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Get the basics on this nonprofit essential

Fund accounting can be confusing, especially if you have a limited finance or accounting background. Still, it's a nonprofit essential. Here's an introduction on fund accounting and why it matters.

What is fund accounting?

Fund accounting is an accounting system used by nonprofits, governments and government agencies to track accountability (rather than profitability).

With fund accounting, all income is dedicated to a particular purpose. These purposes determine the specific types of funds. Small nonprofits might have only one fund, while nonprofits with endowments and donor-restricted funds might have several funds or more.

If your nonprofit is big enough to use the accrual method of accounting, then it's big enough to practice fund accounting.

What are some typical types of funds?

At minimum — and in compliance with generally accepted accounting principles and IRS Form 990 — fund accounting requires general groupings of unrestricted, temporarily restricted and permanently restricted funds.

For example:

  • Unrestricted funds. These are kept on hand for general expenses, including salaries, program administration, facilities care and upkeep, and so on.
  • Fixed-asset funds. These are often subsets of the unrestricted general fund. Fixed-asset funds are set aside to make long-term fixed payments on things such as real estate, rent and equipment. Because the payments are predictable, fixed-asset funds can be separated from the general fund.
  • Restricted funds. Restricted funds come with specific donor restrictions, whether temporary or permanent. These funds may not be accessible before a certain amount of time has elapsed, or they may be earmarked for specific programs. For instance, restricted funds donated to a literacy program might be dedicated to purchasing books — which means that the funds must be kept separate from funds used to pay teachers or cover other expenses.
  • Endowment funds. These are often a subset of restricted funds. The principal of any endowment is permanently restricted, while the income may be restricted to specific programs, such as funding scholarships.
  • Board-designated funds. Board-designated funds are created by moving unrestricted funds into a new category designated by the board of directors for a particular use. These funds resemble restricted funds, but their use is determined by the board.

How many funds do we need?

Aplos, a firm that specializes in nonprofit accounting, says you need a dedicated fund if you ask yourself: "Do I need to know how much money I have set aside for _______?"

So, here's the confusing part. Each fund is, in some ways, like its own business within a business. Each fund has its own accounting ledger, complete with its own assets and liabilities. Given the complexities, you'll want to be careful about setting up too many funds.

For example, you don't necessarily need separate funds for every activity or program. You'll just need to be clear about what funds you can and can't utilize.

How do we get started?

Various types of accounting software support fund accounting, so you don't necessarily need to build a system from scratch — and an inexpensive or free cloud-based accounting solution may be ideal if you have a small organization and few funds. Similarly, various low-cost options provide basic fund accounting functionality. Be sure to review your organization's requirements before choosing a specific type of accounting software.

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Disclaimer

MissionBox editorial content is offered as guidance only, and is not meant, nor should it be construed as, a replacement for certified, professional expertise.

Disclaimer

References

Aplos: What is fund accounting? by Alex Acree (2014)

AccountingEDU.org: Fund accountancy

Araize: Why do nonprofits need fund accounting? by Joseph Scarano (2015)

References

Author

Baltimore-based writer and educator