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Why Do Nonprofits Need Fund Accounting?

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

  • 1. What is a fund?
  • 2. What is not a fund?
  • 3. Why do some organizations have so many funds?

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 nonprofit 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.

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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 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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We value your comments! Feel free to ask questions, suggestions or leave feedback.

Written by Joseph Scarano · Categorized: Nonprofit Fund Accounting · Tagged: Accounting Software for Nonprofits, Fund Accounting, Fund Accounting Software, Nonprofit Accountability, Nonprofit Accounting, Nonprofit Accounting Software, Nonprofit Fund Accounting Software

About Joseph Scarano

About the Author
Joseph Scarano is the CEO of Araize, Inc., developers of cloud-based FastFund Online Nonprofit accounting, fundraising and payroll software solutions to help your nonprofit become more transparent, accountable and sustainable.

Comments

  1. David Martin says

    March 2, 2016 at 5:56 AM

    How do we best manage fund accounting for Private nonprofits? They are increasingly dependent on the financial markets for capital funds, must obtain and maintain satisfactory credit and bond ratings in order to get these funds. But that is not easy.

    Reply
    • Joseph Scarano says

      March 3, 2016 at 10:43 AM

      Regardless of the type of nonprofit you are, managing funds in accounting is the same. From an accounting perspective, you need to track the purpose of the funds and intention of the donor, whether it is unrestricted, temporarily restricted, or permanently restricted. The donor’s intent also dictates the proper categorization of earnings on the investments in the funds. Fund Management as it relates to investments in capital markets and maintaining satisfactory credit and bond ratings has no impact on the accounting of the actions and results of the investments.

      Reply
  2. Jeremy Potoka says

    April 8, 2016 at 11:14 AM

    Great overview of fund accounting. The idea of fund management and keeping funds in balance is a simple idea that can often feel complicated for board members and non financial staff. I would also add that solid Fund Accounting Software reinforces best practices and allows nonprofits to emphasize their accountability over profitability.

    Reply
  3. Sameer says

    November 21, 2016 at 4:43 AM

    This is really something useful for fund accounting. This is really great thing to manage funds as sometimes it become critical for the financial staff.

    Reply
  4. Ryan says

    June 6, 2017 at 12:58 PM

    Hello…. We are a multi site church with a fund established for each campus (all share the same checking). We have one fund that has been operating in the negative year over year because they had a rough couple of years financially. Does that fund have to remain negative until the end of time (the amount negative will never be made up to bring to a zero balance).

    Also, in “for profits” there is the idea of spending from retained earnings. We want to write a check from the “earnings” for 2016…. how to we do that and not effect each individual campus budgets?

    Reply
    • Joseph Scarano says

      July 25, 2017 at 8:52 AM

      Ryan,

      Sorry I did not respond to your question sooner.

      “We have one fund that has been operating in the negative year over year because they had a rough couple of years financially. Does that fund have to remain negative until the end of time (the amount negative will never be made up to bring to a zero balance).”

      No, the church can approve a transfer of funds from the general fund to take care of the deficiency in the negative fund. This is normal in an organization like a church, where activities are split into funds.

      “Also, in “for profits” there is the idea of spending from retained earnings. We want to write a check from the “earnings” for 2016…. how to we do that and not effect each individual campus budgets?”

      You really are not spending money from ‘retained earnings’ It is quite normal for net assets from previous years to be used to cover shortfalls in subsequent years. A Statement of Activities and Changes to Net Assets report will show the carry forward of net assets from one year to another.”

      Hope this helps.

      Reply
  5. Justine says

    July 6, 2017 at 7:53 PM

    Hi! How do we know if the funds donated were actually used as to their purposes by analyzing only their financial statements?

    Reply
    • Joseph Scarano says

      July 6, 2017 at 9:34 PM

      If funds were designated for a specific purposes, then the backup of the financial statements will show the proper classification of a donor’s gift matched against the appropriate expense category that the gift was designated for.

      Reply
  6. Jennifer Hechtman Rosen says

    July 20, 2017 at 4:10 PM

    Hi, I work for a reform synagogue and am getting ready to make transfers using all of our Due To accounts which seem very antiquated and a lot of work. We have about a dozen bank accounts for each Fund with a corresponding Due To account which has never seemed to work quite right. We do not have a separate revenue, expense and balance sheet for each of these accounts nor do they have their own chart of accounts. It makes end of fiscal year transfers very confusing! Any suggestions?

    Reply
    • Joseph Scarano says

      July 21, 2017 at 7:38 AM

      Jennifer:

      To tell you the truth, it sounds like a real mess. First, Why do you have a dozen bank accounts for each fund? All that does is create a ton of extra work. Second, what defines a fund?
      Most religious organization’s I’ve worked with over complicate their accounting by setting up too many funds, when all they really need is the ability to track revenue and expenses for specific ministries, programs, projects, or whatever you want to call them. If all you need to know is how much has been designated and spent for specific ‘funds’ you might be able to simplify your process by creating revenue / expense ‘buckets’ for those activities. What software are you using for your accounting and member / donor management? Of course, I would need a lot more information to provide more concrete suggestions. I would suggest signing up for a demo of our FastFund Online system to show you a better way to manage your finances.

      Reply
  7. Cameron says

    August 31, 2017 at 11:14 PM

    How can I start this conversation at an org who I just joined? I’m the new DBA for a higher education org that specializes in study abroad programs. founded in 1950, they have operated much like a for-profit, and all operational costs are covered by earned income. Makes sense why fund accounting wouldn’t have been used.

    But now, 60+ years later, the organization shifts its strategic vision and commits to giving more financial aid to students with demonstrated financial need. Catch is this extra financial aid has to be fundraised for (but no one has Fundraising experience. They also Cap how much can be awarded from annual earned income. And it wasn’t enough to help. Nearly half of all applicants have to drop out of enrollment due to financial limitations.

    Their solution is to create an Advancement Team to fundraiser. But no one has ever done any fundraising. The advancement dept causes a lot of extra work and effort from accounting even though it’s not a big deal in terms of the status quo. But all of this extra work is caused by the fact that it takes an act of congress to follow the donations to their impact. Donor imposed restrictions are only upheld for true endowmens. Most dontations are in the ledger by what country the money was used in. Not by the donors wishes, like for diversity aid – or summer internships.

    We are raising close to $1million annually and growing. How can I get my finance department to help me without fund accounting?

    Reply
    • Joseph Scarano says

      September 1, 2017 at 8:47 AM

      Cameron:

      Your issue has more to do with providing proper stewardship of donor funds, not necessarily fund accounting. If a donor designates that their donation ‘funds’ for a specific purpose, it is the obligation of your organization to comply with the donor’s wishes. This can be accomplished with the proper accounting tools used in your organization. With proper categorization of donor designations, it is easy to report on the designation and use of those funds. You don’t necessarily need fund accounting, just better fiscal management of funds coming in and funds going out.

      Reply
      • Cameron says

        September 1, 2017 at 12:08 PM

        I worked for years at Blackbaud supporting The Raiser’s Edge, beta testing and QA, then technical project management for Blackbaud in their professional services division. I have never at all seen accounting done like this.

        We use RE in Advancement. I know how to configure RE to make the most of its inherent accounting functionality – not much but enough to get an accurate and legal post file for a GL. But the way accounting is done there is not a clear way to ensure alignment with what a donor wants and how the money is being spent. The only way I know how to do this is via Fund Accounting. RE is set up to require it. Each fund has a credit/debit side for each gift type (pledge, pledge payment, bequests, stock/property, gift-in-kind, cash, etc.) But it sits empty for now.

        Before I got here the advancement coordinator was sending emails to members of the finance department with information about some of the donations, but not all. Not unless it was a really high amount essentially.

        They use Great Plains.

        If you have any resources that you could point me to that would help me better align and map to them while still being good stewards that would be greatly appreciated!

        Reply
        • Joseph Scarano says

          September 1, 2017 at 12:27 PM

          Cameron:

          When you say you have never seen accounting done like this, have you not seen the financial statements of the organizations you have worked for? All nonprofits in the US must generate external financial statements that present their financial position broken down by the three net asset (fund) classes, unrestricted, temporarily restricted and permanently restricted. Since your experience is on the development side, it would be beneficial if the data from the fund raising application that feeds into accounting contains the intent of the donor as to the use of their funds. This will help in providing proper stewardship back to the donor as to the use of those funds. A proper integrated system where the fund raising system is seamlessly integrated to accounting helps facilitate this process. Check out FastFund Online from Araize. It does everything that RE and FE do at a fraction of the cost.

          Reply
  8. Clar says

    April 9, 2018 at 1:02 PM

    We have a Memorial Fund which has no restrictions on how it is used.
    Should the expenses be made out of the Memorial Fund or can they be expensed out of the GOF and transfers made fund to fund and asset to asset?

    Reply
    • Joseph Scarano says

      April 9, 2018 at 1:14 PM

      We need a little more information to properly answer your question. But, if you are following true fund accounting principles, then donations received as a Memorial donation, but have no restrictions placed on them, should be classified as General Fund donations. You can separate the activity by creating a subset code under the General Fund for Memorial Donations, to track all memorial donations. Then you won’t have to worry about transferring assets between funds for expenses.

      Reply
      • Clar says

        April 9, 2018 at 2:11 PM

        thank you!

        Reply
  9. Dorthy says

    June 18, 2018 at 1:51 PM

    I just found your website as I am a CPA looking for an easy way to explain fund accounting to our new secretary of our nonprofit organization. Trying to develop the budget and explain how fund accounting is different was not working!
    Thank you for the help.

    Reply
    • Jane Scarano says

      June 18, 2018 at 2:20 PM

      Thanks! We are happy to help. If you would like more detailed training, we offer an online course designed to make nonprofit accounting easier to understand and master. Here’s the link: Nonprofit Accounting Course

      Reply
  10. Lee says

    September 10, 2018 at 5:53 AM

    Hi, I have many questions about day to day Temporarily restricted net assets entries. Everything I have read, every video I have watched does not answer my questions. And everyone is doing something different. And FASB leaves too much grey area. What are the entries step by step? This is my understanding and it may be wrong but this is the most consistent/simplified I have found from the various methods

    Recording the notice of a Temp restricted fund
    DR receivables
    CR Temp Rest Net Asset (Equity)

    Recording receipt of Temp restricted fund
    DR cash
    CR receivables

    After spending funds, posting the spending in expenses and getting compliance approval from Funder…

    Release Temp restricted funds
    DR Temp Rest Net Assets (Equity)
    CR Temp Rest Net Assets released (Expense)

    Record earned (example: Richard Nixon Foundation) revenue
    DR Temp Restricted Net Assets released (Revenue)
    CR R. Nixon Foundation Revenue

    What I don’t understand is why release to One revenue account (temp rest net assets released) only to reclassify to the fund revenue account?

    Also some are saying that if the full amount of the funds are received in advance, as soon as the funds are received, the entire amount gets posted to revenue. How can this be when it hasn’t been earned yet? Also this will create a fund balance deficit for later years. Let’s say the fund is 100K and by fiscal year end we only spend 40K. Well if all of the funds are posted to revenue in the previous year then it will get closed out to Net Income at year end. How can I forward the 60K that was not spent to the next year? In the past we did this with deferred but now as I return to nonprofit accounting deferred was replaced with unrestricted, temporarily restricted, & permanently restricted net assets methods.

    One more question, my auditor is telling me that the Temp Restricted Net Assets account balance should not change. How can this be when. It has to have new funds flow in and released funds flow out? I’m trying to find official literature to support what the auditors are saying but I’m not finding it. FASB does not go into this much detail on the matter. GAAP does not either. So where do we find the official way to do this?

    Reply
    • Joseph Scarano says

      September 10, 2018 at 12:25 PM

      Lee,

      Thanks for your question. Here is the proper way to record temporarily restricted revenue and the subsequent entries for recognizing revenue released from restrictions:

      Recording the notice of a Temp restricted fund
      DR receivables
      CR Temp Rest Revenue

      Recording receipt of Temp restricted fund
      DR cash
      CR receivables

      After spending funds, posting the spending in expenses and getting compliance approval from Funder…

      Release Temp restricted funds
      DR Temp Rest Revenue Released from Restrictions (Income)
      CR Unrestricted Revenue Released from Restrictions (Income)

      All expenses incurred related to the temporarily restricted revenue are recorded in the Unrestricted Fund. So expenses will match the amount of revenue that is recognized with the Revenue Released from Restrictions.

      You do not post transactions to either the Unrestricted or Temporarily Restricted Net Asset account. If there are funds that have not been used during the course of the fiscal year, then their will be a excess in the fund and closed out to the net asset account balance with the year end closing entry. So it is possible to have an excess in the Temp Restricted fund one year and an deficit the next year, when the funds are released.

      Hope this clarifies the proper recording of your restricted fund revenue.

      Joe Scarano

      Reply
  11. Dawn Thomas says

    October 16, 2018 at 1:55 PM

    Family donor …. the real estate from parents ( deceased ) can have restrictions placed by children ?

    Reply
    • Joseph Scarano says

      December 7, 2018 at 11:59 AM

      Dawn,

      Yes, the children of a family member who is deceased can place restrictions on the donation, if the donation has not yet been made. If the donation as already been made by the deceased donor, without any restrictions, the children cannot place restrictions after the fact that conflict with the donor’s wishes.

      Reply
  12. Jules says

    July 17, 2019 at 11:07 AM

    With restricted gifts (to a specific function in a program) from an individual donor, are you required to spend them out by end of the fiscal year or can you carry funds over to the next year?

    Reply
    • Joseph Scarano says

      July 17, 2019 at 11:23 AM

      Jules,

      Unless the donor has placed a specific time frame on when to use the funds, you can carry the funds over to the next year, classified in the With Donor Designations Net Asset class.

      Joe Scarano

      Reply

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