What is a statement of functional expenses? An essential nonprofit accounting guide 

As a nonprofit accountant, you juggle many responsibilities—tracking funds, ensuring compliance, and keeping your stakeholders informed. It’s no secret that nonprofit financial reporting can be complex and, at times, overwhelming. 

One report that often raises questions is the statement of functional expenses.

You might wonder, “Am I categorizing expenses correctly?” or “How can I make this process easier?” 

This guide will demystify the statement of functional expenses—what it is, why it matters, and how to prepare it accurately—so you can stay compliant, boost transparency, and confidently manage your nonprofit’s finances. 

Here’s what we’ll cover: 

What are functional expenses? 

Functional expenses classify costs based on their purpose, rather than just their type.

Unlike for-profit businesses, which group expenses into categories like rent, salaries, and utilities, nonprofits must also categorize expenses by function: 

• Program services: costs directly tied to delivering your mission (e.g. educational programs, medical supplies for a healthcare nonprofit). 

• Administrative activities: expenses related to overall operations (e.g. office rent, executive salaries, legal fees). 

• Fundraising: costs associated with donor outreach and raising money (e.g. fundraising events, marketing campaigns). 

Functional expense reporting builds trust and ensures compliance by demonstrating how your nonprofit allocates resources. 

What is a nonprofit statement of functional expenses and why does it matter? 

A statement of functional expenses, sometimes referred to as a schedule of functional expenses, is a financial report that details how your nonprofit allocates costs across different categories.

Unlike general financial statements that provide high-level overviews, this report offers a clear breakdown of expenses by both function (why the expense occurred) and nature (what was purchased). 

It’s one of four key financial statements nonprofits rely on. The other three are: 

• Statement of activities: the nonprofit equivalent of an income statement, showing revenue and expenses. 

• Statement of financial position: a balance sheet outlining assets, liabilities, and net assets. 

• Statement of cash flows: tracks cash movement across operating, investing, and financing activities. 

For many organizations, the statement of functional expenses is more than just an internal tool—it’s a compliance requirement.

If your organization files Internal Revenue Service (IRS) Form 990, maintaining this report is necessary to retain tax-exempt status if annual gross receipts exceed $200,000 or total assets are over $500,000.

Even smaller organizations filing Form 990-EZ or 990-PF benefit from detailed expense tracking, making reporting more accurate and efficient. 

Beyond compliance, this statement is a powerful nonprofit financial management tool.

It supports budgeting, strategic planning, and resource allocation, allowing nonprofits to optimize spending and make informed decisions.

It also fosters transparency by showing donors, grantmakers, and stakeholders exactly how funds are used to further the organization’s mission. 

By effectively using this report, nonprofits can stay financially healthy, maintain donor trust, and ensure resources are directed where they’re needed most. 

Functional versus natural expenses  

When preparing your statement of functional expenses, costs must be categorized in two ways as per Financial Accounting Standards Board (FASB) guidelines: 

• Functional classification: the purpose of an expense (e.g. program services, administration, fundraising). 

• Natural classification: the type of expense (e.g. salaries, office supplies, rent). 

By organizing expenses both by function and type, your nonprofit provides a comprehensive picture of how resources are allocated.  

Functional classifications: Three main categories 

Functional expenses typically fall into these categories: 

1. Program expenses 

These are the costs directly related to delivering your nonprofit’s mission.

They include expenses for services, initiatives, and programs that benefit the community or cause you support.

For example, an educational nonprofit might list teaching materials, instructor salaries, and workshop costs as program expenses. 

2. Administrative expenses 

Administrative costs cover the overall management and daily operations of your nonprofit.

These include expenses that keep your organization running smoothly, such as office supplies, legal fees, executive salaries, and accounting services.

While they don’t directly advance the mission, they are essential for compliance and sustainability. 

3. Fundraising expenses 

Fundraising costs include everything required to raise money for your nonprofit.

This might include event expenses, donor outreach efforts, marketing campaigns, and salaries for development staff.

Accurately categorizing these expenses ensures transparency and helps maintain donor confidence. 

This dual classification approach ensures compliance and provides stakeholders with deeper insights into your nonprofit’s financial management. 

Nonprofit statement of functional expenses examples 

Reviewing examples of functional expense statements can help you understand how expenses are categorized and structured.

These samples illustrate how different types of nonprofits allocate costs and ensure compliance while optimizing financial management. 

1. Small community nonprofit 

Here’s an example of how costs for a small educational services non-profit might be classified: 

Expense type	Program services	Administrative	Fundraising	Total
Salaries and wages	$50,000	$20,000	$10,000	$80,000
Office supplies	$2,000	$1,000	$500	$3,500
Rent and utilities	$10,000	$5,000	$2,500	$17,500
Marketing	$1,500	$500	$2,000	$4,000
Travel expenses	$3,000	$1,000	$500	$4,500
Totals	$66,500	$27,500	$15,500	$109,500

Since the nonprofit’s primary focus is educational programs, most expenses are allocated to program services, ensuring resources directly benefit the mission. 

2. Mid-sized health organization 

For a mid-sized nonprofit providing healthcare services, expenses may be higher and more varied: 

Expense type	Program services	Administrative	Fundraising	Total
Salaries and wages	$300,000	$80,000	$50,000	$430,000
Medical supplies	$120,000	–	–	$120,000
Rent and utilities	$30,000	$20,000	$10,000	$60,000
Outreach and marketing	$50,000	$10,000	$30,000	$90,000
Professional services	$15,000	$10,000	$5,000	$30,000
Totals	$515,000	$120,000	$95,000	$730,000

3. Large environmental nonprofit 

Larger nonprofits tend to have more diversified expenses across different functions: 

Expense type	Program services	Administrative	Fundraising	Total
Salaries and benefits	$500,000	$150,000	$100,000	$750,000
Advocacy campaigns	$200,000	–	–	$200,000
Rent and facility costs	$60,000	$30,000	$20,000	$110,000
Events and fundraising	–	–	$150,000	$150,000
IT and software expenses	$40,000	$20,000	$10,000	$70,000
Totals	$800,000	$200,000	$280,000	$1,280,000

By following a structured format and categorizing expenses accurately, nonprofits can meet regulatory requirements, maintain transparency, and improve financial planning. 

How to prepare an accurate statement of functional expenses 

A well-prepared statement of functional expenses ensures clarity, accuracy, and compliance. Follow these steps to create a report that aligns with best practices: 

1. Identify what information you need 

Start by gathering all expenses related to programs, administration, and fundraising from your financial records.  

2. Use reliable financial data 

Pull information from accounting software, bank statements, and internal reports to ensure accuracy and completeness.

Using financial reporting software can help streamline data collection and improve reporting efficiency. 

3. Categorize expenses correctly 

Sort each cost by both function (why it was incurred) and nature (what was purchased) to provide a clear structure. 

4. Review and verify for accuracy  

Cross-check classifications and ensure all expenses are properly allocated and in compliance with reporting standards. 

5. Organize the statement 

Present data in a structured table format, ensuring expenses are clearly divided into program services, administrative, and fundraising categories. 

7. Analyze and identify trends 

Use the statement to assess spending patterns, improve budgeting, and ensure resources are aligned with your mission. 

Understanding functional expense allocation in nonprofits 

Getting functional expenses right is key to accurate financial reporting and regulatory compliance.

In nonprofit accounting, functional expense allocation means distributing shared costs across different functional categories, such as program services, management, and fundraising.  

This practice helps show how your nonprofit’s spending supports its mission.

By reporting expenses by function, your organization provides a clear picture of how resources are utilized, offering transparency to funders, donors, boards of governors, and regulators. 

Nonprofit accountants typically use two main methods to allocate expenses: 

Direct allocation 

This method assigns specific costs directly to a functional category.

For example, if an employee works only on program services, their salary is 100% allocated to that category. This method works well when expenses can be clearly linked to one function. 

Indirect allocation 

When expenses are shared across multiple functions, indirect allocation is used.

Costs like rent, utilities, or shared salaries are divided based on a reasonable and consistent method—such as the percentage of staff time spent on different activities. Indirect allocation ensures that overhead expenses are fairly distributed. 

Common mistakes in a statement of functional expenses 

Nonprofits often make errors that can lead to misreporting and compliance issues. Here are some of the most common mistakes: 

• Misclassifying expenses: placing costs in the wrong category, such as administrative costs under program services, distorts financial reports. 

• Over-allocating to fundraising: inflating fundraising expenses can raise red flags for donors and regulators. 

• Neglecting indirect costs: failing to account for shared expenses results in incomplete financial statements. 

• Inconsistent allocation methods: using different methods each year can make reporting unreliable and difficult to audit. 

• Ignoring compliance requirements: not following IRS and Generally Accepted Accounting Principles (GAAP) guidelines can lead to penalties and compliance issues. 

Simplify your nonprofit statement of functional expenses with accounting software 

Take the hassle out of preparing your statement of functional expenses with our nonprofit accounting and management software.

Our tools guide you through every step—from collecting information to organizing data and structuring reports—so you can easily classify expenses by function and nature.  

Give your team the power to manage resources efficiently, create accurate financial statements, and showcase your nonprofit’s commitment to its mission–all with less effort. 

Final thoughts on the statement of functional expenses 

A well-prepared statement of functional expenses not only enhances transparency and builds trust with donors but also reduces the stress of nonprofit financial reporting.

By structuring it correctly, you can streamline compliance, eliminate confusion over expense categorization, and make smarter budgeting decisions—helping your organization stay focused on its mission instead of getting bogged down in paperwork.