What is fund accounting?
Fund accounting is a system of accounting used by non-profit organizations and governments, to track cash assigned to different purposes and different usages of said cash. The aim of fund accounting is on accountability, rather than profitability. Different funds are set up with a separate set of accounts and a balance sheet each. The set of accounts are unrestricted, temporarily restricted, or permanently restricted, depending on the restrictions set by the provider. An example of fund accounting would be, say, the Salvation Army has $1,000 in its account, with restrictions on how to spend it. A certain part of it goes towards training staff, another amount goes towards quality control, and another amount goes towards campaigns reaching out to people for donations. So, it’s like having a manila envelope, and inside that manila envelope, there are three smaller envelopes that have a certain amount of money in it, for the above needs.
How does it fare in non-profit organizations?
For regular companies, accounting centers around profitability; whereas non-profit organizations use accounting to keep in line with their mission statement. Fund accounting separates the resources received for a specific purpose. If that resource is not used for the whole month/quarter/year, it rolls over to the next month/quarter/year (still to be used for the purpose specified). There are several types of organizations that use fund accounting. Apart from governments and hospitals, non-profits, charities, churches, colleges and universities, and artistic foundations also use fund accounting. The Herzlinger and Sherman paper on the Advantages of Fund Accounting in ‘Nonprofits,’ (1980) argued that it is important to maintain restricted and unrestricted monies that are received from donors, separately. They also claimed that examining the financial statements of nonprofit organizations can give an accurate estimation of how financially well-off these organizations are.
One advantage of using fund accounting is that it separates the assets needed to meet a specific purpose. Fund accounting separates the account balances related to its purpose and keeps these funds from mingling with the other accounts of the organization. This ensures that the assets assigned to each fund remain available for the purpose of that fund.
Another advantage of fund accounting is that it keeps the organization accountable to its donors. When the financial statements are issued at the end of the year, donors can analyze the performance of each fund, as it identifies the monies received per fund, and how the non-profit organization distributed those funds.
According to the Harvard Business Review, there are many recommendations for re-structuring non-profit accounting. This is due to unnecessary complexity which slows down intelligent financial analysis and management. Firstly, most recommendations agree that financial statements need drastic simplification. Usually, non-profit organizations have four or more fund groups, and make three financial statements per group (12 in total). This becomes very confusing, and thus it is proposed that combining the funds into a consolidated set of statements, would be simpler. Secondly, non-profit organizations and especially governmental organizations combine their accounting with their budgetary systems. Meaning that they report the actual revenues and expenditure and compare them with what was budgeted. Expenditures anticipated are based on purchase orders. The total is shown as an obligation against the budget. This obligation against the budget confuses readers of the statement.
However, the Harvard Business Review opines that fund accounting and budgetary accounting should not be abandoned. The types of funds in a non-profit organization are like piggy banks which have resources in them allocated for a specific purpose. The current funds piggy bank has resources for present operating purposes, while the endowment funds has resources for generating income where the principal cannot be spent, but where the income can be spent. The plant funds hold the organization’s fixed assets, and the special purposes funds have resources for clear-cut specific reasons such as providing student loans.
Fund accounting has its advantages: it separates assets as per the instructions of the donor, and aids in holding organizations accountable to their donors, by separating the resources. Some claim that the number of financial statements become confusing, etc; however, the advantages far outweigh the disadvantages of the fund accounting system.