Determining and Allocating the True Cost of Programs

Capturing and allocating both direct and indirect costs to programs should be a priority for nonprofit organizations because of how critical it is to know the true cost of running a program. Indirect costs such as office rent, utilities, supplies and maintenance are often overlooked. In other instances, some direct costs, such as labor, are not allocated to programs either. There are a variety of reasons that will deter organizations from completing this important step in financial reporting. One of the most common reasons is that they dont know how to go about making such allocations. After all, cost allocation can be a tedious process for those who lack an accounting or numbers background. Regardless of the reasons, cost allocation is a critical and important step to producing accurate financial reports and should not be ignored. The Importance of Cost Allocation The reporting of the true cost of a program is vital information to any organization that is focused on being financially sound and profitable while accomplishing its mission. Below is a summary of the reasons why cost allocation is important:
1. 2. 3. 4. It determines the true cost of a product or service Helps in generating cost savings by identifying and reducing negative net income programs Helps senior management make more informed strategic and financial decisions Calculates the true amount of fundraising needed to cover all the costs of a program.

To make it easier to visualize, the graph below illustrates the different program net results before and after labor and indirect cost allocation. Programs that at first seemed profitable, after cost allocations they report losses or profits lower than previously reported.

Definition of Cost Allocation and Methods Cost allocation is the process of identifying, aggregating and applying business costs to several departments or projects across the business. While most direct program expenses are easy to capture, indirect expenses can more complicated. Both direct and indirect costs can be identified and allocated to programs based on a variety of methods. Three common methods are:
1. Personnel. The allocation is based on time spent by employees working on programs. This information can easily be obtained by implementing a timesheet system or by estimating the time.

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Direct Costs. The allocation is based on total direct costs incurred by each program as a percentage of total direct program costs. Square footage. The allocationis based on square footage occupied by employees. As an example, if the Membership department employs 5 people out of 15 total employees, 33% (5/15) of the total office square footage would be used to calculate allocation costs to Membership.

Examples of Cost Allocation Methods Payroll and timesheets are commonly used to calculate both direct labor and indirect expenses for allocation purposes. If an employee splits their time between different programs, the percentage of time spent on each program should be multiplied by their salary. A simple template can be created in excel to do the allocation. For example:

As we can see in the table, 35% ($80,000) of the total labor costs ($230,000) should be allocated to Membership, 25% ($58,000) to Education and finally 40% ($92,000) to Fundraising. The calculated salary amount that needs to be allocated should be applied as a direct cost to the specific program. The percentage of time spent on the program can be determined by tracking hours on a timesheet. It can also be estimated through analysis if there is no timesheet system in place. For indirect expenses, such as office rent, utilities, building maintenance and supplies, most organizations allocate such costs based on a percentage of personnel costs for each program to total personnel costs for the organization. An example of such an allocation is as follows:

Total indirect expenses for the year are multiplied to the allocation percentages. The allocation percentages for the programs are derived from the salary allocation table and plugged in. This result is 35% of indirect expenses being allocated to Membership, 25% to Education and 40% to Fundraising. The end result is a fair distribution of the indirect costs between programs. In closing, program cost allocation should not be overlooked. This is a critical step in helping nonprofits understand the true cost of their programs and allowing them to use their financial resources efficiently while fulfilling their mission statement.

Ta (Blaceri) Gennaro serves as a controller in Tate & Tryons outsourced services department and can be reached at tgennaro@tatetryon.com.