What Are Functional Expenses? A Guide to Nonprofit Accounting

What Are Functional Expenses? A Guide to Nonprofit Accounting

Ayushi Somani
Ayushi Somani
Table of Contents
Table of Contents

There can never be an end if you wish to learn about accounting. This massive pool of information not only enriches your learning but also introduces you to how the business world works with provisions in accounting.

To start with, every profit-making business requires accounting. Nonprofit businesses also require mandatory accounting of their transactions and money flow. If you are curious to learn about accounting at a nonprofit organization, functional expenses are where to start.

Like a profit making business, a nonprofit has its own share of expenses and transactions. The accounting specifications for both kinds of organizations are set to be different. One of mandatory accounting reporting for a nonprofit is to analyze the natural expenses based on their function. This analysis is mostly done through the Statement of Functional Expenses (SOFE.) SOEF is a very efficient method of maintaining the accounting equation as well as this valuable information. The information is not only a requirement but is also super informative and valuable for the organization to track the expenses.

Before diving too deep into the Functional Expenses, let's understand what are natural expenses?

What will you find in this article-

  • What are natural expenses?
  • What are functional expenses?
  • Difference between functional expenses and natural expenses
  • Classification reporting
  • Program Services
  • Management and General
  • Fundraising
  • How to Record Statement of Functional Expenses?
  • Allocation of Functional Expenses
  • Financial Statements Nonprofit Issues
  • Financial Position Statement
  • Functional Expenses Statement
  • Activities Statement
  • Cash Flow Statement
  • The Statement of Functional Expenses is a Compulsion
Girl holding American Dollar Bills

What are Natural Expenses?

Natural Expenses are the benefits a nonprofit organization makes to seek economic benefits in return for the amount. To put it in simple words, natural expenses as the name suggests are the expenses made to keep the organization running. These are the vital expenses that a nonprofit organization would spend naturally.

A lot of expenses can be counted under natural expenses. Some of these expenses are –

  • Office supplies
  • Office assets (Desktops, furniture, etc.)
  • Office utilities
  • Travel expenses
  • Salaries for the staff
  • SaaS and other IT tools required to run the operations

What are Functional Expenses?

Every organization incurs expenses in order to carry out operations or to generate revenue in the longer process. In nonprofit organizations, these expenses are made solely to carry out operations. Functional expenses are the classification of an expense to understand its function.

The parameter has been set by Financial Accounting Standards Board as a mandatory requirement to understand the clear functionality of each individual expense.

Functional Expense

Difference Between Functional Expenses and Natural Expenses

As per Financial Accounting Standards Board’s requirement, a nonprofit organization is supposed to categorize the expenses on the basis of its purpose. Natural expenditure here tells us about where the money went in respect to what in return. Functional expense is the bigger plate here. It mentions each natural expense by type and category.

As per the Form 990 reporting requirements, a nonprofit organization uses these categories when recording functional expenses.

  • Program Services
  • Management and General
  • Fundraising

Let's understand these better in more detail.

Classification Reporting

The classification of the expenses is a process too. Before the accountant goes on to allocate the expenses, they all need to classified. As per the governing board, all the expenses made are mandatory to be classified and recorded in one of these categories of expense.

Program Services

A nonprofit organization runs to achieve a mission. The trustees or the fund pairs provide their resources in the form of money to help the organizations achieve this mission. To achieve the mission, a nonprofit has to arrange programs. These programs can have different natures based on the alignment and the purpose.

The cost that goes into the arrangement of these programs is recorded under the Program Category. This helps the organization to keep a record of the allocation of the money. It also helps the board in analyzing that the money is allocated in fair and required activities. The record helps the trustees, the board, and the organization in keeping track to achieve the greater mission and purpose.

Management and General

This is the general category to record the expenses made for management. Every organization and office needs management for sustainability. The expenses spent to keep the management running every day are recorded in this account. Although the expenses made here do not actively contribute to the mission of the nonprofit organization but are necessary.

Most of the expenses counted here are for bookkeeping, governance, and management. The trustees and the funds raised are not directly involved in this expenditure either.


A nonprofit organization primarily runs on money raised by donors and funding groups. Naturally to raise this money a nonprofit has to carry out fundraising campaigns. The expenditure included in fundraising goes into this account. The campaign includes email marketing activities, printing broachers, and pamphlets, related to fundraising activities, etc.

The costs of salaries of employees working on raising funds go into this account.

In some cases, the cost spent for fundraising has to be counted under the program account.

In Other Cases

Program Services, Management and General, and Fundraising are not the only methods to record and present the expenditure. A nonprofit also has to present expenditure in natural classification. This classification involves multiple categories like

  • Office rent
  • Utilities
  • Office supplies
  • Insurance
  • Salaries
  • Repairs
  • Depreciation

A nonprofit has to mandatorily record all the expenses in natural as well as functional expenses accounts. The most expenses made by a nonprofit are for salaries, benefits, and employment taxes.

These expenses for all three accounts should be recorded in weekly or monthly timesheets. The timesheet helps in sorting different needs and in deeply analyzing the allocation of the funds.

How to Record Statement of Functional Expenses?

A statement for reporting functional expenses is done under two different classifications. This happens because of the rules set by the board for nonprofit organizations. The entire process can be a little tough and intimidating but you do not have to worry. We are here to guide you through the process. Here is an example of how the document is constructed and how the expenses are recorded.

Statement Of Functional Expenses

   Year 2021



Program 1

Program 2

Management and General



Salaries and Benefits






Rent and Utilities







Printing and Supplies



















Here is how you can understand the statement better. The column highlighted in yellow has the nature of the expenses. The column highlighted in red has the functions of expenses.

Allocation of Functional Expenses

As we have discussed above, a nonprofit has to record all its expenses in classifications. The functional expenses account is the record where accountants or bookkeepers classify and store all the functional expenses. With the classification and recording of the expenses in this statement, it gets better to understand why it is important for a nonprofit organization to record and report its functional expenses in classifications by functions.

The financial reporting of a nonprofit is done under the rules of the board or governing body. However, the audience of this statement includes donors and funders. This helps the donors and funders to understand the allocation of their money by the organization. The donors, funders, and stakeholders of the nonprofit organization are interested in understanding if their funds are spent in the right order to meet the greater goal and aim of the organization in favor of the community.  This helps them understand the amount that goes into running the management of the organization and the cost that is derived towards the actual goal achievement.

A clear understanding and recording of the functional expenses are important for the stakeholders, funders, and donors to understand it thoroughly. For this purpose, the classification of the functional expenses is divided into different allocation methods including:


This category uses space as the criteria to determine the expenses a nonprofit organization is making. In simpler terms, a nonprofit organization has to pay for utilities and rent for the office space. The required cost for the same can be counted on the basis of the area on square foot measurement. By this understanding, the stakeholders are able to calculate the area and the cost used for different departments. For example, the area of the fundraising department can be subtracted from the total area of the office to determine the cost of the fundraising department.

Count Per Person

This category works by counting the number of people working on a project and the expenses each person makes. This approach is convenient and gives the right calculations too. However, this approach only works for a smaller organization with less employees or workers. Counting expenses on per person basis in an organization with 1000+ workers can be hectic and the calculation can be flawed.

Time Studies

An employee’s work is counted by the clock in every organization. People get paid for the number of hours they are working for. This category helps a nonprofit organization to understand how much work each employee gets done within the working hours they are being paid for. The organization then divides the number of hours spent in different programs, management, and fundraising. The cost for the hours spent working in each segment is then calculated. At the end of the year, this amount is totaled to find the allocation of the money by nonprofit.

Direct Costs

Like the name suggests these expenses are allocated directly. These costs are spent on this related to one department or segment in particular. For example, grant payments are directly related to one segment.

Financial Statements Nonprofit Issues

Under the rules of governing board, every organization that makes monetary transactions has to issue its financial statements. Thus, both businesses and nonprofits have to release their financial statements. Since the nature of transactions and expenses are different for nonprofits and businesses, the statements for both differ as well. These are the financial statements a nonprofit has to issue.

Financial Position Statement

Every organization has to keep a record of all its financial positioning. This record is similar to a balance sheet of a business. This statement records the value of the assets of the nonprofit. It also records the value of debt to be paid by the nonprofit organization. The statement also includes all the net assets owned by the nonprofit to calculate an estimated net worth of the organization. A similar process is done for a business in for equity reporting.

Functional Expenses Statement

Reporting of functional expenses is mandatory for a nonprofit. The Statement of Functional Expenses allows the nonprofit to categorize, classify, and clearly record the expenses and functionality of expenses made by the organization. The statement is further divided into three classifications: Program, management, and general.

Activities Statement

Like a business issues Business Statement, a nonprofit has to issue an Activity Statement. This statement records all the expenses, costs, and revenue generated by the nonprofit organization in a given period of time. This helps in recording and keeping a track of all the expenses and income statements that the nonprofit experiences. This helps in understanding the allocation of the money as well as in keeping a track of the direction and achievement the organization is making towards the end goal.

Cash Flow Statement

As the name suggests, this statement keeps a track and record of cash transactions happening in the nonprofit. This statement helps in understanding and analyzing where all the cash is coming in from and going out to. This also helps the organization in keeping a record of the usage of cash in each program, event, general, and other choruses. With this, the organization not only is able to run the cash exchange in management swiftly but also in better achievement of goals on financial status.

The Statement of Functional Expenses is a Compulsion

A nonprofit organization, just like any other organization runs on monetary transactions, assets, and liabilities. A business records all the transactions in several ways as it aims to make a profit out of the venture. A nonprofit however works for the betterment of the community and not to make a profit. However, according to Generally Accepted Accounting Principles, nonprofits are still supposed to do financial reporting of all the transactions in a classified way.

These transactions that run the nonprofit organization and help them achieve the main goal are recorded in the Functional Expense Statement.

Key Takeaways

Building a Function Expenses Statement can be overwhelming. This article takes you through the entire process of building, classifying, and recording all the functional expenses a nonprofit needs to record. Here are some of the most important points from the article you cannot overlook.

Remember, the Functional Expenses Statement is a mandatory statement for a nonprofit organization. Thus it is important to pay attention to detail while the account is preparing the statement. Keep these following points in mind while preparing the statement.

  • Natural and Functional expenses are two different classifications to fit the expenses of a nonprofit.
  • The functional and natural expenses are recorded in different statements.
  • Function expenses discuses and classify the expenses based on the functional economic results the amount is being paid for.
  • In the classification, both the nature and the function of expenses are discussed.
  • Functional Expenses Statement has three further classifications: Program, Management, and General, and Fundraising.
  • The statement is prepared to clearly understand the allocation of funds by the nonprofit.
  • There are 4 categories for allocation of the expenses: Area, Count Per Person, Time Studies, Direct Cost.
  • A nonprofit has to issue 4 different kinds of financial statements: Financial Position Statement, Functional Expenses Statement, Activities Statement, Cash Flow Statement.
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