What is fund accounting? Types and examples for nonprofits

Published Tuesday 6 October 2026

Table of contents

• What is fund accounting?
• Fund accounting vs traditional accounting
• Organizations that use fund accounting
• Types of funds in nonprofits
• Characteristics of fund accounting
• Advantages of fund accounting
• Disadvantages of fund accounting
• Best practices for fund accounting
• Using fund accounting software
• Simplify your fund accounting with Xero
• FAQs on fund accounting

Key takeaways

• Fund accounting keeps money in separate funds by purpose, so nonprofits and governments can prove each dollar went where donors or laws require
• Nonprofits report net assets with or without donor restrictions, and many also track board-designated funds within their unrestricted net assets
• Fund accounting software automates multi-fund tracking and financial statements, which cuts manual errors and supports compliance
• Fund accounting takes more admin than business accounting, so plan for enough staff time and accounting expertise

What is fund accounting?

Fund accounting is an accounting method that keeps money in separate buckets, one for each purpose. Nonprofits and government agencies use it to prove money went where donors or laws said it should.

Think of a household that keeps cash in labeled envelopes: one for rent and one for groceries. You only pay each bill from the envelope that matches it, and fund accounting applies the same idea to an organization’s books.

Each fund gets its own set of accounts, so every funding source has clear boundaries. Each fund account includes:

• Dedicated resources and obligations: the fund’s own assets and liabilities, kept apart from other funds
• Individual revenue and expense tracking:transactions isolated from other funds
• Unique financial position: a separate balance sheet showing what the fund owns and owes
• Distinct ledger codes: codes in the general ledger that identify each funding source, such as a specific grant or donor

This separation lets organizations prove they’ve followed donor restrictions and regulatory requirements. Nonprofits record these fund transactions using accrual accounting principles.

Fund accounting examples

Each scenario below tracks a restricted amount through to its release. Each one uses round figures to keep the math simple.

A food bank receives a $50,000 grant to run a summer meals program, so it records the full amount in a restricted fund. Over the summer, it charges $45,000 in food and staff costs to that fund. Once the program is complete and the funder approves, the remaining $5,000 is released to unrestricted funds.

An animal shelter receives a $30,000 pledge, paid as $10,000 a year for three years to support general operations. The shelter records the full pledge as time-restricted. At the start of each year, it reclassifies $10,000 to unrestricted funds, ready to spend.

A city puts $2 million of gas tax revenue into a special revenue fund for road repairs. Paving costs are charged to that fund, while police and parks spending comes from the general fund. At year-end, the city reports each fund’s balance separately, so residents can see the gas tax paid for roads.

Fund accounting vs traditional accounting

Fund accounting differs from traditional accounting in its primary goal. Traditional business accounting measures profitability to see if a company is making or losing money. Fund accounting focuses on accountability and compliance instead.

The main purpose of fund accounting is to show that funds are spent according to legal or donor-imposed restrictions. This makes it essential for nonprofits and government agencies that need to prove they’re using their financial resources responsibly. The Government Accountability Office (GAO) has audited the federal government’s consolidated financial statements since fiscal year 1997. That long record shows how much weight public accountability carries.

Organizations that use fund accounting

Fund accounting is most common in government entities and nonprofits. Here’s who typically uses it.

Government entities

Government agencies at all levels use fund accounting to track public resources. These include:

• Federal agencies, which follow generally accepted accounting principles (GAAP) set out in the Federal Accounting Standards Advisory Board (FASAB) Handbook
• State and local governments, which manage general, special revenue, permanent, debt service, and capital projects funds

Nonprofit organizations

Many types of nonprofit organizations rely on fund accounting. These include:

• Churches and religious organizations
• Hospitals and healthcare facilities
• Universities and colleges
• Nursing homes
• Artistic foundations
• 501(c)(3) organizations recognized by the Internal Revenue Service (IRS)

Fund accounting helps these organizations track who gave each dollar and any limits on how it can be spent.

Types of funds in nonprofits

Nonprofit organizations can have different types of funds. For governments, the Governmental Accounting Standards Board (GASB) groups fund balances by the relative strength of the constraints on spending.

Restricted funds

Restricted funds are donations with specific spending requirements that create legal obligations for the organization. Some gifts also carry conditions, such as one or more barriers to clear. The contributor may then have a right of return if they aren’t met. Restricted funds work as follows:

• Donor control: contributors specify exactly how money must be used
• Legal obligation: organizations must spend funds only as directed
• Clear reporting: organizations show donors how their money was used
• Common examples: building projects, research initiatives, scholarship programs, equipment purchases, and challenge (matching) grant agreements

Spending restricted funds only as directed protects your organization from legal penalties and keeps its nonprofit status secure.

Unrestricted funds

Unrestricted funds are donations without specific donor instructions. The nonprofit can use these funds based on its needs and objectives.

Common uses for unrestricted funds include:

• Operational expenses
• Staff wages
• Emergency repairs
• Mission-aligned initiatives

Temporarily restricted funds

Temporarily restricted funds carry donor stipulations that expire when a set time passes or a specific purpose is met. These funds are reclassified as unrestricted when the restriction ends.

Two conditions can lift restrictions:

• Time-based: the restriction expires after a set period
• Purpose-based: the restriction ends when a specific goal is achieved

For example, a donor gives $12,000 in November to support general operations the following year. The nonprofit records the gift as restricted, then reclassifies the full $12,000 to unrestricted funds on January 1. Under Accounting Standards Update 2016-14 from the Financial Accounting Standards Board, these gifts are reported as net assets “with donor restrictions” until that release.

Board-designated funds

Board-designated funds are unrestricted funds set aside for a specific purpose by the nonprofit’s board. The board makes these designations internally rather than donors.

For example, a board might designate funds for:

• Future expansion projects
• Capital improvements
• Operating reserves
• Strategic initiatives supporting organizational growth

Characteristics of fund accounting

Fund accounting manages both restricted and unrestricted money to ensure proper allocation and compliance reporting. Restricted funds must be spent for specific donor-designated purposes, while unrestricted funds can support any organizational need that aligns with the mission.

Nonprofits using fund accounting prepare these financial statements:

• Statement of financial position: shows assets, liabilities, and net assets
• Statement of activities: tracks revenues and expenses over time
• Statement of cash flows: monitors money movement in and out
• Functional expense analysis: breaks down spending by function and by nature, shown as a separate statement, on the statement of activities, or in the notes

Advantages of fund accounting

Fund accounting provides clear financial accountability that builds trust with donors and regulatory agencies. The GAO reports that over 20 Chief Financial Officer (CFO) Act agencies received clean audit opinions between fiscal years 2011 and 2020. Key benefits include:

• Transparency: show exactly how money is spent through detailed reporting
• Compliance demonstration: prove adherence to donor restrictions easily
• Stakeholder confidence: let donors and agencies verify proper fund usage
• Risk reduction: prevent accidental misuse of restricted funds

This transparency helps organizations maintain their nonprofit status and secure future funding.

Disadvantages of fund accounting

Fund accounting requires more complex record-keeping than traditional business accounting methods. Main challenges include:

• Increased administrative work: maintain separate records and reports for each fund
• Higher time investment: track and report more detailed information
• Limited financial overview: navigate fund separation that can obscure overall organizational health
• Complex reporting: manage multiple financial statements instead of consolidated views

Organizations need adequate staff time and accounting expertise to manage fund accounting well without overwhelming their resources.

Best practices for fund accounting

Effective fund accounting requires consistent processes to maintain compliance and build donor trust. Follow these best practices to manage your funds successfully:

• Maintain clear fund separation: keep each funding source in its own account with distinct tracking codes
• Document all restrictions carefully: record donor requirements and grant conditions when you receive the money
• Reconcile funds regularly: review fund balances monthly to catch errors before they compound
• Communicate with donors: provide transparent updates on how restricted funds are being used
• Plan for annual reporting: schedule time before year-end to prepare required financial statements and compliance documents

These practices help you stay organized, meet regulatory requirements, and show accountability to your stakeholders.

Using fund accounting software

Fund accounting software automates complex tracking and reduces manual errors in multi-fund management. You can put fund accounting into practice in a few ways:

• Certified Public Accountant (CPA): get expert guidance for complex compliance requirements
• Accounting software: automate tracking and reporting with tools like Xero
• Combined approach: use software for daily operations and a CPA for oversight and compliance

Software takes care of the repetitive parts of tracking several funds. Key software benefits include:

• Automated fund allocation: reduce manual entry errors
• Faster reporting: generate required financial statements automatically
• Multi-fund tracking: manage multiple funding sources at the same time
• Clear audit trail: see which fund each transaction belongs to

This approach saves time while keeping the accuracy you need for donor and regulatory compliance.

Simplify your fund accounting with Xero

Clear fund records show donors and regulators where every dollar went. Xero helps you track each fund and manage expenses in one place, so compliance reporting takes less effort.

Keep your bookkeeping accurate and spend more time on your mission. Sign up today and get one month free to see how Xero supports your organization.

FAQs on fund accounting

Here are answers to common questions about fund accounting.

What is an example of fund accounting?

A school district that raises $10 million through a bond sale for a new school building records the money in a capital projects fund. Only construction costs for that building are paid from the fund, keeping them separate from day-to-day costs in the general fund.

What are the three main types of funds?

Under Governmental Accounting Standards Board (GASB) Statement No. 34, governments group funds into three categories: governmental, proprietary, and fiduciary. Governmental funds cover public services, proprietary funds run business-like activities such as utilities, and fiduciary funds hold assets in trust.

Do small nonprofits need fund accounting?

Yes, even small nonprofits benefit from fund accounting. It helps you meet grant requirements and show donors their restricted gifts were used as promised.

How do I transition to fund accounting?

Start by listing your funding sources and noting which donations carry restrictions. Then set up a separate fund for each restriction in your accounting software, ideally with help from an accountant who knows nonprofit accounting.

What are common mistakes to avoid with fund accounting?

Common mistakes include mixing restricted and unrestricted money and recording donor restrictions late or not at all. Reconciling each fund’s balance monthly helps you catch both early.

restricted and unrestricted money and recording donor restrictions late or not at all. Reconciling each fund’s balance monthly helps you catch both early.