenses should come from the same workpapers as your audited note.
One boundary worth naming. Organizations charging indirect costs to federal awards work from a negotiated rate or may elect the de minimis rate of up to 15 percent of modified total direct costs under 2 CFR 200.414(f), effective October 1, 2024, with earlier awards governed by their own terms. That is federal cost recovery, a separate question from GAAP functional reporting, and we cover the nonprofit indirect cost rate in its own guide.
A Worked Example: Allocating Shared Costs at a Fictional Organization
The Riverbend Literacy Collective is a fictional organization, invented for this walkthrough, and every figure below is a percentage of total annual expenses. The point is the basis behind each line, not the number at the bottom. Riverbend lands at a rounded 82 percent program services, 12 percent management and general, and 6 percent fundraising.
Before anything gets split, its finance manager charges every cost that serves one function to that function. Tutor stipends are program work. The donor database is fundraising. The audit fee is management and general. That accounts for 62 percent of the year, and none of it needs a percentage. The allocation only runs cleanly because the close is finished first and the accounts tie, the same discipline behind account reconciliation in any set of books.
| Cost | Percent of total | Function |
|---|---|---|
| Program staff compensation and benefits | 44 | Program services |
| Program delivery: books, tutor stipends, learner transportation | 8 | Program services |
| Development staff compensation and benefits | 3 | Fundraising |
| Donor database and gift acknowledgments | 1 | Fundraising |
| Finance and administrative staff compensation | 4 | Management and general |
| Audit fee, board insurance, state charitable registration | 2 | Management and general |
Direct-charged subtotals: program services 52, management and general 6, fundraising 4.
The four shared pools, 38 percent of total expenses
Pool A, executive director compensation and benefits, 9 percent, on time records. Her weekly activity log shows her directly supervising the tutoring program and running two sites herself, handling board governance, budgeting and audit oversight, and joining major-gift visits. The log supports 68 percent program, 24 percent management and general, and 8 percent fundraising. The management share stays where it is because governance, budgeting and overall oversight are not direct conduct or direct supervision of a program, even performed by the same person. That allocates 6.12, 2.16 and 0.72.
Pool B, occupancy, 18 percent, on square footage. The floor plan tags every room. Classrooms, the tutoring suite and the family waiting area are program. The finance office and the conference room used mainly for board and committee meetings are management and general. The development office is fundraising. The result is 84 percent program, 14 percent management and general, and 2 percent fundraising, which allocates 15.12, 2.52 and 0.36.
Pool C, technology, 8 percent, on full-time-equivalent headcount. The FTE roster by function runs 82 percent program, 14 percent management and general, and 4 percent fundraising, and license counts track headcount closely enough that headcount is the simpler defensible basis. That allocates 6.56, 1.12 and 0.32.
Pool D, the combined newsletter, 3 percent, under the joint cost rules. Riverbend mails one piece a year explaining how adult literacy works in the county, asking readers to volunteer as a tutor or refer a learner, and enclosing a gift envelope. Purpose holds, because a standalone tutor recruitment mailing runs in the same medium at a similar scale and nobody’s pay for the piece is tied to contributions raised. Audience holds, because the list is partner schools, library cardholders and county employers. Had the piece gone to the donor file, the presumption would run the other way and the whole 3 percent would be fundraising. Content holds, because the call to action is something other than giving. Measuring the content, relative direct cost gives 70 percent program and 30 percent fundraising, or 2.10 and 0.90.
The result, and what it doesn’t mean
| Function | Direct | Pool A | Pool B | Pool C | Pool D | Total | Rounded |
|---|---|---|---|---|---|---|---|
| Program services | 52.00 | 6.12 | 15.12 | 6.56 | 2.10 | 81.90 | 82% |
| Management and general | 6.00 | 2.16 | 2.52 | 1.12 | 0.00 | 11.80 | 12% |
| Fundraising | 4.00 | 0.72 | 0.36 | 0.32 | 0.90 | 6.30 | 6% |
| Total | 62.00 | 9.00 | 18.00 | 8.00 | 3.00 | 100.00 | 100% |
The standard asks for the method, not only the numbers. Riverbend’s note says in substance that salaries and benefits are allocated on time records kept by each employee, occupancy and depreciation on square footage, technology on full-time-equivalent headcount, and joint costs of materials carrying a fundraising appeal on the relative direct cost of the program and fundraising content, with the ASC 958-720-45 criteria assessed for each activity.
Read 82 percent as context, not a grade. Riverbend’s program share sits where it does partly because it occupies a building full of classrooms, and an organization doing excellent work with a different cost structure can land many points lower without a single entry being wrong. Keeping the basis per pool documented and reviewed is the part that holds up, and our notes on nonprofit financial management cover where that review fits the monthly calendar.
Common Allocation Mistakes and How to Fix Them
Most functional expense findings trace back to a few habits, and nearly all are fixable with a monthly process and a one-page memo. None of them come from carelessness. They come from capacity, because the person carrying the close is usually also carrying the audit, the grant reports and the 990.
- Allocating once a year, for the 990. The symptom is a December scramble and a split nobody can reproduce. Post the allocation in every monthly close instead.
- One blanket percentage across every line. A single 80/15/5 applied to the whole ledger has no driver behind it. That isn’t a method. Rebuild it as one pool, one basis, documented.
- Pushing all executive time into program. Oversight, budgeting, recordkeeping, financing and board governance stay in management and general, even when the executive director also runs a program.
- Using the budget as the basis for grant-funded salaries. Under 2 CFR 200.430(i), budget estimates alone do not support charges to federal awards. Move to contemporaneous records or a documented periodic time study.
- Allocating a joint activity that fails a criterion. Usually audience, because the piece went to the donor file, or content, because it asks for nothing but money. The California Attorney General’s Charitable Trusts Section publishes a paper on joint cost allocation abuse, a fair signal of how closely state charity regulators read this line.
- Leaving the method out of the notes. Disclosure of the method used to allocate costs among program and support functions is required under ASU 2016-14, not optional.
- Statements and Part IX telling different stories. Presentation differences are legitimate. An unexplained difference in basis is not. Reconcile the two before either one goes out.
- A chart of accounts built on program names. A ledger that says After-School Program where it should say Salaries and Occupancy can’t produce the matrix without a manual rebuild.
Changing a method is allowed, and sometimes necessary when programs or space change. Document the reason and the date, and expect a question about comparability. Our checklist on how to prepare for a nonprofit audit sets out what to have assembled before fieldwork starts.
How the Board, Funders and Auditors Read Your Functional Split
Three audiences read the same three columns for three different reasons, and only one of them is looking for a percentage.
The auditor tests the basis, not the ratio. Because the method is disclosed, the basis is part of what gets examined rather than an internal convenience. Expect requests for the time records and the study’s sample period, the floor plan with square footage by use, the FTE roster, the fixed asset schedule with function tagged, the joint cost assessment for any combined mailing, and evidence that the method ran the same way all year.
Funders read the split for cost structure and indirect recovery. Grantmakers use the functional view to see how your organization is built and to sanity-check the indirect costs in a proposal budget. Our piece on how accounting infrastructure supports fundraising covers what that credibility looks like in a financial section.
Watchdog standards exist, and they are standards, not law. BBB Wise Giving Alliance’s Standards for Charity Accountability include Standard 8, at least 65 percent of total expenses on program activities, and Standard 9, no more than 35 percent of related contributions on fundraising. Standard 13 addresses accurate expense reporting, and sending more than half of a joint cost to program will likely prompt a closer review. These are voluntary accreditation standards, not a legal requirement.
The sector’s own evaluators say the ratio is not a measure of effectiveness. In 2013 the chief executives of GuideStar, now Candid, Charity Navigator and BBB Wise Giving Alliance asked donors to stop using the overhead ratio as the primary measure of performance, a position Candid restated in 2026. Two organizations following accepted practice can allocate the same cost base and land well apart without either one being wrong.
The board’s job here is three questions. What basis are we using for each shared pool, and when did we last review it against how people work now. Does our audited note describe the same method as Part IX. Does the allocation run monthly, or once a year for the return. Read the answers alongside the nonprofit statement of financial position.
Audit requirements themselves sit at the state level. Most states require an independent audit above a threshold, usually triggered by total revenue or total contributions, and both the threshold and the trigger vary considerably from state to state, as the National Council of Nonprofits tracks. Ask your state charity regulator or state auditor for the figure that applies to you.
How Indinero Supports Monthly Functional Expense Allocation
The difference between a painful audit and a quiet one is usually not the method. It’s whether the method ran every month or once a year. That’s the part indinero takes on, through indinero’s nonprofit accounting services.
Books are closed every month, accounts are reconciled, and functional expenses are allocated every month, so the Part IX detail is a byproduct of the close rather than a project. Your controller leads a monthly review and your Part IX functional expense detail comes straight from your monthly books, so the 990 isn’t a once-a-year scramble. The Exchange, indinero’s client platform, shows the program, administration and fundraising split each month, drawn from the books, with categories aligned to Part IX.
Four roles sit on the account. The controller leads your monthly review, the close and your audit preparation. The senior accountant records gifts, grants and bills and reconciles every account. The nonprofit CFO advisor handles budgets, reserves, board preparation and grant reviews. The tax specialist supports Form 990 preparation and your team’s tax questions, and your own preparer still files and signs the return. Indinero prepares your organization for its audit. The independent auditor performs it.
With indinero, every schedule your auditor will request is tracked all year, with an owner and the evidence for each. Restricted grants are reconciled monthly, and the close checklist, grant schedules and policies live in the Exchange rather than in one person’s head, which is how a basis memo and a time study survive a staff departure.
Two scopes are available. A full finance function, where indinero runs the close, controller oversight and audit preparation, CFO advice, budgets and board reporting. Or support for your team, working alongside existing staff through the close, audit season and grant deadlines. Across the firm there are 150+ delivery professionals, 18 days average to onboard, 5+ years average client partnership, and SOC 2 compliance.
The people on your indinero team look at your books through a nonprofit eye, with a nonprofit CFO advisor reviewing your budgets, reserves and grant applications. Dream Machine Innovation Lab launched in 2023 to bring changemakers together on poverty, prisons, pollution and polarization. With a team of ten or fewer, they needed monthly financials and program-level reporting without building an accounting department. Emily Frappier, their Director of People and Finance, put it this way: “They’re looking at it through a nonprofit eye because the people working on my account specifically have nonprofit expertise.”
If your allocation gets rebuilt in a spreadsheet the week the auditor arrives, there’s a steadier way to run it. We’d like to hear about your organization, your finance staff and what’s on the calendar next. Talk to an Expert, and after a review of your books you’ll get a written proposal with the scope laid out.
Frequently asked questions
These are the questions executive directors, finance managers and treasurers ask most often once the method is on the table. Each answer stays at the level of the rule, so take anything specific to your organization to your auditor or counsel.
What costs belong in management and general?
Management and general covers the oversight and administration of your whole organization, not the activities that further its exempt purpose. The Form 990 instructions put board and governance work, general recordkeeping, budgeting, financing activities, overall management, and the audit in this column. Under ASU 2016-14, a cost leaves management and general only where the activity is direct conduct or direct supervision of a program or another supporting function.
Can the executive director’s salary be split across functions?
Yes, an executive director’s salary can be split across functions, and it usually should be, supported by time records. Under ASU 2016-14, time spent directly conducting or directly supervising a program is program services, and major-gift work is fundraising. Governance, budgeting, financing and overall oversight stay in management and general, even when the same person runs the program. For federally funded time, 2 CFR 200.430(i) means budget estimates alone don’t qualify as support.
How often should a nonprofit allocate functional expenses?
Allocate functional expenses every month as part of the close, not once a year when the Form 990 comes due. Monthly allocation means Part IX detail comes straight from the books instead of a year-end reconstruction, and it gives your board a current functional split. Allocating once a year is the most common cause of a filing-season scramble, so indinero allocates functional expenses in every monthly close.
What allocation bases work for shared costs like rent and technology?
Allocate each shared pool on its own documented basis: square footage for occupancy and rent, full-time-equivalent headcount for technology. Salaries and benefits follow time records or a periodic time study, and shared supplies follow usage. The Form 990 instructions permit any reasonable method of allocation where your system doesn’t allocate expenses directly, and ASU 2016-14 requires the method you used to be disclosed. Direct charging comes first, so allocation applies only to genuinely shared costs.
How are joint costs for an event or appeal allocated?
Joint costs are allocated by a reasonable method only when the activity meets the purpose, audience and content criteria for both program and fundraising. Fail any one of the three and the entire cost of the activity belongs in fundraising. Where all three hold, charge identifiable costs to their own function first, then allocate the joint remainder by physical units, relative direct cost or stand-alone cost. Keep the written assessment with the piece and the mailing list criteria.
Is there a required program expense ratio for nonprofits?
No, there’s no required program expense ratio for nonprofits, because no accounting standard, regulation or law sets one. Watchdog and funder expectations exist and vary, and BBB Wise Giving Alliance publishes its own voluntary standards, but none of that is a legal requirement. Read your own split as context rather than a grade, since it reflects what your mission’s work actually requires.
