What Does it Mean to Report Expenses by Function?

When expenses are reported by function, they are being reported by the type of activity being conducted. Examples of income statement line items that are presented by function are administrative expenses, financing expenses, manufacturing expenses, marketing expenses, and selling expenses. Or, a nonprofit entity that reports expenses by function could do so by aggregating its expenses into the following general functions: Programs, fund raising, and management and general.

Reporting expenses by function tends to result in a relatively small number of expense line items, since there are not many functions in an organization. This approach can be useful from the perspective of the department manager, who can see all of the expenses for which he or she is responsible in one place. A sample income statement reported by functional areas appears next.

When to Report Expenses by Function

Expenses should be reported by their function when it provides more meaningful financial information to users, such as investors, regulators, and management. This approach is typically used when:

Required by accounting standards or regulations. Public companies following U.S. GAAP or IFRS often report expenses by function in their financial statements. SEC regulations also require U.S. public companies to present a functional income statement format.
Industry standards favor functional reporting. Some industries, such as nonprofits, manufacturing, and healthcare, commonly use functional expense reporting. Nonprofits (per FASB guidelines) must classify expenses into program, administrative, and fundraising functions.
Management needs functional expense analysis. Companies use functional reporting to analyze cost efficiency in different departments, such as the cost of goods sold, SG&A, and R&D expenses.
For external reporting and comparability. Investors and analysts use the functional expense classification to compare companies within the same industry.

Reporting Expenses by Their Nature

An alternative format is to report expenses by their nature. This approach is more fine-grained, and so results in more line items on the income statement. Examples of reporting by nature are repairs and maintenance expense, salaries expense, and utilities expense. This approach does not yield expense totals by department. Instead, separate expense reports must be prepared for each department. A sample income statement that reports expenses by their nature appears next.