What is Fund Based Accounting?
Accounting for funds, sometimes known simply as fund accounting, is a method of financial management used by charitable organisations and government entities. Accounting for funds has a different objective than accounting done in ordinary for-profit firms, which is maintaining accountability and keeping track of how money is utilised.
How Does Fund-based Accounting Work?
It contrasts with the accounting done in regular businesses, which monitors a company's profitability. Learning about fund accounting is beneficial whether you are affiliated with a nonprofit organisation or a donor who gives to different charities since it will help you understand the capital situation of many organisations. When the nature of the subscription account, they agree to make recurring monthly, quarterly, or annual financial contributions to the NPO.
Example of Fund-based Accounting
Fund accounting aims to handle contributions, financing from outside sources, or revenue from fundraising activities. The following are some examples of possible users of this system:
Charitable organisations and institutions
Sacred places of worship or religious establishments
Regulatory bodies or administrative governments
Hospitals and nursing facilities run by nonprofit organisations
Establishments devoted to education
Building blocks for artistic endeavours
What is a Subscription Account?
In the case of a non-profit group, the primary way they make money is through subscriptions. A member's subscription is the amount of money they pay to the organisation regularly to keep their membership. Members can pay it every month, every three months, every six months, or every year. In the Receipts and Payment Account, it will show up on the Receipts side after any subscription-related changes have been made.
When figuring out the number of subscriptions for the current period, advance subscriptions received for the current period in the previous period and outstanding subscriptions for the current period are added to the subscription received during the current period. On the other hand, the advance subscription received for the next accounting period during the current period and the outstanding subscription for the preceding period are subtracted from the subscription received during the current period.
Characteristics of Fund-based Accounting
The Elements of Fund-based Accounting
In the following paragraphs, we will discuss the essential aspects of fund-based accounting:
Since the fund is handled and accounted for independently, its unique assets, liabilities, revenues, and expenditures must be kept track of.
A limited fund must be established for any organisation that receives legally prohibited money from being used for any purpose.
Typically, it is utilised by groups that do not seek financial gain.
As government grants, private donations, and corporate sponsorships make up most of a nonprofit organisation's operating budget, these funds must be handled lawfully.
All transactions about the special fund should be recorded on a fund-by-fund basis, with account consolidations included in the financial statement for the convenience of readers.
Fund-Based Accounting's Goals and Objectives
The following is a discussion of the purposes that fund-based accounting serves:
Examine and contrast the actual financial results of the various activities with those planned for in the budget
To thoroughly analyse the not-for-profit organisation's financial performance throughout the fiscal year
To guarantee that the guidelines, regulations, and stipulations of the law are adhered to appropriately
To guarantee that the money is used following the guidelines
To maintain a record of both income and expenditures
To evaluate how effectively money was spent on initiatives given the go-ahead
The assets of a nonprofit organisation, minus its debts, create its capital fund. All of the organisation's regular operations can be carried out thanks to this fund, which was established through generous contributions, grants, and gifts.
Such a fund is distinct from designated funds because it is not established to serve a particular objective.
Summary
In fund-based accounting, recurring and one-time revenue streams are separated into discrete pots of money. After everything has been categorised, the fund's account may start to be updated with the many transactions that pertain to it. It allows for easier monitoring of a particular fund's income and expenditures.
To guarantee that designated funds are utilised only for their intended purposes, this accounting is often used by nonprofit organisations, charity trusts, Non-Governmental Organisations (NGOs), educational institutions, sports clubs, etc.
FAQs on Fund-Based Accounting: Explained
1. What is fund-based accounting and why is it used by Not-for-Profit Organisations (NPOs)?
Fund-based accounting is a method of bookkeeping where resources and incomes are grouped into separate self-balancing accounts called 'funds' based on their intended purpose. NPOs use this system to ensure that money designated for a specific purpose (like a building donation or a prize fund) is used only for that purpose, ensuring accountability and compliance with legal or donor-imposed restrictions. It helps track and report the usage of these restricted funds separately from general operational funds. For more details, you can refer to the principles of Accounting for Not-for-Profit Organisations.
2. How are specific and general donations treated differently under fund-based accounting?
The treatment depends entirely on the donor's intent:
- Specific Donations: These are given for a particular purpose (e.g., donation for a new library). They are not treated as income. Instead, they are credited directly to a separate fund account (e.g., 'Library Fund') on the liabilities side of the Balance Sheet.
- General Donations: These are given without any specific condition for their use. They are considered regular income for the NPO and are credited to the Income and Expenditure Account.
This distinction is crucial for maintaining transparency, as explained under Some Peculiar Items in Non-Profit Organisations.
3. Can you provide an example of how a 'Tournament Fund' would be treated in the final accounts?
Certainly. Imagine an NPO has a 'Tournament Fund' with a balance of ₹50,000. During the year, it receives a further donation of ₹20,000 for the tournament and incurs tournament expenses of ₹35,000. The accounting treatment would be:
- The donation of ₹20,000 is added to the Tournament Fund.
- The expenses of ₹35,000 are deducted from the Tournament Fund.
The final balance of the Tournament Fund shown on the liabilities side of the Balance Sheet will be ₹35,000 (i.e., ₹50,000 + ₹20,000 - ₹35,000). None of these items will appear in the Income and Expenditure Account.
4. What are the main types of funds used in fund-based accounting?
Funds in an NPO are broadly classified into two categories:
- Unrestricted Funds: Also known as the General Fund or Capital Fund, these are funds that the NPO can use for any purpose to carry out its general objectives. There are no donor-imposed restrictions on their use.
- Restricted Funds: These are funds whose use is restricted by the donor or governing body for a specific purpose. Examples include Endowment Funds, Prize Funds, Building Funds, and Sports Funds. Any income earned by these funds or expenses incurred must be recorded within the fund itself.
5. What happens if the expenses related to a specific fund exceed the available fund balance?
If the expenses for a specific fund are more than the total amount available in that fund (opening balance + income/donations for the year), the fund balance becomes zero. The excess amount of expense, for which there are no available funds, is not shown as a negative balance. Instead, this excess expenditure is transferred to the debit side of the Income and Expenditure Account as a regular expense for the year.
6. How does fund-based accounting fundamentally differ from the accrual accounting used by for-profit businesses?
The primary difference lies in their objective. Accrual accounting in for-profit businesses is focused on measuring net profit by matching revenues against expenses. In contrast, fund-based accounting in NPOs is focused on accountability and stewardship. Its main goal is to demonstrate that funds provided for specific purposes have been used correctly, rather than to calculate profit. It segregates resources into funds to ensure compliance, a concept not central to standard commercial accounting.
7. Why is a surplus from a specific fund, like a Prize Fund, not transferred to the Income and Expenditure Account?
A surplus in a specific fund (where income/donations exceed expenses) cannot be transferred to the Income and Expenditure Account because it does not represent a general profit for the organisation. The money was given for a specific purpose and must be retained for that same purpose in the future. Transferring it would violate the donor's restriction and misrepresent the organisation's unrestricted income. The surplus simply increases the balance of the specific fund on the Balance Sheet.
8. What is the core difference between a 'Fund' in NPO accounting and a 'Reserve' in commercial accounting?
While both appear on the liabilities side of a Balance Sheet, their nature is completely different:
- A Fund (like a Sports Fund) is a liability that represents money received for a specific external purpose. It is a form of restricted liability, indicating an obligation to spend the money as directed by the donor.
- A Reserve (like a General Reserve) is an appropriation of profit. It is created by setting aside a portion of the company's profits for future needs, strengthening its financial position. It represents owners' equity, not a liability to an outside party.
You can explore the difference between provision and reserve for a deeper understanding of these concepts.
