Fund Accounting (Definition, Example) | How it works?

What is fund accounting?

Fund accounting is a method used by non-profit organizations and governments to account for funds or grants received from individuals, grant authorities, governments, other organizations, etc., who have imposed restrictions or conditions on the use of funds from grants (the condition may be enforced on the full funds or a portion of funds according to the donor).


In the case of non-profit organizations (NPOs) and governments, the rules and requirements for financial reporting are different from those of other organizations because these entities are not for-profit oriented. Hence the main focus is to track and verify the various uses of funds available to the entity. Nonprofits receive two types of funds, one of which is the grant with no restrictions on its use, and the other with some restrictions on the use of the funds. Therefore, it is used to account for these funds.

Hence, it provides bifurcation in the processing of both types of grants and provides traceability of the use of funds which have donor-specific restrictions or conditions.


  • The primary objective of fund accounting is to provide separate accountability for the general purpose fund and the specific purpose fund, allowing for the amount to be traceable.
  • Keeps track of which expenditures are incurred from the funds and if the use is in such an area in exchange for those funds (conditions provided by the donors).
  • It is used to assess the financial condition of an entity and to show reliable financial information about the entity for financial reporting.
  • It provides a justification basis for the expenditures incurred against the Specific Purpose Grant received for any capital projects.

How does fund accounting work?

  • It is used by non-profit organizations or government organizations. It is a recording of resources received from a donor for a specific purpose. There can be two types of chests, one restricted and one not. A restricted fund is used for a specific purpose, but unrestricted funds can be used for any purpose or general purpose.
  • The non-profit organization uses the same standard as the for-profit organization. However, the terms differ in non-profit organizations like instead of preparing Profit and Loss Account, NPO makes Payable and Receipt Account, Revenue and Expense Account and Balance Sheet.
  • Payment and Receipt Account – All the amount receipts in the organization will be calculated on the receiving side, and all payments made will be shown on the payment side.
  • Income and Expense Account – The non-profit organization prepares a revenue and expense account to show the use of funds that have received an allocation to the fund. If the income received is more than the expenditure incurred, it is called a surplus, and if the expenditure is more than the income, then it is called a deficit.
  • Balance Sheet for Statement of Financial Position – The balance sheet of a nonprofit organization is the same as a profit organization. It shows the value of the assets and liability of the NPO.


  • The school operates as a non-profit organization. She has received a donation to repair the building. Also, they received money from a company to provide quality food to the students. The school also received a donation for general purposes, not for any specific purpose.
  • Now the donation to the repair will only be used to repair the buildings. So this donation is not pushed aside. The same donation received for food will be spent for this purpose only. But donations received for general purposes can be used for any purpose, such as teacher salaries, school expenses, etc.

Fund Accounting vs. Non-Fund Accounting

  • Fund accounting is used by non-profit organizations and government. It is also used in portfolio work and in investment banking.
  • Non-fund-based accounting does not deal with money or cash. Deals with bonds, letters of credit, etc.
  • In fund accounting, funds specified for the purpose for which they were received can be used. The general purpose fund can be used to manage the organization.
  • In a non-financing organisation, the entire business entity is treated as a separate business.
  • The financial statement includes the payment and receipt account, the income and expense account, and the balance sheet.
  • The financial statements of non-financial accounting include the trading account, profit and loss account, and balance sheet.


  • It separates specific purpose funds from general purpose funds.
  • The funds are segregated by purpose from the fund provided by law or the donor at the time the grant is made. By splitting the money, it helps in budgeting and projecting the money for future purposes.
  • This requires setting up a receiving and paying account, the accounts show how much is collected in a year or in a specific period of time and how much is paid in a certain period of time. How much is left in the fund?


  • It becomes difficult to keep the amount in separate funds means that it is difficult to separate the amount from the general fund to the specific purpose fund.
  • The calculation does not reflect the true and actual value of the fund. Sometimes a non-profit organization embezzles funds by including the use of cash.
  • Sometimes it leads to higher expenditure on the fund but lowers the control of the fund; Mostly, it happens in government organizations.
  • Fund accounting does not provide a quality analysis of the performance of a non-profit entity or a government entity. Focuses only on accounting for the various funds.
  • With the increase in the different types of grants or funds and management of accountability, the accounting and ultimately tracking of funds becomes very complex.


Fund accounting provides basic accounting methods for non-profit organizations and governments to record their funds and grants received from third parties (ie a general purpose grant or a specific purpose grant). Provides accountability for recorded funds and transactions against them with legal obligations applicable to entities. It assists auditors by providing traceability towards the various funds or grants received from donors and the treatment or expenditures incurred by management against those funds.

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