What is Fund Accounting?
Fund accounting is a method used by Non-Profit Organisations & governments for the accountability of funds or grant received from individuals, grant authorities, governments or other organizations, etc. who has imposed restriction or conditions on the utilization of the funds from the grants (condition could be implemented on full funds or part of the funds as per the donor).
In the case of Non-Profit Organization (NPO) & governments, the financial reportingFinancial ReportingFinancial Reporting is the process of disclosing all the relevant financial information of a business for a particular accounting period. These reports are used by the stakeholders (investors, creditors/ bankers, public, regulatory agencies, and government) to make investing and other relevant decisions. rules & requirements are different from those other organizations as these entities are not profit-oriented. Hence the main focus is to track and validates the various uses of the funds available to the entity. The NPOs receive two types of funds, one is the grant with no restriction for its use, and the others are with some limitation to the usage of the funds. Therefore, it is used for the accountability of these funds.
Hence, it provides the bifurcation in the treatment of both types of grants and provides traceability to the usage of funds having donor-specific restrictions or conditions.
- The fund accounting’s fundamental objective is to provide separate accountability for the general-purpose fund & specific purpose fund, enabling the traceability of the amount.
- It tracks the expenditure that incurs out of funds and if the usage is in such a field was against those funds (conditions which are provided by donor).
- It is used to evaluate the financial condition of the entity & to show reliable financial informationReliable Financial InformationFinancial Information refers to the summarized data of monetary transactions that is helpful to investors in understanding company’s profitability, their assets, and growth prospects. Financial Data about individuals like past Months Bank Statement, Tax return receipts helps banks to understand customer’s credit quality, repayment capacity etc. regarding the entity for financial reporting.
- It provides a justified basis on the expenditure incurred against the specific purpose grant received for any capital projects.
How Does Fund Accounting Work?
- Non-profit organizations or government organizations use it. It is a recording of resources received from a donor for a specific purpose. There can be two types of fund one is restricted, and the other is unrestricted. The restricted fund is used for a particular purpose, but unrestricted funds can be used for any purpose or general-purpose.
- The non-profit organization uses the same standard as profit organization uses. Still, terms are different in no-profit organizations like Instead of preparing profit and loss account, NPO makes payment and receipt account, Revenue and expenses accountExpenses AccountExpense accounting is the accounting of business costs incurred to generate revenue. Accounting is done against the vouchers created at the time the expenses are incurred. and Balance sheet.
- Payment and receipt account- All the Amount receipts in an organization, would be accounted for on the receipt side, and all the payment done will be shown on the payment side.
- Revenue and expenses account- Non-profit organization prepares revenue and expenditure account for showing the use of funds they have received an allocation of the fund. If income received is more than expenses incurred, then it is called an excess, and if expenses are more than income, then it is called a deficit.
- A balance sheet of a statement of financial positionStatement Of Financial PositionStatement of Financial Position represents the current financial status of an entity in terms of assets and liabilities. This statement is used by the stakeholders and shareholders as it affects their investing decisions.– the Balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company. is of the non-profit organization is the same as profit organization. It shows the value of assets and liability of an NPO.
- A School is working as a non-profit organization. It has received a donation for the repair of the building. Also, they received funds from a company to provide good food to students. School also received a donation for general-purpose means, not for any specific purpose.
- Now donation for repair will be used only for building repair. Till the expense does not occur, that donation will be kept aside. Same the donation received for food will be spent for that purpose only. But donation received for general purpose can be used for any purpose, like for the salary of teachers, expenses of school, etc.
Fund Accounting vs. Non-Fund Accounting
- Fund accounting is used by non-profit organizations and government. It is also used by portfolio business and in the investment banking businessInvestment Banking BusinessInvestment banking is a specialized banking stream that facilitates the business entities, government and other organizations in generating capital through debts and equity, reorganization, mergers and acquisition, etc..
- Non-fund based accounting does not deal with funds or cash. It deals with bonds, letters of creditLetters Of CreditA Letter of Credit (LC) is issued by a buyer’s bank to ensure timely, full payment to the seller. If the buyers default, the bank pays the sellers on their behalf., etc.
- In fund accounting, specific funds can be used for the purpose for which it was received. A general-purpose fund can be used for the administration of an organization.
- In a Non-fund organization, the business entity is wholly treated as a separate business.
- Financial statementFinancial StatementFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels. includes payment and receipt account, income and expenditure account, and balance sheet.
- Financial statements of non-fund accounting include trading account, profit and loss accountProfit And Loss AccountThe Profit & Loss account, also known as the Income statement, is a financial statement that summarizes an organization's revenue and costs incurred during the financial period and is indicative of the company's financial performance by showing whether the company made a profit or incurred losses during that period., and balance sheet.
- It separates specific purpose funds from general-purpose funds.
- It segregates funds depending on the purpose of the fund provided by law or the donor at the time of giving a grant. By dividing funds, it helps in budgetingBudgetingBudgeting is a method used by businesses to make precise projections of revenues and expenditure for a future specific period of time while taking into account various internal and external factors prevailing at that time. and projection of funds for future purposes.
- This requires preparation of receipt and payment account that accounts show how much amount collected in a year or in a specific period of time and how much amount paid in a particular period of time. And how much amount has still remained in a fund?
- It becomes challenging to maintain the amount in separate funds means it is difficult to separate the amount from the general fund to a specific purpose fund.
- The account doesn’t reflect the real and actual value of the fund. Sometimes no-profit organization misappropriates the fund by including the use of cash.
- Sometimes it leads to excess spending of a fund but lower control of the fund; mostly, it happens in government organization.
- The fund accounting does not provide quality analysis to the performance of NPO or government entity. It only focuses on the accounting of the different funds.
- With the increase in types of grants or funds and management of different accountability, eventually, the accounting and tracking of the funds become too complicated.
Fund accounting provides essential accounting methods for the Non-profit Organisation & governments to record their funds and grants received from other parties (any grant – general purpose or specific purpose grant). It provides accountability of the recorded funds and transactions against it with the statutory obligations applicable to the entities. Helps the auditorsThe AuditorsAn auditor is a professional appointed by an enterprise for an independent analysis of their accounting records and financial statements. An auditor issues a report about the accuracy and reliability of financial statements based on the country's local operating laws. by providing traceability towards the different funds or grants received from the donors and the transaction or expenditure incurred by the management against those funds.
This has been a guide to what is fund accounting and its definition. Here we discuss objectives, examples, and how does fund accounting work along with advantages and disadvantages. You can learn more about Financing from the following articles –