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.
Schedule a FastFund Online Demo: Learn more about our unique software approach to nonprofit accounting, payroll and fundraising.
Bottom Line
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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Did you find this article useful? We welcome your thoughts and comments.
Great article! Should this be broken out into three separate payroll categories in the books? For example, in the Chart of Accounts, you would have Payroll listed as an Expense account three times – under Programs, Admin, and Fundraising?
Coby,
Yes, not only payroll, but all expenses need to be broken down by your functional areas – Support Services which are comprised of Management and General (Administration) and Fund Raising, along with separate cost centers for each of your programs. By using a nonprofit accounting system, you can have a single expense code (i.e. 5000 – Salaries), with different segment codes for each functional area – 100-5000 Administration Salaries, 200-5000 – Program Salaries and 300-5000 Fund Raising Salaries.
How much time should a CEO/ED allocate toward financial management – how much is too much?
Vivian,
A CEO/ED should allocate as much time as necessary to create financial statements that reflect the current financial position of the nonprofit organization that he or she is responsible for. There is no fixed time. Of course, having the right accounting software tools in place, will reduce the time it takes for generating financial statements. If you are using an accounting software application that is not designed for nonprofit accounting, then you will spend an inordinate amount of time on getting the data in place to generate reports broken down by net asset class (unrestricted, designated) and functional area.
Thanks, this helps me put into focus how nonprofits think of their expenses. I’ve been trying to figure out whether to stick with my current nonprofit payroll software or switch over to a cloud-based solution. I know how to use our current software but I’m not relishing training someone new.
Office Alice,
If you have to allocate payroll salaries and payroll tax expenses to different programs for proper expense distribution and your current software doesn’t easily handle it, then you should consider a new application that will make your job easier.
If you are sharing an employee at another nonprofit, how do you show the salary reimbursement on the books?
Pam,
If you getting reimbursed for an employee’s salary from another nonprofit, the reimbursement would be shown in the same program that the salary was posted to as Revenue – Salary Reimbursement.
Hope this helps.
Great article Joseph!
As a grass-roots nonprofit, most of our funding comes from a special fundraising event. If our Executive Director spends 50% of his time organizing the fundraising event, can that be included in Schedule G and removed from gross before reporting net fundraising in that event?
Thanks for the help!
Mike,
You can classify a portion of the Executive Director’s salary to fund raising expense, but his salary cannot be netted against revenue. On the 990, the gross revenue is reported on Part VIII on line 1c – Fund Raising Events. Expenses are reported on Part IX – Statement of Functional Expenses under either Program Services, Management and General or Fund Raising.
Thanks for the prompt reply!
I work for a nonprofit that has over 120 employees but has no payroll system so they do it manually with Excel allocating payroll expenses and benefits just as you mention in your article. I am wondering if there is a payroll software out there that allows employees to track their time according to the project they are working on, as well as allocate the costs to those projects when payroll is ran. I’ve been looking for weeks but have yet to find any real solution or software that does this. Are you aware of an automated payroll system we could implement that would work in the way your describe in your article?
Nick,
Thanks for reading our blog. Actually, Araize’s FastFund Online Payroll system allows you to set up employees payroll with distribution of their gross salaries and payroll taxes to multiple programs and projects. You can set up a default allocation for each employee based on hours worked, or percentages. When processing payroll the default allocations are loaded into the payroll batch for editing to enter the hours hours in each project.
For more information, or to schedule a demo, go to Araize.com.
Joe Scarano
If our nonprofit receives restricted funding for direct client assistance (which is not something that is specifically part of our mission statement) and we allocate a portion of our staff salaries and fringe benefits to that program budget as admin-related expenses, is the amount of funding allocated to those staff salaries and fringe benefits accounted for as in-budget admin-related expenses? For instance, if we receive a $100,000 grant and $95,000 of it is for direct client assistance and $5,000 of it is for admin-related staff salaries and benefits, would that $5,000 funding count towards our overall budget, since the $95,000 program funding is technically not part of our mission statement?
This has arisen due to COVID-19 and the funding being granted for direct assistance work.
Chance,
Even though the grant you received for COVID-19 related direct client assistance is not part of your core mission, it still can be included in your Program (Mission) based expenses and a portion allocated to Administration. You will need to create a revised budget that reflects the new Grant received with detail line item expenses on how the grant will be expended, in compliance with the grant restrictions. So you would increase your budget by $100,000 grant, with $95,000 allocated to Direct Client Assistance and $5,000 towards Administration.
Hi, thanks for the great article! Is it typical to allocate the employer portion of payroll taxes by function, similar to how employee compensation/employee taxes are broken out by function?
Or are employer payroll taxes more often just allocated as Admin?
Thanks!
Eric,
Thanks for the feedback on our blog. Glad it was beneficial to you.
Typically you would allocate all expenses related to payroll to the program to properly reflect the total cost of employees. So, you should not only allocate salary expense, but also allocate all related payroll taxes and any fringe benefits for the employees. This will then reflect the true personnel costs associated with running your programs.
Joe
How do you handle paid time off? If an employee takes off during a month where does that cost get allocated? Wouldn’t the cost of paid time off need to be spread evenly ($ per hour worked) across all grants/programs that the employee worked during the year?
Kyle,
If you have been allocating an employee’s pay to multiple programs/grants and they take PTO, then time should be allocated to those programs using an aggregate percentage of the time worked in those programs/grants.
Mike,
How would you account for the salaries of the grant accountant?
For example, this accountant works on items administrative items such as payroll, bank reconciliations, and GAAP financial statements. However, they also work on government financial reporting, and invoicing sponsors to receive monies for the programs.
Would the invoicing and specific reporting for programs be programmatic or administrative?
Matt,
You would allocate the salary and payroll taxes (if reimbursable in the grant) to both Administration for the time spent on administrative accounting tasks and to Program for the time spent on program invoicing.
You would need detail time sheets showing the time spent on both for backup of your allocations.
Joe
Hello! we track employee time based on funding sources, however, I was wondering if when the employee has a paid day off for sick, vacation or a stat holiday if these should still be hours allocated towards specific funding that they would be working in or if they should be from the general fund?
Heather,
The vacation and paid time off should be allocated to the funding sources where the employee normally works, unless the guidelines for the funding prohibit the allocation of vacation, sick, or holiday to their funding.
Joe
Is that paid non-work time (vacation, holidays, etc) considered admin or program within that program source? Thanks for your help.
Bonnie,
Vacation, sick and holiday pay can be considered program expenses if the employee works in that program.
Joe
When creating a budget for a non profit, should operating expenses include gross payroll or net payroll?
thanks
Debbie,
Salaries are always reports as Gross and not net. The budget should also include the payroll tax expenses (Social Security, Medicare, SUTA and any other employer supplemental taxes) in your budget.
Joe Scarano