Reasonable Joint Cost Allocations in Nonprofits
Tishlias, Dennis P., Journal of Accountancy
There is growing concern on the part of states' attorneys general that some charitable organizations have been "too liberal" in allocating costs to program expenses (instead of to administration or fund-raising), particularly costs to educate the public. Without objective guidelines, auditors have difficulty determining the reasonableness of nonprofit organizations' joint cost allocations.
Joint cost allocations can have a serious impact on the evaluation of how responsibly a nonprofit social service organization is run. This gave rise to American Institute of CPAs Statement of Position no. 87-2, Accounting for Joint Costs of Informational Materials and Activities of Not-for-Profit Organizations That Include a Fund-Raising Appeal, which amended SOP no. 78-10, Accounting Principles and Reporting Practices for Certain Nonprofit Organizations, and the AICPA Audits of Voluntary Health and Welfare Organizations.
Questions about the accuracy and reliability of data in a nonprofit's financial statements led to increased awareness of joint cost allocation problems. In a notice to members, the AICPA said auditors should "carefully review the requirements of SOP no. 87-2 and consider the sufficiency of evidence supporting any allocation of joint COSTS."
The article's purpose is to explore the bounds of reasonable allocations and offer some equitable solutions to achieve cost sharing within these boundaries.
Current auditing and accounting standards fail to provide auditors with objectives for evaluating the reasonableness of joint cost allocations. For nonprofits, standards defining reasonableness are based on the relative amounts of money spent on programs versus fund-raising or administration. Reasonableness in cost allocations is crucial; it is directly linked to determining a nonprofit's use of voluntarily contributed funds.
SOP no. 87-2 offers guidance to auditors in deciding when joint cost allocations are appropriate. What is not Specified is how allocations should be made. As SOP no. 872 says, there are many possible cost allocation methods. These techniques generally are based on the fundamental assumption joint costs should be allocated in a reasonable and fair manner, recognizing the causeand-effect relationship between the cost incurred and where the cost is allocated. However, the very nature of jointness precludes such an allocation.
When a cause-and-effect allocation is difficult, impractical or impossible to determine, judgment is used to determine the cost assigned to each segment. The principles outlined in the following example help define a range of reasonable allocations.
EXAMPLE OF COST ALLOCATION
One reason nonprofit organizations incur joint costs is the expectation fund-raising, administration and programs can be served simultaneously for less cost than if these goals were pursued separately. The allocation problem arises from the premise that each segment benefiting from a joint action should share in its cost.
Consider an organization with two programs, P1 and P2, and one fund-raising function, FR. Exhibit 1, below, provides data on these activities. The stand-alone cost of P1 is $40,000. The stand-alone costs of P2 and FR are $12,000 and $65,000, respectively, resulting in overall stand-alone costs of $117,000. If P1, P2 and FR act jointly, the total cost is $100,000, saving the organization $17,000.
While the organization as a whole benefits from incurring joint costs, the managements of the two programs and fund-raising must voluntarily collaborate to obtain cost savings. If a segment's share of joint cost is expected to exceed its stand-alone cost, it has no incentive to act jointly. To motivate sharing or joint action, each segment's allocated share of joint cost must be no more than its stand-alone cost-the upper limit of joint cost a segment could reasonably be expected to absorb. …