Information
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.
What Are Functional Expense Allocations, Anyway?
Functional expense allocation is the process of assigning each organizational expense to one of three required categories:
- Program Services (the mission work)
These are the activities that directly fulfill your nonprofit’s purpose.
• Program staff wages
• Supplies for programs
• Travel for program delivery
• Contracted service providers tied to program outcomes
- Management & General (administration)
These support the overall organization but do not directly relate to a specific program.
• Executive Director and admin staff time
• Accounting & legal fees
• Office management
• Insurance
• HR, payroll, and IT support
- Fundraising (donor development)
These expenses support raising contributions.
• Donor events
• Fundraising staff salaries
• Donor communications & mailings
• CRM donor-management costs
• Grant-writing staff time
All three categories are required on the Form 990 and for audited financials prepared under GAAP.
Why Functional Allocation Matters
Functional allocations impact Form 990, audits & GAAP compliance, donor trust & transparency, and promote better internal management.
When leadership sees how funds flow across program, admin, and fundraising, they can plan, budget, and grow more strategically.
How to Allocate Expenses Correctly
The key principle:
Allocate your expenses based on the purpose and benefit of the expense.
Some expenses belong 100% to one category (see the following):
100% Program Examples
- Direct program supplies
• Costs of running events that benefit clients
• Salaries of program-only staff
100% Admin Examples
- Audit fees
• Accounting & HR
• Board meetings and governance work
• CEO/ED time (unless they directly run programs)
100% Fundraising Examples
- Fundraising gala expenses
• Donor mailings
• Grant writer (if they do not also run programs)
Other expenses must be split, shared, or mixed, based on reasonable, supportable methods.
Time allocations (for salaries)
• Square footage (for rent & utilities)
• Output metrics (rare but possible)
• Percentage of usage (for software)
How to Create a Simple Allocation Method
Step 1: Identify all staff roles
Have each employee estimate how much of their time is spent on:
• Program
• Admin
• Fundraising
Update at least quarterly, if possible.
Step 2: Assign natural expenses
- Software subscription (admin or fundraising)
• Supplies (program)
• Insurance (admin)
• Travel (depends on purpose)
Step 3: Allocate shared costs
For rent, utilities, office supplies, and IT support, use square footage or time-based allocation.
Step 4: Document your method
Auditors and the IRS want to see that you apply a consistent policy.
Step 5: Review annually
Things change, so it’s a good idea to update allocations when programs expand or staffing shifts.
Watch Out for These Common Mistakes…
- Putting everything in program expenses (this looks unrealistic and raises audit/IRS red flags).
• Failing to allocate executive or leadership time.
• Ignoring fundraising use of software or staff (if a CRM or staff member supports fundraising, it must be allocated properly).
• Not documenting your method of allocation (you must be able to show auditors how you arrived at your numbers).
If your allocations feel confusing or inconsistent, you’re not alone. Most nonprofits struggle with this, and a clear system makes an enormous difference.
Anchor Hill Accounting is here to help you build a clear, confident functional expense system that truly supports your mission. Contact us below...