Fund accounting tracks revenue and expenses, demonstrating accountability to funding sources. Understanding nonprofit fund accounting ensures proper stewardship of funds. Let’s take a deep dive into what is fund accounting.
What is fund accounting?
Fund accounting tracks and manages finances for nonprofits and government agencies. It shows how revenue is being spent and whether funds are used for its designated purpose. This assures proper stewardship of funds.
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 must demonstrate accountability and proper stewardship of funds. For-profits show profitability.
Primarily, applying the basics of 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.
What are the basics of fund accounting?
To be clear, fund accounting focuses on accountability and proper stewardship. This is a must-have for compliance with government regulations. A fund accounting system monitors 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. Primarily, 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.
Getting started with a fund accounting system
In its basic form, 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.
1. Setting up a nonprofit fund accounting system
To set up a nonprofit fund 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.
2. 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. As an added benefit, 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.
What is 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.
1. 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.
2. 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: 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 Asset: 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 Asset 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.
What is proper stewardship of funds?
Donations are designated by the donor as either restricted or unrestricted. For example, donors can specify their intention through an agreement with the nonprofit. Likewise, nonprofits must be transparent when asking for money.
1. 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.
2. The importance of following protocols
Most importantly, following basic principles of fund accounting 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.
Grants from foundations are usually restricted to a particular program or purpose. Under these conditions, documentation will specify the restrictions of a grant award.
Common fund accounting mistakes and misconceptions
Many nonprofits make the mistake of making separate funds for each program activity, or grant received by your organization.
Mistake # 2
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 maintain their nonprofit status by understanding what is fund accounting.
By implementing the basics of fund accounting, organizations become more compliant and accountable to funding sources. Above all, fund accounting provides a transparent, birds eye view for the nonprofit board and the general public.
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