Fund Accounting: Definition, Examples, Types, Advantages and Disadvantages

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Most business entities prepare financial statements that focus on profitability. The accounting systems these businesses use also reflect this focus. However, the same does not apply to nonprofits and government organizations where profitability is not the emphasis. For these entities, other accounting systems exist, including fund accounting.

What is Fund Accounting?

Fund accounting is an accounting system that nonprofits use to report their activities. This framework focuses on tracking funds allotted to different purposes. Usually, nonprofits allocate funds across various projects. Therefore, fund accounting can help these entities regulate the funds used in those projects. This system differs from that used by companies and other businesses.

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Fund accounting does not focus on reporting profits. Instead, it promotes accountability in using funds across nonprofits. This accounting system requires nonprofits to state how they have used resources in different projects. On top of that, fund accounting also entails showing whether a nonprofit uses its funds for the intended purposes. Consequently, nonprofits can report this activity to third parties.

How does Fund Accounting work?

Nonprofits obtain funds from different sources and use them for specific purposes. Usually, these funds come in two forms, restricted and unrestricted. The difference between the two is whether these funds have restrictions on how a nonprofit can utilize them. When reporting on these funds, nonprofits cannot use the same accounting systems as other businesses.

Therefore, fund accounting provides a framework for nonprofits to report their activities. This system uses the same accounting standards as other businesses. However, they involve some modifications to the systems applied within those businesses. These modifications are required since fund accounting does not focus on profitability.

Some modifications applied by fund accounting include using receipt and payments statement and statement of source and use of funds. As stated above, they follow similar rules as other accounting reports. However, these focus more on accountability and reporting the use of resources across various projects.

What are the advantages and disadvantages of Fund Accounting?

Fund accounting can provide nonprofits with some advantages and disadvantages. Some of the benefits of this system include the following.

  • It focuses on accountability and the use of resources.
  • It separates restricted and unrestricted funds.
  • It helps nonprofits decide on the best use of their limited resources.
  • It reports on how a nonprofit obtains and spends its cash and cash-equivalent resources.

However, fund accounting may also involve some disadvantages, as listed below.

  • It requires additional work to report restricted and unrestricted funds separately.
  • It does not reflect on how efficiently and effectively a nonprofit has used its funds.
  • It does not provide complete information about a nonprofit’s financial position.

What are the types of funds in Fund Accounting?

Funds used within fund accounting can include several categories. These include the following.

  • Current unrestricted funds.
  • Current restricted funds.
  • Endowment funds.
  • Fixed asset funds.
  • Board-designated funds.
  • Specialized fund groupings.

Nonprofits must identify and report these funds separately when using fund accounting.

Conclusion

Fund accounting refers to the accounting system used in nonprofits and government organizations. This system focuses on reporting activities and the use of resources rather than profitability. While it follows the same accounting standards, fund accounting does not use the same reports. This system reports on different types of funds, as listed above.

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