Fund Accounting Definition Example How Does It Works

What is Fund Accounting?

Explanation

In the case of Non-Profit organizations (NPO) & governments, the financial reportingFinancial ReportingFinancial reporting is a systematic process of recording and representing a company’s financial data. The reports reflect a firm’s financial health and performance in a given period. Management, investors, shareholders, financiers, government, and regulatory agencies rely on financial reports for decision-making.read more rules & requirements are different from those of other organizations as these entities are not profit-oriented. Hence the main focus is to track and validate 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.

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Objectives

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 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.read more regarding the entity for financial reporting.It provides a justified basis for 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 records resources received from a donor for a specific purpose. There can be two types of funds 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 a profit organization uses. Still, terms are different in non-profit organizations. Instead of preparing a profit and loss account, NPO makes payment and receipt accounts, 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.read more and balance sheets.Payment and receipt account- All the Amount receipts in an organization, would be accounted for on the receipt side, and all the payments done will be shown on the payment side.Revenue and expenses account- Non-profit organization prepares revenue and expenditure accounts to show the use of funds they have received and the 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.read more– 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.read more of the non-profit organization is the same as a profit organization. It shows the value of assets and liability of an NPO.

Example

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 donations for repair will be used only for building repair. Till the expense does not occur, that donation will be kept aside. The donation received for food will be spent for that purpose only. But donations received for general purposes can be used for any purpose, like the salary of teachers, expenses of school, etc.

Fund Accounting vs. Non-Fund Accounting

Non-profit organizations and the government use fund accounting. It is also used by portfolio businesses 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.read more.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.read more, etc.In fund accounting, specific funds can be used to receive them. A general-purpose fund can be used for the administration of an organization.In a Non-fund organization, the business entity is treated as a separate business.The 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.read more includes the payment and receipt account, income and expenditure, 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.read more, and balance sheet.

Advantages

It separates specific purpose funds from general-purpose funds.It segregated funds depending on the purpose of the fund provided by law or the donor when giving a grant. Dividing funds help 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.read more and projection of funds for future purposes.This requires preparing a receipt and payment account showing how much was collected in a year or a specific period and how much was paid in a particular period. And how much amount has remained in a fund?

Disadvantages

Maintaining the amount in separate funds makes it difficult to separate the amount from the general fund to a specific purpose fund.The account doesn’t reflect the actual value of the fund. Sometimes no-profit organization misappropriated the fund by including the use of cash.Sometimes it leads to excess spending but lower control of the fund; mostly, it happens in government organizations.The fund accounting does not provide a qualitative analysis of the performance of NPO or government entities. It only focuses on the accounting of the different funds.With the increase in types of grants or funds and management of different accountability, the accounting and tracking of the funds eventually become too complicated.

Conclusion

Fund accounting provides essential accounting methods for the Non-profit organizations & 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.read more 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.

What is Fund Accounting?#

Explanation#

Objectives#

How Does Fund Accounting Work?#

Example#

Fund Accounting vs. Non-Fund Accounting#

Advantages#

Disadvantages#

Conclusion#

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