Understanding Fund Accounting: A Key to Transparent Financial Management

What is Fund Accounting?

Fund accounting is a specialized method of accounting used by nonprofit organizations, specifically religious institutions such as churches and synagogues, based on the principle that resources should be tracked separately according to their intended use. Organizations not only need to know how much money they have made, spent, and have left over, but also how much they have made, spent, and have left over for various purposes. Fund accounting streamlines the tracking and reporting of financial resources that are earmarked for specific purposes by donors and governing bodies to ensure that resources are being allocated and spent in line with the organization’s mission and donor intentions.

What are Funds?

A fund is an area of the organization that needs to be tracked separately from general operating activity. Examples of funds may include, but are not limited to, capital project funds, endowment funds, special project funds, grant funds, etc. Each fund has a self-balancing set of accounts comprised of its own assets, liabilities, net assets, revenue, and expenses. Funds can be thought of as mini organizations within the organization as a whole. When combined, the funds create the organization’s financial statements. If you find yourself asking, “Do I need to know how much money is set aside for X purpose?” then you’ll likely want to set up a fund to (1) segregate the receipt of financial resources restricted or designated for X purpose from unrestricted or undesignated financial resources, (2) segregate the spending of restricted or designated resources from general operations, and (3) determine what is left to spend for X purpose.

Why Use Fund Accounting?

• Ensures Accountability – Fund accounting allows organizations to be transparent with donors, grantors, and the public regarding how their donations are being used in accordance with their intended purpose, as well as how the donations are benefitting the organization and the community. This is crucial for organizations that rely heavily on donations as transparency is a key factor in retaining major and recurring donors.
• Facilitates Fund Management – Many nonprofits receive restricted donations for which organizations are required to spend the donations in compliance with donor-imposed stipulations. Fund accounting assists organizations in complying with these restrictions by isolating restricted financial resources from financial resources available for spending on general operations. It also provides transparent reports to ensure that restricted funds are not accidentally used for other purposes.
• Enhances Budgets and Promotes Discipline – Fund accounting allows organizations to manage and allocate their financial resources effectively by ensuring expenditures align with the specific purpose of each fund. By tracking expenditures within each fund, organizations can ensure they do not overspend allocated budgets and will be able to track expenditures against levels of available financial resources.
• Enhances Reporting – By building funds into your chart of accounts, reports outlining the financial resources available for spending for various purposes can be generated by the click of a button in your accounting software.
• Reduces the Need for Subsidiary Schedules Outside of the Accounting Software – Nonprofits that have not implemented fund accounting typically use Excel or other spreadsheets to track additions and releases of donor restricted money. Fund accounting reduces the need for subsidiary and manual reports because all activity is already being captured in the fund’s chart of accounts. This streamlines the accounting function and allows for real-time reporting.

Fund Accounting Best Practices

1.) Use Accounting Software Designed for Fund Accounting

Choosing an accounting software application that fits the needs of your organization is important to effectively implement fund accounting. Key features to look for in accounting software include fund segregation, grant management, detailed financial reporting, budgeting tools, donor management, integration with other systems, a user-friendly interface, and scalability. While general accounting software can be adapted to meet the needs of a nonprofit organization, such as using classes in QuickBooks to segregate fund activity, specialized nonprofit accounting software, such as Fund EZ and NetSuite, offer additional functionalities that are better suited for large organizations with various funds.

2.) Categorize Funds Based on Purpose and Source

Separate funds should be created for each unique purpose. Activity not designated or restricted for a specific purpose should be recorded in a general fund. Keep in mind that too many funds with overlapping purposes can overcomplicate and add complexity to your chart of accounts. Clear documentation should be retained to support the receipt of restricted donations and their intended use.

3.) Avoid Physically Segregating Assets by Fund Unless Legally Required

Although each fund has its own set of accounts with assets, liabilities, and a fund balance, creating a separate bank account for each fund is unnecessary (unless required by donors restricting funds) and adds complexity. For example, all cash can be maintained in the general fund checking account. Money collected for specific purposes will be captured as an asset in the restricted fund through an interfund journal entry to move financial resources between funds without having an impact on the organization’s financial statements as a whole.

4.) Regularly Review Fund Balances

Accounting personnel should review fund balances and activity on a regular basis to ensure that what is being reported appears to be in line with the operations of the organization. For example, if the organization recently received a large donation to be spent on a specific project, but that project’s fund balance does not reflect the donation, an interfund journal entry may be needed to move the financial resources from the general fund to the project’s fund.

5.) Consider Providing Donors with a List of Projects to Support

If a donor stipulates that their donation be used for a purpose for which there is not already a restricted fund set up, a new fund will need to be created. By providing donors with a list of projects to support, (1) they may be more likely to donate due to awareness of how their donations will be spent (2) they will choose to donate to a fund that already exists and for a project that your organization is promoting, eliminating the requirement to create a new fund.

Fund accounting is an essential tool for nonprofit organizations and specifically religious institutions that manage restricted and Board-designated funds. By categorizing funds based on their purposes and restrictions, fund accounting enhances transparency, accountability, and compliance, ensuring that funds are used as intended. While it can be complex and resource-intensive, with the right systems in place, fund accounting can greatly improve an organization’s financial management and performance.

This article was featured in our Religious Organization Guide. View the guide and more related topics here!