What Is Fund Accounting for Nonprofits: Basics and Best Practices (2024)

Feeling overwhelmed by the challenge of keeping track of donations and their specific donor conditions? Fund accounting is a specialized accounting system used by nonprofit organizations to track and report on funds based on donor restrictions. It demands a thorough grasp fund accounting basics, ensuring every dollar is accounted for and spent in alignment with donor preferences.

Fund accounting isn’t about making money; it’s about showing your supporters that you’re using their contributions responsibly and transparently. Whether you’re a seasoned nonprofit accountant or new to the sector, this guide is your first step toward simplifying your accounting processes and refocusing on what matters most—your mission. Let’s take a deep dive into nonprofit fund accounting and why nonprofits need to understand it.

Basics of Fund Accounting

Fund accounting tracks revenue and expenses for nonprofit organizations, churches and state and local government agencies and other government entities. Consequently, financial reports demonstrate how the spending of revenue aligns with government regulations and donor designations.

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 funds allocated to each operation, program, or event.

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Why do nonprofits need fund accounting?

Nonprofits use fund accounting to segregate their financial activities into different funds, each with its own set of financial statements. Fund segregation helps organizations manage and report on specific activities or programs. This system enables nonprofits to maintain transparency and accountability, providing clear financial reports to stakeholders.

Anyone involved in the financial management of a nonprofit organization must understand the basics of fund accounting. It provides insights into the organization’s financial health and helps ensure compliance with donor restrictions and legal obligations. Fund accounting categorizes funds into restricted and unrestricted categories or classes, allowing for precise tracking and reporting.

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, 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.

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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.

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. It ensures use of funds for its intended purpose. It also promotes 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, tracking funds and expenses ensures the integrity of donated funds.

How to setup a nonprofit fund accounting system

First, assign a code for each transaction, facilitating 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.

1. 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.
2. 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.
3. 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.
4. 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. Nonprofit fund accounting software offers numerous advantages for nonprofits, streamlining the tracking and reporting of financial activities. It helps organizations ensure that funds are used in accordance with donor intentions, maintain financial accountability, and generate accurate financial reports.

Combine Cash Accounts

Best practices in fund accounting include consolidating funds for similar programs and activities to simplify financial management and reporting. It’s also important to avoid creating separate cash accounts for each fund, as this can lead to unnecessary complexity. Instead, nonprofits can use a single cash account and allocate transactions to the appropriate funds using their accounting software.

Answer 3 Fundamental Fund Accounting Questions

True fund accounting software tracks revenue to a designated purpose and prevents misuse of donations. So what are the key advantages of using nonprofit fund accounting software?

In order to fully understand fund accounting basics, you need to understand three fundamental questions:

1. Who is the source of revenue?
2. What is the designated purpose?
3. 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.

FastFund Accounting provides true fund accounting and functional accounting methods, ensuring proper compliance and accountability to funding sources.

Case Study

Take for example, the Northeast Louisiana Arts Council (NLAC), dedicated to enriching their local community through art education and events. NLAC has been growing steadily, thanks to the support of local artists, community members, and some generous donors. However, as their programs expanded and the number of donations increased, the team at NLAC found themselves overwhelmed by the complexities of tracking their finances, especially when it came to managing restricted and unrestricted funds.

FastFund Nonprofit Fund Accounting, has been a game-changer for NLAC. With FastFund, the team can easily categorize their funds based on donor restrictions, ensuring that every dollar is allocated and spent according to the donors’ wishes. This not only simplifies their financial management but also boosts their credibility and trustworthiness in the eyes of current and potential supporters.

NLAC recently received a grant specifically designated for youth art workshops. With FastFund, they can create a separate fund for this grant, tracking all related expenses and demonstrating the money is used solely for its intended purpose. This level of transparency and accountability is crucial for maintaining good relationships with their donors and for complying with grant requirements.

Provides insight into the basics of fund accounting

Many of NLAC’s team do not have extensive accounting backgrounds. FastFund’s user-friendly interface allows them to navigate the software with ease. They can generate detailed financial reports in just a few clicks, making it simpler to share their financial status with their board members, donors, and the community.

By using FastFund, NLAC now focuses more on what they do best—bringing art to the community—while feeling confident and in control of their financial management. It’s like having a dedicated financial expert who understands the basics of fund accounting.

For nonprofits like Northeast Louisiana Arts Council, transitioning to Araize FastFund Nonprofit Fund Accounting isn’t just a smart financial choice—it’s a step toward a more sustainable and impactful future.

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Bottom Line

Understanding the basics of fund accounting is essential for anyone involved in the financial management of a nonprofit organization. It provides insights into the organization’s financial health and helps ensure compliance with donor restrictions and legal obligations. Fund accounting categorizes funds into restricted and unrestricted categories, allowing for precise tracking and reporting.

FAQs

What is nonprofit fund accounting?

Nonprofit fund accounting is a method of accounting that emphasizes accountability, rather than profitability. It separates financial information into funds based on their source and intended use, ensuring that money is spent in accordance with donor restrictions and organizational missions.

How does nonprofit fund accounting differ from for-profit accounting?

Unlike for-profit accounting, which focuses on profitability and shareholder value, nonprofit fund accounting centers on stewardship and ensuring funds are used according to their designated purposes. It involves categorizing funds into unrestricted and restricted classes.

Why is fund accounting important for nonprofits?

Following the basics of fund accounting is crucial for maintaining the trust of donors, complying with legal and regulatory requirements, and providing transparent reporting about how funds are used. It ensures that money is allocated and spent in line with the organization’s mission and donor intentions.

What are some common challenges in nonprofit fund accounting?

Common challenges include tracking and reporting on restricted funds, managing grant requirements, and ensuring compliance with accounting standards and regulations specific to nonprofits.

Can any accounting software be used for nonprofit fund accounting?

While general accounting software can be adapted to some nonprofit needs, specialized nonprofit fund accounting software like Araize FastFund is designed to address the specific challenges and requirements of fund accounting, offering more suitable functionalities.

What are unrestricted and restricted funds?

Unrestricted funds can be used for any of the organization’s purposes. Restricted funds are meant to be maintained intact in perpetuity, often in the form of endowments.

How should a nonprofit organization handle donor-restricted funds?

Nonprofits must track these funds separately, use them in accordance with the donor’s restrictions, and report on their use accurately to maintain transparency and donor trust.

What is the role of fund accounting in a nonprofit’s financial statements?

Fund accounting plays a vital role in the preparation of financial statements, ensuring they reflect the organization’s financial activities and fund balances accurately, segmented by each fund category.

How can a nonprofit ensure compliance with fund accounting standards?

Staying informed about the latest accounting standards, using appropriate fund accounting software, and possibly consulting with a financial professional knowledgeable in fund accounting can help ensure compliance.

Where can I learn more about implementing fund accounting in my nonprofit?

Visiting websites like araize.com, attending workshops and webinars, reading relevant books and articles, and seeking advice from financial professionals experienced in fund accounting are great ways to learn more about effective fund accounting implementation.

Want to read more? Check out these insightful articles:

• Chart of Accounts for Nonprofits: Guide to Proper Setup
• Nonprofit Funds and Programs: How to Categorize in Accounting
• Nonprofit Accounting Questions: Blueprint for Compliance
• Donor Stewardship: Relationship Building Strategy for Nonprofits
• Nonprofit Restricted Assets: Best Advice for Managing Funds
• Nonprofit Cash Flows Forecast: How to Avoid Deficits

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