What makes fund accounting unique to nonprofits? In a word — accountability. Nonprofits and government agencies must track all income to a specific purpose. It is a system of grouping unrestricted and restricted funds.
In order to fully understand nonprofit fund accounting, you must be able to answer three basic questions:
Three Fundamental Questions
Fund accounting is unique to nonprofit organizations and government agencies. Most readers of commercial financial statements are not familiar with this type of accounting. As a result, it tends to be very confusing. Some organizations only have one fund, some have many.
What Is A Fund?
- Unrestricted Fund: There are no restrictions placed on the resources of this fund and the organization can use the amounts in the fund as it chooses.
- Current Restricted Fund: These funds are resources that are given to the organization as part of their normal activities, but only for specific purposes.
- Restricted Endowment Fund: These funds contain resources donated to the organization with the stipulation that only the income earned by these assets can be used, while the original gift is kept intact forever, or a stipulated period of time.
- Designated Fund: allow the donor to specify organizations or charities for their fund to support.
- Fixed Asset Fund: A separate fund for the cost of fixed assets, buildings, land, etc. The purpose of this fund is to separate these assets from the unrestricted fund, so the unrestricted fund represents the current activity of the organization.
Each nonprofit has its own set of programs, administrative and fundraising activities. Separate funds are established for these entities to track how revenue and expenses are spent.
Other specialized fund groupings are used by organizations reflecting either donor restrictions or board designations, but they all fall under one of the five fund categories mentioned above.
What Is Not A Fund?
One of the major errors that nonprofit organizations make is the segregation of their assets by fund. For example, separate bank accounts do not need to be maintained for the cash attributable to a fund, especially when all of the organization’s cash is in a single bank account. All this does is create extra work for the accounting staff.
Why So Many Funds?
A major mistake made by some nonprofit organizations and a governing agency is to create a fund for every program, grant, mission, project, or other activity that they operate. Churches and religious ministries carry the separate fund principle to the extreme. I’ve seen churches and ministries set up separate funds for every ministry, i.e., women’s, men’s, children’s, alter guild, flowers, refreshments and bible study, etc.. Also some nonprofits set up separate funds for each of their grants. The reason is nonprofit management thinks they need these for both internal and external reporting. They have taken the use of funds to the extreme.
All of those activities should not be classified as funds in your fund accounting system. The better way to track all of this activity is the use of program codes within a fund. With the proper set up, a program classification within a fund can properly track the designated revenue and associated expenses for a specific activity. These separate program areas are referred to as functional areas and fall under three categories, management and general, program and fundraising.
The Principles of Fund Accounting
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.
The code contains unique identifiers which can include a code for the donor, grant, project, location etc. This helps identify the sources of an organization’s revenue, and it shows how efficiently the organization is using those revenues for their designated purpose. Proper fund accounting highlights areas of strength and weakness, and it provides transparency for external audiences.
Nonprofits just need to get past the idea that everything they do should be classified as a separate fund.
Purpose Behind Fund Accounting
Its purpose is to allow a 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.
The Financial Accounting Standards Board (FASB) has issued new rules for nonprofit which went into effect December, 2017. The new rules simplify the treatment of net assets. Under the new rules the Statement of Financial Position will only have two classes of “Net Assets” — net assets with donor restrictions and net assets without donor restrictions. In order to fully understand the why behind fund accounting, it is import to first review basic nonprofit organization accounting questions.
If a nonprofit wants to be compliant with GAAP and FASB 116/117, all of their funds must be grouped into two categories of net assets: (1) without donor restrictions and (2) net assets with donor restrictions, which replace the three former categories of unrestricted, temporarily restricted and permanently restricted net assets. To be GAAP-compliant, nonprofits only need two funds to report on the breakdown of net assets on IRS form 990.
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