Nonprofits practice accounting as they record money received from donors and fundraising and money spent on administrative or operating expenses. The accounting method used by nonprofits varies from for-profit businesses. For-profit businesses use their financial reporting to identify profitability. Nonprofits use their financial reporting to ensure that assets feed the organization’s mission. Nonprofits use fund accounting and benefit from several advantages of using this method.
Fund accounting separates all financial accounts into individual categories, or funds. Each fund includes its own set of financial accounts, including assets, liabilities, revenues and expense accounts. The account balances contained within each fund add up to zero and balance each other out.
Types of Funds
Each fund focuses on a different aspect of the organization’s operation. These include current operation funds, restricted funds or fixed asset funds. Current operation funds provide for the administrative needs of the nonprofit. This includes paying salaries or purchasing supplies. This also includes paying for the services the nonprofit provides. Restricted funds provide financing to pay for a specific purpose. Donors who wish to support a submission of the organization might donate money and specify that the organization use it for that purpose. Fixed asset funds focus on accumulating the money needed to purchase a building or upgrade equipment.
One advantage of using fund accounting involves its ability to isolate the assets needed to meet a specific purpose. Fund accounting segregates the account balances related to its purpose and keeps these funds from mingling with the other accounts of the organization. This ensures that the assets assigned to each fund remain available for the purpose of that fund.
Another advantage of fund accounting relates to keeping the organization accountable to the donors who support the organization. Each contributor wants to see the nonprofit serve the individuals who need its assistance. When the nonprofit issues its financial statements at the end of the year, the donors can review the performance of each fund. The financial statements identify the money received for each fund and how the nonprofit distributes those funds.