Fund-Based Accounting

What is Fund-Based Accounting?

Fund-based accounting refers to a method in which all long term and short term sources of revenue are classified into different funds. Once the classification is complete, then different transactions associated with the fund are recorded in its fund account. This facilitates tracking of the revenues and expenses of any particular fund account.

Simply put, Fund Based Accounting is a book-keeping technique in which individual sets of accounts for each fund are kept and maintained for each contribution for a particular period. For instance, prize fund, tournament fund, building fund, library fund etc.

Non-profit organizations, charitable trust, Non-government organizations (NGOs), educational institutions, sports club, etc. often use this system of accounting, to ensure that specific funds are used for that purpose only, for which they have been created.

Features of Fund Based Accounting

Upcoming points will talk about the salient features of fund-based accounting:

  • A special self-balancing set of assets, liabilities, incomes and expenditures are maintained, which means that the treatment of the fund is done separately, as well as its accounting is done accordingly.
  • On the receipt of a legally restricted fund by an organization, then a restricted fund has to be created for it.
  • It is mostly used by non-profit organizations.
  • Grants, aids and contribution are the major financial resources of non-trading concerns, hence they should be used as per the rules.
  • Recording of all the items as regards the separate fund should be done fundwise and the consolidation of the statement of accounts are shown in the financial statement for the benefits of its users.

Classification of Funds

Basically, funds are classified into two categories, which are represented as under:classification-of-funds

  1. Revenue Fund: These funds typically keep a record of normal revenue transactions, so as to meet the operating expenses. The use of these funds can be restricted or unrestricted.
    • Restricted Funds: As the name indicates, restricted funds are the one which is to be used for a specific purpose only, i.e. for which the fund has been created and not otherwise.
    • Unrestricted Fund: Also otherwise called a general fund or capital fund, these funds are not limited to exclusive use, as they are created to undertake general activities. these are created out of grants, gifts and annual subscriptions. In the case of unrestricted funds, the accrual method of accounting is used by the profit-making entities.
  2. Special Fund: To record transactions of a capital nature, special funds are used. Such funds keep a record of those resources which may not be used or spent currently, instead they are to be used in future. Further, the contribution is directly credited to the concerned fund account.
    • Endowment Fund: Endowment fund is commonly for not-for-profit organizations, that originate from inheritance or gift, provided that the principal amount will be maintained forever while the income arising from that amount can be used for different activities or dedicated to a specific purpose.
    • Annuity fund: The fund is established from contributions made by the members and it is utilized for providing regular payments annually to the donor’s beneficiaries.
    • Fixed Asset Fund: To make an investment in fixed assets of the organization such as building, land, etc, a fixed asset fund is established. It is also known as a development fund, and it is created out of special grants, or general funds to acquire fixed asses.
    • Loan Fund: Debt Fund or Loan Fund created to grant loans to the staff members of a long term nature.
    • Prize Fund: Fund collected to award prizes for achievements, is Prize Fund.

Objectives of Fund-Based Accounting

The objectives of fund-based accounting are discussed below:

  • To make the comparison of the actual financial results of different activities with the budgeted ones.
  • To analyse the financial performance of the not-for-profit enterprise during the financial year.
  • To make sure that the rules, regulations and legal provisions are duly complied with.
  • To ensure that the funds are utilized as instructed.
  • To keep a record of revenues and expenses.
  • To ascertain the efficiency in using money on approved activities.

Steps of Accounting in Fund Based Accounting

The following steps of accounting are followed in fund-based accounting:Process-of-Fund-Based-Accounting

  1. Classify funds: In a not for profit enterprise, in place of capital members bring donations. Hence, the initial donation should be classified in different funds. For example: Suppose a charitable trust to provide free education to poor children is set up, and members donated money in this regard. So this money received in the form of donation is to be transferred to different funds like school building fund, general expenses fund, free books fund, etc.
  2. Prepare Budget: Prior to using the fund amount into various activities, one must make sure that the budget is prepared, as to how much amount should be spent on the activities, which is helpful in keeping control of unnecessary expenses.
  3. Recording of future revenues and expenses: Rather than creating an income and expenditure account, the accountant is required to create income and expenditure of each fund and keep a record of them, which is helpful in comparing the actual expenses with the budgeted expenses.
  4. Measure the Performance of the fund: When the donation is used effectively and honestly, it will be regarded as the best performance of the fund. So, to gauge the performance of the project, on the basis of different funds, financial statements are prepared.

In fund-based accounting, there is fund-wise preparation of financial statements and consolidation of the financial statement, so as to indicate the financial position of the entire organization.

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