Cost allocation plans can be a real pain point for nonprofit professionals. So why mess with them?

For some nonprofits, the obvious answer is, “Because you have to.” If you meet the threshold necessary for an annual audit, for example, having a cost allocation plan may be required. It also may be a requirement of your funding sources, particularly if you receive grants from federal, state, or local government agencies.

The not-so-obvious answer is, “Because they’re good for business.” Preparing and maintaining a cost allocation plan will help you understand the true cost of each of your programs and activities. Subsequently, understanding your true costs will help you fundraise for the entire amount. It also illustrates to your constituents – whether they’re grantors, individual donors, or your community at large – you’re being a good steward of their dollars.

So, let’s take a look at the what, how, why, who, and when of cost allocation planning.

WHAT is a Cost Allocation Plan?

A cost allocation plan is a documentation of the systematic allocation of indirect or shared expenses. More simply put, it’s a record of how you calculate your true costs of providing various services to your community. These indirect or shared expenses might include depreciation, occupancy costs, or even office supplies.

HOW Are Costs Allocated?

Your allocation method depends largely on your organization, and must be a reasonable representation of your underlying activities. Some common methodologies for allocating indirect costs are by square footage of your facilities or using payroll or related activities as a basis.

Square Footage – If your nonprofit’s electricity bill is $1,000 per month, you can allocate that cost across your various programs, based on the square footage allotted to each. For example, if Administration is housed in 10 percent; Program A in 20 percent; Program B in 50 percent; and Program C in 20 percent; you would allocate $100 to Admin; $200 to both Program A and Program C; and $500 to Program B of this shared expense.

Payroll – If you are using payroll activities as an allocation basis, your allocations might be based on a percentage of the total time worked or the total payroll dollars expensed by your employees in each functional area.

WHY Is It Important to Have a Cost Allocation Plan?

Expenses not directly connected to a particular activity or those that benefit more than one activity in your nonprofit need to be allocated fairly and equitably across your functional and program areas.

If you over allocate expenses to a given program or funding source, you could potentially incur penalties from your grantor, who may assess you a fine or demand you pay back the over-allocated dollars. If you under allocate shared costs to a given program or funding source, you run the risk of not reporting all fully-eligible or potentially reimbursable expenses.

Without a consistently applied and documented allocation method you might inadvertently be “double dipping” by unintentionally allocating expenses to multiple funding sources; and double reporting those expenses.

WHO Develops a Nonprofit’s Cost Allocation Plan?

Your nonprofit’s financial officer oversees developing and maintaining your cost allocation plan. It’s likely accomplished in conjunction with your executive director, and maybe even your audit committee or financial committee.

WHEN Should a Nonprofit Develop its Plan?

Your plan is typically developed and/or updated with the beginning of your fiscal year activities. Not-For-Profit Accounting says, “It generally works well to ‘dump’ all shared costs into cost centers – temporary holding tanks for functional areas – and then allocate them out across those functional areas on a periodic basis, usually monthly or yearly.”

The “when” also depends on your funding sources, some of whom may require you to submit your cost allocation plan as part of your regular grant reporting.

Regardless, your plan is a living document and should be continually updated and understood by your finance and executive teams and readily available on demand.

The what, how, why, who, and when of a cost allocation plan are a mystery to many, but developing one is extremely important, because as Not-For-Profit Accounting states, “… done accurately and consistently, it can provide a realistic picture of what different programs and other activities cost. Your allocation method also determines the percentages of program, management and fundraising that will appear on your Form 990 and other reports – numbers that potential donors use to judge your organization’s worthiness for their contributions. It is also used in cost recovery for reimbursable expenses, directly impacting your bottom line and related fundraising decisions.”