When it comes to nonprofit payroll expenses, such as salary and payroll taxes, understanding direct cost allocations can help your organization become more compliant and accountable.
Nonprofit Payroll Expenses Classification
Every nonprofit organization must classify all of their expenses into three main categories – management and general, fund raising and program. These categories are called functional areas and are fundamental to your financial management and reporting. We covered functional expenses in depth in Nonprofit Accounting: Guide to Classifying Functional Expenses and in Why Nonprofits Need to Understand Direct Cost Allocations .
Since it is common for an employee to spend their work week in different areas of your organization, it is critical that their salary expenses reflect the areas they worked. For example, your Jennifer Conner, Executive Director at Apple Seed Child Services spends 24 hours a week working on administrative duties, 8 hours helping in a specific program area and another 8 hours fundraising.
You would think that since she is part of the organization’s administrative staff that her entire salary would be charged to Administration. But, a more equitable allocation of her salary would be to calculate the percentage of time worked in each area and apply that percentage to the specific functional area. So 40% of the Executive Director’s salary and related payroll taxes would be charged to administration, 20% to program and 20% to fundraising.
Allocating Nonprofit Payroll Expenses
Allocating nonprofit payroll expenses, including salary and payroll tax expenses, to the areas where each employee worked is critically important to all aspects of your financial management. Since nonprofit payroll, payroll taxes and benefits are collectively a nonprofit’s highest expense, it is essential to properly distribute all payroll expenses to the appropriate functional area.
An equitable distribution of payroll expenses to the proper functional area will help you determine the actual costs necessary to run each program effectively, build more accurate budgets and provides you with data for future forecasting of expenses and future funding requirements.
What About Nonprofit Fringe Benefits
Along with direct allocation of salaries and payroll taxes, fringe benefits and other personnel related expenses should also be allocated to benefitting programs. Typically, the allocation of these expenses is done based on the total direct salaries posted to each program area.
All of these expenses can be first posted to a ‘holding’ cost center and at the end of every month, once all expenses have been posted to their direct program areas, a calculation can be made of the total salaries expense in each program. These totals can be used to determine the percentage of salaries in each program area. These percentages are then applied to the allocation of the fringe benefits and other related business expenses.
Employee Hours Used for Allocating Expenses
Employee’s hours can also be used to generate allocation percentage of the total actual time worked in each area, so it is critical that your payroll allocation also include each employee’s hours worked in each program.
Allocating nonprofit payroll expenses can seem difficult and time consuming. But, with careful planning a consistent and reliable system can be put in place. Once you have established the procedures and systems it will become a standard practice in your accounting and financial reporting process.
An equitable allocation of your payroll expenses will best reflects the what it takes to operate each of your organization’s programs, administration and fund raising efforts.
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