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Fund accounting 101: The basics and best practices

Fund Accounting 101: The Basics and Best Practices

Wednesday, April 27, 2022

Nonprofit Management Accounting Basics Fund Management For Executive Directors For Nonprofit Accountants

Those who repeat the mantra “accounting is black-and-white” are wrong because not all accounting is the same. It changes based on the industry in which the accountant operates. This is because the financial goals change per industry and therefore the management of those finances will also change.

While for-profit companies are focused on generating a profit (as indicated in the name), other not-for-profit organizations like nonprofits, government agencies, associations, and churches leverage a type of accounting called fund accounting. This financial management system focuses on leveraging finances to be as accountable to the revenue generation sources as possible and to advance the organization rather than generate a profit.

In this guide, we’ll discuss the essentials of fund accounting, covering the common questions associated with it. We’ll cover the following:

Ready to get started with this discussion on fund accounting? Let’s dive in!

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What is fund accounting?

Fund accounting is a system of accounting used to track the amount of money allocated to various operations at an organization. It’s a system designed to ensure funds are used productively and for the benefit of the organization as a whole.

This is a useful method of accounting when all of the funds an organization earns are recycled and reinvested back into the organization itself rather than collected as a profit.

For example, when a nonprofit organization earns a $100 donation from a donor, that money can be used to fund the operational costs of the organization, be dedicated toward a specific program, or be used to help host the next fundraising event. The money is not collected as profit.

How does fund accounting differ from regular accounting?

Fund accounting is unique to organizations that do not aim to earn a profit. The element that makes it truly unique is that it focuses on ensuring the “accountability” of the organization because these organizations generally rely on the generous contributions of supporters (donors at a nonprofit, congregation at a church, etc).

Some of these supporters may give a large gift to organizations, but require the money to be maintained, invested, and only the interest spent on specific projects. These are referred to as restricted gifts and they must be honored by the organization that agrees to the terms.

For example, a major donor at a church may ask their contribution to be dedicated to the mission trip scholarship program, allowing members of the youth group to attend mission trips.

When these organizations encounter financial audits, their accounting documents are checked to ensure that the funds they accepted are dedicated to the proper projects and causes. Essentially, this is designed to ensure organizations have remained accountable to those who ask to restrict funding.

What organizations use fund accounting?

Fund accounting is generally used by any organization that focuses on accountability rather than profitability. This includes nonprofit organizations, government entities, churches, and associations.

Nonprofits, governments, and churches are common users of find accounting

Nonprofit organizations

These 501(C)(3) organizations are the primary type of organization discussed in matters of fund accounting.

Charitable organizations rely on contributions from supporters, grants from numerous organizations, federal and state funding, and sponsorships. These generous contributions all play an important part in keeping the organization afloat and working toward the mission.

Nonprofits must restrict their funding to keep track of how their monies are used based on who contributed those funds and how they were restricted. For example, organizations that rely heavily on grants likely have specific deadlines and requirements they need to meet for each grant. Therefore, they use fund accounting to keep track of those deadlines in addition to tracking donor-restricted funds.

Governments

Governing entities are not focused on generating a profit. They need to keep a tight grip on their finances to determine how funds are leveraged for a variety of purposes and different projects. This is true for all levels of government—federal, state, and local.

These governments must stay true to the standards set by the Governmental Accounting Standards Board (GASB). This board has the responsibility of setting financial standards for state and local governments. Its purpose is essentially the same as the Financial Accounting Standards Board (FASB), which holds the same responsibilities, but for non-governmental organizations.

Fund accounting helps government entities keep accurate and tight control over their financial information, with a particular focus on the remaining resources. This helps prevent general overspending or overspending in areas outside of the set budget for the government.

Churches

Consider what all the church needs to pay for out of their bank account. They have a general fund, a missions fund, and a building fund:

  • The general fund covers most of the expenses incurred by the church, allowing it to continue operating.
  • The missions fund helps cover the philanthropic good the church does in the community and world.
  • The building fund covers building expenses like plumbing repairs or landscaping.

Because these expenses fall somewhat neatly into different categories and because the church is (like nonprofits and governments) working to keep a close eye on how their finances are used, fund accounting is the perfect system of financial management and reporting for churches.

Churches also run into fund restrictions and grant management needs, requiring them to remain accountable to their generous funders. Therefore, church accounting is similar to nonprofit accounting in the need to organize finances into funds.

Why is fund accounting important?

Imagine you purchase a new pair of shoes for $50. At the time of the purchase, you’re primarily excited about the fact that they look good, are comfortable, and match an outfit you look forward to wearing to a big event.

You’re probably not thinking as much about where you’re money went when you purchased the shoes. You may have checked up on the company to be sure they treat their employees well and have a positive community impact, but this just means you wanted to support a good company. If you hear that the $50 is going to help pay the salary of an employee, you’ll probably be happy that it’s not going into the pocket of the CEO.

Now, imagine you give a $50 donation to a nonprofit organization. You might be more interested in how that money is used because you gave it out of the goodness of your heart. You want to make sure that money will help people in need. You may even be less excited to hear that the money was used to help pay someone’s salary.

Fund accounting is important because it helps organizations appeal to these supporters who want to better understand where their money is going and how it’s helping.

Fund accounting helps organizations stay accountable in several ways:

  • It helps them keep a tight grip on where money is going. If a nonprofit needs to dedicate $25,000 toward project A, $15,000 toward project B, and $10,000 to project C, they need to make sure that all funding is properly allocated as such. If they have a grant covering $20,000 for project A, they only need to allocate $5,000 more to that project and other fundraising revenue can be allocated toward B and C. This can be hard to keep track of if the system of accounting is not primarily focused on the allocation of funds.
  • It helps them report their finances to the IRS. 501(C)(3) organizations are required to report their finances and how their funds are used to the IRS. For nonprofits, this is completed through the Form 990. It’s important to keep a close eye on how resources are used for this type of reporting because it’s what allows some organizations to remain tax-exempt from year to year.
  • It helps them honor any restrictions placed on assets. When people give to organizations and place restrictions on those gifts, they expect those restrictions to be honored. More than that, organizations want to honor them. But if the system is unorganized and emphasis is not placed on how monies are used, it’s challenging to ensure all money is used in the way promised.
  • It helps them ensure they have the funds necessary to continue operating. Fund accounting allows nonprofits to clearly understand how much of their funding is spent on various fundraising, program, and operational expenses. This allows the organization to make more accurate budgets and ensure they have the funds necessary to continue operating in the future.

Fund accounting allows organizations to allocate their funds based on the liquid assets in their system. Restricted monies, grants, and other funds are less liquid than other monies at the organization. Therefore, they can’t be used as easily as other funds to help the organization operate.

What are the “funds” in fund accounting?

Fund accounting allows your organization to separate your revenue into buckets, including the restricted, unrestricted, and temporarily restricted funds:

  • Restricted funds are those that must be maintained for a specific purpose at the organization. For instance, an endowment fund must be maintained, but the interest can be spent on specific projects.
  • Unrestricted funds are those that can be used for whatever purpose has the greatest need at the organization. Monies spent on operating expenses (salaries, rent, utilities, etc.) typically come from the unrestricted funds at an organization.
  • Temporarily restricted funds were received with a donor-imposed restriction that will be satisfied at a specific point in time in the future.

When contributions are made to nonprofits, they are recorded in the chart of accounts based on where they came from and how they’re used. The organization assigns numbered classifications for funds. For example, contributions may be listed under the 4000s, with individual contributions listed as 4100s and in-kind contributions listed as 4200s.

This breakdown helps keep the funds all organized. This organization and allocation also acts as the basis for various statements that help nonprofits make financial decisions. For example, the following statement of financial position breaks down monies by liabilities and assets as well as restricted and unrestricted funds.

Example nonprofit statement of financial position

This particular statement allows organizations to see their liquidity because it takes restrictions into account when measuring net assets. Other statements also take these restrictions and fund accounting specifics into account, allowing the organization to further analyze its finances and make smarter financial decisions.

Nonprofit Statement of Financial Activities Template

This template provides a clear and organized way to present financial information, including revenues, expenses, and net change in financial position, by class, location, and project.

Free Download

How do organizations get started with fund accounting?

Smaller organizations often don’t have the resources to find a dedicated fund accounting professional. Therefore, they end up relying on their executive director to complete all of their financial management tasks. However, these individuals likely didn’t enter the field the crunch numbers and have other things to worry about than learning how to do fund accounting.

For most organizations, the best way to get started and ensure fund accounting is completed correctly is by outsourcing their needs to a dedicated accounting firm that understands (and specializes in) the intricacies of fund accounting.

By putting your accounting needs in the hands of fund accounting experts, your organization will ensure you meet all of the Generally Accepted Accounting Principles (GAAP) and FASB requirements.

Here at Jitasa, we’d be honored to be those experts for your organization!

Our team works with nonprofits, churches, and other organizations that leverage fund accounting, helping them maintain an organized accounting system and answering any of their questions. We focus on helping these organizations get back to their missions while we take care of ensuring they’re in a financially sound position.

Get a quote to see how affordable it is to work with dedicated experts!

Wrapping Up

Fund accounting allows organizations to ensure they remain accountable to their funders and to their missions. It’s a system of organization that makes it easy for organizations to track their funding, how it’s allocated, and how they can best keep the organization operating at the highest caliber.

If you’re curious to learn more about fund accounting and financial management for organizations that leverage this type of accounting, check out these additional resources:

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