Fund accounting definition
/What is Fund Accounting?
Fund accounting is a system of accounting used by non-profit entities to track the amount of cash assigned to different purposes and the usage of that cash. The intent of fund accounting is not to track whether an entity has generated a profit, since this is not the purpose of a non-profit. Thus, the focus of fund accounting is on accountability, rather than profitability. Those running a non-profit need enough information to make decisions about how to use limited resources, as well as to report to third parties about how well they are preserving and using those resources.
A non-profit may use a number of funds, each of which is set up with a separate set of accounts and a balance sheet, so that users can determine the extent to which cash has been used for its intended purpose. For example, a city government might have separate funds for street repairs, police, sewage treatment, and schools.
Advantages of Fund Accounting
The advantages of fund accounting include:
Facilitates fund management. Many non-profits receive restricted funds that can only be used for specific purposes. Fund accounting ensures compliance with these restrictions by isolating these funds from unrestricted funds. It ensures restricted funds are not accidentally used for other purposes.
Enhances budgetary control. Fund accounting helps organizations manage their financial resources effectively by ensuring that expenditures align with the specific purposes of each fund. By tracking expenditures within each fund, organizations can ensure they do not overspend allocated budgets.
Provides assurance to donors. Donors can see that their contributions are being used for the designated purposes. Donors are more likely to contribute when they are assured that funds will be used appropriately.
Enhances reporting. Fund accounting provides detailed financial reports for each fund, making it easier to prepare reports for stakeholders, donors, or regulatory bodies.
Improves audit efficiency. The separation of funds simplifies auditing, as each fund has its own set of financial transactions, making it easier to verify compliance with accounting standards and donor requirements.
Fund accounting is essential for organizations that manage multiple sources of funding with specific restrictions, ensuring financial integrity, compliance, and efficient use of resources.
Disadvantages of Fund Accounting
There are some disadvantages associated with fund accounting. One is that it requires extra accounting staff time to record transactions into a large number of fund “buckets,” as well as to create reports for this information. This can result is a disproportionately large accounting expenditure for a non-profit. A further concern is that the focus of the system is entirely on whether funds are being properly targeted at specific uses, rather than on whether the funds are being used efficiently. A further concern is that it focuses attention on specific funds, rather than on the financial health of the organization as a whole.
Fund Budgeting
A separate budget may be established for each fund. By doing so, the manager of a non-profit can track the amount of expenditures against the level of available funding and manage the expenditure level so that the services provided via a fund are made throughout the budget year without triggering a deficit in the amount of available funds. Given the presumably limited amount of funding available each year, this is a critical tool for non-profit management.
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Examples of Entities Using Fund Accounting
Examples of the types of entities that may use fund accounting are artistic foundations, charities, churches, colleges and universities, governments, hospitals, nursing homes, and orphanages.
Governmental Funds
The governmental fund is the default fund to be used to account for all activities of a government, except for those required to be accounted for in a different fund. Thus, the governmental fund is a government’s primary operating fund. The governmental fund category includes the following funds:
Capital projects funds. Used to account for financial resources that have been set aside for capital outlays (usually major outlays).
Debt service funds. Used to account for financial resources that have been set aside to pay for principal and interest.
General fund. Used to account for all financial resources not being reported in any other fund.
Permanent funds. Used to account for financial resources for which only the earnings can be used for the support of government programs.
Special revenue funds. Used to account for the proceeds from targeted revenue sources for which there is a commitment for expenditures other than capital projects or debt service.
Proprietary Funds
Proprietary funds are used to account for the business-type activities of a government. The proprietary funds category includes the following funds:
Enterprise funds. These funds are used to account for any activity for which external users are charged a fee for goods and services, even when the government subsidizes a portion of the activity’s costs.
Internal service funds. These funds are used to account for activities that provide goods or services to other funds, as well as departments or agencies of the primary government, or to other government entities on a cost-reimbursement basis.
Fiduciary Funds
Fiduciary funds are used to report on assets held in trust for the benefit of organizations or other governments that are not part of the reporting entity. The fiduciary funds category includes the following funds:
Agency (custodial) funds. Used to report on resources held in a custodial capacity, where funds are received, temporarily invested, and remitted to other parties.
Investment trust funds. Used to report the external portion of an investment pool that is reported by the sponsoring government.
Pension and employee benefit trust funds. Used to report on assets held in trust for pension plans, other postemployment benefit plans, and employee benefit plans.
Private-purpose trust funds. Used to report on trust arrangements where individuals, private organizations, and other governments are the beneficiaries.