Fund accounting

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Diagram demonstrating the difference between general and fund accounting Fund Accounting diagram.png
Diagram demonstrating the difference between general and fund accounting

Fund accounting is an accounting system for recording resources whose use has been limited by the donor, grant authority, governing agency, or other individuals or organisations or by law. [1] [2] It emphasizes accountability rather than profitability, and is used by Nonprofit organizations and by governments. In this method, a fund consists of a self-balancing set of accounts and each are reported as either unrestricted, temporarily restricted or permanently restricted based on the provider-imposed restrictions. [1]

In ethics and governance, accountability is answerability, blameworthiness, liability, and the expectation of account-giving. As an aspect of governance, it has been central to discussions related to problems in the public sector, nonprofit and private (corporate) and individual contexts. In leadership roles, accountability is the acknowledgment and assumption of responsibility for actions, products, decisions, and policies including the administration, governance, and implementation within the scope of the role or employment position and encompassing the obligation to report, explain and be answerable for resulting consequences.

In economics, profit in the accounting sense of the excess of revenue over cost is the sum of two components: normal profit and economic profit. Normal profit is the profit that is necessary to just cover the opportunity costs of the owner-manager or of the firm's investors. In the absence of this profit, these parties would withdraw their time and funds from the firm and use them to better advantage elsewhere. In contrast, economic profit, sometimes called excess profit, is profit in excess of what is required to cover the opportunity costs.

A nonprofit organization (NPO), also known as a non-business entity, not-for-profit organization, or nonprofit institution, is dedicated to furthering a particular social cause or advocating for a shared point of view. In economic terms, it is an organization that uses its surplus of the revenues to further achieve its ultimate objective, rather than distributing its income to the organization's shareholders, leaders, or members. Nonprofits are tax exempt or charitable, meaning they do not pay income tax on the money that they receive for their organization. They can operate in religious, scientific, research, or educational settings.

Contents

The label fund accounting has also been applied to investment accounting, portfolio accounting or securities accounting – all synonyms describing the process of accounting for a portfolio of investments such as securities, commodities and/or real estate held in an investment fund such as a mutual fund or hedge fund. [3] [4] Investment accounting, however, is a different system, unrelated to government and nonprofit fund accounting.

To invest is to allocate money in the expectation of some benefit in the future.

A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. These investors may be retail or institutional in nature.

A hedge fund is an investment fund that pools capital from accredited investors or institutional investors and invests in a variety of assets, often with complex portfolio-construction and risk management techniques. It is administered by a professional investment management firm, and often structured as a limited partnership, limited liability company, or similar vehicle. Hedge funds are generally distinct from mutual funds, as their use of leverage is not capped by regulators, and distinct from private equity funds, as the majority of hedge funds invest in relatively liquid assets.

Overview

Nonprofit organizations and government agencies have special requirements to show, in financial statements and reports, how money is spent, rather than how much profit was earned. Unlike profit oriented businesses, which use a single set of self-balancing accounts (or general ledger), nonprofits can have more than one general ledger (or fund), depending on their financial reporting requirements. [5] An accountant for such an entity must be able to produce reports detailing the expenditures and revenues for each of the organization's individual funds, and reports that summarize the organization's financial activities across all of its funds. [6] [7]

General ledger central repository for accounting data

A general ledger contains all the accounts for recording transactions relating to a company's assets, liabilities, owners' equity, revenue, and expenses. In modern accounting software or ERP, the general ledger works as a central repository for accounting data transferred from all subledgers or modules like accounts payable, accounts receivable, cash management, fixed assets, purchasing and projects. The general ledger is the backbone of any accounting system which holds financial and non-financial data for an organization. The collection of all accounts is known as the general ledger. Each account is known as a ledger account. In a manual or non-computerized system this may be a large book.

Fund accounting distinguishes between two primary classes of fund. [1] [8] Those funds that have an unrestricted use, that can be spent for any purposes by the organization and those that have a restricted use. The reason for the restriction can be for a number of different reasons. Examples include legal requirements, where the moneys can only be lawfully used for a specific purpose, or a restriction imposed by the donor or provider. These donor/provider restrictions are usually communicated in writing and may be found in the terms of an agreement, government grant, will or gift. [8]

When using the fund accounting method an organization is able to therefore separate the financial resources between those immediately available for ongoing operations and those intended for a donor specified reason. This also provides an audit trail that all moneys have been spent for their intended purpose and thereby released from the restriction. [1]

An example may be a local school system in the United States. It receives a grant from the its local state government to support a new special education initiative, another grant from the federal government for a school lunch program, and an annuity to award teachers working on research projects. At periodic intervals, the school system needs to generate a report to the state about the special education program, a report to a federal agency about the school lunch program, and a report to another authority about the research program. Each of these programs has its own unique reporting requirements, so the school system needs a method to separately identify the related revenues and expenditures. This is done by establishing separate funds, each with its own chart of accounts.

Chart of accounts

A chart of accounts (COA) is a created list of the accounts used by an organization to define each class of items for which money or the equivalent is spent or received. It is used to organize the finances of the entity and to segregate expenditures, revenue, assets and liabilities in order to give interested parties a better understanding of the financial health of the entity.

Nonprofit organizations

Nonprofit organization's finances are broken into two primary categories, unrestricted and restricted funds. [8] The number of funds in each category can change over time and are determined by the restrictions and reporting requirements by donors, board, or fund providers. [9]

Unrestricted funds are, as their name suggests, unrestricted and therefore organizations don't necessarily need more than a single General Fund, however many larger organizations use several to help them account for the unrestricted resources. Unrestricted funds may include:

Restricted funds may include:

Accounting basis and financial reporting

Like Profit making organizations, nonprofits and governments will produce Consolidated Financial Statements. These are generated in line with the reporting requirements in the country they are based or if they are large enough they may produce them under International Financial Reporting Standards (IFRS), an example of this is the UK based charity Oxfam. [10] If the organization is small it may use a cash basis accounting but larger ones generally use accrual basis accounting for their funds. [12]

Nonprofit organizations in the United States have prepared their financial statements using Financial Accounting Standards Board (FASB) guidance since 1993. [13] The financial reporting standards are primarily contained in FAS117 and FIN43. [14] FASB issued a major update in 2016 that changed reporting net assets from three primary categories to two categories, restricted and unrestricted funds and how these are represented on financial statements. [15]

Nonprofit and governments use the same four standard financial statements as profit-making organizations:

In the United States there may also be a separate Statement of functional expenses which distributes each expense of the organization into amounts related to the organization's various functions. These functions are segregated into two broad categories: program services and supporting services. Program services are the mission-related activities performed by the organization. Non-program supporting services include the costs of fund-raising events, management and general administration. [20] This is a required section of the Form 990 that is an annual informational return required by the Internal Revenue Service for nonprofit organizations. [21]

United Kingdom governmental system

The United Kingdom government has the following funds:

Accounting basis and financial reporting

The United Kingdom government produces the financial statements called the Whole of Government Accounts. They are produced using the annual basis and generated under the International Financial Reporting Standards like any other large organisation. [18]

United States governmental system

State and local government funds

State and local governments use three broad categories of funds: governmental funds, proprietary funds and fiduciary funds. [2] [7]

Governmental funds include the following. [25] [26]

Proprietary funds include the following. [25]

Fiduciary funds are used to account for assets held in trust by the government for the benefit of individuals or other entities. [34] The employee pension fund, created by the State of Maryland to provide retirement benefits for its employees, is an example of a fiduciary fund. [32] Financial statements may further distinguish fiduciary funds as either trust or agency funds; a trust fund generally exists for a longer period of time than an agency fund. [35]

Fixed assets and long-term debts

State and local governments have two other groups of self-balancing accounts which are not considered funds: general fixed assets and general long-term debts. These assets and liabilities belong to the government entity as a whole, rather than any specific fund. [36] Although general fixed assets would be part of government-wide financial statements (reporting the entity as a whole), they are not reported in governmental fund statements. [37] Fixed assets and long-term liabilities assigned to a specific enterprise fund are referred to as fund fixed assets and fund long-term liabilities. [38]

Accounting basis

The accrual basis of accounting used by most businesses requires revenue to be recognized when it is earned and expenses to be recognized when the related benefit is received. Revenues may actually be received during a later period, while expenses may be paid during an earlier or later period. (Cash basis accounting, used by some small businesses, recognizes revenue when received and expenses when paid.)

Governmental funds, which are not concerned about profitability, usually rely on a modified accrual basis. This involves recognizing revenue when it becomes both available and measurable, rather than when it is earned. Expenditures, a term preferred over expenses for modified accrual accounting, are recognized when the related liability is incurred. [39] [40]

Proprietary funds, used for business-like activities, usually operate on an accrual basis. [41] Governmental accountants sometimes refer to the accrual basis as "full accrual" to distinguish it from modified accrual basis accounting. [42]

The accounting basis applied to fiduciary funds depends upon the needs of a specific fund. If the trust involves a business-like operation, accrual basis accounting would be appropriate to show the fund's profitability. Accrual basis is also appropriate for trust funds using interest and dividends from invested principle amounts to pay for supported programs, because the profitability of those investments would be important. [43]

Financial reporting

State and local governments report the results of their annual operations in a comprehensive annual financial report (CAFR), the equivalent of a business's financial statements. A CAFR includes a single set of government-wide statements, for the government entity as a whole, and individual fund statements. The Governmental Accounting Standards Board establishes standards for CAFR preparation. [7]

Governments do not use the terms profit and loss to describe the net results of their operations. The difference between revenues and expenditures during a year is either a surplus or a deficit. Since making a profit is not the purpose of a government, a significant surplus generally means a choice between tax cuts or spending increases. A significant deficit will result in spending cuts or borrowing. Ideally, surpluses and deficits should be small. [7] [44] [45]

Federal government funds

Federal government accounting uses two broad groups of funds: the federal funds group and the trust funds group. [46]

Federal funds group

  • General fund. Technically, there is just one general fund, under the control of the United States Treasury Department. However, each federal agency maintains its own self-balancing set of accounts. The general fund is used to account for receipts and payments that do not belong to another fund. [47]
  • Special funds are similar to the special revenue funds used by state and local governments, earmarked for a specific purpose (other than business-like activities). [48]
  • Revolving funds are similar to the Proprietary funds used by state and local governments for business-like activities. The term, revolving, means that it conducts a continuing cycle of activity. There are two types of revolving funds in the Federal Funds Group: public enterprise funds and intragovernmental revolving funds. [49]
    • Public enterprise funds are similar to the enterprise funds used by state and local governments for business-like activities conducted primarily with the public. [48] The Postal Service Fund is an example of a public enterprise fund. [50]
    • Intragovernmental revolving funds are similar to the internal service funds used by state and local governments for business-like activities conducted within the federal government. [48]

Trust funds group

  • Trust funds are earmarked for specific programs and purposes in accordance with a statute that designates the fund as a trust. Its statutory designation distinguishes the fund as a trust rather than a special fund. The Highway Trust Fund is an example of trust funds. [51]
  • Trust Revolving Funds are business-like activities, designated by statute as trust funds. They are, otherwise, identical to public enterprise revolving funds. [51]
  • Deposit funds are similar to the agency funds used by state and local governments for assets belonging to individuals and other entities, held temporarily by the government. State income taxes withheld from a federal government employee's pay, not yet paid to the state, are an example of deposit funds. [52]

Accounting basis and financial reporting

The United States government uses accrual basis accounting for all of its funds. Its consolidated annual financial report uses two indicators to measure financial health: unified budget deficit and net operating (cost)/revenue. [53]

The unified budget deficit, a cash-basis measurement, is the equivalent of a checkbook balance. This indicator does not consider long-term consequences, but has historically been the focus of budget reporting by the media. Except for the unified budget deficit, the federal government's financial statements rely on accrual basis accounting. [53]

Net operating (cost)/revenue, an accrual basis measurement, is calculated in the "Statements of Operations and Changes in Net Position" by comparing revenues with costs. [54] The federal government's net operating (cost)/revenue is comparable with the net income/(loss) reported on an income statement by a business, or the surplus/(deficit) reported by state and local governments.

Fund accounting fiscal cycle (fictitious example)

The following is a simplified example of the fiscal cycle for the general fund of the City of Tuscany, a fictitious city government.

Opening entries

The fiscal cycle begins with the approval of a budget [55] by the mayor and city council of the City of Tuscany. For Fiscal Year 2009, which began on July 1, 2008, the Mayor's Office estimated general fund revenues of $35 million from property taxes, state grants, parking fines and other sources. The estimate was recorded in the fund's general ledger with a debit to estimated revenues and a credit to fund balance. [56]

Ledger accountDebitCredit
1Estimated revenues$35,000,000
Fund balance
$35,000,000

An appropriation was approved by the city council, authorizing the city to spend $34 million from the general fund. The appropriation was recorded in fund's general ledger with a debit to fund balance and a credit to appropriations. [56]

Ledger accountDebitCredit
2Fund balance$34,000,000
Appropriations
$34,000,000

In subsidiary ledgers, the appropriation would be divided into smaller amounts authorized for various departments and programs, [57] such as:

Fire department$5,000,000
Police department$5,000,000
Schools$10,000,000
Public works$6,000,000
Transportation$4,000,000
Mayor's office$4,000,000

The complexity of an appropriation depends upon the city council's preferences; real-world appropriations can list hundreds of line item amounts. An appropriation is the legal authority for spending [58] given by the city council to the various agencies of the city government. In the example above, the city can spend as much as $34 million, but smaller appropriation limits have also been established for individual programs and departments.

Recording revenues

During Fiscal Year 2009, the city assessed property owners a total of $37 million for property taxes. However, the Mayor's Office expects $1 million of this assessment to be difficult or impossible to collect. Revenues of $36 million were recognized, because this portion of the assessment was available and measurable [39] [40] within the current period.

Ledger accountDebitCredit
3Taxes receivable$37,000,000
Estimated uncollectible taxes
$1,000,000
Revenues
$36,000,000

Payroll expenditures

The city spent a total of $30 million on its employee payroll, including various taxes, benefits and employee withholding. A portion of the payroll taxes will be paid in the next fiscal period, but modified accrual accounting requires the expenditure to be recorded during the period the liability was incurred. [39] [40]

Ledger accountDebitCredit
4Expenditures$30,000,000
Wages payable
$20,000,000
Taxes payable
$5,000,000
Benefits payable
$5,000,000

Other expenditures

The Public Works Department spent $1 million on supplies and services for maintaining city streets. [59]

Ledger accountDebitCredit
5Expenditures$1,000,000
Vouchers payable
$1,000,000

Closing entries

At the end of the fiscal year, the actual revenues of $36 million were compared with the estimate of $35 million. The $1 million difference was recorded as a credit to the fund balance. [60]

Ledger accountDebitCredit
6Revenues$36,000,000
Estimated revenues
$35,000,000
Fund balance
$1,000,000

The city spent $31 million of its $34 million appropriation. A credit of $3 million was applied to the fund balance for the unspent amount. [60]

Ledger accountDebitCredit
7Appropriations$34,000,000
Expenditures
$31,000,000
Fund balance
$3,000,000

When the current fiscal period ended, its appropriation expired. The balance remaining in the general fund at that time is considered unexpended. City government agencies are not allowed to spend the unexpended balance, even if their expenditures during the now-ended fiscal period were less than their share of the expired appropriation. A new appropriation is necessary to authorize spending in the next fiscal period. (Liabilities incurred at the end of the fiscal period for goods and services ordered, but not yet received, are usually considered expended, allowing payment at a later date under the current appropriation. Some jurisdictions, however, require the amounts to be included in the following period's budget.) [61]

Instead of re-applying the unspent balance from the general fund to the same programs, the city council may choose to spend the money on other programs. Alternatively, they may use the balance to cut taxes or pay off a long-term debt. With a large surplus, reducing the tax burden will usually be the preferred choice. [7]

See also

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Account (bookkeeping) the central data structure in the accounts and payment services

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Deferral

A deferral, in accrual accounting, is any account where the asset or liability is not realized until a future date, e.g. annuities, charges, taxes, income, etc. The deferred item may be carried, dependent on type of deferral, as either an asset or liability. See also accrual.

A revolving fund is a fund or account that remains available to finance an organization's continuing operations without any fiscal year limitation, because the organization replenishes the fund by repaying money used from the account. Revolving funds have been used to support both government and non-profit operations.

Revenue recognition

The revenue recognition principle is a cornerstone of accrual accounting together with the matching principle. They both determine the accounting period in which revenues and expenses are recognized. According to the principle, revenues are recognized when they are realized or realizable, and are earned, no matter when cash is received. In cash accounting – in contrast – revenues are recognized when cash is received no matter when goods or services are sold.

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The United States federal budget comprises the spending and revenues of the U.S. federal government. The budget is the financial representation of the priorities of the government, reflecting historical debates and competing economic philosophies. The government primarily spends on healthcare, retirement, and defense programs. The non-partisan Congressional Budget Office provides extensive analysis of the budget and its economic effects. It has reported that the U.S. is facing a series of long-term financial challenges, as the population of the country ages and healthcare costs continue growing faster than the economy, leading to the debt held by the public exceeding GDP by 2030. The United States has the largest external debt in the world and the 14th largest government debt as % of GDP in the world.

Government financial statements are annual financial statements or reports for the year. The financial statements, in contrast to budget, present the revenue collected and amounts spent. The government financial statements usually include a statement of activities, a balance sheet and often some type of reconciliation. Cash flow statements are often included to show the sources of the revenue and the destination of the expenses.

Reserve (accounting) accounting

In financial accounting, "reserve" always has a credit balance and can refer to a part of shareholders' equity, a liability [Reserve for Claims better called Liability for Estimated Claims], or an asset contra account [Reserve of Uncollectible Accounts, better called Allowance for Uncollectible Accounts].

The following outline is provided as an overview of and topical guide to accounting:

Comprehensive annual financial report

A Comprehensive Annual Financial Report (CAFR) is a set of U.S. government financial statements comprising the financial report of a state, municipal or other governmental entity that complies with the accounting requirements promulgated by the Governmental Accounting Standards Board (GASB). GASB provides standards for the content of a CAFR in its annually updated publication Codification of Governmental Accounting and Financial Reporting Standards. The U.S. Federal Government adheres to standards determined by the Federal Accounting Standards Advisory Board (FASAB).

Financial position of the United States

The financial position of the United States includes assets of at least $269.6 trillion and debts of $145.8 trillion to produce a net worth of at least $123.8 trillion as of Q1 2014.

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  27. Fixed assets are sometimes referred to as capital assets, a broader term than fixed assets.
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  30. Governmental Accounting Standards Board Statement 34, para. 65
  31. Hay, p. 232
  32. 1 2 State of Maryland Comprehensive Annual Financial Report, FY 2009 See "Fund Financial Statements," p. 12-13
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  34. Hay, p. 286
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  38. Hay, p. 10
  39. 1 2 3 Hay, p. 8
  40. 1 2 3 State of Maryland Comprehensive Annual Financial Report, FY 2009 See "Basis of Accounting," p. 48.
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  47. Hay, p. 476-477
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  51. 1 2 OMB Circular A-11, Section 20 – "Terms and Concepts" See "Trust funds," p. 39-40. Office of Management of the Budget (2009).
  52. OMB Circular A-11, Section 20 – "Terms and Concepts" See "Deposit funds," p. 40. Office of Management of the Budget (2009).
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  54. Financial Statements of the United States Government for the Years Ended September 30, 2009 and 2008 U.S. Government Accountability Office. See "Statements of Net Cost," p. 39. Retrieved 2010-03-26
  55. In most jurisdictions, the budget is a legal document authorizing the government to incur debts, collect taxes and spend money. Hay, p. 20.
  56. 1 2 In the opening entries for a fiscal year, estimated revenues are recorded with a credit to the fund balance, while appropriations are recorded as a debit. Hay, p. 44.
  57. Subsidiary ledger details are used to provide an appropriate level of budgetary control over government spending. Hay p. 43.
  58. Hay, p. 687
  59. When goods or services are received, the amount to be paid is debited to the expenditure account and credited to a liability (payable) account. Hay, p. 63. Transactions involving purchase orders involve encumbrance accounting, requiring a more complex transaction than the simplified example shown here.
  60. 1 2 Closing entries for a government's funds are similar to those of a for-profit business. The totals recorded in revenues and appropriations are reversed with debits while expenditures and estimated revenues are reversed with credits. The difference is applied to fund balance as a credit (surplus) or debit (deficit). Hay, p. 76-77.
  61. Hay, p. 20-21.