Fund accounting tracks nonprofit revenue and expenses, demonstrating accountability rather than profits to funding sources. Let’s take a deep dive into the basics of fund accounting and why nonprofits need to understand it.
Basics of Fund Accounting
This type of accounting method tracks revenue and expenses for nonprofit organizations, churches and state and local government agencies and other government entities. Consequently, financial reporting will show how revenue spending complies with government regulations.
What is fund accounting?
Fund accounting is a system that reveals the financial position and success of a nonprofit organization’s activities. Understanding the basics of fund accounting provides valuable insights into how well not-for-profit organizations are running. Above all, it also builds trust by demonstrating accountability to funding sources.
Why do nonprofits need fund accounting?
Primarily, it helps your organization identify areas of strength and weakness. For example, a fund is like a separate company within the organization. Each fund tracks assets, liabilities, revenue, expense and fund balances or net assets.
Is fund accounting GAAP?
This type of nonprofit accounting plays an important role in demonstrating compliance. As a result, nonprofit organizations use fund accounting to show donors how the organization spends donor money on programs, fundraising, and administrative costs. In addition, nonprofits manage revenue using GAAP, or Generally Accepted Accounting Principles. GAAP guidelines were created by the Financial Accounting Standards Board (FASB).
What is a fund?
Funds consist of pools of money used to make expenditures. The term “fund” describes the pool of money and not a specific account or bank account.
Firstly, funds classify the type of revenue received by a nonprofit and purpose of these funds. Secondly, funds track revenue and expenses. Lastly, some funds represent donor restrictions or board designations.
What is the purpose of fund accounting?
Using a nonprofit accounting system helps monitor donor restrictions by separating different types of revenue into individual funds. Thereby, preventing mismanagement of funding.
Each fund has its own:
- Revenue and expense report
- Excess or deficiency calculation
- Balance sheet
Restricted and Unrestricted Funds
Nonprofits treat revenue in specific ways. For instance, restrictions break down net assets into: net assets with donor restrictions and net assets without donor restrictions. In some instances, revenue may have restrictions placed by the board. It is important to note, these types of restrictions are either temporary or permanent.
Most importantly, following basic principles ensures proper use of donations. Be aware, donations not used according to the wishes of a donor can cause problems. To avoid this, give donors a choice at the time of the donation. This lets donors choose their intended purpose. This can lead to a refund or legal action.
Donors can choose to designate their donation as either restricted or unrestricted donations. For example, donors can specify their intention through an agreement with the nonprofit. Likewise, nonprofits must be transparent when asking for money.
The two most common types of funds that nonprofits use are unrestricted and restricted funds. Nonprofits can spend unrestricted funds in any way that supports its mission. However, restricted funds must be used for specified purposes or projects.
- Restricted Fund: Donations specified with conditions Upon receipt and deposited into the organization’s bank
- Unrestricted Fund: Receipt of income from operations or other sources, such as sale of goods or services. Used for any purpose within the nonprofit’s mission.
Making the case for unrestricted funds
When reaching out to potential donors, organizations can ask for unrestricted donations. To clarify, they must state this on the donation form or the gift acknowledgment.
Subcategories Identify Funds for Specific Purpose
In addition to funds, there are sub-categories of funds as part of your financial makeup. For example, board designated funds are a subcategory of unrestricted funds.
- Endowment Fund: The original gift remains restricted either forever or for a specified time. However, Organizations can use earned income.
- Capital Fund: Used to track all revenue and expenses for capital, building projects.
- Fixed Assets Fund: Used for fixed assets, buildings, land, etc.
In some cases, a board will transfer funds into a special fund, or subcategory, for a specific purpose. For example, a Fixed Assets Fund tracks buildings, furniture and fixtures and equipment. In this case, the board can separate these assets from the unrestricted fund. By doing this, the unrestricted fund will show the funds available for current program use. Finally, the decision to establish a separate fixed asset fund is up to the board.
How to setup a nonprofit fund accounting system
To get started, assign a code for each transaction to facilitate financial management. Assigning a code for transactions helps track revenue and expenses. This provides a way to measure how well your nonprofit meets their goals. In order to manage this, you will need true nonprofit accounting software.
To set up a nonprofit accounting system, start with net assets without donor restrictions. This includes the general activities of the organization, or the unrestricted fund. Other names include: operating fund, general fund or current unrestricted fund. Keep in mind, this fund is the backbone of financing your organization’s mission.
Next, set up net assets with donor restrictions. It is important to note, nonprofits must use this revenue in the way the donor intended. However, nonprofits may use the earned income to carry out the organization’s ongoing activities. On the other hand, some endowment gifts stipulate how to use the funds.
What are unique identifiers?
Further more, the chart of accounts for nonprofits breaks down accounts using unique identifiers. These include codes which classify donors, grants, projects, locations and more. Most importantly, this aids in identifying sources of revenue shown in GAAP financial statements and reporting. In addition, applying the basics of fund accounting uncovers areas of strengths and weaknesses. Best of all, it provides transparency for outside audiences.
How to record the expenses that use the funds from the grant?
Grants from foundations restrict use funds for a particular program or purpose. Under these conditions, documentation will specify the restrictions of a grant award. In order to record the expenses that use funds from a grant, you’ll need to create an expense category specific for cash and cash equivalents.
Role of Nonprofit Accountant
Nonprofit Accountants provide nonprofits with the information they need to manage their finances, specifically cash flows. A nonprofit and governmental accounting professionals assists in making sure that the organization is meeting its goals and objectives, while staying within financial guidelines. Fund Accountants maintain the financial records of a nonprofit organization. They also provide information to help the organization manage its finances and plan for future growth.
Best Practices for Fund Accounting
Many nonprofits make the mistake of making separate funds for each program activity, or grant received by your organization.
Consolidate Funds for Programs and Activities
The notion that every program activity, or grant received by your nonprofit must be set up as a separate fund causes confusion. While management might think this is giving them better information, it really is clumsy, confusing and creates an inordinate amount of work. With the proper nonprofit accounting software tools and management practices that establish budgets for each of your program activities, money that is set aside for specific purposes can easily be tracked in the same fund.
Combine Cash Accounts
Setting up separate cash accounts for each fund can lead to problems. It does not require a physical segregation of the assets of each fund. So you don’t need separate bank accounts for each fund, or separate receivables or payables for revenue and expenses related to the fund. All the organization’s cash may be kept in a single bank account and the receivables and payables are kept in the general fund. With a true fund accounting software system, you will be able to track the accountability of each fund.
In conclusion, nonprofits must maintain a clean reputation to fulfill legal requirements and to maintain their nonprofit status by understanding fund accounting basics.
By implementing this, organizations become more compliant and accountable to funding sources. Above all, applying these principles provides a transparent, birds eye view for the nonprofit board and the general public.
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