Joint costs: The right way to allocate

PSNwi16_3With so much attention these days paid to fundraising ratios, many nonprofits feel pressure to minimize their fundraising expenses. This makes allocating joint costs — costs associated with activities that have both fundraising and other functions — appealing. But before you take that step, make sure that you’re familiar with some frequently misunderstood accounting rules.

The allocation issue
Nonprofits may combine program (or management) and fundraising activities to achieve efficiencies. For example, an organization whose mission includes improving individuals’ health might send out a mailing with tips on how to stop smoking, along with a donation solicitation.

In this scenario, the not-for-profit would probably prefer to assign most of the cost to program expense, on the basis that the fundraising part of the mailing is relatively minor. But charity watchdogs might allege this overstates the program component, skewing the nonprofit’s fundraising ratio.

3 essential criteriastrong>
The costs of a joint activity can be allocated between fundraising and other functions, rather than charged entirely to fundraising, but only if three criteria are met:

1.Purpose. This criterion is satisfied if the activity is intended to accomplish a program or management purpose. A program purpose requires a specific call to action for the recipient to help further the nonprofit’s mission — other than making a donation. In the above mailing example, encouraging recipients to improve their health by quitting smoking would qualify. Calls to action also might include urging recipients to contact public officials about an issue, volunteer with your organization or participate in a study.

2.Audience. If the audience for the joint activity includes prior donors or is selected based on its ability or likelihood to contribute, it’s assumed that this criterion isn’t met. But you can rebut that assumption if, for example, the audience was selected because of its need or reasonable potential to use the call to action — in our example, people identified as smokers.

3.Content. The content criterion is satisfied if the activity actually supports program or management functions. If not obvious, the activity must describe the need for and benefits of the action it calls for. Note that the purpose criterion focuses on intention while the content criterion considers execution.

Allocation method
Accounting rules allow you to allocate costs using a systematic methodology, applied consistently, that results in a reasonable allocation. The most common method is based on physical units, with costs proportionally allocated to the number of units of output.

In the case of a mailing, the units could be lines or square inches of print. If you engage in a year-long mailing campaign with bimonthly mailings, each mailing (and each component of that mailing, such as envelope, insert and premium item) must be analyzed on its own.

Other approaches include the relative direct cost and stand-alone joint cost allocation methods. The former uses the direct costs that relate to each component of activity to allocate indirect costs. The latter determines proportions based on how much each component would cost if conducted independently.

Don’t forget the disclosures
You must make certain disclosures about joint cost allocation in your financial statements, including whether joint activities comply with the three criteria, as well as including a disclosure on your Form 990. If you have any questions about allocating joint costs, your CPA can help.