Nonprofit accounting differs from for-profit accounting in many ways. One very important distinction is the necessity of fund accounting in the nonprofit world. Although at first it may seem like a nuisance to track money by its purpose and restrictions, it is a necessity to ensure you know whether or not specific money was used according to its designated purpose.
There’s more to it than just a bookkeeping quirk in the nonprofit world. Not only is it necessary, but it is also required in order to meet donor and grant stipulations and expectations. It’s also important for nonprofits to remain in compliance with the accounting guidelines auditors use.
Let’s take a look at fund accounting: what it means and how to make it easier for your organization to adhere to fund accounting best practices.
What Is Fund Accounting?
Fund accounting is a method of bookkeeping used mainly by governments and nonprofit organizations to track money based on its purpose. Instead of focusing on profit, it separates financial resources into different funds so each one can be monitored to ensure the money is used only for its intended goal.
Common funds in nonprofit fund accounting typically include a general operating fund, which holds unrestricted money for everyday needs, restricted grant funds that must be spent on specific programs, capital campaign funds used for major building or equipment projects, endowment funds where the principal is kept permanently and only earnings can be used, and board designated funds that the board sets aside for particular purposes even though they remain unrestricted.
How many funds your organization has compared to others can vary significantly. Small nonprofits may have only one or two funds, while larger, complex organizations with multiple projects may have many funds to track. Tracking a general operating fund and donor-restricted funds is standard practice. Depending on an organization’s specific activities, it may also track specialized categories like endowments, capital or plant funds, and agency or custodial funds to ensure transparency and accountability.
Restricted versus Non-Restricted Funds
As the name implies, restricted funds come with stipulations on how the money can be spent, while non-restricted funds come with no (or few) strings attached.
Why put restrictions on funds? Because some donors and grantors want to be sure the money given to an organization is spent for a particular purpose. The restrictions imposed on such funds may limit their use to specific projects, such as a capital improvement project or another special activity. A good example may be a local animal shelter that accepts a bequest from long-time supporter, Kitty Dogood, intended solely for the shelter’s expansion project. In this case, the funds are restricted to the capital improvement project. They cannot be used to pay employees, print direct mail fundraising solicitations, or any of the many other projects the shelter has underway.
Restrictions, however, may or may not be permanent, so it’s important to note the parameters for each fund. Some may be temporary; once the conditions of the donation are met, any leftover funds may be unrestricted. Some are conditional and tied to specific performance objectives that must be met before revenue can be recognized. Others are permanently restricted, which means the principle cannot be used; the fund must be maintained indefinitely. The latter is more common in educational or other endowment scenarios.
Using our animal shelter as an example, we can more easily understand temporary and conditional restrictions. In our example, Kitty Dogood gives $100,000 with a donor restriction specifying it can only be used for the new kennel expansion. The shelter spends $99,000 to successfully complete the project. The remaining $1,000 cannot be absorbed into general operations; it remains restricted to the project unless Kitty gives explicit permission to redirect it or the original agreement allowed for general use of surpluses.
Now let’s look at a conditional gift. Kitty promises the shelter $100,000 but includes a measurable barrier: the shelter must successfully rehome 100 cats by December 31st. If they adopt out 100 cats, the condition is met, and the shelter recognizes the $100,000 as revenue. If they only adopt out 99 cats, they have failed to meet the condition, and they cannot recognize the revenue.
Use Software for Easier Tracking
There’s a lot more to fund accounting than this simple introduction, and many nonprofits, unfortunately, make mistakes. One way to prevent mistakes and keep fund accounting clear is by using software expressly designed for nonprofit organizations. Many common off-the-shelf small business accounting packages lack the details needed to handle fund accounting. Using purpose-built nonprofit accounting software can greatly simplify things and ensure accuracy.
True fund accounting systems like MIP Fund Accounting or Sage Intacct track necessary entries on the balance sheet (cash) by each donor restriction as well as the income statement. Software like Quickbooks or QBO allows for classes or tags to be attributed to the income statement only and requires manual entries for the fund accountant and other accounting staff. And you know what we’ve said time and time again about manual data entry: the more you have to type into the system, the greater the chances of errors. Because true fund accounting automates much of the process, it reduces the risk of data entry errors and makes it much easier to track restricted versus unrestricted funds.
If you need a true fund accounting system that makes your accounting entries and reporting easier, then contact us at Welter Consulting, LLC.
Welter Consulting
Welter Consulting bridges people and technology together for effective solutions for nonprofit organizations. We offer software and services that can help you with your accounting needs. Please contact us for more information.
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