Reporting Nonprofit Operating Expenses

Most nonprofit organizations use much of their income or funding to further their organization’s mission, but many must also spend money on their day-to-day operations.

The funds a tax-exempt nonprofit spends on employee salaries, rent, transportation, and fundraising costs are known as “operating expenses,” or “overhead costs.” They must be reported annually along with other information. Nonprofit organizations must do this so donors, the public, and the IRS can track nonprofit spending.

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Statement of Functional Expenses

A nonprofit’s statement of functional expenses tracks costs by functional category. The Financial Accounting Standards Board guidelines state that all U.S. nonprofits must report their costs based on their classification as functional and natural expenses.

A nonprofit’s functional classifications are usually broken down into:

• Administrative expenses. These expenses are often considered operating expenses, like office management, accounting, human resources, legal services, and board of directors’ meetings.

• Program expenses. These are the program costs that are directly related to carrying out the nonprofit’s exempt purposes.

• Fundraising expenses. These are the operating expenses related to fundraising campaigns, which include maintaining donor lists and soliciting donations.

The statement of functional expenses should also list a nonprofit’s expenses by natural classifications, which may include the following expense categories:

• Salaries.

• Rent.

• Office supplies.

• Utilities.

• Insurance.

• Repairs.

Functional Expense Allocation

The process through which a nonprofit classifies its expenses by functional classification is known as functional expense allocation. This allocation is important because the statement of functional expenses will be read by individual donors, regulators, and other outside parties interested in how your nonprofit is spending its money.

Other Nonprofit Financial Statements

In addition to filing a statement of functional expenses, many nonprofits will issue the following financial reports:

• Statement of financial position lists a nonprofit’s assets and debts like a business’s balance sheet.

• Statement of cash flows tracks the cash flowing into and out of a nonprofit.

• Statement of activities reports on a nonprofit’s revenues and expenses during the reporting period.

A nonprofit’s program expenses are usually the money that is spent to achieve its purpose or mission. For example, a nonprofit that builds houses for low-income families would classify its money on building supplies as program expenses.

Generally, program expenditures are broken down into direct and indirect costs. Direct costs are those spent on a specific program or activity. Indirect costs are the administrative expenses to administer the program.

Administrative costs are not unique to nonprofits, and any business or organization that spends money as part of its core operations incurs operating expenses. The IRS allows most companies to deduct their operating expenses from their profits, but since tax-exempt nonprofits do not pay tax on their income, they can’t take advantage of the deduction. However, the IRS still requires most exempt nonprofits to file annual Form 990 informational returns, including operating expenses.

What Is an IRS Form 990?

Most tax-exempt organizations must file an annual Form 990 tax return — it is how the IRS collects financial data on exempt organizations. This reporting requirement gives the IRS an overview of the activities of exempt organizations. Nonprofits use it to prove they should retain their tax-exempt status.

Additionally, Forms 990 are public documents, and several websites offer databases where visitors can access the information reported on the forms. Finally, many states use the forms to monitor and regulate organizations that have claimed state deductions.

Form 990 Data Often Differs From Other Financial Statements

Unfortunately for nonprofits that prepare nonprofit statements in accordance with generally accepted accounting principles (GAAP), Form 990 requires reporting based on a mix of GAAP and tax-basis accounting. That means that the numbers reported in categories like revenue and expenses rarely match on the financial statements and Forms 990.

It is a good idea to use a nonprofit accountant familiar with the reporting requirements. If you have legal questions about nonprofit operating expenses, consult with a local business attorney.

Related Resources

• Nonprofit Financial Statements
• Business Accounting
• Nonprofit Organizations