Having accurate and meaningful financial information is essential to properly running your charity, and complying with Canada Revenue Agency (CRA) requirements. An important step in having accurate and meaningful financial information is deciding how to record expenses or costs (these terms are used interchangeably in this section).
Expenses are recorded in specific General Ledger accounts within an organization’s accounting system. There are several ways of organizing these accounts. How you go about this depends on your charity and on what information will be most useful to the people who make use of your financial statements.
Often a single financial transaction relates to more than one expense account. Because of this, you must have a fair and consistent way of splitting costs and recording them in the proper accounts.
Organizing expense accounts
One way to organize expense accounts is by type of expense. In this method, expense categories could include items such as:
- salaries and benefits;
- office supplies; and
- travel, and so on.
Organizing accounts by type of expense is quite common and lets you answer questions such as:
- How much did we pay in salaries to all of our employees last month?
- How much has our office space cost us this year?
- How much more does it cost to heat our building this year compared to last?
If your charity is very small and has only one program or activity, this may be all the information you need in order to manage and report on your activities. Most charities will need a different approach to give them more information, however.
Another common way of organizing expenses is by function. This approach bases expense accounts on the functions, activities, or programs of a charity. Depending of the charity and its operations, expense categories might include:
- counselling services,
- administration, and so on.
Organizing accounts by function allows you to answer questions such as:
- What did we spend on fundraising last month?
- How much have we spent offering counselling services this year?
- How much more did we spend on research this year compared to last?
There are other, less common, ways of organizing expenses that may be useful in some circumstances. For example, accounts can be organized:
- by department, for larger charities (for example: communications, member services, finance, human resources, executive office, and so on);
- by geography, for multi-location charities (for example: by province, city, or country); or
- by organization sub-unit, for federated or other complex, multi-level charities (for example: local chapters, regional offices, provincial offices, etc.)
Each of these approaches provides answers to a different set of questions, but rarely does one approach answer all of your questions. And, none of these approaches by itself is adequate to provide all of the information required in a charity’s annual reporting to the Canada Revenue Agency (CRA). To meet your charity's needs, you will probably have to combine more than one method of allocating expenses.
Combining methods of organizing accounts
In order to meet the needs of more users, expenses can be recorded both by type and by function. Unfortunately, this means a significant increase in the number of expense accounts that you will need to set up. Using the examples above, these would include:
- salaries & benefits – fundraising;
- salaries & benefits – counselling services;
- salaries & benefits – research;
- salaries & benefits – administration;
- consultants – fundraising;
- consultants – counselling services;
- consultants – research;
- consultants – administration;
- rent – fundraising; and
- rent – counselling services, etc.
To decide on the right account structure for your charity, keep the following suggestions in mind:
- Start by identifying who will use your financial information and what they need it for. Think about the kinds of questions they will ask, and which methods will provide answers to those questions.
- Remember that the Canada Revenue Agency (CRA) needs specific financial information about your organization. For example, you need to be able to complete the annual Registered Charity Information Return (Form T3010). See the section Filing the T3010 return for details.
- Remember that it is easier to summarize detailed information than it is to split out details from summarized information.
- Think about how you expect your organization to grow. What may be simple today could become more complex in the future. You should try to organize your accounts in a way that will accommodate this growth.
Costs relating to multiple expense categories
It is likely that many expense items will relate to more than one account, particularly if you have a complex or detailed set of expense accounts. For example:
- The office supplies your organization purchases may be used in both administration and fundraising activities.
- An airline ticket purchased for your charity’s executive director may allow her to attend two meetings; one to monitor your programs and another to solicit funding.
- Your charity’s monthly telephone bill covers phones used by both your charity’s counselling service and its education program staff.
- Your charity’s rent pays for office space for every staff member and every program and activity of the charity.
When a cost relates to more than one expense account, you will have to split, or allocate, that cost to each relevant account. Depending on the nature of the cost item and your account structure, this may be a simple or a complex task.
Direct expenses are the costs you incur when you carry out a specific activity. If you did not carry out this activity, you would not have these costs. Examples include the cost of:
- printing flyers to advertise an event,
- an instructor's travel to present an education program, or
- laboratory supplies used exclusively in a research program.
Recording direct expenses
In principle, it is usually possible to accurately determine direct expenses. This is because the cost is directly related to a specific activity. However, identifying a specific direct expense is not always simple. This is usually because the direct cost for one activity may be included on an invoice with other costs for other activities. For example:
- The cost of printing a flyer to advertise an event is included on an invoice from the printer along with other print jobs for other activities. You will have to find the cost of printing the flyer on the invoice and record it in the account for event promotion.
- The instructor's travel expenses are included in a larger invoice from the travel agency that booked all the organization’s travel for the month. Each flight, hotel room charge, and so on must be identified and charged to the right activity;
- The cost of lab supplies is included on an invoice along with supplies for many other projects. All supplies must be identified and recorded appropriately.
Recording these costs is simply a matter of locating each specific expense and recording it in the relevant account.
In some cases you may simply be able to estimate the detailed costs of items rather than breaking each one out individually. This is appropriate if the work involved in doing the detailed calculations is large compared to the benefit of the improved information. For example, if an invoice for telephone expenses included hundreds of long distance calls at a few cents each, it would be reasonable to estimate the total value of calls for each activity rather than to individually identify each caller and the purpose of each call and adding these up.
Indirect expenses are expenses that support more than one activity of the charity or that permit the charity to carry on its work. Even if you did not carry out a specific activity, you would still incur some or all of these costs. For example:
- The charity's telephone system is used to provide counselling services as well as support other services and activities.
- The executive director travels across the country, teaching education programs, visiting funders, and doing performance reviews with regional staff members.
- A laboratory is sometimes used by several researchers and sometimes rented out to other organizations.
Recording indirect expenses
Indirect expenses typically relate to more than one activity and may be incurred whether or not the activity takes place (for example, even if a charity has no event to advertise, it still puts out a regular monthly newsletter). Because of this, it is usually harder to identify what portion of indirect expenses relates to each of a charity’s activities. In such cases, you need to develop a reasonable basis for spreading the costs – or allocating them – among the relevant activities.
Common ways of allocating expenses
Expenses that relate to more than one activity or to the general operations of your charity need to be allocated to the relevant accounts. Generally, this allocation is based on some underlying way of measuring the cost item. For example, the allocation could be based on the:
- number of staff or volunteers who work on each activity,
- staff time spent on each activity,
- floor space taken up by each activity,
- direct costs, etc., of each activity, or
- revenues of each activity.
These examples present several possible approaches to allocating some common indirect costs.
Principles of allocating expenses
There are many ways to allocate costs. For a given situation, there may be more than one reasonable way. Use the following principles to decide on the best approach for your organization:
- The basis for allocating expenses should be reasonable: there should be a clear relationship between the cost of an item, the activities it relates to, and the basis of allocation. For example, it would generally not be reasonable to allocate office heating costs on the basis of staff salaries, since there is simply no relationship between the two.
- The amounts allocated should be reasonable in relation to the other costs and value of activities to the charity. For example, if one activity has $5,000 of direct costs and another has $500,000 of direct costs, it is probably not reasonable to divide the indirect costs equally between the two activities.
- The allocation method should be applied consistently over time. The approach used one year should continue to be used the next, unless circumstances change significantly and in a way that specifically supports a change in how costs are allocated.
- Allocation methods should be consistent for similar items. For example, it is probably not reasonable to allocate rent on the basis of square footage used in each program while allocating property taxes on the basis of the number of staff engaged in each activity.
- The basis of allocation should be as simple as possible. Greater complexity should be justified by the improvement in the quality and accuracy of the information. For example, you could allocate costs based simply on the primary function of each staff member or based on details of the actual amount of time each staff member spends on each function each week. If you expect both of these methods to give you similar information, use the simpler method. For example, it is much easier to allocate costs based on each staff member's primary function than it is to have them record their time on time sheets each week and then to analyze these sheets.
Whatever expense allocation method you use, it must be clearly documented. This will help you apply the method consistently, particularly where staff or volunteers change. This will also allow you to explain your allocation process to auditors or the Canada Revenue Agency (CRA).
Keep in mind:
- Funded projects may have guidelines on what types of costs can be allocated to them and budgeted levels for such allocations. These guidelines may differ from project to project. You will need to comply with these requirements for each project. This can greatly complicate your accounting.
- You may not have to allocate costs invoice-by-invoice. For example, the cost of office administration (such as the receptionist and bookkeeper's salaries and benefits, their associated office supplies and so on) might be accumulated in an Administrative Costs section of the general ledger and allocated to the programs once a month rather than each time a salary cheque is issued or an invoice is paid.
- It is possible to allocate costs more than once. For example, the cost of providing and supporting personal computers to staff could be allocated to the staff cost (noted as "1" below); then, the cost of staff (including their allocated PC costs) could be allocated to specific programs (noted as "2" below).
- For example:
Cost of employee salaries
Cost of employees' PCs
Cost of annual PC maintenance
Total cost of employees
Allocated to (2):
Total employee costs allocated
In this way, some cost allocation processes in larger organizations can become extremely complex and sophisticated.