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Business and Policy Areas
Business and Policy Areas

FASB Considers Statement of Functional Expense Requirement

January 8, 2014

At its meeting on December 18, 2013, the Financial Accounting Standards Board (FASB) tentatively decided to require Not-for-Profit (NFP) entities to present expenses by both functional and natural classifications within their financial statements. Currently, all NFPs must present expenses by function, but not by natural classification. In addition, Voluntary Health and Welfare Organizations (VHWO) are required to present a statement of functional expenses that reconciles functional to natural expenses.

Under the proposed guidance, NFPs would be required to provide an analysis of the relationship between natural and functional expenses within the financial statements. The Board did not feel the format of that analysis should be prescriptive. Rather, they tentatively decided that NFPs could choose to present the information on the face of the statement of activities, in a separate statement of functional expenses, or in the footnotes in a matrix format or as a narrative discussion.

In addition, the Board decided to recommend that all expenses—both operating and nonoperating—appear in the analysis. Nonoperating expenses, such as interest expense, would not be required to be functionalized.

Impact on Higher Education

A review of approximately 200 FY2011 financial statements of independent colleges and universities showed that 85 percent presented their expenses by function on the face of the statement of activities (SoA). Of those, only 17 percent also presented expenses by natural classification in the notes. While we have noted that more institutions are moving to a presentation by natural class on the face of the SoA, the majority still present by function. As a result, the requirement to provide an analysis of functional and natural expenses would require additional effort. That effort, however, is not expected to be significant because most institutions manage their operations by natural expense.

While the FASB does not plan to propose a specific format for presenting the analysis, a matrix that contains natural expenses by function will likely prove the easiest and most straightforward approach.

In addition to the natural and functional expense analysis (using, for example, a matrix presentation) institutions should include a discussion of the methods for allocating overhead amounts to the various functions.

A separate, but tangential, issue for higher education is the current NACUBO functional expense definitions. These definitions, which have become the basis for the Integrated Postsecondary Data System's (IPEDS) financial survey, are decades old and make consistent categorization across institutions difficult. A working group of NACUBO's Accounting Principles Council (APC) is addressing the issue of functional expense definitions and considering changes to the current definitions. Look for an article on this topic in the February edition of Business Officer Magazine.

This is the fifth web article in a news series covering FASB decisions that are designed to improve the NFP reporting model. NACUBO staff and members of its Accounting Principles Council will continue advising the Board on this project, remaining in close contact with FASB staff. Look for enhancements to NACUBO's accounting webpage to provide more project details and gather membership feedback in preparation for an industry response to proposed changes when an exposure draft is issued for comment. An exposure draft is expected to be issued before the fourth quarter of 2014. 


Sue Menditto
Director, Accounting Policy