Not-for-profit organizations are supposed to present their operating results on what is known as a functional basis. That is, they are supposed to identify expenses for program activities separately from expenses for administrative and fundraising activities. This is a basic financial reporting requirement contained within generally accepted accounting and financial reporting principles.

In order to present operating results on a functional basis, an organization must identify expenses by their function as they are made. For some expenses that might benefit more than one function, it is up to the organization to allocate those expenses over the functions that have benefited from the expenditure. This involves some systematic and rational allocation system.

A recent study of reports filed with the Internal Revenue Service indicates that over 40% of the charities probably do not accurately report how they raise money. In the latest reports filed with the IRS, over 38,000 organizations that each raised more than $1 million in gifts, approximately 41% did not report any fundraising expenses. For example among Goodwill Industries International’s 127 major affiliates, 48 reported no fundraising costs. That is just amazing!

It is ridiculous to think that an organization could raise $1 million or more and do so without spending any money to do it. Charity leaders admit that they are under pressure from donors to minimize overhead costs, including fundraising costs. However, reported results such as this calls into question the entire cost allocation system in place at these organizations.

It is important to be clear and transparent. However, being clear and transparent with information that does not make sense, is not in your best interest. If your organization does actually have an abnormally low (or high) expense in any area, it is best to explain that in footnotes to your financial statement and in Schedule O of your Form 990 tax return.

My mother used to tell me to be careful about claiming to “always” do something or “never” do something. Charities should also be careful about claiming zero fundraising expenses when they are the recipients of contributions.

As one of the largest CPA firms in Boston, KLR is unique because they service over 220 not-for-profit organizations with compliance and consulting services. We have extensive experience helping Nonprofit organizations regarding boards, and board responsibilities, charitable contributions, taxes and 990 filing requirements.