Fund Accounting in Non-Profit Organizations

What is Fund Accounting in Non-Profit Organization?

Government and non profit organizations are required to organize their accounting systems on a fund basis. A fund is defined as an independent fiscal and accounting entity with a self- balancing set of accounts recording cash and/or other resources together with liabilities, obligations, reserves, and equities which are segregated for the purpose of specific activities to achieve certain objectives in accordance with special regulations, restrictions and limitations. Thus, each type of fund is a sub accounting entity for the purpose of internal as well as external reporting of financial estimates, budgets and performances to the stakeholders. Not-for-profit organization uses it. Which are legally responsible for ensuring that certain funds are used only for such specific purpose for which the same have been contributed by the donors. Hence, there is a need for separate accountability whenever, a Not-for-profit organization receives such restricted contributions.

Fund Accounting is the method by which non-profit organizations maintain multiple funds (activities) within one set of records. These funds are typically the General (Operating) Fund, Temporary Restricted Funds and Permanent Restricted Funds. Fund Accounting is a system of accounting in which separate records are kept for:
  • Resources donated to an organization that are restricted by donors or other outside parties for certain specified purposes or use.
  • Portions of an organization's unrestricted resources that the board has set aside for some specified future use.
  • All other unrestricted amounts.

According to CPAs Gross. Larkin. Bruttomesso, and McNalley, "Financial and Accounting Guide for Not-For-Profit Organizations', the definition of these three terms are as follows: 

  1. A fund is any part of an organization for which separate account records are kept. 
  2. Assets are valuable things owned or controlled by the organization. Typos of assets include cash, investments, property, and amounts owed to the organization. 
  3. Fund balance is the mathematical number obtained by subtracting total liabilities from total assets; It is a numerical representation of the not worth of the organization, but has no other significance. Fund balances do not exist except on paper unlike assets. They have no intrinsic value and cannot be spent. Both assets and fund balances (as well as liabilities, revenues, and expenses) are part of the accounting records of a fund.

Objectives of Accounting for Non Profit Organizations

Following are the objectives of accounting for Not-for-profit entities: 

  1. To show flow of resources and how the resources have been spend based on certain restrictions such as legal, donor or other requirements. Therefore, to reflect this level of detail accounts are set up to account for the type of revenue or expense, type of fund, and type of grantor, department etc. Due to this level of detail, many nonprofit organizations accounts have several digits to identify general ledgers accounts. departments, grants, funds etc. 
  2. To compare the actual financial results of operations with organization's approved and legally adopted budget.
  3. To assess financial performance of the entity during the current accounting year.
  4. To determine the compliance with rules, regulations and laws under which Not-for-profit accounting system is operating.
  5. To evaluate the organization's efficiency in spending money on meeting the assigned tasks and responsibilities.

Features of Fund Accounting

Following are the features of fund accounting in non-profit organizations
  1. This system of accounting is used by Not-for-profit organizations of both types, viz., Governmental and Non-Governmental.
  2. Each fund is a separate entity for accounting and accountability. 
  3. Each fund has to balance for income received and expenditure made in accordance with the restrictions placed on their use. 
  4. Budget approval and appropriation is the basis of income generation and spending. 
  5. Despite restrictions being placed on 'the use of specific funds, there will always be a general fund from which organizational expenses will be passed. 
  6. In addition to fund accounting entities, there will be memo-account groups which disclose the assets required and liabilities incurred. In case of large borrowings, organization may choose to crate "Debt Fund". It is to be noted that cash generated to raising of debt is treated as revenue, raising of debt is treated as revenue.

In order to better understand the mechanism of accounting under Fund Accounting System, the relationship of various accounts can be expressed as follows:

Assets+ Expenditure + Encumbrances + Estimated revenues + Interfund Claims Liabilities + Appropriations +Revenues +Interfund Obligations+ Fund Balance

Types of Funds for Non Profit Organizations

Following are the most commonly used group of funds:

1) Current Unrestricted or General Funds: 
This fund is created to carry out the general activities and is also called "Operating Fund", "Unrestricted Fund" or "General Fund". This fund does not contain any restrictions on the use of assets contributed to it. This fund is used for the attainment of objectives for which the organization was established. All unrestricted grants, gifts, contributions and incomes are recorded in this fund. If the organization does not receive any restricted fund, this fund would show all activities of the organization. For example, annual membership fee, non-specified gifts and grants, contributions.

For the purpose of presentation in the income and expenditure account and the balance sheet the unrestricted funds can be further classified into three categories viz, corpus, designated funds and general fund.
  • Corpus: Corpus refers to funds contributed by founders/promoters generally to start the NPO. They we non-reducible funds which can however be increased by additional contribution by, the founders promoters to further the objects of the NPO. These funds need to be distinguished from funds which are in the nature of founders/promoters contribution, which are grants given by contributors other than founders/promoters with reference to the total investment in an undertaking or by way of contribution towards outlay. No repayment is ordinarily expected of such grants.
  • Designated Funds: Designated funds are unrestricted funds which have been set aside by the trustees/management of an NPO for specific purposes or to meet future commitments. Unlike restricted funds any designations are self-imposed and are not normally legally binding. The NPO can lift the designation whenever it wishes and reallocate the funds to some other designated purpose. 
  • General Fund: Unrestricted funds other than 'designated funds' and 'corpus' are a part of the 'General Fund'.

2) Temporary Restricted Fund/Current Restricted Fund: 
This fund accounts for contributions received by the Not-for-profit organization for carrying out those activities for which such contributions are made. This fund is also called "Donor-restricted Fund" or "Fund for Specified Purposes". For example, a school may receive 1 Lakh for a program of Public Education for Drug Abuse. In this case, this is a restricted fund, which is to be used for promoting Drug abuse program. Such amounts are recorded in the specific funds. In the given example, the amount will be recorded in Drug Abuse Fund Account. Often the Current Restricted Funds are relatively small in amount and are used either in the current year or in the following year. Usually, all Current Restricted Funds are clubbed under one head.

3) Permanent Restricted Funds: 
Permanently restricted fund is also popularly known as "endowment fund." In most cases the organization uses investment income and leaves the principal intact. Permanent Restricted Funds are used for receipts when the principal can never be used or disposed of, even if the original purpose no longer applies. In many cases, the dividends or increases in value can be used for a specific purpose or for general use. If the dividends or increases can be used for a specific purpose, that money would be considered Temporary Restricted. If the proceeds can be used for general use, then the dividends or increases carry no restriction at all and would be placed in the General Fund. For example, a University may receive 1Lakh for awarding gold medal to the meritorious student. In this case, the endowment for Gold Medal is a restriction and hence, the expenditure on the Gold Medal will be less than or equal to the interest income arising from the investment In case of surplus, the same will be invested and added to the fund.

4) Fixed Asset Fund: 
The gifts and contributions received by Not-for-profit organizations for the acquisition/creation of assets are recorded in "Fixed Assets Fund" Building & Equipment Fond"/ "Plant Fund". Often amount spent are funded by both donor restricted and unrestricted gifts. This fund will also include unspent Building Fund contributions. Creating a separate fund and thereby indicating that this amount is not available for day-to-day operations of the Not-for-Profit Organizations. Sometimes, the amount of unrestricted gifts/general fund may be transferred to another fund. Such transfer of amount is known as Inter fund transfer. Depreciation is shown in the Plant Fund or in the unrestricted fund. In the latter case, an amount equal to the depreciation charge is transferred from the unrestricted funds to Plant Fund.

5) Other Types of Funds: 
Other specialized fund groupings reflect either donor restrictions or board decisions regarding the use of unrestricted resources. For example, colleges and universities may have loan or scholarship funds, custodian or agency funds, annuity and life income funds, and retirement of indebtedness funds. Usually the title describes the nature of these resources and their intended use.
Occasionally a donor will give such a large sum of money, often for endowment purposes, that the board will want to create (or the donor asks the board to create) a separate fund bearing the name of the donor (or some other name specified by the donor), rather than merely burying this separate fund in the financial statements with similar funds. The principal reason for this separate reporting is to be able to track and give the donor public recognition for a substantial gift.

Financial Statement of Non Profit Organizations 

1) Income and Expenditure Account: 
It is an income statement of a non-profit organization. All revenues (or incomes) and expenditure (or expenses) of a non-profit organization are shown in income and expenditure account

2) Balance Sheet or Statement of Financial Position: 
A statement which presents assets, liabilities and capital of an entity. All in all, it represents the financial position of an entity.

3) Cash Flow Statement or Statement of Cash Flow: 
A statement that presents the cash and cash equivalents receipts and cash payments during a specific accounting period. 

Accounting policies adopted while preparing financial statements and explanatory notes as to how the financial statements were prepared, what methods/procedures were utilized in the preparation of financial statements.