Fund accounting is a bookkeeping system. It is used by nonprofit and government organizations to focus on accountability for how they spend resources provided by donors or taxpayers that are designated for a particular purpose.
“Fund” used in this context doesn’t refer to an asset account, such as a mutual fund account, but rather the grouping of resources by the purpose they are intended to fund. By monitoring these funds, managers, donors and other stakeholders can ensure that nonprofits are spending donations and revenues as agreed upon or required by law.
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There are some slight differences between fund accounting for nonprofit organizations and government entities. This article focuses on helping nonprofits understand the basics of fund accounting. |
Nonprofits must separate all their activities by fund. Essentially, each fund will have its own set of books and financial statements, but fund accounting software will account for all funds simultaneously in a single system and combine all funds automatically into a single set of financial statements for the organization. However, fund accounting software can also provide financial statements separated by fund when needed.
When a nonprofit records activity, it needs to not only choose the accounts affected but also designate a fund. For example, when a donation is received, it’s not enough to record the receipt of cash and the contribution income — you must also designate the fund for which this activity belongs.
To illustrate how each fund has its own set of financial statements, here is a sample balance sheet and statement of activities separated by fund for a hypothetical nonprofit. Externally issued financial statements generally will only show the amounts in the total column, but note that even the total column separates the “net assets” section of the balance sheet by fund (yellow highlights).
| Total | Unrestricted general fund | Unrestricted capital investment fund | Permanently restricted – donor endowment | ||
|---|---|---|---|---|---|
| Assets | |||||
| Cash | 121,000 | 105,000 | 11,000 | 5,000 | |
| Investments | 1,215,000 | 15,000 | 1,200,000 | ||
| Fixed assets | 500,000 | 500,000 | |||
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Total assets |
1,836,000 |
105,000 |
526,000 |
1,205,000 |
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| Liabilities | |||||
| Accounts payable | 13,000 | 13,000 | |||
| Mortgage payable | 150,000 | 150,000 | |||
| Total liabilities | 163,000 | 13,000 | 150,000 | ||
| Net assets | |||||
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92,000 | |||
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Unrestricted capital investment fund |
376,000 |
376,000 | |||
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Permanently restricted – donor endowment |
1,205,000 |
1,205,000 | |||
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Total net assets |
1,673,000 |
92,000 |
376,000 |
1,205,000 |
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Total liabilities and net assets |
1,836,000 |
105,000 |
526,000 |
1,205,000 |
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| Total | General fund | Capital investment fund | Permanently restricted – donor endowment | ||
|---|---|---|---|---|---|
| Revenues and support | |||||
| Contributions | 350,000 | 350,000 | |||
| Investment income | 110,000 | 110,000 | |||
| Total rev and support | 460,000 | 460,000 | |||
| Expenses | |||||
| Program services | 325,000 | 325,000 | |||
| Fundraising | 10,000 | 10,000 | |||
| Administrative | 85,000 | 80,000 | 5,000 | ||
| Total expenses | 420,000 | 415,000 | 5,000 | ||
| Change in net assets | 40,000 | 45,000 | –5,000 | ||
| Beginning in net assets | 1,633,000 | 47,000 | 381,000 | 1,205,000 | |
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Ending net assets |
1,673,000 |
92,000 |
376,000 |
1,205,000 |
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Notice that the financial statements don’t only balance in the total column, but each fund column also independently balances. On the balance sheet, total assets equals total liabilities plus net assets (blue highlights) for each column. The ending net assets on the statement of activities equals the total net assets on the balance sheet (green highlights) for each column.
When contributions to a nonprofit are designated by the donor for a specific purpose, they must be accounted for separately from other funds. Nonprofits create separate accounting by creating multiple funds of the following types:
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Some organizations may not have any restricted funds, but all must have at least one unrestricted fund — usually called a general fund. Many organizations choose to create multiple unrestricted funds to track contributions and spending for multiple goals or activities. |
For example, a church might track the following unrestricted funds:
While restricted funds are created by donors making restricted donations, unrestricted funds are created by the nonprofit’s management team for specific programs that they would like to track separately from the general fund. Amounts in unrestricted funds can be transferred to other funds if management decides they are needed.
In the example above, the church has allocated a portion of its resources to the missionary fund and capital investment fund. These unrestricted funds can be reallocated later if needed. These unrestricted funds exclude donations where the donor specifically instructed the church that the donation must be used for missionary work. If the church accepts that donation, then it would need to create a new fund called, “Temporarily restricted missionary fund.”
Fund accounting is crucial to ensure that nonprofits are complying with stipulations established by donors. In addition to restricted funds, tracking unrestricted funds by the purpose is useful to stay accountable to nonprofit stakeholders and contributors. Even donors who don’t stipulate a particular use are generally interested in how their donations are being spent.
Fund accounting helps nonprofit managers from overspending in one area to the detriment of another. Knowing the funds available for each of the major activities of the organization helps the budgeting process and with spreading the available resources properly across activities.
Users of fund accounting can be split into three groups based on the complexity of their operations. The necessity of a solid understanding of fund accounting varies greatly among these groups.
Very small organizations might have a single unrestricted fund, so fund accounting is pretty simple as all net assets of the organization belong in the single fund. These organizations can typically use inexpensive accounting software designed for for-profit organizations without any special modifications.
The amount shown as owner’s equity on the for-profit balance sheet should be labeled as unrestricted assets. Visit our guide to the best accounting software to find affordable for-profit accounting software that will work for nonprofits with only one fund.
While there is no requirement to establish multiple unrestricted funds, larger organizations that collect donations and spend money on multiple programs can benefit greatly from using fund accounting.
Each major program should have a separate unrestricted fund. By tracking the donations, revenues and expenses separately, donors can see how their donations are being spent. In addition to transparency, the separate funds ensure that managers know the exact resources available for each purpose.
Fund accounting becomes critically important for organizations accepting restricted donations. Restricted donations are usually large donations that come with legal documents, such as a will or trust, which provide very specific, legally enforceable stipulations on how the money can be used. If nonprofits spend the money in any other way, they can be sued by the donor or their representatives.
Traditional accounting software programs are not designed to be used for fund accounting. While nonprofits with no restricted funds and only one unrestricted fund can get by using traditional for-profit software, other organizations need to invest in fund accounting software. Fund accounting software tends to be a bit more expensive but will minimize fund accounting mistakes.
A less-expensive option to true fund accounting software is to use QuickBooks and create a class for each fund. You can print your financial statements separated by class, which mimics fund accounting. You’ll need to be vigilant to always assign a class to every transaction. Visit our guide to the best nonprofit accounting for additional options.
It is critical that a separate restricted fund is created for each donation or set of donations with unique restrictions and spending requirements. If you receive restricted donations through wills frequently, you’ll need a separate restricted fund for each bequeath.
While it is good to create separate unrestricted funds for your major program services, creating unnecessarily narrow unrestricted funds will cause headaches without adding much value to your accounting system. For example, if you manage several homeless shelters, it’s probably unnecessary to create a separate unrestricted fund for each location.
Many donors like to have input on how their money is spent, so you can save a lot of headaches by allowing them to choose from a list of restricted funds for which you’re seeking additional support. Donors often don’t realize what an incredible accounting headache they create when they designate their donation for a unique purpose.
For example, say you’re a nonprofit offering childcare to allow parents to attend classes you provide. A thoughtful donor might think that is a wonderful idea and designate that their donation go toward this program. However, they don’t realize that for the nonprofit to accept their donation, it must create a separate restricted funds account.
It’s hard to turn away money, but think things through before accepting restricted funds if you’re a small organization. You must be 100% confident that your nonprofit has the proper fund accounting, controls and oversight to guarantee the money is spent properly.
Be sure to consider if you’ll need to incur additional expenses like upgrading to a more sophisticated accounting software or outsourcing your accounting to a nonprofit accounting pro. Mistakes can result in litigation that might drag your organization through the mud and affect donations from other donors.
Before refunding restricted donations, explain your situation to the donor and see if they’ll allow you to accept the donation as unrestricted. This might work for small donations; for instance, when a donor provides a designated purpose in the memo section of their check. However, larger restricted donations through trusts and estates may not be flexible.
As discussed above, each fund is essentially its own set of books complete with assets, liabilities and a fund balance. However, it is unnecessary — as well as often creates unnecessary work — to separate each fund’s assets physically in a separate bank account. For example, cash for all funds can be kept in the same checking account and then each fund’s share of the checking account balance is tracked in the fund accounting software.
| Fund accounting | Regular accounting | |
|---|---|---|
| Objective | Provides accountability to show that organization resources are spent in accordance with legal requirements and donor intentions | Measures profit and loss for a period and tracks profits that are paid to owners versus retained by the company |
| Best for | Nonprofit and government organizations | For-profit companies including sole proprietors, partnerships, S-corps and C-corps |
| Required financial statements | Balance sheet Statement of activities and change in net assets Statement of cash flow |
Balance sheet Statement of profit and loss Statement of cash flow Statement of owner’s equity |
| Balance sheet formula | Assets = Liabilities + Fund Balance | Assets = Liabilities + Owner’s Equity |
| Net asset accounts | Permanently restricted funds Temporarily restricted funds Unrestricted funds |
Contributed capital Retained earnings |
| Primary users of financial statements | Donors, taxpayers, creditors and regulators | Owners, creditors and regulators |
| Complexity of bookkeeping | More complicated than regular accounting because all transactions must be assigned to specific funds | Less complicated than fund accounting |
Funds in accounting can sometimes refer to available cash, but when used in the context of “fund accounting,” it’s different. In fund accounting, a fund is a separate set of books maintained by nonprofits that tracks the assets, liabilities, income and expenses designated for a particular purpose. Nonprofit accounting combines all the separate funds into a single set of financial statements.
Nonprofit and government organizations use fund accounting to track assets, liabilities, revenue and expenses separately for designated purposes. It provides additional transparency and accountability to stakeholders by showing how contributions and earnings are spent.
“Fund accountant” can refer to two completely distinct jobs. In investment accounting, a fund accountant helps record transactions and calculate the fair market value of an investment fund, such as mutual funds. In nonprofit and government accounting, a fund accountant is a bookkeeper with specialized knowledge of how to separately track activity by designated purposes.
Fund accounting requires nonprofit and government organizations to account for restricted or designated funds separately from unrestricted funds. This is done by creating a separate set of books for each required fund. Good fund accounting software is essential as it allows for the maintenance of a separate set of books for each fund while also being able to consolidate them easily into a single set of financial statements.
