Fund accounting is the practice of tracking money by the strings attached to it rather than by a single bottom line.
A nonprofit has no owners and no equity to grow, so the question its accounts have to answer is not "did we make a profit" but "did we spend each pot of money on what it was given for".
One point before you go further: "fund accounting" is not a term FASB defines. You will not find it in the accounting standards. What the standards require is that net assets be classified by donor restriction. Fund accounting is the bookkeeping method most organizations use to get there.
That distinction matters more than it sounds, because it tells you which rules are real. Below are the four that cause almost every error we see.
What GAAP Requires: Net Assets With and Without Donor Restrictions
ASU 2016-14 rebuilt nonprofit reporting and it is the framework still in force. It did three things that matter day to day.
It cut three net asset classes down to two. Unrestricted, temporarily restricted and permanently restricted became:
This has applied to fiscal years beginning after December 15, 2017, so for a calendar-year organization it has been the rule since 2018. If your chart of accounts still carries a temporarily restricted class, it is eight years out of date.
It required an analysis of expenses by both nature and function, plus disclosure of the methods used to allocate costs between them. More on what that does and does not mean below.
It required liquidity disclosure. Both a qualitative explanation of how you manage liquid resources and a quantitative figure for the financial assets available for general expenditure within one year of the balance sheet date. This is where an organization with a healthy-looking balance sheet discovers how little of it can actually be spent.
Not sure your restricted funds are being tracked properly?
Restricted Is Not the Same as Conditional
If you take one thing from this page, take this one. These two words get used interchangeably and they produce opposite accounting.
ASU 2018-08 says a donor-imposed condition requires two things together:
- A barrier that must be overcome before you are entitled to the money. A measurable outcome, a matching requirement, a specific level of service delivered.
- A right of return or release. The donor can demand the money back, or is released from the promise to hand it over, if the barrier is not met.
Both, not either. And the barrier has to be determinable from the agreement itself, not inferred from what everyone assumed.
A worked example. In December 2026 a foundation gives you $60,000, unconditionally, for a 2027 literacy program. You record $60,000 of revenue in 2026, in net assets with donor restrictions. During 2027, as the program spends, you release the money into net assets without donor restrictions. That is a reclassification, not new revenue.
Now change one thing. The same grant says the money must be returned unless 500 students complete the program. That is a barrier plus a right of return, so it is conditional: you record a refundable advance, which is a liability, and no revenue at all until the target is met.
Almost every "we recognized that grant at the wrong time" conversation is really this. The organization saw the word restricted, booked deferred revenue, and never asked whether there was a barrier with a right of return behind it. Sometimes there was and the deferral was right for the wrong reason. Often there was not, and revenue that should have been recognized sat in a liability for a year.
A related trap sits next to it. Whether a government grant is a contribution or an exchange transaction turns on whether the funder receives commensurate value in return. The standard is explicit that the resource provider is not the general public, and that you carrying out your mission does not count as value received by the funder. That is why many government grants to nonprofits turn out to be contributions rather than exchange transactions, even when the contract reads like a purchase order. Each agreement still has to be assessed on its own terms.
Your Board Cannot Create a Restriction
A board votes to set aside $200,000 as an operating reserve. Is that restricted?
No. FASB's glossary defines board-designated net assets as net assets without donor restrictions that are subject to self-imposed limits by action of the governing board. They sit on the unrestricted side of the balance sheet, because the body that set the limit can unset it at the next meeting.
What the board vote does create is a disclosure obligation: the amounts and purposes of board designations have to be disclosed. So the reserve is visible, it is just not restricted.
Only a donor can impose a donor restriction. Say this plainly at the finance committee meeting, because treating a board designation as restricted overstates the restricted class and understates the money the organization can actually reach in a difficult month.
When a Restriction Comes Off
A restriction expires when the purpose is fulfilled or the time period passes. The amount then moves between net asset classes as a reclassification. It is not new revenue, and showing it as revenue double counts the gift.
One case has a hard rule, and organizations get it wrong for decades at a time. Where a donor gives money to buy or build a long-lived asset and says nothing more, the restriction is treated as expiring when the asset is placed in service. ASU 2016-14 removed the old option to release that restriction gradually over the asset's useful life.
If your accounts still release a building restriction gradually over thirty years, that stopped being acceptable in 2018.
The Statement of Functional Expenses Is Not Required
This surprises many people, especially organizations whose auditors have prepared one every year.
What is required of every nonprofit is an analysis of expenses by both natural and functional classification. Natural means what you bought: salaries, rent, insurance. Functional means what it was for: program services, management and general, fundraising.
What is not required is that the analysis appear as its own financial statement. The standard allows three locations, and you choose:
- On the face of the statement of activities.
- As a schedule in the notes.
- In a separate statement, which is the one everyone calls the statement of functional expenses.
ASU 2016-14 removed the old requirement that voluntary health and welfare organizations present a separate statement. Many organizations still do, because it is the clearest format and because their auditor prefers it. That is a choice, not an obligation, and knowing the difference is useful when you are deciding how much to spend on presentation.
You also have to disclose the method you used to allocate costs between functions. Pick something you can evidence: timesheets, square footage, actual usage. Headcount is popular because it is easy, and it is only defensible when headcount genuinely reflects how the cost was consumed.
How This Lands on Form 990
Form 990 Part IX, the Statement of Functional Expenses, runs four columns: (A) total expenses, (B) program service expenses, (C) management and general, and (D) fundraising.
The note printed under that heading is the part people miss. Only 501(c)(3) and 501(c)(4) organizations must complete all columns. Every other filer completes column (A) only. A 501(c)(6) trade association files a full Form 990 but does not have to split expenses by function on Part IX. If it prepares GAAP financial statements, it still needs the functional analysis there.
Column (B) over column (A) on line 25 is where the program expense ratio comes from. Be precise about its status: neither the IRS nor FASB defines it. It is a sector convention. The nearest thing to a benchmark is the BBB Wise Giving Alliance standards, which ask for at least 65% of total expenses on program activities and no more than 35% of related contributions on fundraising.
Those are accreditation standards from a charity watchdog. They are not law, they are not GAAP, and an organization below them is not non-compliant. It may well have some explaining to do to a funder, which is a different problem and a real one.
Can QuickBooks or Xero Do Fund Accounting?
Not natively, and you should hear that from someone who is not selling software.
- QuickBooks Online. Intuit's own guidance recommends setting up a separate Class for each fund, and bank sub-accounts underneath a parent account. That is a workaround, described by the vendor as a workaround.
- Xero. The nonprofit fund accounting guide describes tracking each fund within the ledger and recommends setting up a separate fund for each restriction. It does not claim native fund accounting either.
The practical limit on both is the same: tags and classes produce reports, not self-balancing funds. Your balance sheet does not balance by fund, nothing stops restricted cash being spent on something else, and the discipline lives in whoever is doing the coding rather than in the system.
For most organizations under a few million dollars that is a perfectly workable trade, provided somebody reconciles the restricted balances every month and the chart of accounts was designed for it rather than grown by accident. Above that, or with a lot of separately restricted grants, dedicated nonprofit software starts earning its cost. The question to ask is not which product is best but whether anyone is currently reconciling your restricted funds at all.
What Changed for 2026, and What Did Not
- No change to the framework. At the time of writing, FASB has not changed the nonprofit net asset or functional expense reporting framework. ASU 2016-14 remains the governing standard.
- The new government grants standard does not apply to you. ASU 2025-10 on government grants scopes not-for-profit entities out explicitly, because Topic 958 already covers government transfers that meet the definition of a contribution. If your board has been told to prepare for it, check with your adviser. For not-for-profit entities, it does not apply.
- Gifts in kind still need separate presentation. Under ASU 2020-07, contributed nonfinancial assets go on their own line in the statement of activities, with notes disaggregating them by category and explaining whether each was monetized or used.
- The single audit threshold is $1,000,000 of federal awards expended, raised from $750,000 by the 2024 revision to the Uniform Guidance. For a calendar-year organization the first affected year is 2025, so for a 2026 or 2027 audit the $1,000,000 figure is simply the current rule.
- The de minimis indirect cost rate is 15% of modified total direct costs for recipients without a federally negotiated rate.
Bottom Line: Four Distinctions Worth Getting Right
Orbit Accountants sets up and runs nonprofit bookkeeping built around restricted fund tracking, with a chart of accounts designed for the reporting you actually have to produce. If the restricted balances have not been reconciled in a while, our catch-up bookkeeping team starts there.
Frequently Asked Questions
What is fund accounting?
It is the practice of tracking resources by the restrictions attached to them rather than toward a single bottom line, so an organization can show that each pot of money was spent on what it was given for. It is a bookkeeping method rather than an accounting standard: FASB does not define the term. What the standards require is that net assets be classified by donor restriction.
What are the two net asset classes?
Net assets with donor restrictions and net assets without donor restrictions. ASU 2016-14 replaced the previous three classes, which were unrestricted, temporarily restricted and permanently restricted, for fiscal years beginning after December 15, 2017.
What is the difference between a restricted and a conditional gift?
A restriction limits what the money can be used for. A condition is a barrier you must overcome before you are entitled to the money at all, combined with a right for the donor to take it back or be released from the promise. Conditional cash already received is recorded as a refundable advance, which is a liability. An unconditional but restricted gift is revenue immediately, recorded in net assets with donor restrictions.
Are board-designated funds restricted?
No. FASB classifies board-designated net assets as net assets without donor restrictions subject to self-imposed limits by the governing board. Only a donor can create a donor restriction. The board designation does have to be disclosed, including its amount and purpose, but it does not move the money into the restricted class.
Is a statement of functional expenses required?
No. What is required is an analysis of expenses by both natural and functional classification. The standard allows that analysis to appear on the face of the statement of activities, as a schedule in the notes, or as a separate statement. Many organizations present the separate statement because it is the clearest format, but it is a choice.
When is a donor restriction released?
When the purpose is fulfilled or the time period passes, at which point the amount is reclassified between net asset classes rather than recognized as revenue again. For gifts to acquire or build a long-lived asset, where the donor said nothing further, the restriction expires when the asset is placed in service. The old option to release it over the asset's useful life was eliminated by ASU 2016-14.
Does QuickBooks or Xero do fund accounting?
Neither offers it natively. Intuit's own guidance for QuickBooks Online recommends a Class per fund plus bank sub-accounts, and Xero's nonprofit guide describes tracking each fund within the ledger. Both are workarounds: tags and classes produce reports rather than self-balancing funds, so nothing in the system prevents restricted cash from being spent elsewhere. For many smaller organizations that is a workable trade if someone reconciles the restricted balances monthly.
Is the 65% program expense ratio a legal requirement?
No. It is an accreditation standard published by the BBB Wise Giving Alliance, a charity watchdog, alongside a standard that fundraising should not exceed 35% of related contributions. Neither the IRS nor FASB sets a program ratio. Falling below it is not non-compliance, although it may well prompt questions from funders.
Can Orbit Accountants set up fund accounting for our nonprofit?
Yes. We design the chart of accounts around the restrictions you actually hold, set up the tracking in your existing system or recommend a move if the volume justifies one, and reconcile restricted balances monthly as part of our nonprofit bookkeeping service.
Legal Disclaimer
This article is for general information only and is not tax, legal, accounting or audit advice. It reflects US GAAP for not-for-profit entities and IRS forms as of [publish date]. Accounting standards, thresholds and reporting requirements change, and the right treatment of a particular gift or grant depends on the terms of the agreement behind it. Please speak with a qualified professional about your own position. Reading this article does not create a client relationship with Orbit Accountants.
