NONPROFITS | 03/01/2024
Key Insights
- For nonprofits, ensuring that wages and expenses are accurately allocated is essential—not only for compliance with regulatory requirements but also for providing management with a clear understanding of program performance.
- We recommend that nonprofits implement a comprehensive cost allocation plan, which should encompass direct, indirect, and overhead costs. This plan helps ensure transparency and efficient financial management.
- Once the relevant costs are identified, it is important to determine the appropriate allocation basis. Different allocation methodologies may be needed depending on the specific circumstances and nature of the costs, allowing for more accurate financial reporting and decision-making.
Does allocating expenses across grants and programs frustrate you because of complexity and lack of automation? It’s a common nonprofit pain point.
For nonprofits, it’s critical wages and expenses are appropriately allocated both for compliance purposes and management’s understanding of program performance. The allocation process is often manual and time-consuming.
Review some helpful tips for making the allocation process smoother.
Adopt a Cost Allocation Plan
Developing a cost allocation plan is essential for nonprofits to ensure financial transparency and consistency. This plan should outline which costs need to be allocated and document the approach and methodology for doing so. It is important to review and update the plan annually to reflect any changes in operations or regulations.
A well-documented cost allocation plan provides several benefits, including month-over-month consistency in financial reporting and a clear rationale for the allocation decisions made each month. This structure not only supports compliance but also enables better decision-making and financial oversight.
Determine Which Costs to Allocate
Identifying which costs to allocate is a critical step in developing an effective cost allocation plan. Below are key considerations for determining if and how costs should be allocated:
- Direct Costs: These costs are directly attributable to a specific program or grant and can be easily linked to it. Examples include staff whose work is 100% dedicated to a program or grant, as well as supplies used exclusively by that program or grant.
- Indirect Costs: These costs are necessary to support program and grant activities but are shared across the organization. Examples include supervisory staff overseeing program staff, as well as expenses related to training, travel, and supplies that benefit multiple programs.
- Overhead Costs: These are organization-wide expenses, such as occupancy and administrative costs. It is important to assess whether any portion of these overhead costs can be allocated to programs or grants, where allowable, to ensure a more accurate reflection of program expenses.
By clearly defining and allocating these costs, nonprofits can ensure accurate financial reporting, enhance transparency, and better demonstrate the efficiency and impact of their programs.
Determine Allocation Basis
Once you have identified which costs will be allocated, the next step is to determine the appropriate allocation basis. Different allocation methods may be required depending on the nature of the cost and the specific circumstances. Here are a few examples:
- Employee Costs: For employees who work across multiple programs, allocation can be based on the time spent in each program, as documented on their timecards.
- Employee Benefits: These may be allocated based on the number of full-time equivalent (FTE) employees working in each program.
- Occupancy Costs: These can be allocated according to the amount of square footage each program uses within the organization’s facilities.
The key is to establish a consistent, logical, and well-documented allocation basis that reflects the true cost of each program. This ensures accuracy, transparency, and alignment with both internal management needs and external reporting requirements.
Implementing the Cost Allocation Plan
The implementation of your cost allocation plan will depend on your organization’s software capabilities and how frequently allocation percentages may change. To streamline this process, it is important to utilize appropriate allocation methodologies based on the nature of the costs and the available tools. Below are key approaches:
- Transactional Allocations: This method involves directly coding the expense to the appropriate cost center at the time of entry. It is most effective for direct program costs or for allocations that are predictable and known in advance, such as software expenses shared across departments. Many general ledger and spend management systems can automate these allocations, improving efficiency and accuracy.
- Payroll Allocations: Payroll expenses, including salaries and taxes, can be allocated through your payroll system. By assigning employees to specific locations, departments, or programs within the system, wages and taxes can be allocated accordingly. If employees track time against specific grants, integrating grant tracking into payroll will allow for more detailed and accurate allocations. Work with your payroll provider to establish a system integration or general ledger export to streamline the entry of payroll data into your financial management system.
- Dynamic Allocations: These allocations apply to indirect and overhead costs that may fluctuate periodically, such as monthly general and administrative expenses or health benefits allocated by FTE. Ideally, these allocations are calculated on a monthly basis, using allocation bases such as FTE percentages by program, and applying those percentages to shared costs like health care. Many modern financial management systems can automate these dynamic allocations, ensuring accuracy and consistency across periods.
By leveraging these allocation methodologies, your organization can ensure that expenses are consistently and accurately distributed, providing clearer financial insights and supporting more effective decision-making.
How We Can Help
If you’re finding it challenging to manage your current cost allocations—or lack thereof—our team at Chartered is here to assist. We offer comprehensive consulting and outsourcing services designed to streamline and optimize your allocation processes, ensuring accuracy and efficiency. Let us help take the complexity out of your allocations, so you can focus on what matters most: achieving your organization’s mission and financial goals.