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Mar 24 2017

Nonprofit Payroll: Managing Expense Allocations For Compliance

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: How To Allocate Them Properly - araize.com

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.

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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.

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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.


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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.

Want to read more? Check out these insightful articles:

  • Nonprofit Payroll Software: Blog Series
  • Advantages of Fund Accounting Software for Nonprofits
  • FastFund Nonprofit Payroll
  • Araize Service Bureau Program
  • Nonprofit Payroll: Online Software Simplifies Complexity
  • Why Nonprofits Need to Understand Direct Cost Allocations

Did you find this article useful? We welcome your thoughts and comments.

Written by Joseph Scarano · Categorized: Nonprofit Payroll Software · Tagged: Accounting Software for Nonprofits, Cost Allocations, Functional Accounting, Fund Accounting, Nonprofit Accounting, Nonprofit Accounting Software, Nonprofit Payroll, Nonprofit Payroll Salary Allocations, Nonprofit Payroll Taxes

About the Author

Joseph Scarano is the CEO of Araize, Inc., developers of cloud-based FastFund Online Nonprofit accounting, fundraising and payroll software solutions to help your nonprofit become more transparent, accountable and sustainable.

Reader Interactions

Comments

  1. Coby says

    April 3, 2018 at 8:35 pm

    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?

    Reply
    • Joseph Scarano says

      April 3, 2018 at 9:08 pm

      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.

      Reply
  2. Vivian says

    August 29, 2018 at 10:57 am

    How much time should a CEO/ED allocate toward financial management – how much is too much?

    Reply
    • Joseph Scarano says

      August 29, 2018 at 11:02 am

      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.

      Reply
  3. Office Alice says

    October 21, 2018 at 10:05 pm

    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.

    Reply
    • Joseph Scarano says

      October 22, 2018 at 8:30 am

      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.

      Reply
  4. Pam Hoffman says

    June 12, 2019 at 3:29 pm

    If you are sharing an employee at another nonprofit, how do you show the salary reimbursement on the books?

    Reply
    • Joseph Scarano says

      June 12, 2019 at 4:02 pm

      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.

      Reply
  5. Mike says

    December 18, 2019 at 3:49 pm

    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!

    Reply
    • Joseph Scarano says

      December 18, 2019 at 4:02 pm

      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.

      Reply
      • Mike says

        December 19, 2019 at 10:52 am

        Thanks for the prompt reply!

        Reply
  6. Nick Faught says

    March 10, 2020 at 6:42 pm

    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?

    Reply
    • Joseph Scarano says

      March 11, 2020 at 8:59 am

      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

      Reply
  7. Chance McKee says

    August 7, 2020 at 9:22 am

    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.

    Reply
    • Joseph Scarano says

      August 9, 2020 at 10:28 am

      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.

      Reply
  8. Eric says

    January 22, 2021 at 11:08 am

    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!

    Reply
    • Joseph Scarano says

      January 22, 2021 at 11:15 am

      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

      Reply
  9. Kyle Cornelius says

    March 3, 2021 at 5:01 pm

    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?

    Reply
    • Joseph Scarano says

      March 3, 2021 at 5:19 pm

      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.

      Reply
  10. Matt says

    May 15, 2021 at 1:03 pm

    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?

    Reply
    • Joseph Scarano says

      May 15, 2021 at 2:14 pm

      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

      Reply
  11. Heather says

    August 10, 2021 at 8:23 pm

    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?

    Reply
    • Joseph Scarano says

      August 11, 2021 at 1:27 pm

      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

      Reply
      • Bonnie says

        February 16, 2022 at 10:24 pm

        Is that paid non-work time (vacation, holidays, etc) considered admin or program within that program source? Thanks for your help.

        Reply
        • Joseph Scarano says

          February 17, 2022 at 2:10 pm

          Bonnie,

          Vacation, sick and holiday pay can be considered program expenses if the employee works in that program.

          Joe

          Reply
  12. Lizzie says

    November 8, 2021 at 9:41 pm

    When creating a budget for a non profit, should operating expenses include gross payroll or net payroll?
    thanks

    Reply
    • Joseph Scarano says

      November 9, 2021 at 6:10 pm

      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

      Reply
  13. Candace S. says

    July 21, 2022 at 9:10 pm

    Running payroll for a nonprofit takes a lot of careful consideration. You need to be fully aware of the nuances involved with it. I would definitely recommend reading up some more on how nonprofit software can be both responsive and affordable for nonprofit payroll.

    Reply

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