Introduction to fund accounting principles and best practices

Alli Hansen

Fund accounting is bookkeeping performed by community foundations, social good organizations, grantmakers, and similar entities. Under this practice, an organization’s resources are classified into different funds based on their usage limitations.

Fund accounting is crucial for nonprofits, charities, and other social good organizations as they often have strict regulations governing how their money can be spent. It presents a clean, easy-to-follow record of income, expenditures, and other transactions so funders, auditors, and other interested parties can quickly assess your ledger.

This level of transparency is necessary to give donors insights into your operations, maintain compliance with tax and legal codes, and responsibly steer your organization's finances. This guide gets to the heart of fund accounting, highlights key fund accounting principles, and offers key advice for strengthening your foundation’s bookkeeping practices.

What is fund accounting?

At its core, fund accounting is a financial system designed for organizations such as nonprofits and social good foundations to manage two different kinds of funds:

Restricted funds: Restricted funds are simply any amount of cash set aside for a specific purpose. For nonprofits and other charitable foundations, this could be money earmarked for debt service funds to pay back the interest on prior loans, support for social outreach programs, investment funds for future growth, or any other legitimate purpose. Generally, donors set up restricted funds for direct control over how their contributions are used.
Unrestricted funds: Unrestricted funds are the direct opposite of restricted funds. They’re amounts of cash with no predetermined usage or purpose. Generally, the recipient organization's directors control how they spend unrestricted funds and can use them for any purposes they see fit.

Through fund accounting, social good organizations can separate different income streams, accrue cash for disparate purposes, and maintain legally compliant spending habits.

Fund accounting is also a key way of ensuring accountability across organizations. Restricted funds are carefully controlled and monitored, meaning each dollar received or spent is scrutinized more than it would in an unrestricted fund.

Nonprofits must also legally report on their restricted funds in their financial statements. This allows shareholders, government agencies, and the public to see how the organization spends its restricted funds and whether it’s using them for the designated purpose.

If an organization misappropriated restricted funds, as per Investopedia, their donors retain the right to:

Initiate legal action
Demand their donation back
Report the foundation to the Office of the United States Attorney General

Separating organizational resources into multiple funds also makes it easier to track your funding sources. Whether grants, donations, or other restricted funds, having a clear record from receipt to expenditure simplifies future bookkeeping tasks and reduces accounting labor hours.

Core fund accounting principles

Like other forms of accounting, fund accounting has core guidelines that dictate how to track, report, and manage cash flow.

The key fund accounting principles include:

Accountability and transparency: Nonprofits and social good organizations manage unique spending limitations. Fund accounting practices, like separating earmarked money into a restricted fund, ensure that the cash is used as intended. Transparent bookkeeping and regular reporting likewise prevent misappropriations and build donor trust.
Utilizing both restricted and unrestricted funds: Restricted funds generally come with donor-imposed conditions—such as every dollar going directly to support an organization's core mission. On the other hand, unrestricted funds can be used for various purposes with no prior approval. Both are necessary for social good organizations to operate normally, and all income should be designated into separate funds—though it’s not necessary to hold restricted and unrestricted funds in different bank accounts.
Tracking fund balances and preparing financial reports: As noted, unrestricted and restricted funds should be separated, with every dollar trackable to its source. Similarly, releasing regular financial reports that detail your spending lets your donor know their money is being used appropriately.
Managing grants and endowments: Recurring funding sources, such as annual or yearly endowments, must be recorded and reported responsibly. Accounting for them before they’re received may artificially inflate your organization's value and be considered an unethical (or potentially illegal) bookkeeping practice.
Following Generally Accepted Accounting Principles (GAAP): Fund accounting is still accounting. Therefore, you must still adhere to GAAP, such as reporting income in the right amount, during the correct period, and on the appropriate ledger.
Adhering to Financial Accounting Standards Board (FASB) guidelines: Alongside GAAP, fund accounting follows the rules set by the FASB, the independent nonprofit in charge of creating and updating financial and accounting reporting standards.

Best practices for effective fund accounting

For fund managers, accountants, and others in charge of financial management for nonprofits, the key fund accounting best practices include:

Implementing strong internal controls: Track every contribution from donor to expenditure to avoid misallocation. Limit who has access to funds, put strict oversight on all spending and maintain reporting transparency to keep tight control on restricted funds.
Using cloud-based fund accounting software: Cloud-based fund accounting software allows you to work on your books and balance sheets anywhere. With secure access, only you and your chosen accounting professionals can see your sensitive financial data. If you need to bring on more help for a job, however, cloud-based software’s infinite scalability allows you to grant access to anyone immediately.
Automating financial reporting: Robust nonprofit accounting software allows you to instantly generate reports in real-time. If you ever need to audit your funds or submit records for grant compliance, such automation features save a wealth of accounting work and labor hours.
Integrating grant and donor management: Using separate programs, such as Customer Relationship Managers (CRMs), to deal with grants and donors only silos information, making it difficult to track and move across systems. However, integrating fund accounting with other aspects of your organization simplifies data sharing, making work quicker and easier.
Regularly reviewing fund allocations: Understand where your money is going and if it’s being used efficiently. Review your spending regularly to avoid misallocations and encourage fiscal responsibility within your organization.

How Foundant CommunitySuite supports fund accounting

Foundant CommunitySuite isn’t just for general nonprofits—it’s purpose-built to assist funders as they manage their organization's finances. CommunitySuite software is designed with legal, ethical, and tax compliance in mind. It helps your organization remain transparent by closely tracking every contribution, allocation, and expenditure in the correct fund, ledger, or balance sheet.

Additionally, CommunitySuite likewise offers seamless end-to-end integration with other aspects of your operations, including tools for:

Grant management: Grant Lifecycle Manager (GLM) simplifies grantmaking with cloud-based management you can access anywhere. It can create and process applications, monitor compliance, report and analyze your grant performance, and more with intelligent automation tools specifically designed for social good organizations.
Donor management: CommunitySuite helps you segment your base into similar groups, manage recurring donations, promote funding opportunities, and more. With its lineup of donor management features, you can foster stronger relationships, build a larger community, and collect more donations with less effort.

On top of all this, CommunitySuite also offers a variety of other automated reporting features. You can generate filtered financial reports based on your organization's unique accounting needs. And, with financial insights telling you which campaigns worked and which lost money, you’ll have the guidance you need going into future fundraising efforts.

The best part for budget-conscious nonprofits? CommunitySuite pricing is some of the most affordable in the industry, and with all the features you receive, it boasts the best value for your money of any fund accounting software.

Strengthen your fund accounting practices

Fund accounting allows organizations to separate and manage restricted and unrestricted funds. Restricted funds have donor-imposed conditions limiting how they can be spent, while unrestricted funds can be used for any purpose a foundation's directors deem necessary.

However, other important fund accounting principles must also be adhered to. You should always follow GAAP and stick to FASB standards.

It’s also key to track your funding, spending, and cash flow and prepare routine financial reports to share with donors and auditors. Above all, accountability and transparency are key in fund accounting; social good organizations run on donations and grants, so it’s essential to avoid misallocations and spend as efficiently as possible.

Handling your accounting with CommunitySuite helps you track funds, prepare reports, and streamline operations for increased efficiency.

Contact Foundant today to see how CommunitySuite can enhance your fund accounting process.