Fund accounting for nonprofits 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. It is an accounting method used by nonprofit organizations, churches, and other charitable organizations to ensure the proper allocation of funds.
The main purpose is to maintain accountability and transparency for the money received from donors and grants. It tracks the amount of money allocated to each operation, program, or event in order to ensure that the funds are utilized in the most productive and beneficial way. This type of accounting system helps to ensure that all funds are cycled back into the organization, rather than being collected for profit.
Why do nonprofits need fund accounting?
Nonprofits and governments need to understand fund accounting basics in order to ensure transparency, accountability, and responsibility in their financial management. It allows nonprofits and government programs to keep track of where their money is going, which is especially important for organizations that receive grants or other restricted funds that need to be used for specific purposes. It also helps them report their finances to the IRS, honor any restrictions placed on their assets, and ensure they have the funds necessary to continue operating. This is essential for for making sure funds are managed properly and used for the right reasons.
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
Unrestricted funds are beneficial for organizations because they allow for flexibility. With unrestricted funds, organizations can use the money for whatever need arises, making it easier to respond to unexpected needs or changing conditions. Furthermore, unrestricted funds can be used to cover operating expenses, as well as for major capital expenditures, giving organizations the freedom to decide how best to use the money.
Additionally, unrestricted funds are not tied to any specific purpose, meaning that organizations can move the money to different funds, depending on the need. This flexibility allows organizations to be more agile and adaptable, which can be extremely beneficial in today’s ever-changing environment. Lastly, unrestricted funds can provide organizations with a source of income if they are invested wisely. This additional income can be used to further the organization’s mission and objectives.
All in all, unrestricted funds can make a good case for themselves by providing organizations with flexibility, responsiveness, and additional income. 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.
Identifying funds for specific purposes helps with fund accounting by enabling organizations to track and monitor the use of money within each fund. This helps to ensure that funds are being used for the intended purpose and helps to promote financial discipline. By allocating a certain amount of money for each designated purpose, organizations can better plan for the future and can make sure that the necessary funds are available when needed. Furthermore, by tracking each fund and its associated expenses, organizations can ensure that the budget is being followed and that funds are not being misused or misspent.
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.
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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.
- When using funds from a grant for expenses, the money must be recorded in the appropriate fund. This is done by identifying the fund that the grant money is being allocated to, and recording the amount of the grant in the fund’s asset or equity account.
- After recording the grant money in the fund’s asset account, expenses associated with the grant money must be recorded. This is done by debiting the expense account, and crediting the fund’s asset account.
- As the grant money is used, the fund’s asset account will be reduced. The amount of money left in the fund’s asset account can be tracked by subtracting the total expenses recorded to the grant from the total amount of grant money received.
- Any money that is not spent from the grant should be recorded as unspent grant money in the fund’s equity or liability account. This will help to ensure that the grant money is accurately tracked and reported.
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.
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Advantages of Fund Accounting Software for Nonprofits
True fund accounting software tracks revenue to a designated purpose and prevents misuse of donations. Let’s take a deep dive into the key advantages of using nonprofit fund accounting software.
In order to fully understand fund accounting basics, you need to understand three fundamental questions:
- Who is the source of revenue?
- What is the designated purpose?
- Why nonprofits need to classify revenue?
Who is the source of revenue?
“Who” identifies the source of revenue and provider of services and expenses. This is know as donor designated revenue. Who is donating or granting funds to the nonprofit? Who is the nonprofit paying expenses, such as salaries, payroll taxes, services, rent, utilities?
What is the designated purpose?
“What” identifies the designated purpose of revenue in order to monitor the restrictions often attached to revenue received. This provides transparency and proper stewardship of funds. By identifying revenue into appropriate designations, fund accounting enables organizations to keep the revenue it receives in the proper classifications and prevents this revenue from being spent on inappropriate expenses.
It also highlights areas of strength and weakness, providing transparency for funding sources.It allows nonprofit to manage the diverse streams of revenue they receive and monitor the donor restrictions often attached to revenue. By breaking up an entity’s finances into appropriate funds, fund accounting enables organizations to keep revenue it receives in the proper categories and prevent revenue from being spent on inappropriate expenses. Each fund will have its own revenue and expense report, its own excess or deficiency calculation and its own balance sheet.
Why do nonprofits need to classify revenue?
To properly track revenue and expenses separately, you will need to setup a fund accounting system and a specific code for these transactions. This type of system provides organizations with a method to measure how they are meeting their goals.
Each nonprofit has its own set of programs, administrative and fundraising activities known as functional accounting. Separate funds are established for these entities to track how revenue and expenses are spent.
This answers why this type of revenue was received and the type of expense incurred. It classifies the type of revenue and expense of each transaction. It is standard for all accounting and it is a detailed list of the nature of each revenue — grants, program services, contributions and fundraising events — and expenses, such as salaries, payroll taxes, rent, professional services, etc.
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In conclusion, nonprofits must maintain a clean reputation to fulfill legal requirements and to maintain their nonprofit status. By implementing fund accounting basics, nonprofit organizations have a clear understanding of their financials and ensure that their funds are being used according to the restrictions set by donors, sponsors, and grants. Above all, applying the basics of fund accounting provides a transparent, birds eye view for the nonprofit board and the general public.
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