What Is Fund Accounting for Nonprofits?

Fund accounting is a way of organizing nonprofit financial activity so the organization can understand where resources came from, what restrictions apply, and how those resources are being used.

Unlike a for-profit business, a nonprofit may receive money that can only be used for a specific program, purpose, time period, or activity.

Fund accounting helps leadership and the board distinguish between resources that are available for general operations and resources that are subject to donor, grantor, legal, or contractual restrictions.

Why Is Fund Accounting Important?

For nonprofits, not all dollars are interchangeable.

An organization may receive:

  • unrestricted contributions;

  • donor-restricted contributions;

  • government grants;

  • foundation grants;

  • program service revenue;

  • investment income;

  • endowment funds; and

  • other resources with different requirements.

Good fund accounting helps the organization answer important questions such as:

  • How much money is available for general operations?

  • Which resources are restricted?

  • Have restricted funds been used for their intended purpose?

  • How much remains available under a particular grant?

  • Are programs operating within budget?

  • Are we accurately reporting financial activity to the board and funders?

The goal is not simply to keep the books balanced.

It is to maintain financial records that reflect the nature and purpose of the resources entrusted to the organization.

Does Nonprofit GAAP Require Separate Bank Accounts for Every Fund?

Usually, no.

Fund accounting does not necessarily mean opening a separate bank account for every grant, donor restriction, or program.

In many cases, a nonprofit can maintain one operating bank account while using its accounting system to track activity by:

  • class;

  • department;

  • program;

  • grant;

  • project;

  • funding source; or

  • another tracking dimension.

The accounting records should be detailed enough to show which resources are restricted and how they were used.

Separate bank accounts may be appropriate in some circumstances, but they are not automatically required simply because funding is restricted.

What Is the Difference Between Restricted and Unrestricted Funds?

In current nonprofit financial reporting, net assets are generally presented in two broad categories:

Net assets without donor restrictions

and

Net assets with donor restrictions.

Resources without donor restrictions are generally available for the organization to use in support of its mission, subject to board-designated or other internal decisions.

Resources with donor restrictions are subject to restrictions imposed by donors.

Those restrictions may relate to:

  • a particular program;

  • a specific purpose;

  • a future time period;

  • acquisition of a particular asset; or

  • preservation of principal, such as certain endowment arrangements.

It is important to distinguish a true donor restriction from an internal designation made by management or the board.

A board designation can generally be changed by the board.

A donor restriction generally cannot be removed simply because management would prefer to use the funds elsewhere.

What Happens When a Restriction Is Satisfied?

When the purpose or time restriction has been satisfied, the related amount is generally released from donor restriction.

For example, assume a donor contributes $100,000 specifically for a youth program.

The organization initially records the contribution as donor-restricted revenue.

As qualifying program expenses are incurred and the restriction is satisfied, the applicable amount is released from restriction.

Internally, the nonprofit should maintain enough detail to support:

  • the original contribution;

  • the restriction;

  • amounts spent;

  • amounts released; and

  • the remaining restricted balance.

This is one reason good grant and contribution tracking is so important.

Is a Grant Always Restricted?

No.

The accounting for grants depends on the underlying terms and conditions.

A grant may be:

  • an exchange transaction;

  • a contribution;

  • conditional;

  • unconditional;

  • restricted;

  • unrestricted; or

  • some combination depending on the arrangement.

For example, a grant agreement may require the nonprofit to perform specific activities and return unused funds.

Another award may provide broad support for the organization without a donor restriction.

The accounting should follow the actual substance of the agreement rather than assuming every grant is treated the same way.

What Does Fund Accounting Look Like in Practice?

Consider a nonprofit that receives:

  • $400,000 of general operating contributions;

  • $250,000 restricted for a housing program;

  • $150,000 restricted for a future capital project; and

  • $300,000 under a government grant.

The organization might maintain one primary operating account, but its accounting system should still allow management to identify:

  • general operating resources;

  • housing-program activity;

  • capital-project resources;

  • grant-related expenditures; and

  • remaining restricted balances.

That information allows leadership to avoid making decisions based solely on the total cash balance.

A nonprofit may have $800,000 in the bank and still have significantly less cash available for general operations if a large portion is restricted.

Why Cash and Available Resources Are Not the Same Thing

This is one of the most important concepts in nonprofit financial management.

Cash in the bank does not necessarily equal cash available to spend.

For example:

Total cash: $1,000,000

Less donor-restricted resources: $600,000

Potentially available for general purposes: $400,000

The exact calculation can be more complex, but the principle is important.

Leadership should understand both:

How much cash do we have?

and

How much of that cash is actually available for the decisions we need to make?

Strong fund accounting helps answer both questions.

How Should Nonprofits Track Programs and Grants?

A well-designed chart of accounts and accounting system should allow the organization to produce useful information without becoming unnecessarily complicated.

Depending on the organization, tracking dimensions might include:

  • natural account;

  • program;

  • department;

  • grant;

  • funding source;

  • restriction;

  • location; and

  • project.

The right structure depends on how the organization operates and what information leadership, funders, regulators, and the board need.

Too little detail can make reporting and compliance difficult.

Too much detail can make the accounting system cumbersome and create unnecessary work.

The goal is a structure that is simple enough to maintain and detailed enough to support good financial stewardship.

How Does Fund Accounting Affect Financial Statements?

Nonprofit financial statements generally include information such as:

  • statement of financial position;

  • statement of activities;

  • statement of functional expenses; and

  • statement of cash flows.

The statement of activities typically distinguishes changes in net assets with donor restrictions from changes in net assets without donor restrictions.

The financial statements may also include disclosures describing:

  • donor restrictions;

  • liquidity;

  • endowments;

  • significant grants;

  • contributed nonfinancial assets; and

  • other relevant matters.

Strong fund accounting supports the accuracy of those financial statements.

How Does Fund Accounting Affect Board Reporting?

Boards generally need more detail than a year-end financial statement alone provides.

Good internal reporting may show:

  • budget-to-actual results;

  • operating surplus or deficit;

  • cash available for operations;

  • restricted fund balances;

  • grant performance;

  • program-level results;

  • liquidity;

  • revenue concentration; and

  • forecasted cash needs.

The board should be able to understand whether the organization is financially healthy without confusing restricted resources with operating capacity.

Related Resource: What Should a Nonprofit Board Financial Dashboard Include? →

What Are Common Fund Accounting Mistakes?

Common problems include:

  • treating all cash as unrestricted;

  • failing to track donor restrictions separately;

  • releasing restrictions incorrectly;

  • using one grant to cover costs associated with another program;

  • failing to reconcile grant schedules to the general ledger;

  • creating too many unnecessary funds or tracking categories;

  • relying on spreadsheets that do not reconcile to the accounting system;

  • confusing board-designated funds with donor-restricted resources; and

  • waiting until year-end to determine what remains restricted.

These issues can affect management reporting, Form 990 preparation, grant reporting, and the annual audit.

Does a Small Nonprofit Need Fund Accounting?

Yes, but the system should be proportionate to the organization.

A small nonprofit with primarily unrestricted contributions may need relatively simple tracking.

An organization with multiple restricted grants, government funding, programs, and reporting requirements may need substantially more structure.

Fund accounting should grow with the organization.

The objective is not complexity.

It is transparency and accountability.

The Bottom Line

Fund accounting helps nonprofits understand which resources are available, which are restricted, and whether money is being used in accordance with donor, grantor, legal, and organizational requirements.

Good fund accounting creates a foundation for:

  • accurate financial statements;

  • reliable grant reporting;

  • audit readiness;

  • board oversight;

  • budgeting;

  • cash-flow planning; and

  • better financial decisions.

When the accounting system clearly reflects how resources are intended to be used, leadership can spend less time reconstructing the past and more time managing the organization forward.

How Bilotta & Company Can Help

Bilotta & Company, CPAs, LLC works with nonprofit organizations on accounting, financial reporting, audits, reviews, Single Audits, Form 990 compliance, and ongoing financial stewardship.

Through our Nonprofit Navigator® Financial Stewardship program, we help organizations build accounting structures and reporting processes that provide greater visibility into grants, restrictions, programs, cash flow, and overall financial performance.

The goal is not simply compliant accounting.

It is financial information that helps leadership and the board make better decisions in support of the mission.

Related Resource: How Should Nonprofits Track Restricted Funds? →

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This article is provided for general educational purposes and should not be considered accounting, tax, or legal advice for a specific organization.