Although there are few "requirements" for the disclosure of expenses, it is useful to consider some aspects of the reporting of expenses, namely:
- the functional classification of expenses and classification by program
- the natural classification of expenses and reporting expenses by object
- budgeted expenses
The Functional Classification of Expenses and Classification by Program
Classifying expenses functionally or by program is to classify them according to the purpose of the expense. For example, a church may want to report on the expenses of the youth program, outreach to the community, music and so on. Organizations that are activity based, for example condominium corporations, may report on activities like maintenance, and landscaping. These types of classifications show how money is spent in achieving the purposes of the organization and is required of non-profit organizations in the United States by FASB Statement No. 117 (26). The Canadian Public Sector Accounting and Auditing Handbook (PS 1500.96) requires this type of breakdown for government organizations. The functional classification of expenses is not required for non-profits in Canada but is considered desirable. This latitude may allow some organizations an easier presentation of actual expenses against budgeted figures, where budgeted figures are determined by object rather than by function.
When classifying expenses functionally, FASB requires a separate classification for management and administrative expenses, and total fundraising expenses. Total fundraising expenses are required by Revenue Canada in the completion of the T3010.
The Natural Classification of Expenses and Classification by Object
In the United States, FASB No. 117 requires the functional classification of expenses, and for certain non-profits, voluntary health and welfare organizations, it requires the additional disclosure of the natural classification of expenses. For other organizations, FASB only suggests this as desirable disclosure. The natural classification of expenses shows expenses by the nature of the expense, for example salaries, professional fees, interest and so on. This disclosure would typically be presented in a supporting schedule that reconciles to the expenses reported in the statement of operations.
Many non-profit organizations in Canada use a hybrid of the natural and functional classification, reporting by activity and by function. This type of reporting can become misleading to the reader, and may result in poor decision making. For example, the organization shows course revenue and course expenses (reporting functionally), but certain course expenses are reported "naturally", for example printing costs, or amortization. The course revenue now appears to be too high as some costs are classified elsewhere, and the Board is encouraged to lower course fees. In some cases it may appear as though reporting functionally and naturally comes to the same result. For example, a condominium corporation will report professional fees, describing the nature of the expense, alongside landscaping, describing the function. This only works because "professional fees" really describes a function "accounting", that is unassociated with the expense of all other reported functions.
In Canada, we refer to the classification of expenses by object which is similar to the "natural classification" of expenses. This is required disclosure for government organizations in Canada, per PS 1500.95, but is not required of non-profit organizations in Canada. To classify by object is to classify by the type of expense, for examples salaries and benefits, supplies and services, grants, and interest expense. There is perhaps a subtle distinction between the nature of the expense and the type of the expense.
An additional disclosure of expense by object or function may be presented in a separate schedule to the financial statements.
Profit orientated enterprises have a natural tendency to want to control costs. Especially where management bonuses, and other incentives are geared toward profit.
Non-profit organizations do not have the same incentive to control costs. In some cases, spending patterns may only be limited by conscience and the funds available. For this reason, budgeting can be very important in a non-profit organization. It helps to ensure that spending is well thought out, looking at the big picture.
One of the primary objectives of financial reporting is to demonstrate the stewardship of management. Contributors want to know that funds are being handled prudently. Presenting the budgeted expenses alongside the actual expenses may help to achieve this accountability. There may be cases where actual spending dramatically exceeds budgeted spending, for example in responding to a crisis, or perceived need. The organization’s management discussion and analysis section of the annual report is an ideal place to highlight such occurrences and management’s responsibility in dealing with unanticipated needs or situations.