Cost Allocation Methods for Nonprofits to Ensure Fairness and Accuracy

ARTICLE | June 04, 2024

Cost allocation is perhaps not recognized enough for the vital role it plays in nonprofit financial management. It is key to accurate financial reporting, grant and tax compliance, donor confidence, decision-making—and more.

Let’s take a closer look at how some common cost allocation methods work, and how they can help your nonprofit allocate costs fairly and accurately across programs and administrative functions.

What is cost allocation?

Cost allocation is the process of assigning costs to specific programs, projects, and services within an organization to ensure a fair representation of the costs incurred in each program area and supportive service.

For nonprofits, effective cost allocation is essential for accurate financial reporting and to perform accurate cost analyses, such as comparing actual versus budgeted costs. Along with demonstrating stewardship of funds, knowing the cost of programs and the costs covered by grants also allows organizations to make more informed decisions when evaluating funding opportunities and planning for operational changes.

Common cost allocation methods

Nonprofits have a number of cost allocation methods to choose from, each with its own advantages and limitations. While some costs can easily be assigned to specific activities and do not need to be allocated at all, many indirect costs need to be proportionately distributed across activities and the organization, resulting in greater complexity and a higher potential for errors.

Popular indirect cost allocation methods include:

• The full-time equivalent (FTE) method allocates indirect costs based on records of how much time employees spend on the program or project during the reporting period.

• The per-participant method assigns costs in proportion to the ratio of participants in each program or project.

• The square footage method allocates costs based on the square footage occupied by each project or program.

In practice, most organizations use at least two cost allocation methods to ensure they report costs in a fair and accurate way that reflects where employees actually spend their time and where other resources are actually being deployed.

Get professional support

Insero & Co.’s experienced nonprofit consultants offer strategic support to organizations, as well as recurring accounting, bookkeeping, and process-driven services. Contact us to talk about the range of relationship-based services we provide and how we can help you and your teams strengthen financial management, accelerate decision-making, and spend more time devoted to your mission.