Definition of Fund; Assets; and Fund Balance

According to the “Financial and Accounting Guide for

Not-For-Profit Organizations” written by CPAs Gross, Larkin,

Bruttomesso, and McNalley, (fifth edition, pg 25) the

definition of a these three terms is as follows:

• A fund is any part of an organization for which separate

account records are kept.

• Assets are valuable things owned or controlled by the

organization. Types of assets include cash, investments,

property, and amounts owed to the organization.

• Fund balance is the mathematical number obtained by

subtracting total liabilities from total assets; it is a

numerical representation of the net worth of the organization,

but has no other significance. Fund balances do not exist

except on paper; unlike assets, they have no intrinsic value

and cannot be spent. Both assets and fund balances (as well as

liabilities, revenues, and expenses) are part of the accounting

records of a fund.

What are non-profit organizations?

A few years ago, a dentist client of mine, who did a lot of

work for low-income patients under the California medical

assistance program called “MediCal”, asked me a bizarre

question. He wanted to know if he could be considered a

“non-profit organization” since he did so much MediCal work. At

first, I thought he was joking, but he was serious. I told him

that just because he charged less for his services did not

qualify him to become exempt from paying taxes. In fact, he

made a very nice profit. However, this is a good example of how

non-profit organizations (NPO’s) are misunderstood by a large

segment of the general public.

Most countries around the world have NPO’s, but outside the

U.S. they are called non-governmental organizations (NGOs) or

civil society organizations. These organizations are exempt

from paying taxes because they provide some sort of public

benefit. They are said to enhance the fabric of society. They

differ from a business organization in that there are no

owners. A Board of Directors oversees operations of the

organization. An Executive Director, who reports to the Board,

functions like a CEO of a business. Usually there is a lengthy

application process to establish the mission or purpose of the

organization before exempt status is granted.

According to Independent Sector, an organization that serves as

an information resource for non-profit boards, there are 1.5

million non-profits that, when combined, have general annual

revenues totaling more than $670 billion dollars. They report

that six percent of all organizations in the U.S. are

non-profits and one in twelve Americans work for a non-profit.

That’s big business and has caused profit-making businesses to

become alarmed that some of these NPOs are competing unfairly.

Think about a private hospital as compared to a non-profit

hospital. The profits of the private hospital are taxed, but

the NPO hospital can apply all their profits to higher

salaries, more equipment, etc. Hence, there is high scrutiny of

NPOs by the Internal Revenue Service, state Attorney General

offices, private watchdog organizations, and the press.

There are all types of non-profit organizations. Public

charities are exempt under the Internal Revenue Service code

501(c)(3). These organizations, such as hospitals, museums,

orchestras, private schools, churches, scientific research

organizations, soup kitchens, etc., obviously do much more than

provide free care and services to the needy. To qualify for

exempt status, these organizations must show broad public

support, rather than funding from an individual source. In

addition, there are private foundations, colleges,

universities, social welfare organizations, professional and

trade organizations, and many more. Governmental organizations

such as communities and agencies are also non-profit

organizations, however, their accounting and record keeping is

handled quite differently from 501(c)(3) organizations.

How are non-profit books organized?

Briefly, the books of an NPO are organized in the same way as a

profit-making business except for a few differences. It’s okay

for a non-profit to make a profit because there may be many

uses the board has planned for the extra money. But, NPOs

traditionally refer to profit as “Excess Revenues over

Expenses” to avoid being mischaracterized as a profit-making

organization. A net loss is called “Excess Expenses over

Revenues”. Recall the fundamental equation that makes

double-entry accounting work:

ASSETS = LIABILITIES + EQUITY

Instead of the term EQUITY, a non-profit will substitute the

words FUND BALANCE or more recently NET ASSETS. The concept is

still the same. After subtracting liabilities from assets the

difference is what is owned by the organization. Where NPOs

differ in their financial statement presentation from

profit-making businesses is what is called Fund Accounting.

Obviously, the presentation varies depending on the purpose and

size of the organization. For instance, a Little League baseball

organization may only have one fund for which they have to

account. They also may not have any restrictions placed on the

usage of contributions they receive. Everything is

straightforward.

Or, a scientific research organization may be working on

various projects at the same time with funding sources made up

of private and governmental grants or contracts, private

donations, sales of research documents, some of it restricted

to specific expenditures and the rest unrestricted. The

accounting challenge is to report the revenue and expenses

accurately for each fund or project and be able to combine all

the funds into one cohesive financial statement.

The problem in the past for the contributors was that they

could not easily tell from the financial documents what funds

were restricted and unrestricted and whether their

contributions were being spent properly. The Financial

Accounting Standards Board (FASB) decided that all external

accounting should be done using the “Net Assets” approach as

opposed to the “Fund Balance” approach. Essentially, the net

assets approach requires that the equity of the organization be

presented with three classes of assets, i.e., Restricted Assets;

Temporarily Restricted Assets; Unrestricted Assets. You can

still use Fund Accounting for internal bookkeeping purposes,

but for external reporting purposes you are required to

disclose your restricted and unrestricted funds. If you have no

restricted funds, then it is not much of a challenge.

One of the key factors in setting up non-profit books is a well

thought out Chart of Accounts. In other words, this is choosing

which general ledger accounts are the most appropriate for

recording revenue and expenses, etc., and organizing them in

such a way as to provide meaning. Some U.S. organizations

simply follow the same format found on the 990 IRS form for

non-profits. They do this so that their financial statements

are in conformity with the way that return is organized. This

makes it easy to transfer information from their financial

statement to the 990 form.

Nevertheless, the main thing is to design your accounts so that

they tell you exactly where your revenue came from and what

expenses are related to that revenue. I have worked with NPOs

that have not done a very good job of this in the beginning,

and I can testify that it is no fun trying to straighten the

accounts out later. It may be well worth the money to hire a

competent accountant to guide you through the set up phase.

Better yet, let your accountant review your books a couple of

times a year just to make sure you are on track and save

yourself some year-end grief.