Fund accounting is a way to separate money and other resources into categories based on the source of funds and any restrictions on the use of those funds. Organizations use fund accounting to track money related to a specific project or purpose. Each fund is an independent accounting entity, where accounts are maintained to make sure that the funds are used for their intended purposes.
Government and nonprofit organizations often receive money that they are required to use in a specific way. Fund accounting is intended to ensure that any limitations and restrictions placed on the use of those funds are observed. The focus of fund accounting in this context is on accountability rather than profitability.
Modified Accrual Accounting
Fund accounting uses modified accrual accounting, which records revenue when it's available for use rather than when it's earned. Modified accrual accounting treats acquisitions of long-term assets like expenses and long-term debt like income, meaning that fund-based balance sheets show no long-term assets or liabilities, just working capital. This type of accounting also enters the budget into the accounts in reverse, using debits for budgeted revenue and credits for budgeted expenditures. Another aspect of modified accrual accounting is the use of an entry called an encumbrance when goods are ordered. When the goods arrive, the encumbrance is reversed and an expense is entered.
Types of Government Funds
Government fund accounting uses three basic groups of funds. The first, governmental funds, generally account for the acquisition, use and balances of expendable financial resources and related current liabilities. Examples include general funds, special revenue funds, debt service funds, capital projects funds and permanent funds. The second, proprietary funds, are used for activities that resemble private sector business activities and are generally self-supporting funds. Two types of proprietary funds are enterprise funds, for activities that charge a fee, and internal service funds, used to account for the provision of goods or services by one department or agency to other departments or agencies. The third type of government fund is fiduciary funds, used to account for assets that a governmental unit holds in a trustee capacity. The four types of fiduciary funds are pension (and other employee benefit) trust funds, investment trust funds, private-purpose trust funds and agency funds.
Although fund accounting is most common in governmental and nonprofit organizations, for-profit business may sometimes use a version of fund accounting for a specific purpose. For example, a retail store may want to track individual locations or departments, or a contractor may want to track projects.