All nonprofit organizations need to classify their expenses in one of three functional areas:
Most expenses are easily identified as ‘direct costs’ to one or more of these areas, but other expenses cannot be easily identified and expended to a specific program, so they are posted to ‘cost pools’ to be allocated (distributed) to the functional areas that these expenses benefit.
Developing a fair and equitable cost allocation process is key to proper financial management and reporting and helps your organization understand what it costs to run each of your programs. It also is the key to measuring the sustainability of each program.
All costs that benefit programs and cannot be identified to a specific program are first pooled and then allocated using a basis that results in an equitable distribution.