Finding Text
Criteria:
Under Accounting Standards Update (ASU) 2016-14, not-for-profit entities are required to present expenses by both natural and functional classification, and to disclose the methods used to allocate costs among program services and supporting activities. Management must exercise judgment in selecting reasonable, consistent, and supportable allocation methodologies. In addition, the organization should maintain written policies and controls over the application of allocation methods to ensure reliable financial reporting.
Condition:
The Organization did not allocate joint or shared costs (e.g., occupancy, personnel, administrative services) among program and supporting activities in accordance with an implemented allocation plan. In addition, a newly established program did not include costs associated with general oversight and management, despite shared staffing functions. No documented allocation methodology or policy was in place at the time of audit.
Context:
Costs that are shared across functional categories, such as salaries, rent, or general office expenses, were recorded directly to a single function or not allocated at all. This resulted in financial statement presentations that may not accurately reflect the costs of services provided across the Organization’s activities. The Organization currently has a written prototype of a cost allocation plan; however, it has not been customized to the entity, nor does the Organization perform time studies or use analyses to support allocation decisions.
Effect:
The financial statements are not fully presented in conformity with U.S. Generally Accepted Accounting Principles and the guidance provided in ASU 2016-14. This may impair the ability of management and those charged with governance to understand the Organization’s full cost structure and program efficiency and could lead to misinterpretation by users of the financial statements.
Cause:
Management has not fully implemented financial reporting policies and internal controls to ensure the application of a reasonable, documented, and consistently applied allocation methodology for shared or joint costs.
Recommendation:
We recommend that the Organization adopt a formal cost allocation policy in compliance with ASU 2016-14. This policy should outline methodologies for allocating personnel, occupancy, and other shared costs across functions, based on time studies, usage metrics, or other reasonable bases. We also recommend management ensure staff are trained on expense allocation principles and incorporate periodic reviews to assess consistency and compliance with the policy.
These improvements will support accurate functional expense reporting and better align the Organization’s financial reporting practices with U.S. GAAP.