Fund Accounting 101: Definition, Use, and Other Essentials

03.10.2022
Ivana

Accounting practices are contingent on the industry, type of entity, and financial goals. For-profit organizations are focused on maximizing profits, while nonprofits, churches, government agencies, and associations care less about profit generation and more about accountability. This article covers the fund accounting basics, from the fund accounting meaning and differences with traditional accounting, to fund accounting use and frequently asked questions. 

Fund Accounting Definition

This is a type of accounting used to track the amount of money assigned to different operations. The fund accounting process ensures that the funds are used to benefit causes and purposes, not generate profit. Accounting statistics show that this system is best for nonprofits, government agencies, and associations, helping them allocate their limited resources productively, reinvest the earnings into the organization, and report to the parties that fund them.

Differences Between Basic and Fund Accounting 

The main difference between fund and basic accounting is that the former is used only by entities where accountability and not profit is the goal, while for-profit companies use the latter as the focus on profits. Organizations that the different types of fund accounting rely on contributions from supporters to keep their operations running, meaning they must be fully transparent with their supporters on where the money goes. Some contributors may ask their cash to be spent in specific ways. These contributions are known as restricted funds. Here are some examples of fund accounting:

  • An animal shelter may receive a $5,000 donation for vet bills and treatment of their animals, meaning they can’t use the cash for general maintenance, expanding their capacity, or other purposes.
  • A church donor may ask that their contribution be used for bringing food to the table of disadvantaged kids. Church fund accounting will allocate this donation in the restricted funds dedicated to that program.
  • A company may request their donation to a nonprofit that’s advocating for female empowerment to be used for supporting single moms. Nonprofit fund accounting will help the organization allocate the contributions in the right restricted fund. 
  • A school may receive a donation with a restriction to use it only for playground renovations. In the school fund accounting system, this donation will be recorded as restricted and allocated to the fund for renovations. 

Accounting fraud figures are lower when organizations use this type of accounting. This system ensures the received funds are allocated to the proper projects and causes, and supporters are honored with accountability and transparency from the organizations they support. 

Organizations that Use Fund Accounting

This system maximizes accountability and minimizes errors and fraud, especially in combination with accounting software. Let’s look at the type of organizations that use it and how the fund accounting principles play a role in their day-to-day operations. 

Nonprofits

Nonprofits, also known as 501(C)(3) organizations, are the primary users of this accounting system. They rely on donations from supporters, federal and state funding, sponsorships, and grants to accomplish their essential missions and causes. 

They use the fund accounting process to categorize their funds based on who contributed the money and whether the funds were somehow restricted. For instance, a donor to a charitable organization that supports disadvantaged youth may ask their money to go to programs that help kids stay in school by providing school materials and other related support. 

Nonprofits that rely on grants often deal with requirements and deadlines they have to meet for each grant. Fund accounting for nonprofit organizations ensures funds are used according to those requirements and within the agreed deadlines. 

Types of Funds in Nonprofit Fund Accounting

A fund is a project or purpose within an organization that needs to be tracked separately. Fund accounting for nonprofits allows organizations to separate their resources into different categories, including unrestricted, restricted, and temporarily restricted funds. To maximize accuracy and efficiency, these organizations often use fund accounting software for nonprofits.

  • Unrestricted funds can be used for any purpose or project within an organization. This could include high-priority needs, general maintenance, salaries, rent, etc. Unrestricted funds typically cover the organization’s operating expenses. 
  • Restricted funds are those dedicated to an organization’s specific project or purpose. Contributors ask the company to spend their money for a particular cause, and they must honor their request and provide proof that the money went to the right place. 
  • Temporarily-restricted funds are those received with some type of restriction by the supporter that will be fulfilled at an agreed time in the future.

Government Entities

Profit is not the primary goal of government organizations, whether federal, state, or local. Instead, they use government fund accounting to manage the resources for different projects. Fund accounting gives them a clear view of their finances and prevents overspending in certain areas. These entities must respect the Governmental Accounting Standards Board (GASB) guidelines in their accounting practices. 

Types of Funds in Government Fund Accounting

Governmental Funds

Government organizations have their own classification of funds. The governmental fund is the primary fund used for all governmental activities, excluding those that need to be recorded in a separate fund. This fund is further divided into the following categories:

  • General — used for recording all financial resources that aren’t recorded in other funds.
  • Permanent  — used for accounting resources that can be used only to support government programs.
  • Capital project funds  — used for tracking financial resources allocated for capital outlay. 
  • Debt service funds — used for recording financial resources that are set aside to cover principal and interest. 
  • Special revenue funds — used to account for the funds collected from targeted revenue sources aimed at purposes other than debts or capital projects.
Governmental Proprietary Funds

Proprietary funds are used to track government activities that have a business nature. These funds include:

  • Enterprise — used for accounting activities that involve collecting fees for goods and services from users, even when the government contributes a portion of the costs.
  • Internal service funds  — used to record financial resources from activities that provide goods or services to other funds, departments, agencies, or government entities. The collaborations are on a cost-reimbursement basis.
Government Fiduciary Funds

Fiduciary funds account for assets held in trust for the benefit of other organizations and governments. These funds include: 

  • Employee benefit trust funds and pension  — used to track the financial resources held in trust for employee benefit plans, pension plans, and other post-employment benefit plans.
  • Investment trust funds — used to account for the external part of an investment pool that a sponsoring government reports.
  • Agency funds — used to report on financial resources in a custodial capacity. These resources are received, temporarily invested, and sent to other parties. 
  • Private-purpose trust funds — used to track trust arrangements where private organizations, individuals, and other governments are beneficiaries.

Churches

Fund accounting for churches allows them to track the finances in different categories and ensure proper use of their resources. Churches may also deal with fund restrictions and grants requiring even greater accountability. They often use church accounting software to simplify their bookkeeping and eliminate errors. 

Types of Funds in Fund Accounting for Churches

Church fund accounting typically divides funds into: 

  • General fund — covers expenses related to day-to-day operation.
  • Missions fund — supports philanthropic projects and causes the church does for the community or globally.
  • Building fund — covers expenses related to landscaping, plumbing, repairs, etc.

How Fund Accounting Works 

This system relies on double-entry accounting, meaning that each event is recorded on two sides. The type of contribution determines in which bucket will be registered. The money will go into restricted or temporarily restricted funds if the donors have specific requests. If the organization can use it in any way, the resources will end up in the unrestricted bucket.

When organizations receive contributions, they record them in the chart of accounts depending on where they come from and how they are expected to be used. For example, in a church fund accounting chart of accounts, each fund has a numbered classification for easier categorization and decision-making. Donations may be recorded under the 2000s, with individual contributions under 2100s, donations in kind under 2200s, and so on. 

Instead of preparing profit and loss accounts, organizations that use fund accounting, typically nonprofits, have payment and receipt accounts, revenue and expenses accounts, and balance sheets. The payment and receipt accounts are used to record the cash receipts and payments extracted from the organization. 

The revenue and expenses accounts show how the resources are allocated and used. If income is higher than expenses, it’s called an excess; if the situation is the opposite, it’s called a deficit. The fund accounting balance sheet at non-profits is the same as in for-profit organizations, showing the value of assets and liabilities. 

Importance of Fund Accounting

Focused on accountability, this type of accounting helps organizations: 

  • Control their finances and ensure they have the necessary funds to stay operational — the allocation of resources in separate funds throughout the accounting cycle provides a clear view of their resources and expenses, allowing them to make the right decisions and take the right actions to keep things going. 
  • Keep their promises to use restricted funds as agreed — when donors ask their money to be used for e specific purpose, those resources are immediately placed under restricted funds. By making this selection, organizations can direct the donation as requested. If their funds are unorganized, the money can quickly end up elsewhere.
  • Oversee where their money is going — when organizations work on multiple projects and have various sources of contributions, fund accounting helps them ensure how much they need to dedicate to each project, how much is missing, where they need to allocate the restricted funds, the deadlines and requirements they have to meet when using grants, etc. These things can be tough to track if there isn’t a system that divides the funds into different categories.
  • Prepare reports for the IRS — 501(C)(3) (the system allows these organizations to track how resources are used and remain tax-exempt. Organizations must report their finances and show how their funds are used to the IRS by filing a Form 990 after the closing month of the accounting year.

Fund Accounting FAQs

What is fund accounting and how does it work?

This is a system that focuses on accountability rather than profitability. Nonprofits, governments, and churches are its primary users. This type of accounting divides resources into separate funds, helping organizations ensure that the money is used productively and adequately. 

Is fund accounting GAAP?

Fund accounting is one of the basic principles of governmental GAAP. 

What is a fund accountant?

Fund accountants work for nonprofits, governments, or churches, helping them manage their day-to-day bookkeeping operations. They may also provide tax and accounting services, assisting organizations in preparing financial reports for the IRS and making better decisions for their future work. Fund accountants can also refer to accountants responsible for managing mutual and institutional funds. They help these businesses manage their everyday accounting tasks and prepare financial statements. 

What is fund accounting in government?

Government fund accounting is similar to fund accounting for nonprofits but differs from traditional accounting because it’s focused on categorizing revenue from multiple sources into funds to ensure full accountability. The goal is not to maximize profits like in basic accounting but use the funds in the most productive ways to provide specific services or support causes. Fund accounting helps governments organize their resources for easy management and tight control, all while staying compliant with laws and regulations. 

What is the primary reason that governmental entities use fund accounting?

Government entities rely on the fund accounting process for control and accountability over their resources. By dividing their resources into funds, they can easily supervise how many resources are allocated to each project, control overspending, set limits, ensure limited resources are used within the agreed terms, etc. This accounting system helps them demonstrate a more significant fiscal responsibility to their resource providers. 

What comes under fund accounting?

This accounting system includes managing funds where resources from different contributors are allocated while demonstrating accountability. Some of these resources may come with restrictions requested by the donor. Grant accounting may fall into this category when used by churches and nonprofits. 

Why is fund accounting used?

Fund accounting is used to help nonprofits, governments, and churches understand how much resources they need to keep their operations going, how much money is required for specific projects, and how they are used, all while demonstrating accountability to their contributors and other users of accounting information. Categorizing resources into funds also helps them make better decisions for future actions, control overspending, ensure restricted funds go in the right direction, etc. 

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