About Cost Accounting

(See the note on Costs and Expenses at About Expenses, if you’re feeling any confusion, since I use the terms interchangeably in this discussion.)

Why Cost Accounting?
Every organization needs to know how it spends its money. And donors nearly always want some form of financial reporting of how the recipient organization has spent their gifts.

But beyond these simple practicalities of business, there are two important reasons why nonprofits—especially grant-funded nonprofits—need a sophisticated approach to cost accounting.

  • Expenditures must be reported to the IRS (annually, via the IRS Form 990), and this requires grouping total expenditures into three distinct categories: Program Service Expenses, Management & General Expenses, and Fundraising Expenses. The definitions for these three categories are precise. Additionally, all expenses must also be identified with a list of over 24 descriptive line items.
  • The US federal Cost Principles (Subpart E of 2 CFR 200 and related appendices) provide for reimbursement of (nearly) the total cost of conducting projects funded by federal awards. This is accomplished by defining the total cost of a federal award as “the sum of the allowable direct and allocable indirect costs less any applicable credits.” (2 CFR 200.402)

So now we have two similar (but significantly different) requirements to categorize and report costs:

IRS Form 990 categories:
Program Service Expenses; Management & General Expenses; and Fundraising Expenses

USG Cost Principles categories:
Allowable Direct Costs; and Allocable Indirect Costs

You need an accounting system that allows you to meet all of these requirements while optimizing your ability to receive reimbursement under cost reimbursable awards. See About Cost Reimbursement.

You might be tempted to assume that you could simply treat all (and only) your Management & General (M&G) costs (per the 990) as the costs that you allocate (per the federal cost principles), and call it done.

But it isn’t that simple. There are two problems to be solved (990 reporting and determining the total cost of individual awards), and the solutions need to be harmonized within a single accounting system.

I recommend starting by first addressing how to determine project cost under the US federal cost principles.
Once you’ve wrapped your head around that problem, it’s not so hard to map your federal costs to the Form 990 categories.

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