Nonprofit Accounting
By Diane Gorham · Anchor Hill Accounting
If your organization has ever wondered “Is this program or admin?”, “Where does this staff person’s time go?”, or “Why does our auditor keep asking about allocations?” — this guide is for you.
Functional expense allocation is simply the process of assigning each expense your organization makes to one of three required categories, so your board, your donors, and your auditor can all see clearly where the money goes.
These are the activities that directly fulfill your nonprofit’s purpose.
These support the organization as a whole rather than any one program.
These expenses support raising the contributions that make everything else possible.
All three categories are required on the Form 990 and for audited financials prepared under GAAP — so getting this right isn’t optional, but it doesn’t have to be overwhelming either.
Good functional allocation touches more than compliance. It shapes your Form 990, your audit, and your GAAP-based financials — and just as importantly, it builds donor trust and transparency. When your leadership can see exactly how funds flow across program, admin, and fundraising, budgeting and long-term planning get a lot easier too.
The guiding principle is simple: allocate each expense based on its purpose and who benefits from it. Some expenses belong entirely to one category:
Direct program supplies, costs of events that benefit clients, salaries of program-only staff.
Audit fees, accounting & HR, board meetings and governance work, CEO/ED time (unless directly running programs).
Fundraising gala expenses, donor mailings, grant writer time (if they don’t also run programs).
Other expenses need to be split or shared, based on a reasonable, supportable method — for example:
Have each employee estimate how much of their time is spent on program, admin, and fundraising. Update this at least quarterly if you can.
Software subscriptions (admin or fundraising), supplies (program), insurance (admin), travel (depends on purpose) — sort each expense by what it’s actually for.
For rent, utilities, office supplies, and IT support, use square footage or time-based allocation.
Auditors and the IRS want to see that you apply a consistent, written policy — not numbers pulled out of thin air.
Programs expand, staffing shifts, and your allocations should keep up. Build in a yearly check-in.
If your allocations feel confusing or inconsistent, you’re not alone — most nonprofits struggle with this. A clear system makes an enormous difference, and Anchor Hill Accounting is here to help you build one that truly supports your mission.