Not-for-profit entities (NFPs) are under constant pressure to devote an increasing portion of their expenditures to accomplishing their mission programs. While this goal sounds appealing, the NFP must also perform management activities to operate the NFP effectively and maintain sustainable fundraising efforts to support the organization.
NFP ratings agencies use the percentage of expenses devoted to programming as a key component in the formulas they use to monitor, rate, and compare NFPs. Because of the reliance on and ease of availability of this information, donors and the press also track these percentages carefully.
NFPs often hold events, produce newsletters or videos, or conduct other activities that both serve their mission programs and provide fundraising opportunities. The costs related to these joint activities are appropriately allocated in part to program expenses and in part to fundraising or management and general expenses. That allocation can appear somewhat subjective and has come under increased scrutiny.
Recent media reports have questioned the efficacy and subjective nature of NFPs’ reporting of joint costs. Indeed, the risk of improper allocation makes accounting for costs of activities that include joint costs a complex area for NFPs and their auditors.
This is not a new issue for the profession. Industry guidance to address criticism in this area dates to 1964. In 1998, the AICPA adopted Statement of Position (SOP) 98-2, Accounting for Costs of Activities of Not-for-Profit Organizations and State and Local Governmental Entities That Include Fund Raising, which is now part of FASB ASC Subtopic 958-720, Not-for-Profit Entities–Other Expenses. With an increased focus on the cost of fundraising being used as an industry benchmark, it is incumbent on management and auditors of NFPs to understand and consistently apply these rules to accurately report these costs.
As pressures increase for NFPs to be efficient and effective in delivering on their missions, combining like activities can be a successful method of addressing common audiences. When properly applied, the criteria set forth in the accounting standards support the identification of joint costs that meet the requirement for allocation when a fundraising appeal exists. The guidance describes acceptable allocation methods in order to provide a consistent framework for allocating these costs and also details disclosure requirements intended to promote transparency in this area.
To identify valid activities that would require the allocation of joint costs, three criteria related to purpose, audience, and content must be evaluated. Processes for evaluation of these criteria are described in the Accounting for Joint Activities flowchart in ASC Paragraph 958-720-55-2, Not-for-Profit Entities—Other Expenses—Implementation Guidance and Illustrations—Flowchart of Application of the Criteria for Classification of Joint Costs.
The purpose criterion is met if the purpose of the fundraising activity includes accomplishing program or management and general functions and these functions meet the definitions set forth in paragraphs 33–37 of ASC Section 958-720-45, Not-for-Profit Entities—Other Expenses—Other Presentation Matters. Program functions should call for a specific action by the audience to help accomplish the NFP’s mission. Such calls for action should benefit either the recipient individually or society as a whole.
Three tests to evaluate whether the purpose criterion is met are the compensation-or-fees test, the separate-and-similar-activities test, and the other-evidence test:
- Compensation-or-fees test. The basic premise is that the purpose criterion is not met if a majority of compensation or fees for any party’s performance of any component of the discrete joint activity is tied to contributions raised. For example, if a commission-based fundraising consultant is used for any part of the activity, the activity would fail this test. The compensation-or-fees test is a negative test. It either results in failing the purpose criterion or does not determine whether the purpose criterion is met.
- Separate-and-similar-activities test. The purpose criterion can be determined to be met under this test if a similar program or management and general activity is conducted separately and on a similar or greater scale. These tests may not always be determinative.
- Other-evidence test. All available evidence, both positive and negative, should be considered to determine whether, based on the weight of that evidence, the purpose criterion is met under this test.
For the audience criterion, unless sufficient evidence to justify other functional classification exists, the activity should be considered entirely fundraising (i.e., the audience criterion is not met) if the audience includes prior donors or is otherwise selected for the likelihood to contribute to the NFP. For example, a mailing with a fundraising appeal to a list of prior donors would fail the audience criterion and be considered fundraising costs. ASC Section 958-720-55 provides additional guidance for the audience criterion.
The content criterion is met if the joint activity supports program or management and general functions.
As described, program activities have calls for action that should either benefit the recipient or benefit society. A call for an individual to improve his or her health by quitting smoking is an example of a call to action that helps accomplish an NFP’s mission that includes improving individuals’ physical health. Material that simply educates an audience about a cause and fails to call for a specific action is considered support of fundraising. Specific situations related to educational institutions are included in the guidance; refer to paragraphs 22–24 of ASC Section 958-720-55 for more details.
Some fundraising activities conducted in conjunction with program or management and general activities are incidental to such activities. The guidance allows for, but does not require, allocation of joint costs in these situations. However, in circumstances in which the program or management and general activities are incidental to the fundraising activities, it is unlikely that the criteria to permit allocation of joint costs would be met.
DETERMINING COSTS TO ALLOCATE
The ASC Master Glossary defines joint costs as those costs
of conducting joint activities that are not identifiable with a
particular component of the activity. Joint costs may be analogized to
costs charged to an indirect cost pool, in which those indirect costs
cannot be readily identifiable and charged to a specific
program/project, as described in ASC Paragraph 958-730-45-29. It
follows, therefore, that the first step in allocating joint costs is
to go through the exercise of sorting and classifying costs that are
identifiable with a particular functional classification. Those costs
would not be considered joint costs to be allocated. For example, the
cost of postage for a letter that includes both fundraising and
program components is a joint cost. The wage cost for the staff person
who prepares the program portion of the letter would be a program
expense and not part of the joint costs to be allocated.
To properly allocate joint costs, the allocation methodology used
should be rational and systematic; it should result in an allocation
of joint costs that is reasonable; and it should be applied
consistently given similar facts and circumstances. Some examples of
allocation approaches include the physical-units,
relative-direct-cost, and stand-alone joint-cost-allocation methods.
Under the physical-units method, costs are proportionally allocated to
the number of units of output, such as lines or square inches. The
relative-direct-cost method uses the relative direct costs of each
component to allocate indirect costs. The stand-alone method
determines proportions based on what each component of activity would
cost if conducted independently. Care should be taken with each of
these methodologies so that they do not provide an unreasonable
allocation given the circumstances.
ASC Paragraph 958-720-50-2, Not-for-Profit Entities—Other Expenses—Disclosure—Accounting for Costs of Activities That Include Fundraising, requires that an NFP that allocates joint costs disclose the types of activities for which joint costs have been incurred, a statement that such costs have been allocated, the total amount allocated during the period, and the portion allocated to each functional expense category. An NFP is also encouraged, but not required, to disclose the amount of joint costs for each kind of joint activity, if practical.
Several examples that are included in the FASB Accounting Standards Codification help to illustrate the joint cost concepts and illustrate the evaluation of the three criteria. Additional examples can be found in ASC Section 958-720-55.
Example 1. NFP A’s mission is to prevent drug abuse, with one of its objectives being to assist parents in preventing their children from abusing drugs. NFP A mails informational materials to the parents of all junior high school students explaining the prevalence and dangers of drug abuse. The materials encourage parents to counsel children about the dangers of drug abuse and inform them about how to detect it. The mailing also includes a request for contributions. NFP A also conducts other activities informing the public about the dangers of drug abuse and encouraging parents to counsel their children about drug abuse that do not include requests for contributions and that are conducted using different media.
In this example, the purpose, audience, and content criteria are met, and the joint costs should be allocated. The purpose criterion is met based on the evidence because (1) the program component of this activity calls for specific action by the recipient (encouraging parents to counsel children about the dangers of drug abuse) that will help accomplish the NFP’s mission, and it otherwise conducts the program activity in this example without a request for contributions, and (2) performing such programs helps accomplish the NFP’s mission. The audience criterion is met because the audience (parents of all junior high school students) is selected based on its need to use or reasonable potential to use the action called for by the program component. Finally, the content criterion is met because the activity calls for specific action by the recipient (encouraging parents to counsel children about the dangers of drug abuse and informing them about how to detect drug abuse) that will help accomplish the NFP’s mission (assisting parents in preventing their children from abusing drugs), and it explains the need for and benefits of the action (the prevalence and dangers of drug abuse).
Example 2. All the facts in Example 1 remain the same; however, the audience was selected from a list composed of prior donors. In this case, the purpose and content criteria are met; however, the audience criterion is not met because the audience includes prior donors. Although the audience has a need to use or reasonable potential for use of the program component, that was an insignificant factor in its selection. All costs, including those that might otherwise be considered program or management and general costs if they had been incurred in a different activity, should be charged to fundraising.
Example 3. NFP C is a university whose mission is to educate the public (students) in various academic pursuits. The university’s political science department holds a special lecture series in which prominent world leaders speak about current events. Admission is priced at $250, which is above the $50 fair value of the lecture and, therefore, $200 of the admission price is a contribution. As a result, the audience’s likelihood to contribute to the university is a significant factor in its selection. The university advertises the lectures by sending invitations to prior attendees and to prior donors who have contributed significant amounts, and by placing advertisements in local newspapers read by the general public. The university presents similar lectures that are priced at the fair value. In this case, the purpose and content criteria are met. The audience criterion is not met. Therefore, costs that might otherwise be considered program or management and general costs excluding the costs of the direct donor benefit (the lecture), should be charged to fundraising. Note that the purchase of the tickets is an exchange transaction and, therefore, is not a contribution.
The purpose criterion is met because (1) the program component of the activity calls for specific action by the recipient that will help accomplish the university’s mission (educating the public [students] in various academic pursuits) and (2) the program is also conducted using the same medium on a scale that is similar to or greater than the scale on which it is conducted with the request for contributions (other lectures in the series are conducted on a scale similar to the scale of the lecture in this example without including a contribution in the admission price).
The audience criterion is not met because the audience is selected based on its likelihood to contribute to the university. The fact that the $250 admission price includes a $200 contribution leads to the conclusion that the audience’s ability or likelihood to contribute is an overwhelmingly significant factor in its selection, whereas there is no evidence that the audience is selected for its need to use or reasonable potential for use of the action called for by the program component (attending the lecture).
Finally, the content criterion is met because the activity calls for specific action by the recipient (attending the lecture) that will help accomplish the university’s mission (educating the public [students] in various academic pursuits), and the need for and benefits of the action are clearly evident (attending the lecture is a positive educational experience).
Example 4. NFP D’s mission is to provide food,
clothing, and medical care to children in developing countries. NFP D
conducts television broadcasts in the United States that describe its
programs, show the needy children, and conclude with appeals for
contributions. NFP D’s operating policies and internal management
memoranda state that these programs are designed to educate the public
about the needs of children in developing countries and to obtain
contributions. In this case, the purpose, audience, and content
criteria are not met. All costs should be charged to fundraising. The
activity does not include a call for specific action because it only
educates the audience about causes. The audience criterion is not met
because the audience is selected based on its ability or likelihood to
contribute, rather than based on its need to use or reasonable
potential for use of the action called for by the program component,
or its ability to take action to assist the NFP in meeting the goals
of the program component of the activity. (The audience is a broad
segment of the population of a country that is not in need of or has
no reasonable potential for use of the program activity.)
An NFP’s management has the responsibility to assess joint activities for these criteria to ensure they are met and that joint costs are accounted for under the current accounting standards. If material, an auditor has the responsibility to perform procedures to obtain audit evidence about the amounts and disclosures for joint costs. Together, scrutiny by NFPs and their auditors can help increase confidence in applying this standard. Properly applied, these accounting standards provide a framework for ensuring that the allocations are consistent and valid.
Editor’s note: This article was submitted on behalf of the AICPA Not-for-Profit Entities Expert Panel, of which the author, Joseph Cruitt, is a member.
Not-for-profits (NFPs) often conduct activities that mix program activities and fundraising. Management is responsible for ensuring proper cost allocation for these activities to facilitate accurate reporting in NFP financial statements.
Three criteria must be evaluated to identify valid activities that would require the allocation of joint costs. These criteria are related to purpose, audience, and content.
The allocation methodology should be rational, systematic, and applied consistently. Examples of allocation approaches include the physical-units, relative-direct-cost, and stand-alone joint-cost-allocation methods.
FASB requires NFPs to disclose the types of activities for which joint costs have been incurred. Also required are a statement that such costs have been allocated, the total amount allocated during the period, and the portion allocated to each functional expense category. If practical, an NFP is also encouraged to disclose the amount of joint costs for each kind of joint activity.
Joseph W. Cruitt ( email@example.com ) is vice president for finance and CFO of the National Board of Osteopathic Medical Examiners in Chicago, and a member of the AICPA Not-for-Profit Entities Expert Panel.
To comment on this article or to suggest an idea for another article, contact Ken Tysiac, editorial director, at firstname.lastname@example.org or 919-402-2112.
- “How Not-For-Profits Can Reduce Fraud Risk,” June 2014, page 44 (sponsored report)
- “Gifts-in-Kind: What Are They Worth?” Aug. 2013, page 44
- “Checklist: Risk With Donor Pledges,” March 2012, page 20
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