Lesson 7.1: Introduction to Cost Allocations
In nonprofit accounting, accurately tracking how funds are spent across different programs and grants is essential for compliance and transparency. Cost Allocation is the process of distributing shared costs—such as rent, utilities, and administrative salaries—across the specific programs or grants that benefit from them.
FastFund Online provides two distinct systems for handling these distributions: Point of Entry Allocations and Indirect Cost Allocations. This lesson introduces the concepts of direct vs. indirect costs and explains when to use each of FastFund’s allocation methods.
Direct vs. Indirect Costs
To use allocations effectively, you must distinguish between direct and indirect costs.
• Direct Costs: These are expenses that can be identified specifically with a particular cost objective, such as a program, grant, or project.
◦ Examples: Salaries of employees working exclusively on a specific program, materials purchased for a specific project, or travel expenses for a specific grant.
• Indirect Costs: These are expenses that are not readily identified with a particular program but are necessary for the general operation of the organization. Because these costs support multiple programs, they must be “allocated” or shared among them.
◦ Examples: Rent, electricity, accounting fees, and the Executive Director’s salary.
Two Methods of Allocation in FastFund
FastFund offers two different tools to handle allocations, depending on when you want the distribution to happen.
1. Point of Entry (POE) Allocations
When it happens: During data entry. How it works: This method is designed to speed up data entry for individual transactions. If you have a recurring bill (like a telephone bill) that is always split 30% to Administration and 70% to Program A, you can set up a POE Allocation. When you enter the bill in Cash Disbursements or Vendor Invoices, you select the allocation, and FastFund automatically splits the transaction lines for you. Best for: Recurring bills with fixed percentage splits or fixed account distributions that happen at the time of payment.
2. Indirect Cost Allocations
When it happens: After the fact (usually at month-end). How it works: This is a more sophisticated tool used to distribute pooled costs based on a specific calculation basis (e.g., square footage or total direct costs). Instead of splitting every single rent check manually, you post the rent to a “holding” cost center (like Administration). At the end of the month, you run the Indirect Cost Allocation process, which calculates the correct percentages and generates a Journal Entry to distribute the costs to your programs. Best for: Complex allocations, such as distributing occupancy costs based on square footage or allocating fringe benefits based on total salaries.
The Importance of Chart of Accounts Structure
For Indirect Cost Allocations to work properly, your Chart of Accounts must be set up correctly.
• Cost Centers: The Cost Center segment is the main control for indirect allocations. You allocate activity from one cost center (e.g., Administration) to other cost centers (e.g., Program A, Program B).
• Object Codes: The process distributes the amount from one object code (e.g., Rent Expense) to the same object code in the benefiting cost centers.
• Limitation: The Indirect Cost Allocations program does not work with Sub-Accounts. You must rely on Funds, Cost Centers, and Object Codes to run these allocations.