Fund Accounting

Fund Accounting

Fund Accounting is an accounting system often used by nonprofit organizations and by the public sector.


Because there is no personal profit motive for owners or members of nonprofit organizations and organizations in the public sector, such as governments, accountability is measured instead of profitability. The main purpose is stewardship of financial resources received and expended in compliance with legal or other requirements. Financial reporting is directed at the public, fund contributors, or to private members, who are concerned with adequate fund balances or net financial assets to provide future programs and services, rather than investors, who seek a profit or return on investment. Funds, which are a self-balancing set of accounts, may be established to provide reporting of expenditure for designated purposes depending on the needs of financial statement users. Fund accounting may also adopt budgets that are formally recorded in the accounts of the related fund. Contractual obligations, commitments or encumbrances may be formally recorded in some funds.

Fund accounting serves any nonprofit organization or the public sector. These organizations have a need for special reporting to financial statements users that show how money is spent, rather than how much profit was earned. Profit oriented businesses only have one set of self-balancing accounts or general ledger. On the other hand, nonprofits can have more than one general ledger depending on their needs. A business manager in charge of such an entity must be able to produce reports that can detail expenditures and revenues for multiple funds, and reports that summarize the financial activities of the entire entity across all funds. For example, if a school system receives a grant from the state to support a new special education initiative, and receives federal funds to support a school lunch program, and even receives an annuity to award to teachers for research projects - at any given time, the school system must be able to extract the financial activities attributed to these programs and report on them.

Given that funds are essentially having more than one general ledger, the accounts can be designed by the special use of account numbers, each set of numbers therein represent a specific fund. Alternatively, they can be designed by using certain recording and reporting capabilities and features of the accounting software being used. For this reason, many nonprofit organizations and the public sector will often use off-the-shelf or custom-designed accounting software that is flexible enough to accommodate the needs of special reporting.

The use of fund accounting has often been a topic of debate in the accounting profession who question its usefulness, particularly in the standard-setting process. However, it is the unique nature in which nonprofit organizations and the public sector operate that has made fund accounting a useful system for financial reporting to meet the needs of financial statement users. To that end, the accounting profession has recognized this need and continues to support the use of fund accounting by providing extensive standards and principles in this area.

Generally Accepted Accounting Principles (GAAP) For the Public Sector

The objective of financial reporting should be the basis for determining specific accounting principles used by a governmental entity. There are 11 principles of accounting and reporting applicable to municipal governments, developed by the National Council on Governmental Accounting (NCGA). These principles are summarized below as stated in NCGA Statement 1 (Governmental Accounting and Financial Reporting Principles):

*Principle 1:Accounting and Reporting Capabilities. A governmental accounting system must make it possible both (a) to present fairly and with full disclosure the financial position and results of financial operations of the funds and account groups of the governmental unit in conformity with generally accepted accounting principles; and (b) to determine and demonstrate compliance with finance-related legal and contractual provisions.

*Principle 2:Funds Accounting Systems. A specific governmental unit is not accounted for through a single accounting entity. Instead, the accounts of a government are divided into several funds and nonfund account groups. The NCGA defines a fund as "a fiscal and accounting entity with a self-balancing set of accounts recording cash and other financial resources, together with all related liabilities and residual equities and balances, and changes therein, which are segregated for the purpose of carrying on specific activities or attaining certain objectives in accordance with special regulations, restrictions, or limitations."

*Principle 3: Types of Funds and Account Groups. NCGA recommends the following categories and types of funds and account groups:Governmental Funds (5 Types)
#The General Fund, used to pay the regular operating and administrative expenses not properly accounted for in other funds.
#The Special Revenue Fund, used to account for the proceeds of specific revenue sources that are legally restricted to expenditure for specified purposes.
#The Capital Projects Fund, used to account for financial resources earmarked for the acquisition or construction of major capital facilities and improvements.
#The Debt Service Fund, used to account for the payment of principal and interest on long-term general obligation bond issues and other long-term debt.
#Permanent Funds

Proprietary Funds (2 Types)
#Enterprise Funds: providing services to external parties
#Internal Service Funds: providing services to other governmental units

Fiduciary Funds (4 Types)
#Agency Funds
#Private Purpose Funds
#Investment Trust Funds
#Pension Trust Funds

*Principle 4:Number of Funds. A government should have only one General Fund, one General Fixed Account Group, and one General Long-term Debt Account Group. It may have one, none, or several of the other types of funds, depending on its activities. Only the minimum number of funds consistent with legal and operating requirements should be established.

*Principle 5:The Budget and Budgetary Accounting. (a) An annual budget should be adopted by every governmental unit, whether required by law or not; (b) the accounting system should provide budgetary control over general governmental revenues and expenditures, (c) Budgetary comparisons should be included in the appropriate financial statements and schedules for governmental funds for which an annual budget has been adopted.

*Principle 6:Valuation of Fixed Assets. Fixed Assets should be accounted for at original cost, or at the estimated cost if the original cost is not available, or, in the case of gifts, at the appraised value as of the time received.

*Principle 7:Depreciation of Fixed Assets.

*Principle 8:Basis of Accounting.

*Principle 9:Classification of Accounts.

*Principle 10:Common Terminology and Classification. A common terminology and classification should be used consistently throughout the budget, the accounts, and the financial reports.

*Principle 11:Financial Reporting. Financial statements and reports showing the financial position, operating results, and other pertinent information should be prepared periodically to control financial operations. At the close of each fiscal year, a comprehensive annual financial report covering all funds and financial operations of the governmental unit should be prepared and published. [Joel G. Siegel, Ph.D, Accounting, Barron's Educational Series, Inc 2006]


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