The Benefits of Cost Allocation

Segdrick Byrd

The benefits of cost allocation

Cost allocation can be a cumbersome task for not-for-profits, especially organizations with many activities. However, the process is critical for multiple reasons, and it is worth reviewing your cost allocation practices regularly to ensure they are working as intended.

Why make allocations?

Cost allocation often refers to how an organization’s costs are assigned to its programmatic, administrative and fundraising activities to determine the actual costs of those activities. While it is obvious how some costs (usually direct costs) should be allocated, indirect costs (for example, management compensation, utilities, rent and other overhead) can prove more challenging.

Proper cost allocation is important to not-for-profit management. It is a prerequisite for accurate financial statements, which enable informed decision making on a variety of matters, including budgeting, cost cutting and program evaluation.        

Cost allocation also is indispensable when it comes to grant compliance. Grants often come with budgetary and expense restrictions. Proper allocation helps you ensure adherence with grant terms and conditions. It also can reduce the risk of charging the same expense to multiple grants. And, regardless of whether you deal with grant funds, cost allocation is vital for sustainable operations. Without a reliable account of your costs, you could unexpectedly fall short of the funding needed to maintain operations, forcing you to dip into reserves or other unrestricted assets.

Allocation methods

There are different methods to use to allocate expenses.  For example, costs can be allocated to an activity based on the:

• Proportion of total employee hours that have been spent on it;
• Proportion of facility space dedicated to it; or
• Usage percentage of expenses such as supplies or equipment for it.

The selected method or methods need to be reasonable. If federal funds are involved, the methodology must comply with the cost principles in the Office of Management and Budget (OMB) Uniform Guidance. Your allocations may differ depending on the reasons for allocating.

Other tips

It is generally wise to limit the number of different methods you use to avoid confusion and make it easier to apply the methods consistently. Developing a formal written policy that supports the methodology choices and explains how and when to apply them will also aid in consistency.

Rather than allocating each cost individually, you can simplify the process by grouping costs for similar functions into cost pools. For example, pool all indirect costs related to marketing. You can then allocate the pool to different activities. Note that the allocated percentage can differ depending on the cost category. A program might, for instance, be allocated a larger percentage of rent than of fundraising expenses, based on the method of allocation.

Make sure you maintain documentation to support your computations. When allocating salaries, you might need timesheets or other time-tracking data. For square footage allocation, you will need up-to-date measurements for the different departments.

Finally, review your cost allocation policy at least annually and whenever your organization has any substantial changes in programming or other activities. If you determine you should change methodologies for your new circumstances, document how and why you selected a different method.

Ask for help

Whether you are reviewing an existing cost allocation policy or choosing methodologies for the first time, a CPA with not-for-profit experience can help. Your auditors can review to avoid audit adjustments later on.

For more information, contact Segdrick Byrd at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Not-For-Profit Group.

Donor-Advised Funds are Here to Stay

Jurgita Kalina, CPA

Grants from donor-advised funds (DAFs) to charitable organizations totaled $52 billion in 2022 and contributions to DAFs reached $85 billion, an all-time high, according to the 2023 Donor-Advised Fund Report from the National Philanthropic Trust (NPT). Data for the NPT’s 2024 report is currently being collected.

Even with these astounding numbers, NPT data from 1,151 charities shows that DAFs actually grew at a slower pace than in previous years. Nevertheless, not-for-profits should keep their eye on them. Here is what your organization needs to know if it is considering DAF funds.

What are the benefits to donors?

DAFs enable donors to contribute assets, including cash, securities and real estate, to an account controlled by a “sponsoring organization.” They receive an immediate tax deduction up to 60% of their adjusted gross income in exchange for their irrevocable gifts.

Most DAF organizations fall into one of two categories: 1) community foundations and 2) charitable wings of investment-service companies, such as Vanguard Charitable and Schwab Charitable. A smaller group of sponsors focuses on single issues or charitable grantees. All types of DAF organizations generally invest and manage DAF assets, screen charities that will receive grants, and make distributions. But policies vary widely by sponsor about issues such as the types of assets accepted, how funds are invested and how often donors must request distributions. And DAFs have been criticized for stockpiling funds indefinitely without making distributions.

Related Read: Donor-Advised Funds Offer a Low-Cost Alternative to Private Foundations

Who are sponsors?

Donors make grant recommendations, and although sponsoring organizations are not legally required to honor them, they almost always do. However, it is worth noting that sponsors play a major role in determining which organizations ultimately receive grants. Sponsors often suggest charities to donors that match their charitable criteria.

Sponsors also may step in when donors fail to request distributions. For example, if Fidelity Charitable donors do not name grantees after two years, Fidelity names charities for them. But not all sponsoring organizations have such policies. And some critics contend that both donors and sponsoring organizations have incentives to hold onto DAF money as long as possible.

How do you access DAFs?

To encourage sponsoring organizations to direct gifts to your charity, prioritize these relationships. Let community foundations know that you welcome such gifts and are equipped to handle them. And as your mission and programming evolve, keep sponsors up to date so they can accurately match your organization with donor interests.

Because some DAFs are anonymous, building relationships can be a little harder. If you have already received a DAF grant, you likely found the name of the fund in the gift letter. Be sure to send the donor a thank-you note (via the sponsoring organization, if necessary) and indicate your interest in receiving future gifts or being named a beneficiary of a trust. Also put prominent notices on your website, including a link to DAF Direct (dafdirect.org) on social media pages and in emails to donors. And think about featuring DAF supporters in your publications.

Related Read: Donor-Advised Funds: How They Work and How to Land Them 

What does the IRS think?

The IRS issued its first set of proposed DAF regulations in late 2023. Some of these regulations may affect not-for-profits. For more information, contact your legal and tax advisors.

Even with the proposed guidance, there are still some unanswered questions. For example, whether DAF funds can be used to fulfill pledges remains uncertain. The IRS has stated that DAF funds can be used for this purpose. However, donors cannot take additional tax deductions for them, and sponsoring organizations are not allowed to tell grantees that a gift is being issued to fulfill a pledge.

DAF grants cannot be used to pay for tickets to events, galas, or auctions or used to cover membership fees unless the cost is fully tax deductible. Thus, do not accept DAF funds if the donor will receive something of value in return, such as dinner or entertainment. For this reason, you should not let donors use DAF gifts to buy event tickets.

Time to act

DAFs are here to stay and not-for-profits should be aware of this additional source of funding. Be sure to consult with your advisors as you move forward with soliciting DAF-related grants.

For more information, contact Jurgita Kalina at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Not-For-Profit Group.