Introduction:
Fund accounting plays a pivotal role in the financial management of nonprofit organizations (NPOs), ensuring transparency, accountability, and compliance with donor stipulations. In this article, we explore the fundamentals of fund accounting, highlighting its advantages, challenges, and solutions to overcome obstacles.
1. What is Fund accounting?
Fund accounting is a system of accounting that facilitates non-governmental/non-profit organizations (‘NPO’) to manage streams of funds designated for specific purposes.
2. For whom is Fund accounting applicable?
Fund accounting is applicable to all types of NPOs like charities, churches, government agencies, nonprofit nursing homes, hospitals, and educational institutions, etc. Though that is no mandate per se, it is a recommended practice considering the true and fair view of the financial statements that adequately meets the accountability requirements of donor-agencies, including government and other stakeholders such as members/beneficiaries, governing board, management staff, volunteers and general public.
3. Why is fund accounting important for NPOs?
Following the basics of fund accounting is crucial for maintaining the trust of donors, complying with regulatory requirements, and providing transparent reporting about how funds are used. It ensures that money is allocated and spent in line with the organization’s mission and donor intentions.
4. How is non-profit different from for-profit on fund accounting?
For-profit businesses consolidate resources to maximize profit annually, while NPOs allocate funds for specific purposes aligned with their mission. Surplus funds in for-profits are distributed to stakeholders, whereas in NPOs, they sustain operations.
Fund accounting ensures nonprofits remain transparent and accountable, essential for maintaining tax-exempt status and donor support, showcasing how they advance their causes.
5. Is there any specific accounting standard that governs fund accounting?
There is no specific accounting standard for NPOs. However, there is an accounting standard (‘AS’) 12, that deals with accounting for Government grants specifically.
You can read more about it in “Technical Guide on Accounting for Not-for-Profit Organisations” issued by the Research committee of “The Institute of Chartered Accountants of India” (‘ICAI’) that recommends with a view to harmonizing the diverse accounting practices being followed across NPOs, a standardized framework for the preparation and presentation of financial statements in NPOs.
Before we delve into the concept of fund accounting, let's first examine the types of funds that NPOs receive. This will help us understand how fund accounting applies to these different fund types.
6. Understanding Unrestricted and Restricted Funds”
Unrestricted funds:
Unrestricted funds refer to contributions made to an NPO without any specific restrictions on their use.
When an NPO accepts an unrestricted donation or grant, it is obligated to use these funds for the organization's general purposes or towards self-sustainability.
Following are some of the example:
a. Donations
b. Income from Investment, namely fixed deposits
Restricted Funds:
Restricted funds should be for a specific purpose only. Specific purpose could be towards (say):
a. Any of the projects run by NPO
b. Any specific activity undertaken by NPO
c. Any specific object covered by trust deed/Memorandum of Association
Note: Corpus donations will fall under the category of restricted funds. This will be discussed in detail in a separate article.
In determining what funds exist and how they should be presented, NPOs could follow a two-step process suggested below.
Step one is to determine which funds exist.
Step two requires the assessment of each of the funds identified to determine whether it is a fund with restrictions.
Here's a decision tree illustrating the existence of a fund with restrictions:
The above diagram is taken from the Practitioner Advisory Group Issue Paper dated 08th February 2024 on Fund Accounting published by www.ifr4npo.org.
Terms used:
Funds without restrictions = Unrestricted funds
Fund with restrictions = Restricted funds
7. Reconciliation with Income Tax Return
Considering the amendment in section 11 of the Income tax Act, 1961 vide Finance bill 2022, it mandates NPO’s to claim application in ITR only on the basis of payment irrespective of the method of accounting followed.
Here there are 2 views if grant fund accounting followed:
View 1:
Reporting funds on books of accounts basis, accordingly grant funds received would be reported only to the extent of spent applying the principles of fund accounting.
View 2:
Reporting funds on a cash basis, to adhere to the matching concept. Further, in Form 10BD too, reporting of donations and grants is required to be done on “receipt basis” and the same has a reference in Audit report, from which the application is also derived at, thereby making the view of reporting on cash basis more appropriate.
If View 2 is adopted, internal reconciliation would be necessary because the books will be on an accrual basis, while the ITR will be on a cash basis. View 2 is a more conservative view. NPOs can carry forward / accumulate the unspent grant income to next year / upto 5 years under section 11 of Income-tax Act.
8. What are some of the advantages of Grant fund Accounting?
Below are some of the advantages of using Grant fund Accounting:
a. Accountability and Transparency: Fund accounting isolates funds with donor restrictions, providing accountability and transparency in financial management.
b. Detailed and Accurate Financial Statements: Fund accounting enables nonprofits to produce more accurate and detailed financial statements, offering insights into expenses.
c. Understanding of Structure and Spending: Fund accounting helps nonprofits track how money is spent, aiding in understanding the organization's structure and expenditures.
d. Accurate Financial Reporting: Fund accounting facilitates accurate financial reporting, crucial for grant applications and demonstrating fund utilization.
Exception cases: In certain cases, restricted / tied-up grants fulfilling certain conditions have been allowed by Courts as tax-exempt (on the ground that such funds are held by NPO in fiduciary capacity). One of the common conditions for such a claim has been appropriate accounting treatment in books.
9. What are the challenges that NPOs face in implementing Grant fund Accounting?
Though Fund Accounting’s advantages are attractive, there are few disadvantages that NPOs do face in implementing the same.
a. Resource Intensive Maintenance: Fund accounting demands significant time and effort, particularly when managing a large number of funds. Often, designated staff or external accounting firms are required, which can be financially burdensome for small nonprofits.
b. Reconciliations: Grant fund accounting entails reconciliations at multiple levels for various reporting purposes. For instance, reconciliations are necessary for Form 10BD, Income Tax Return (ITR), and reconciling profit and loss statements with cost centers or other software systems used to ensure accurate reporting.
10. How can Aria CFO Services help in resolving the challenges?
Aria CFO Services has assisted over 400 NPO’s in over a decade with multiple interventions. Here are 2 key ways that we can help with fund accounting:
Technology:
ERP4Impact.com is a specialized SaaS platform designed to address the unique needs of nonprofits. Amongst several features, it offers the following:
Grant and Donor Management
Interactive Grant and Donor Dashboards'
Automation of Utilisation Certificates
Automate Accounting in Tally
Consulting:
As specialists in nonprofit accounting, Aria CFO Services cab build capacity of your finance team and help navigate challenges through regular on-site reviews. Simplify your financial management and focus on your mission — contact us today.
Conclusion:
Grant fund accounting is a vital component of financial management for NPOs, enabling transparency, accountability, and effective stewardship of donor funds. While challenges may arise, proactive measures such as capacity building, leveraging technology, and seeking expert guidance can empower NPOs to overcome obstacles and thrive in their mission-driven endeavors.
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