Connections for Success

 

03.03.16

Joint Costs: The Right Way to Allocate
Kenneth Tornheim

With so much attention these days paid to fundraising ratios, many not-for-profit organizations feel pressure to minimize their fundraising expenses. This makes allocating joint costs appealing. Joint costs are costs associated with activities that have both fundraising and other functions. However, before you take the step of allocating joint costs, be certain that you are familiar with some frequently misunderstood accounting rules.

The Allocation Issue

Not-for-profit organizations may combine program activities and/or management activities with 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 organization 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. However, charity watchdogs might allege this overstates the program component, skewing the not-for-profit organization’s fundraising ratio.

Three Essential Criteria

The costs of a joint activity can be allocated between fundraising and other functions, rather than charged entirely to fundraising. However three criteria must be 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 organization’s mission, other than making a donation. In the previously mentioned 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, volunteering with your organization or participating 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 is assumed that this criterion is not met. However, you can quash 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 would meet the audience criterion.
  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.

Do Not 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, contact Ken Tornheim at ktornheim@orba.com, or call him at 312.670.7444. Visit ORBA.com to learn more about our Not-For-Profit Group.

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