Your board treasurer just asked why the grant money you spent on the youth program shows up in the same bucket as the donations you can use however you like. You open the spreadsheet, and you can’t answer. If that sounds familiar, you’ve run into the central challenge of nonprofit bookkeeping: tracking why money came in, not just that it came in.
Unlike a for-profit business, a nonprofit has to prove it used restricted money for its intended purpose. That’s what fund accounting is for. This guide explains the basics in plain English, so you can set up your books correctly and stay ready for funders, auditors, and the IRS.
What Is Fund Accounting for Nonprofits?
Fund accounting is a method of tracking resources by their purpose or restrictions rather than lumping everything together. Each “fund” is like its own mini set of books with its own income, expenses, and balance. Together, they roll up into your organization’s total financial picture.
Under current US GAAP (FASB ASU 2016-14), nonprofits report net assets in two classes: net assets without donor restrictions and net assets with donor restrictions. Many organizations still track individual funds internally to manage grants and programs, and that’s where good bookkeeping makes the difference.
Restricted vs. Unrestricted Funds: The Core Distinction
- Unrestricted funds: general donations, membership dues, and fundraising event revenue you can spend on any mission-related purpose, including overhead.
- Temporarily restricted (with donor restrictions, time or purpose): a $25,000 grant for a literacy program, or a pledge payable next year. Once you meet the condition, you release the money to unrestricted.
- Permanently restricted (endowments): gifts where the principal must be kept intact and only investment income may be spent.
A simple example: you receive a $10,000 grant restricted to after-school tutoring. You record the $10,000 as revenue with donor restrictions. As you spend $2,500 on tutor stipends, you record the expense and release $2,500 from restrictions. If you can’t show that trail, a funder can ask you to return the money.
How to Set Up Your Nonprofit Books Step by Step
1. Build a Chart of Accounts Designed for Nonprofits
Start with a standard chart of accounts, then adapt it. Revenue accounts should separate individual contributions, grants, program service fees, and special events. For a deeper walkthrough, see our guide on setting up your chart of accounts.
2. Use Classes or Tracking Categories for Funds and Programs
You don’t need expensive fund accounting software to start. QuickBooks Online uses Classes and Locations, and Xero uses Tracking Categories. Tag every transaction with a fund or grant, and a program, so you can run reports by either. Intuit also offers a nonprofit-specific QuickBooks setup with donor management features.
3. Record Restrictions the Moment Money Arrives
Don’t wait until year-end to figure out which gifts were restricted. Keep the grant agreement or donor letter, note the restriction in your accounting system, and code the deposit correctly right away.
4. Allocate Expenses Across Functions
Nonprofits must report expenses by function: program services, management and general, and fundraising. Shared costs like rent, utilities, and staff time need a documented allocation method, such as percentage of staff time or square footage. This feeds the Statement of Functional Expenses and Form 990, Part IX.
5. Reconcile Every Month
Reconcile bank and credit card accounts monthly, and review a report of fund balances. A restricted fund with a negative balance means you’ve spent money you haven’t received or aren’t allowed to use.
Key Nonprofit Financial Statements
- Statement of Financial Position: the nonprofit version of a balance sheet, showing assets, liabilities, and net assets.
- Statement of Activities: the nonprofit version of a profit and loss statement, showing revenue, expenses, and changes in net assets by restriction class.
- Statement of Functional Expenses: expenses broken down by function and natural category.
- Statement of Cash Flows: how cash moved through operating, investing, and financing activities.
Compliance Basics: Form 990, Grants, and Donor Receipts
Most tax-exempt organizations must file an annual information return with the IRS: Form 990-N (e-Postcard) for very small organizations, Form 990-EZ, or the full Form 990, depending on gross receipts and assets. The IRS has stated that organizations that fail to file for three consecutive years automatically lose their tax-exempt status, so staying current matters. Check IRS.gov for the current thresholds.
For donations of $250 or more, donors need a written acknowledgment to claim a charitable deduction, and gifts where the donor received goods or services (like a gala dinner) require a disclosure of the value of what they received. Organizations that spend $1,000,000 or more in federal awards in a fiscal year (raised from $750,000 for fiscal years beginning on or after October 1, 2024) also face a Single Audit under the Uniform Guidance, so confirm the current figure with your auditor.
Common Nonprofit Bookkeeping Mistakes to Avoid
- Recording grants as plain income without noting restrictions.
- Using one bank account and one big “donations” line for everything.
- Failing to track in-kind donations and volunteer-related records properly.
- Not documenting how shared expenses are allocated.
- Skipping monthly reconciliations until the auditor or board asks questions.
A note on limits: this article is general educational information, not tax or legal advice. Rules vary by state and by funder, so have a CPA familiar with nonprofits review your setup, especially for audits, Form 990, and grant compliance.
How Ask For CPA Can Help
Our team provides bookkeeping services and online accounting for small organizations, including fund and class tracking and monthly reporting your board can understand. See all services or review pricing. If you also run staff, our payroll services handle the details.
Frequently Asked Questions
Do small nonprofits really need fund accounting?
If you receive any restricted gifts or grants, yes, at least in a simple form. You can do it in QuickBooks or Xero with classes or tracking categories rather than buying specialized software.
What is the difference between a grant and a contribution?
Accounting-wise, a grant can be a contribution (donor gives with no real return) or an exchange transaction (you deliver specific services in return). The classification affects when you recognize revenue, so review the grant agreement carefully.
How often should a nonprofit review its financials?
Monthly. Boards should see a Statement of Activities and Statement of Financial Position, with budget-to-actual comparisons, at every regular meeting.
Can a nonprofit pay for overhead with restricted funds?
Only if the donor or grant terms allow it. Many grants permit an indirect cost rate, but check the agreement. Unrestricted funds usually need to cover what restricted gifts don’t.
Ready to Get Your Nonprofit’s Books in Order?
Clean, fund-aware books make audits, grant reports, and board meetings far less stressful. Contact Ask For CPA today to talk through your nonprofit’s bookkeeping needs.
