By Michael F. Cade, CPA, CGMA
Many nonprofits accumulate program costs in their projects. This is an effective way to understand the value gained and direct costs expended by a program. However, program costs are only part of the organization’s expenses.
Other nonprogram costs are often grouped into cost centers and allocated across programs to determine the net value contributed or expended. There are a variety of allocation techniques that vary in accuracy and consistency. Allocations are estimates, and minimizing them or using better data to support them improves overall reporting quality.
One effective way to understand nonprogram costs and minimize allocations is Total Project Accounting. This method assigns all costs to a direct, indirect, or administrative project. The concept is to record all costs in a way that more accurately shows their nature and source.
To begin, it is helpful to understand some of the limitations of cost centers.
Cost centers often align to functions, such as accounting, information technology, or human resources (HR). As such, accountability for these costs can become split. For instance, HR manages recruiting costs, but a program needs a quick hire and wants to engage an outside recruiter. The HR leader is responsible for controlling the cost, and the program leader is requesting additional costs that will ultimately not be directly reflected in the performance of the program.
Costs accumulated in cost centers are spread across all programs using an allocation basis, such as revenue or headcount. Continuing with the prior example, one program drives the majority of the recruiting costs in a year. If it does not generate the largest revenue, then a revenue-based allocation of HR costs will not accurately assign costs.
Common bases of cost center allocations are historical data or, for labor, time studies. Historical data allocations do not reflect change, while time studies are time consuming, inaccurate, and must be done repeatedly.
True Cost of Programs
In the example, the program that benefits from recruiting but does not get charged its fair share is performing worse than the results indicate. All other programs overcharged by the recruiting allocation are performing better than results indicate. This false data may lead an organization to expand a poorly performing program or exit a well-performing program.
Cost centers clearly have limitations. Total Project Accounting improves on cost centers in several important ways, not only between programs and functions, but within the functions as well.
More Accurate Results and Dual Reporting
In the recruiting example, capturing costs in projects instead of costs centers improves the accuracy of performance measures. This also may result in fewer remaining nonprogram costs to allocate.
Capture the project as part of the program for performance reporting and as part of HR for financial reporting purposes. This dual reporting provides an understanding of the nature of the cost as well as its source. Be careful not to double count.
Functional Budget Justification
At budget time, it is often challenging to justify additional resource requirements. By identifying key process drivers and capturing related costs in projects, it will be possible to forecast resource requirements tied to either program growth or other factors.
Process Improvement Assessment
Cost centers can make it a challenge to measure the impacts of process changes. For an initiative to decrease the days to close, set up a project to track the hours and costs related to the close. Measure a baseline at the beginning of the project, and it will be possible to determine real efficiencies gained by the initiative. Without this tracking, activities could be shifted out of the close cycle or extra hours might be spent. This may appear to shorten the days to close, but is not actually improving efficiency.
For nonprofits, justifying overhead costs to a funder can be a recurring nightmare, and describing broad allocation methodologies and all of the tasks required to maintain them can be confusing for funders. Consider the benefit of being able to shrink allocations by identifying more of the costs related to programs. Funders will also positively respond to concrete evidence of process efficiency efforts.
Ultimately total project accounting provides better, more precise data than cost centers. It gives nonprofit accountants the inputs required to produce reliable, actionable information.
Michael F. Cade, CPA, CGMA, is a strategy consultant and executive coach for MFCCoach LLC in Morrisville, and a member of the Pennsylvania CPA Journal Editorial Board. He can be reached at firstname.lastname@example.org.