81. Fund Accounting for Nonprofits: How It Works
Fund accounting is a specialized accounting system used by nonprofit organizations to track and manage financial resources more effectively. It ensures that funds are used for their designated purposes and helps demonstrate financial accountability to donors, grant makers, and other stakeholders.
Here’s a breakdown of how fund accounting works for nonprofits:
Fund accounting is a method of accounting that focuses on separating resources into categories (funds) based on their purpose and any restrictions imposed by donors or grantors. Each fund is treated as a separate entity, and the organization ensures that each fund is used only for its specific purpose.
Nonprofits must comply with legal requirements and maintain transparency about how they use donated funds. Fund accounting helps:
Track the use of restricted and unrestricted funds.
Ensure that donations and grants are used according to the donor’s intentions.
Demonstrate accountability to donors, funders, and regulatory bodies.
Nonprofits typically use different types of funds, which fall into two broad categories: restricted and unrestricted funds.
Restricted Funds:
These funds have specific instructions or conditions placed by the donor or grantor about how they should be used.
They are further divided into temporarily restricted (funds that must be used within a certain period or for a particular project) and permanently restricted (funds that must be maintained in perpetuity, with only income being used for a specific purpose).
Example: A donor gives $10,000 for a specific education program; this would be recorded in a restricted fund and only used for the education program.
Unrestricted Funds:
These funds can be used for any purpose the organization sees fit, without specific restrictions from donors.
Example: General operating funds that a nonprofit can use for any of its programs or administrative costs.
Designated Funds:
These are similar to restricted funds but are designated by the nonprofit’s board of directors for a specific purpose, not a donor. The designation can be changed by the board.
Tracking and Reporting: Each fund is tracked separately, with its own accounting records, balance sheet, and income statement. This ensures that the nonprofit adheres to the restrictions set on the funds and that the organization can provide transparent reports to stakeholders.
Separate Fund Statements: The nonprofit prepares financial statements for each fund to ensure that the donor’s or board’s instructions are met. For instance, a nonprofit might prepare an income statement for restricted funds to show how they were spent on a specific program.
Fund Balances: Fund accounting also tracks the fund balances for each account to monitor how much is available for future use. It helps the organization ensure it has enough resources to continue projects in the future while maintaining compliance with donor restrictions.
Statement of Financial Position (Balance Sheet): This statement reports the assets, liabilities, and net assets of the nonprofit, broken down by fund type (restricted and unrestricted).
Statement of Activities (Income Statement): This shows revenues, expenses, and changes in net assets for the period. It also categorizes income and expenses by fund type (restricted or unrestricted).
Statement of Cash Flows: This is similar to a for-profit organization’s statement, showing the flow of cash in and out of the organization. Nonprofits can also categorize cash flows by fund type.
Nonprofits must ensure that funds are used as directed by donors or grantors. The key to compliance in fund accounting is:
Monitoring: Regular monitoring of fund balances to ensure that restricted funds are not used for unrestricted purposes.
Reporting: Clear and accurate reporting of how restricted funds are spent, typically on a project-by-project basis.
Internal Controls: Implementing internal controls to prevent mismanagement or misuse of funds, ensuring that only authorized personnel have access to fund details and that there are checks and balances in place.
Transparency and Accountability: Fund accounting helps ensure that the organization uses funds in compliance with the wishes of donors and adheres to regulatory requirements.
Simplifies Financial Reporting: By separating funds into specific categories, it simplifies reporting and auditing processes for both internal management and external stakeholders.
Supports Strategic Planning: It helps nonprofits plan their activities effectively, as they can easily track the availability of resources and identify any financial gaps.
Complexity: Managing multiple funds can be time-consuming and requires detailed tracking to ensure compliance with restrictions.
Increased Reporting: Nonprofits must produce separate reports for each fund, which may increase the workload for accounting teams.
Fund accounting is crucial for nonprofit organizations to maintain accountability, transparency, and compliance with donor restrictions. It helps nonprofits ensure that funds are used properly and provides clear financial reporting that builds trust with donors and regulatory bodies. By separating funds based on restrictions, nonprofits can manage their resources more efficiently and demonstrate their commitment to fulfilling their mission.