Fund accounting tracks nonprofit revenue and expenses, making certain funds are being used for its designated purpose. Let’s take a deep dive into the basics of nonprofit fund accounting and why nonprofits need it.
Fund Accounting Basics
Fund accounting tracks revenue and expenses for nonprofit organizations, churches and state and local government agencies. It demonstrates through financial reporting how revenue is being spent and whether funds are used for its designated purpose.
What is the purpose of fund accounting?
Primarily, fund accounting 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. Therefore, revenue received by nonprofits is treated differently from revenue earned by for-profit businesses.
Fund accounting is a system that reveals the financial position and success of a nonprofit organization’s activities. The information gained from this provides valuable insights into how well not-for-profit organizations are running. It also builds trust by demonstrating accountability to funding sources.
Is fund accounting GAAP?
This type of nonprofit accounting plays an important role in demonstrating accountability and compliance. Nonprofit organizations use it to show donors how the organization spends donor money on programs, fundraising, and administrative costs. Nonprofits manage revenue using GAAP, or Generally Accepted Accounting Principles.
What is the difference between for-profit and nonprofit accounting?
The difference between for-profit and nonprofit accounting comes down to how it determines its bottom line. For-profit businesses have one bottom line. Whereas, nonprofits have two bottom lines. One bottom line fulfills their stated mission. The other one shows it has the necessary funding to support their mission. More than anything else, nonprofits are held to different standards than for-profits. Nonprofits show accountability to funding sources. For-profits show profitability.
How does fund accounting work?
Nonprofits are held to a higher standard and must be in compliance with government regulations. Using a fund 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
Nonprofits treat revenue in specific ways. Restrictions are broken down by 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. However, problems can occur when donors discover their donation was not used according to their wishes. To avoid this, give donors a choice at the time of the donation. This lets donors choose their intended purpose. Keep in mind, if their wishes are not followed, the donor can demand a refund or take legal action.
Donations are designated by the donor 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.
What is a fund?
Funds are pools of money that can be used to make expenditures. The term “fund” is typically used to describe the pool of money and not a specific account or bank account.
The two most common types of funds that nonprofits use are unrestricted and restricted. Unrestricted funds can be spent on any area within the nonprofit’s mission, while a restricted fund is set aside for specific purposes or projects.
Funds are typically created when a donation is received and deposited into the organization’s bank account. The donor may specify that the funds be used for a specific purpose, such as youth programs or education. The nonprofit can then create a separate account for this purpose, which is called a restricted fund.
Funds may also be created when an organization receives income from its operations or other sources, such as the sale of goods or services. This income is called unrestricted revenue and can be used for any purpose within the nonprofit’s mission.
Financial management of fund accounting assigns a code for each transaction. Assigning a code for transactions helps track revenue and expenses. In so doing, it provides a way to measure how well your nonprofit meets their goals. In order to manage this, you will need true nonprofit accounting software.
How to setup a nonprofit accounting system
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. Most importantly, it shows whether donations are used for its designated purpose. Plus, implementing proper fund accounting uncovers areas of strengths and weaknesses. Best of all, it provides transparency for outside audiences.
Examples of a fund
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.
Examples of funds
- Unrestricted: No restrictions placed on the resources of this fund. The organization can use the revenue in the fund as it chooses.
- Restricted: Revenue used for specific purposes.
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 Funds: The original gift remains restricted either forever or for a specified time. However, Organizations can use earned income.
- Capital: Used to track all revenue and expenses for capital, building projects.
- Fixed Assets: 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 record the expenses that use the funds from the grant?
Grants from foundations are usually restricted to 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. This is because grants are typically paid out in chunks of cash rather than the purchase of goods.
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.
Nonprofit Accountant’s Role
Nonprofit Accountants provide nonprofits with the information they need to manage their finances. 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.
Common mistakes and misconceptions
Many nonprofits make the mistake of making separate funds for each program activity, or grant received by your organization.
Mistake # 1
Notion that every program activity, or grant received by your nonprofit must be set up as a separate fund. 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.
Mistake # 2
Setting up separate cash accounts for each fund. Fund accounting 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 the basics of fund accounting, organizations become more compliant and accountable to funding sources. Above all, applying the principles of fund accounting provides a transparent, birds eye view for the nonprofit board and the general public.
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