Introduction
There are about 1.9 million registered nonprofit organizations in the United States. These groups comprise, together, a large sector of the U.S. economy, and this means non-profits needed an entirely different accounting perspective than that of a business. Fund accounting is the way that non-profits will manage finances. Fund accounting manages records in orderly and clear manner for organizations, keeps them compliant with rules, and keeps the donor transparent with their restrictions.
As charitable giving skyrockets in record amounts, both the attention to and the accuracy of non-profit fund accounting is under increasing scrutiny. Charitable giving in the U.S. rose to an estimated $592.50 billion in 2024, or a 6.3% increase in current dollars. Donors, regulators and auditors are demanding accountability systems with institutions of the big money, so that every dollar has a trail from receipt to expenditure. Fund accounting principles help bookkeepers implement accountability systems so their organization can maintain donor trust, comply with regulation, and avoid audit findings or regulatory fines.
What Is Fund Accounting?
Fund accounting is a unique type of accounting which follows the use of resources through restrictions and intended uses. The real uniqueness of fund accounting is not profitability, it is to show stakeholders, without guilt, that funds donated to nonprofit organizations have been spent according to the intentions of the donor, grantor, or board of directors.
Rather than thinking of profit, focus on fund accounting as the application of resources separated by donor restrictions, legal restrictions, and board designated funds. When things are in a fund, then you have one accounting entity for that fund with its own assets, liabilities, and net assets. Even though an organization has multiple funds, they are all part of the same entity, restricted resources and unrestricted resources can never mix, in doing so could be regulated as someone not following the rules or violating the trust of the donor.
Fund accounting is an entire different animal from commercial accounting in almost every way in terms of purpose and presentation. For profit organizations assess profitability and return of an investment while non-profit fund accounting is mostly focused on stewardship and accountability to the intersection of the organization’s various funding streams with different restrictions and requirements. Whereas commercial organizations report one net income bottom line per report, non-profit organizations need to report on all funding has been used as intended and for the designated purposes required in the reporting element. (AICPA & CIMA)
Net Asset Classes & Recent Presentation Rules
ASU 2016-14 from the FASB made a big change in nonprofit financial reporting because it reduced net asset classification from three to two, which are: “net assets with donor restrictions, and net assets without donor restrictions” (at the time of the issuance of ASU 2016-14).
For net assets with donor restrictions, nonprofits need to classify any donor-contributed resources that carry donor-imposed restrictions for use for specific purposes, time periods, or activities as donor-restricted. Although limited, donor restrictions are legally binding while the organization, as the donee, is bound by law to meet the specific condition(s) in the restriction, or until the donor releases the donee from adhering to the contractual aspects of the restriction. Net assets without donor restrictions consist of all other organization resources, including resources set aside by the board for internal use or designations of funds restricted for specific purposes.
This reclassification bolsters a good deal of the uncertainty that existed with the old categories of temporarily and permanently restricted, along with providing a clearer definition for attorneys and compliance officers. The new presentation rules will mean that organizations with donor imposed restrictions will have a legal obligation to report on those restricted net assets, while boards of governance will have the ability to internally designate the net assets similarly for whatever legitimate and allowed reason they see fit and can reverse any internal designations without obligation when board action is taken. The bookkeeper will have to manage and maintain the documentation that specifies the source of the net assets and the restriction status to determine the proper reporting based upon the new classifications.
Key Fund Types and What to Track
There are going to be many types of funds for nonprofit organizations that have specific requirements related to tracking and documentation. Donor-restricted funds are probably the most prevalent type of fund and contain assets that someone provided the nonprofit with for a specific program or activity and/or a specific time frame. It is the responsibility of the bookkeeper to track the name of the donor, the exact restriction language(s), when it is to be or was used, and the fund balance for each donor-restricted contribution.
Permanently restricted funds are now considered net assets with provider restrictions, which are endowed principal balances and any other restricted fund which donors permanently restricted. Donor-restricted funds require tracking of the original principal amount along with any contributions to the permanently restricted fund, and/or features for use and investment therein.
Board-designated funds are unrestricted resources that the nonprofit’s board or organizational leadership has set aside for a purpose internally, such as capital improvements, an emergency fund, or programmatic growth. There are no legal restrictions for board-designated funds; however, it is appropriate for the bookkeeper to maintain the board resolution that approved board-designated funds along with tracking their uses.
Grant funds require a little more, just a little more, attention to management obligations because grant funds come with some difficult compliance and reporting expectations. A bookkeeper will want to be aware of all parts of the grant agreement looking at things like references, allowable expenses, allowable expense categories, indirect cost rates, match requirements, and performance milestones.
An agency fund lets an organization carry resources for another organization without variance power. A capital campaign fund has to be aware of pledges and when loans become due and what project the expenditure is being spent upon. And a operating fund has unrestricted resources to be used for general operations and overhead of the organization.
Revenue Recognition & Donor Restrictions
Alright, so nonprofit revenue recognition is based on rules very different from commercial accounting standards, especially with regards to donor contributions that are either conditional or unconditional. Unconditional contributions must be recognized as revenue once they are received (either cash or non-cash value), regardless of whatever donor restrictions there may be regarding the use of those funds. Conditional contributions, on the other hand, cannot recognized as revenue until all conditions are met by the organization.
It’s important for bookkeepers to read the correspondence from donors including any grant agreements, and pledge documentation to determine if the contributions have conditions or restrictions. Traditionally, conditions are those that require the organization to fulfill specific performance obligations or measurable outcomes before the revenue can be recognized. Restrictions limit how the organization may use the funds (represented in assets/organization’s financial statements), but do not impede the organization’s ability to recognize revenue immediately.
Pledge accounting requires particular attention to both collectibility assessments and the timing of payment. Organizations need to develop their procedures for recognizing pledge revenue separately and creating an allowance for those pledge amounts that would be uncollectible based on historical experience and donor payment tendencies. For multi-year pledges, and when the time value of money is significant, bookkeepers must perform calculations for present value. Bookkeepers must
Bookkeepers should retain grant agreements, donor letters, pledge cards, board resolutions, and whatever correspondence that clarifies the contributions and their intended use. This will be the basis for consistently classifying the funds into proper categories and showing compliance with donor intent if there are audits or reviews.
Functional Expense Reporting & Allocation
Functional expense reporting is probably one of the most complicated areas of nonprofit bookkeeping. Organizations are required to classify, or allocate, all expenses to program services, management and general, or fundraising activities. The way expenses are classified can significantly influence the public’s perception of the organization’s efficiency, as well as compliance with the requirements of multiple grants that limit administrative expense ratios.
Program service expenses include all costs that are directly related to carrying out the organization’s exempt purposes and providing services to its beneficiaries. Management and general expenses include governance, oversight, business management, record, and the administrative support of the entire organization. Fundraising expenses include all costs associated with soliciting contributions, grants, and other support.
When distributing salaries and benefits, employers need to have a consistent and systematic way to record the time worked or have reasonable estimation methods that would hold-up during an audit. Organizations need to develop consistent policies for billing out the operational costs of shared expenditures such as rent, utilities, and administrative salaries across functional areas. Such policies need to reflect actual usage patterns and demonstrate a reasonable basis for expense classification.
When the organization reports functioning expenses on Form 990, it affects their CFDA compliance for federal funding sources. Federal grants typically stipulate maximum percentages of allowable administrative expenses acceptable as part of the total project costs. It is critical to classify your expenses correctly to maximize your grant eligibility as well as to avoid repayment of functional expenses.
Audit Readiness, Single Audit & Federal Awards
For organizations expending $750,000 or more in federal awards during a fiscal year, a single audit must be completed in accordance with the Uniform Guidance provisions of 2 CFR Part 200. This threshold applies to direct federal grants, pass-through awards from other organizations and federal contracts to the extent they meet the definition of federal awards.
Single audit preparations require fund-level trial balances that show compliance with all activities and restrictions in the federal award. Auditors expect to see reasonable reconciliations between the fund accounting records and the consolidated financial statements along with schedules showing federal award expenditures at the grant and funding source level.
Financial Draw schedules must show the actual expenditures for the period and comply with cash management requirements that minimize the time elapsed from receipt of federal funds and expenditures. Indirect funded cost allocation methodologies must be documented, as well as evidence the allocated costs adhere to the federal cost principles.
Monthly federal award expenditure reports should be prepared by bookkeepers that provide management information on fund expendability to monitor compliance and allow management to resolve issues before they become audit findings. Federal award expenditure reports should account expenditures against the approved budget, have some methodology to track compliance costs sharing requirements as specified in the award agreement and highlight questionable costs that may need additional documentation and/or approval.
Conclusion & Call to Action
Fund accounting is integral to accountability in the nonprofit space. Nonprofits need to enact fund accounting for stewardship to their donors, and fulfill legal and regulatory obligations. With fund accounting guidance and principles in hand, nonprofits ease compliance and transparency with its stakeholders. The nonprofit sector builds a confidence baseline with their donors as a result of being able to convey information with accounting methods, provide greater transparency with its stakeholders, mitigate the risk of audit findings, and facilitate meaningful growth and advancement while reducing compliance risks and also doing all of that again down the line to make compliance easier by using time and resources to implement fund accounting infrastructure (work paper or system), organizational change, and eliminate unnecessary compliance risk through administrative work and processes for transparency.
While bookkeeping and accounting want to be easy enough for self service, that is unfortunately rarely in the case, and now that data is a high-risk way for a non profit organization to have a legal obligation to classify funds, generate revenues, and comprehend and prioritize expenses.
