Fund Accounting for Nonprofits: Complete Basics Guide

Nonprofits manage money they can’t freely spend, and one wrong move puts grants and donor relationships at risk. Fund accounting mitigates these risks.  

Fund accounting is specifically designed for nonprofits, allowing organizations to track spending by purpose rather than just profit and loss. 

Discover the basics of fund accounting below and learn how to set up your organization for success.    

What Is Fund Accounting?  

Fund accounting is a system of record-keeping that segregates resources into funds based on their source and the restrictions placed upon them. Instead of a single giant pot of money, your financial structure is divided into distinct funds with its own balance sheet and income statement. 

Three major concepts make up the fundamentals of fund accounting:   

Fund Structure:

Resources are sorted into three categories: Unrestricted (used at the organization’s discretion), Temporarily Restricted (tied to a specific project or period), and Permanently Restricted (endowments where only the interest can be spent).    

Multidimensional Chart of Accounts:

To track these funds accurately, your chart of accounts must include a fund segment. This allows you to record every revenue and expense against a specific fund without the need for manual spreadsheets.   

Segregation of Resources:

This approach assures that funds intended for a New Building Fund are not used to cover General Operating costs. 

Fund Accounting vs. General Accounting 

General accounting and fund accounting are two distinct approaches to financial management, each with a specific purpose and application. Here’s how general accounting and fund accounting differ: 

Factor	General Accounting	Fund Accounting
Purpose	Focuses on capturing and reporting an organization’s overall financial activities and performance.	Designed for nonprofit organizations and focused on tracking and managing resources by separate funds.
Approach	Combines all financial transactions and activities into a single, consolidated set of accounts, typically referred to as the general ledger.	Segregates financial transactions and activities into different funds based on their source, purpose, or donor-imposed restrictions.
Scope	Encompasses all financial aspects of an organization, including revenue, expenses, assets, liabilities, and equity.	Captures and reports on the financial activities of each individual fund, ensuring compliance with donor restrictions and facilitating accurate reporting.
Reporting	Financial statements, such as the income statement, balance sheet, and cash flow statement, provide an overview of the organization’s financial health and performance.	Nonprofit organizations typically prepare separate financial statements for each fund, allowing stakeholders to understand the allocation and utilization of restricted and unrestricted resources.
Applicability	Commonly used in for-profit entities, where the focus is on profitability and generating returns for shareholders or owners.	Predominantly used in the nonprofit sector, where organizations receive and manage funds with specific purposes, donor restrictions, or project requirements.

Beyond that, fund accounting incorporates several nonprofit-specific requirements, including:   

Focus on compliance:

Fund accounting focuses on compliance with donor restrictions and the tracking of restricted funds, whereas general accounting focuses more broadly on performance and profitability.  

Reporting requirements:

Fund accounting requires separate reporting for each fund to provide transparency and accountability for fund utilization, while general accounting typically produces consolidated financial statements for the entire organization. 

Types of Nonprofit Funds Explained 

Nonprofit funding is defined by a series of restrictions. Your organization’s funds fall into these categories:   

Unrestricted Funds: 

These are resources available for the organization’s general expenditures. They are not subject to donor-imposed stipulations, meaning the board of directors and management have full autonomy to use them for any purpose that supports the entity’s mission. 

Restricted Funds: 

These represent resources subject to specific external stipulations. They are often divided into two subcategories:  

1. Temporarily Restricted: Resources that must be used for a specific purpose (such as a scholarship program) or during a specific period.  
2. Permanently Restricted: Resources that must be maintained in perpetuity are often referred to as the principal. 

Endowment: 

A specific type of restricted fund where the original principal investment is intended to remain untouched forever. The organization generally spends only investment income, or a small percentage of the fund’s market value, each year to support long-term sustainability. 

Designated Funds: 

These are a subset of unrestricted funds set aside by the organization’s governing board for a specific project or future use. Unlike restricted funds, these are not legally bound by a donor’s request and can be undesignated at any time by a board vote. A similar fund, board-designated funds, often fall into this category, but technically, these funds are unrestricted.  

Fixed Asset Funds: 

This category is used to track the value of the organization’s long-term physical assets, such as land, buildings, and equipment. Segregating these ensures that the value tied up in a building is not confused with liquid cash available for monthly bills.  

How Restricted and Unrestricted Funds Work 

In practice, restricted and unrestricted funds operate very differently. These differences are apparent in a real-world example:  

Your nonprofit receives a $50,000 workforce development grant.  

Before a single dollar is spent, your finance team needs to create a dedicated fund to track the grant, code it as temporarily restricted, and document the grantor’s stipulations, like allowable expenses, reporting deadlines, and the grant period end date.  

From that point forward, every expense charged to that grant is paid from that fund. 

When the grant period ends, funds are released from restriction to pay off the documented, allowable expenses. That changes the fund from temporarily restricted to unrestricted net assets.  

Fund tracking is where compliance mistakes tend to occur. Nonprofits commonly use restricted dollars to cover general operating costs when unrestricted cash runs tight, or co-mingle grant funds with operating funds in a way that makes expense documentation impossible to reconstruct.  

These compliance mistakes put your organization at risk — not only of a grant claw back, but of damaging your relationship with the grantor and stakeholders in your organization.  

Grantors and major donors expect their money to be used exactly as intended, and they expect documentation to prove it. Nonprofits that can produce clean, fund-level financial reports on demand are the ones that get renewed, get referrals, and get the next gift. 

Core Fund Accounting Principles for Nonprofits 

A chart of accounts is the backbone of fund accounting and its No. 1 principle. A nonprofit chart of accounts is segmented by fund, combining a fund segment, a program segment, and a natural account number.  

An example COA number, such as 01-4100-200, could represent unrestricted funds for the workforce development program.  

Every transaction is coded to that level of specificity, which makes fund-level reporting possible.  

Because of that level of specificity, each fund functions as a sub-entry in a general ledger.  

Fund accounting software simplifies the management of these funds by tracking every fund’s revenue, expenses, assets, and liabilities separately. If a grantor wants to see how their money is spent, the fund’s COA entry documents that.  

That structure reflects how leadership and boards see financial information. Rather than reviewing an organization-wide income statement, leadership wants fund-level reports that show financial position and activity independently. 

Fund-level visibility isn’t just a management preference; it’s the foundation of compliance. Nonprofits follow ASC 958, the GAAP framework specific to not-for-profit entities.  

ASC 958 governs how net assets are classified and disclosed, requiring organizations to report net assets in two categories: with donor restrictions and without donor restrictions.  

It also requires organizations to provide disclosures around the nature and amounts of those restrictions. 

Understanding where your funds map to those classifications isn’t just an audit requirement; it determines how your organization shows organizational health to funders, boards, and regulators. 

How to Set Up a Fund Accounting System 

Setting up a fund accounting system begins before you ever log into software:  

Step 1: Define your fund structure. Before touching your accounting system, map out every fund your organization currently manages or expects to manage. List each funding source, note whether it carries donor restrictions, and identify which funds are temporary versus permanent. This exercise often surfaces funds that have been informally tracked in spreadsheets or lumped together in ways that won’t hold up to an audit.  

Step 2: Build a segmented chart of accounts. Design your account string structure to capture fund, program, and natural account at a minimum. Decide on your segment lengths and naming conventions before entering a single account — changing your COA structure after transactions have been posted is painful and disruptive. If you’re moving from spreadsheets or a general accounting system, this is the most important architectural decision you’ll make.  

Step 3: Establish internal controls. Document who has the authority to approve spending against each fund, how restrictions will be monitored, and what the process is for releasing funds from restriction. These policies don’t need to be lengthy, but they must be documented in writing before your first audit. 

Step 4: Map existing transactions. If you’re migrating from another system, assign every open transaction and balance to the correct fund before going live. Migrating clean data is far easier than reconciling a messy conversion six months later. 

Step 5: Build your reporting templates. Determine what fund-level reports your board, leadership, and major grantors will need — and build those reporting templates before you need them under deadline pressure. Standard outputs include fund-level balance sheets, fund-level income statements, and grant spending reports tied to award periods. 

Advantages of Fund Accounting Software 

Fund accounting software is the ideal software for nonprofits. While smaller organizations use spreadsheets to manage their finances. As your organization grows, spreadsheets increase your audit risk with their lack of internal controls, are subject to human errors, and don’t offer a real-time view into your finances.  

Fund accounting software automatically tracks each individual fund, includes built-in internal controls and a complete audit trail, and makes it simple to report on multiple funds simultaneously.  

From boosting audit readiness to keeping your board and stakeholders adequately informed, fund accounting software saves your finance team time while ensuring your organization is a good steward of donated funds. 

When evaluating fund accounting software, consider selecting software that offers these features:  

Automated Segregation: Transactions are routed automatically to the correct fund based on predefined rules, eliminating manual data shuffling and ensuring donor intent is met. 

Real-Time Fund Reporting: Instead of waiting for a month-end close, you can generate fund-specific balance sheets, income statements, and FASB-/GASB-compliant reports with a single click.  

Encumbrance Accounting: Track commitments before they become actual expenses. This allows you to reserve funds for future obligations, preventing budgetary overspending,  

Native Integration: By connecting your accounting system directly to payroll and donor management tools, you create a unified ecosystem with a 360-degree view of institutional health.  

Scalable Modules: Modern systems allow you to add specific modules for grant management, procurement, or advanced forecasting as your organization grows. 

How MIP Fund Accounting Supports Nonprofit Finance Teams 

MIP Accounting by Momentive Software, is purpose-built for the way nonprofits operate. Our multidimensional chart of accounts supports unlimited funds and program segments, so your financial structure can reflect your organization’s real complexity. Built-in audit trails, iron-clad internal controls, and encumbrance accounting give finance teams the compliance measures auditors expect and boards require. 

With more than 40 years serving the nonprofit sector, the platform was built by nonprofits for nonprofits, and it’s why 5,000 nonprofits across the country trust MIP with their finances. 

Frequently Asked Questions