What Is Fund Accounting and How Does It Work?

Fund accounting is a specialized financial management method used by organizations that do not operate for profit. It tracks financial resources based on specific restrictions or objectives, ensuring money is managed and reported according to its intended use. This system emphasizes accountability and the proper stewardship of funds. It contrasts with accounting practices in businesses that aim to maximize earnings for owners or shareholders. This approach is essential for demonstrating transparency to donors, grantors, and the public. It confirms resources are applied consistent with their designated purposes.

Core Principles of Fund Accounting

Fund accounting segregates resources into distinct “funds.” Each fund operates as a separate accounting entity, maintaining its own accounts for assets, liabilities, revenues, and expenses. This separation ensures financial resources are used strictly for their intended purposes.

Accountability is a primary principle, taking precedence over profitability. The goal is to show how resources were managed and spent responsibly, demonstrating compliance with external restrictions and internal policies. Stewardship is also central, requiring organizations to safeguard assets and use them efficiently to fulfill their mission.

Fund accounting categorizes resources by restrictions. Unrestricted funds can be used for any mission-aligned purpose. Restricted funds have temporary restrictions, expiring over time or upon meeting conditions, or are permanently restricted, where the principal must be maintained indefinitely, such as endowments. This classification ensures donor intent is honored.

Who Employs Fund Accounting

Fund accounting is primarily used by organizations with public service missions, where demonstrating accountability for resources is paramount. Governmental entities, from federal agencies to state and local governments, rely on this method to manage taxpayer money. It helps them track spending and ensure compliance with legal mandates.

Non-profit organizations, including charities, educational institutions, healthcare providers, and religious organizations, also widely employ fund accounting. These organizations often receive funding with specific usage restrictions. The adoption of fund accounting by these entities stems from the need to maintain public trust and demonstrate compliance. For non-profits, it ensures adherence to donor-imposed restrictions and regulatory requirements. For governments, it provides transparency regarding the use of public funds. This system allows them to provide detailed reports to stakeholders, confirming funds are allocated and expended according to their designated purposes.

How Fund Accounting Differs from Commercial Accounting

Fund accounting fundamentally differs from commercial accounting in its primary objective. Commercial accounting focuses on generating profit for owners, emphasizing profitability and financial performance. Fund accounting prioritizes accountability and stewardship of resources to fulfill a mission.

A significant distinction lies in the concept of equity. Commercial entities report “owner’s equity,” representing the owners’ stake. Fund accounting uses “fund balance” or “net assets,” representing the residual interest in a fund’s assets after liabilities are settled. This reflects the non-profit nature, where any surplus is reinvested into the organization’s mission.

Revenue recognition also differs, particularly concerning restricted revenues. Fund accounting categorizes revenues as restricted or unrestricted based on donor stipulations, tracking these restrictions to ensure funds are spent as intended. Commercial accounting recognizes most revenues when earned, regardless of external usage limitations.

Commercial accounting focuses on measuring profitability and financial health. Fund accounting centers on demonstrating how resources are managed and expended in adherence to specific purposes. Both use accrual accounting, but fund accounting often includes budgetary control mechanisms like encumbrances to track spending against approved budgets.

Key Financial Statements in Fund Accounting

Non-profit organizations prepare financial statements. The Statement of Financial Position, similar to a balance sheet, presents the organization’s assets, liabilities, and net assets at a specific point in time. Net assets are classified as without or with donor restrictions, reflecting fund availability.

The Statement of Activities, comparable to an income statement, reports revenues, expenses, and changes in net assets over a period. This statement details how the organization generated and used resources, showing revenues from contributions, grants, and program services, and expenses by function. The Statement of Cash Flows reports cash inflows and outflows, categorized into operating, investing, and financing activities, providing insights into liquidity.

Governmental entities, guided by the Governmental Accounting Standards Board (GASB), present both government-wide and fund financial statements. Government-wide statements, using accrual accounting, include the Statement of Net Position and the Statement of Activities, offering an overview of the government’s financial performance. Fund financial statements provide detailed information for specific funds: governmental, proprietary, and fiduciary. Governmental funds use a modified accrual basis of accounting, focusing on current financial resources. Their statements include a Balance Sheet and a Statement of Revenues, Expenditures, and Changes in Fund Balances. Proprietary and fiduciary funds use the accrual basis of accounting.