A non-profit organisation and other government-related projects are required to show how money is spent rather than provide a report on how much profit was earned. This guide will discuss how fund accounting works, what it is, why non-profits and government entities require it. We will also touch on some basic principles, a definition of terms, how non-profits benefit from this system, how technological advancements can help non-profits, and other matters related to fund accounting.
I. What is Fund Accounting?
Fund accounting is a type of accounting method or strategy that puts an emphasis on accountability rather than on tracking the generation of profits. It is used by organisations that exist to achieve a specific mission or purpose other than to make a profit. These entities are called non-profits or not-for-profit organisations, such as government agencies, churches or other religious affiliations, hospitals, schools and the like. Fund accounting as a methodology is unique to non-profits.
What is a Fund?
Funds are defined as a self-balancing set of accounts, wherein each fund represents the amount of money that has been set aside to achieve a specific goal within an organization. These areas need to be tracked separately from other expenses.
Why Fund Accounting Uses Several General Ledgers
To show a detailed account of how and where the money is spent, several general ledgers are maintained instead of a single general ledger, as opposed to a single ledger which is used by for-profit businesses. As previously mentioned, one way to distinguish this accounting methodology from profit-oriented businesses is in the way it uses its ledger: fund accounting uses multiple general ledgers or a set of self-balancing accounts that are segregated for specific purposes among various funds.
II. Why Do Nonprofits Need Fund Accounting
Fund accounting is unique to nonprofits. It is a method that allows both donor and recipient to keep track of the resources and ensure that such resources go towards achieving their designated purpose. Here are the main reasons why fund accounting is the best method to be used by non-profits.
By keeping each fund separate under specific categories, the inflows of donations, endowments and resources can be tagged appropriately. Using fund accounting methods will also show how the funds earmarked for a specific project is used.
Nonprofits enjoy special privileges in the form of tax breaks and other government concessions, but they can only continue to benefit from it for as long as they remain compliant. They must abide by the rules stipulated in forming their organisation; otherwise, such privileges will be removed.
3. Measure Progress
Applying fund accounting principles in a non-profit setting allows those who are managing it with a systematic method that shows how goals are being met. By identifying the revenue coming in and immediately investing it towards the fund it was earmarked for, it’s easier to track how close they are to meeting a specific purpose.
4. Funding Sources
Funds can come from various sources, and each one must be properly categorized before being placed in its correct fund. Designating the inflows of resources from the get-go lessens the chances of making accounting mistakes as well as ensure that no compliance issues or problems are encountered.
The main sources of income are the following: Donations and gifts, grants, equity capital and loan financing, contracts, and trading.
5. Donations and gifts
These funds are sourced from any of the following entities: individuals, companies, charitable trusts, foundations, fundraising events, or other philanthropists who want to leave a legacy after they pass away. These funds in general can be applied in any way a non-profit chooses to use it, unless it was given in response to a specific purpose or campaign. It is also a good way to receive tax breaks and other privileges to reduce overhead.
These types of funds usually come from the public sector such as charitable trusts and foundations, and the money coming from these sources do not have to be repaid. Grants are also typically tax exempt, and usually come with a list of conditions before it can be applied. Such conditions are those related to following specific results or outputs, achieving previously agreed milestones, returning unspent funds, and strict reporting requirements that show how the funds are used and how the project is progressing.
7. Equity Capital
The source of these funds come from external investors who require a permanent stake in the organization. Typically used by social enterprises, an equity investor shares in the rewards of an organisation once it achieves some measure of success. Investors of this type don’t always make monetary contributions; they might also choose to provide services or expertise as a form of donation.
8. Debt Financing
Debt or loan financing is used by organisations that borrow money from various lenders in order to fund their projects. These loans have to be repaid, usually with interest. Some lenders might also require collateral for secured loans, although unsecured debt financing can also be granted, usually with higher interest.
This fund source is secured through a formal written agreement between two parties. Both parties are bound by the terms covered by the contract and by contract law. If either one fails to do what is included in the contract, then they must abide by the consequences that is written on the document.
A contract is considered to be a commercial agreement, and as such the income from it may be subject to Value Added Tax (VAT) or other taxes.
Nonprofits can also choose to engage in business-like activities to raise funding. They can do so by selling goods and services to the public or other organisations. Trading provides organisations with the most flexibility and freedom as to how funds are used and appropriated, because the source does not come from a benefactor or grant with a list of conditions attached to it.
III. Basic Principles of Fund Accounting
To retain a nonprofit’s integrity and the donor’s confidence, the basic principles of fund accounting focus on the recording and reporting of activities as prescribed by the Financial Accounting Standards Board (FASB). Following these guidelines assures donors that endowments received are disbursed properly and are aligned with any agreed upon conditions and limitations, including the nonprofit’s overall mission.
- The nonprofit receives donations or gifts on an unconditional and non-reciprocal basis.
- A grant that includes a donor-imposed condition or restriction will have a set of requirements on how the funds can be applied. Such conditions must be agreed upon by both parties and its limitations followed for the grant to be valid.
- Funding received by a nonprofit are technically considered to be revenue, and will be booked as Contributions Received.
- All Contributions Received are recorded at their fair value or the current asking or selling price in the market. Otherwise, other available valuation techniques will be used.
- If a fair valuation for a donated object is not established based on available valuation techniques, it will not be recognized as an asset.
- Income generated from a donation will be recognized as part of that donation received from the donor.
- Donations or gifts without donor-imposed conditions are booked as Contributions Received-Unrestricted Support. Donations of long-lived assets will also be booked under Unrestricted Support, unless the nonprofit has an existing policy on how these types of assets will be recognized and use for.
- The nonprofit must maintain consistent and accurate financial reports.
- Donation pledges that are due in the future are booked under Restricted Support. These fund sources cannot be used in the current year’s activities without explicit permission from the donor.
- Any donated assets that are not recorded in the books of account will be recorded as Contributions Received, not capitalized asset.
- All expiring donations that occur within donor-imposed restrictions are booked within the same accounting period as the lapsed date; expenses accrued but paid after expiration will still be borne by the donor.
- Donations in the form of skills or professional expertise must abide the regulations outlined under FASB 116.
- Accrual method is used for booking disbursements.
- Any expenses incurred must be clearly defined and matched to the project or program the cost falls under.
- Operating costs must be proportionately matched with contributions received when presenting separate reports to donors.
Assets and Liabilities in Fund Accounting
Because nonprofit organizations are not profit-oriented businesses, these entities do not use capital. Any funds acquired fall either assets or liabilities, and are shown in the balance sheet.
Assets are bought by the nonprofit organization with money from funds acquired from donations and other sources. It may either be liquid assets (i.e. cash) or fixed assets such as land, building, machinery, and the like.
Liabilities are financial obligations that may be in the form of loans or collected but unused funds.
Expenses and Revenue in Fund Accounting
All expenses and revenues are used towards the operating costs of achieving a specific nonprofit’s mission or purpose. Both are recorded and placed into the segregated funds to which each have been assigned. Excess revenue are booked as surplus to fund new projects, and will be recorded as liabilities in the accounting books.
IV. Benefits of Fund Accounting
Due to their unique corporate set-up, nonprofit organisations are required to create detailed reports about how and where donations are disbursed. It can be challenging to keep track of all the funding sources, which is why fund accounting helps nonprofits to properly manage funds while remaining compliant. Some of the benefits include:
1. Uncomplicated auditing
Fund accounting makes it easier to retrieve data quickly. Instead of having to go through various receipts to deliver the required reports, all these pieces of information can be referred to in the books. All data can be accessed in one place, making the auditing process faster and easier.
2. Better Compliance
Nonprofits are typically exempt from income and property taxes, but some areas impose a threshold so that any excess needs to filed as taxable income. Using fund accounting methods will help accountants keep track of expenditures and inflows, making it easier to trace any excesses and do the proper filing as needed.
3. Easier fund planning
Seeing how and where funds are going makes it easier to decide what the next course of action will be. This makes it easier to create strategies for the next fund raising event or other programs in the pipeline.
4. Increased Efficiency
When all data points are recorded properly, disbursements are implemented faster. Programs can be finished at a faster pace and within the projected timelines.
5. Clearer accountability
Clear programs and clear descriptions allows both donors and nonprofits to see how and where funds are going. Fund accounting also allows everyone to see how a specific project is progressing, and implement counter-measures to correct mistakes, if any.
V. Important Fund Accounting Terms
These are resources, assets, and funds used as part of the normal operations of a nonprofit organization. Current funds can either be restricted or unrestricted; restricted funds use current assets subject to external limitations set by donors, while unrestricted funds can be used at the discretion of the nonprofit’s governing board.
Refers to the normal, day to day activities of a nonprofit organization. Uses current funds for transactions and other proceedings.
Refers to funds used that fall under loan programs, endowment activities and capital outlay activities.
A loan program provides financing for nonprofits by borrowing money from various lenders. The loan proceeds are used to fund their projects.
These are activities by the nonprofit organization that use endowment funds. Endowment funds are donations that include a stipulation that states only income earned from the fund can be used while the original nation amount remains intact either in perpetuity or for a specified time period.
Capital Outlay Activities
Refers to the nonprofit organisation’s activities that pertain to money spent to maintain, acquire, or repair current assets, including liquid and fixed assets.
These are used to account for resources used by the nonprofit in a purely custodial capacity on behalf of other entities such as government agencies, private organisations or individuals. (Source)
These are funds that are held and disbursed following the donors specific instructions.
VI. How Technology Helps Nonprofits in Fund Accounting
Profit oriented enterprises have long embraced the numerous advantages that technology has done to increase efficiency in business. Such benefits can be applied for nonprofit organisations as well. Here’s how.
Fund accounting software provides a competitive advantage when applying for grants
Nonprofits that invest in fund accounting software will have the ability to provide the necessary reporting required when applying for grants. Grant donors that provide additional conditions or limitations may need specific reports that can easily be created with the right software system. A reliable accounting system also assures the funder that the nonprofit is able to report in a fast, efficient manner once funds are given.
Online fundraising systems widens the avenues for sourcing funds
Donors want an easy way to give, and what could be simpler than giving donations through mobile devices and smartphones? Mobile-giving increases your donor base and allows nonprofits to meet funding raising goals in a timely manner.
Mobile devices allow real-time access to important information anytime, anywhere
Those who work for nonprofits now have the ability to access their fund accounting software on their mobile devices. This means that they can update vital information on their fund raising activities, access, edit and verify data for reporting purposes, and share documents with others within the organization.
Mobile apps and software increase efficiency
Instead of being bogged down by countless data and numerous paperwork, the latest technologies frees up time and resources so that more of it can be delegated toward important fund-raising and mission-related tasks.
Going paperless reduces overall cost
Using online systems reduces paper, ink, and labor costs. It also promotes efficiency by streamlining documents and processes into a single software system that is available to anyone who needs it.
Fund accounting principles allow nonprofit organisations to properly manage donations in an efficient, transparent manner. Funds can come from a variety of sources, and it’s important to keep track of each one to ensure that donations are used appropriately. As such, it has unique identification and reporting challenges that will help prevent the co-mingling of funds. It is a critical method for easier and better institutional and managerial reporting, one that will streamline operations and help nonprofits achieve their overall mission.