Fund accounting is the bookkeeping method nonprofits use to track money by its purpose and donor restrictions rather than by profit. Under U.S. GAAP — specifically FASB Accounting Standards Update (ASU) 2016-14, effective for fiscal years beginning after December 15, 2017 (as of 2026 — verify) — every dollar lands in one of two net asset classes: net assets without donor restrictions and net assets with donor restrictions. Those classes flow into four financial statements: the Statement of Financial Position (balance sheet), the Statement of Activities (income statement), the Statement of Functional Expenses, and the Statement of Cash Flows.
Funders, auditors, and the IRS each read these statements for different reasons: a foundation checks whether its restricted grant was spent on the right program; a bank checks liquidity; a watchdog checks how much of each dollar reaches the mission. This guide explains each class and statement in plain English, walks through a filled-in mini Statement of Activities, and gives you a checklist to bring to your bookkeeper or CPA. Figures and dates below are illustrative — confirm specifics with a nonprofit accountant before relying on them.
What fund accounting actually is
For-profit accounting answers one question: did we make money? Nonprofit accounting answers a harder one: did we use each dollar the way its source intended? That is the entire idea behind fund accounting — a system that segregates resources into categories ("funds") based on restrictions and purpose, then proves through the books that restricted money was spent on its restricted purpose.
Two ideas drive everything:
- Restriction follows the donor, not the board. Only the donor or grantor can place an external restriction on a gift. When your board decides to set money aside — say, for a future building — that is a board designation, which is internal and reversible. Board-designated funds are still legally unrestricted ("without donor restrictions") even though they feel earmarked.
- Purpose and time both create restrictions. A donor can restrict a gift to a purpose ("for the after-school program") or to a time period ("for next fiscal year"), or both. Endowment gifts the donor says must be held in perpetuity are also "with donor restrictions."
You do not need separate bank accounts for each fund — restrictions are tracked in the accounting system, not the bank. A clean chart of accounts and a method like classes or fund codes in your accounting software is what makes fund accounting work in practice. For the broader picture of how the pieces fit together, see nonprofit financial management basics.
Restricted vs. designated — the costly mix-up
Spending a purpose-restricted grant on general operations, or reporting board-designated reserves as "restricted" on your statements, are two of the most common errors auditors flag. The first can require returning funds; the second misstates your financials. When in doubt, keep the grant award letter and the board minutes side by side — the documents define the restriction.
The two net asset classes under ASU 2016-14
Before 2018, GAAP required three net asset classes: unrestricted, temporarily restricted, and permanently restricted. FASB ASU 2016-14 collapsed those into two, effective for fiscal years beginning after December 15, 2017 (as of 2026 — verify with your CPA). The two classes now are:
| Class | What it includes | Examples |
|---|---|---|
| Without donor restrictions | Resources the organization can use for any mission purpose. Includes board-designated funds. | General donations, earned revenue, board-designated reserve, unrestricted grants |
| With donor restrictions | Resources subject to donor- or grantor-imposed limits on purpose, time, or perpetuity. | Program-specific grants, pledges for future years, endowment principal a donor requires be held permanently |
The old "temporarily" vs. "permanently" split moved out of the face of the statements and into the notes. So if you hold a true endowment, you still disclose the perpetual portion — you just do it in a footnote rather than as a separate column. FASB made this change because, in many states, modern endowment law (UPMIFA) blurred the line between temporary and permanent, making the three-class presentation more confusing than helpful (as of 2026 — verify).
Two related disclosures arrived with ASU 2016-14 and matter for how lenders and funders judge you:
- Liquidity and availability. You must disclose, qualitatively and quantitatively, the financial assets available to meet general expenditures within one year of the statement date — and the policy you use to manage liquidity. This is closely tied to your operating reserves.
- Functional expense analysis. Every organization must present expenses by both nature (salaries, rent) and function (program, management, fundraising) in one place — a statement, a schedule, or the notes.
Net asset quick check
- Restriction comes only from a donor or grantor — never from your board.
- Board-designated reserves are "without donor restrictions."
- Released restrictions move from "with" to "without" when the purpose or time condition is met.
- Permanent (endowment) restrictions now live in the notes, not a separate column.
The four nonprofit financial statements
A complete GAAP set has three required statements; the functional-expense analysis is the fourth piece, most often shown as its own statement. Here is what each one does:
| Statement | For-profit cousin | Answers |
|---|---|---|
| Statement of Financial Position | Balance sheet | What do we own and owe on a given date? Net assets by class. |
| Statement of Activities | Income statement | Did revenue exceed expense this period, and how did each net asset class change? |
| Statement of Functional Expenses | (none) | How was spending split across program, management, and fundraising — by natural category? |
| Statement of Cash Flows | Cash flow statement | Where did cash come from and go (operating, investing, financing)? |
The Statement of Financial Position lists assets, liabilities, and net assets, with net assets split into the two classes. The Statement of Activities shows revenue, expenses, and "net assets released from restrictions" — the mechanism by which a restricted grant becomes spendable once you do the work. The Statement of Cash Flows has three sections (operating, investing, financing) and reconciles your change in net assets to the change in cash, which matters because accrual revenue and cash rarely arrive together. If the difference between recording revenue when earned versus when received is unfamiliar, start with cash vs. accrual accounting.
These four are the GAAP-basis statements an auditor produces. They are related to, but not identical to, the IRS Form 990 — the 990 reorganizes much of the same data into its own format (more on that below).
Worked example: a mini Statement of Activities
Numbers tell the story better than definitions. Below is a simplified Statement of Activities for a fictional youth-mentoring nonprofit, "Riverside Mentors," for a single year. All figures are illustrative. Notice the two columns for net asset classes and the net assets released from restrictions line, which appears as a positive in the unrestricted column and an equal negative in the restricted column — it nets to zero overall but moves money between classes.
| Line | Without donor restrictions | With donor restrictions | Total |
|---|---|---|---|
| Contributions & grants | $148,000 | $90,000 | $238,000 |
| Program service fees | $22,000 | $0 | $22,000 |
| Investment income | $3,000 | $0 | $3,000 |
| Net assets released from restrictions | $65,000 | ($65,000) | $0 |
| Total revenue & support | $238,000 | $25,000 | $263,000 |
| Program services expense | $181,000 | $0 | $181,000 |
| Management & general expense | $34,000 | $0 | $34,000 |
| Fundraising expense | $28,000 | $0 | $28,000 |
| Total expenses | $243,000 | $0 | $243,000 |
| Change in net assets | ($5,000) | $25,000 | $20,000 |
| Net assets, beginning of year | $96,000 | $40,000 | $136,000 |
| Net assets, end of year | $91,000 | $65,000 | $156,000 |
How to read it:
- The org grew net assets by $20,000 overall, even though the unrestricted column shows a $5,000 deficit. That gap is normal: $90,000 in new restricted grants came in, but only $65,000 of restricted work was completed and released this year, so $25,000 of restricted support carries forward.
- Restricted money is not "profit" you can spend freely. The $65,000 ending restricted balance is committed to specific programs or future periods.
- The $5,000 unrestricted deficit is the number a board should watch. Day-to-day operations spent slightly more than flexible revenue brought in — a signal to review the budget and reserves, even though the headline total looks positive.
Expenses here are shown by function (program / management / fundraising). The companion Statement of Functional Expenses would break those same totals down by natural category — for example, of the $181,000 program expense, how much was salaries, rent, supplies, and travel. To build the budget that feeds a statement like this, see the nonprofit budgeting guide.
A quick sanity check anyone can run
The "net assets released from restrictions" line must equal zero in the Total column (here, $65,000 minus $65,000). And ending net assets on this statement must match the net assets shown on your Statement of Financial Position for the same date. If either fails, the books don't tie out — flag it before the audit, not during.
Functional expenses and the Form 990
The Statement of Functional Expenses is the one statement with no for-profit equivalent, and it is the one charity watchdogs scrutinize most. It arranges every expense in a grid: natural categories (salaries, benefits, rent, supplies, professional fees) down the side, and functions across the top — program services, management and general, and fundraising.
The hard part is allocating shared costs. A program director's salary may split 70% program / 20% management / 10% fundraising; rent might allocate by square footage or headcount. ASU 2016-14 requires you to disclose the method used to allocate costs among functions, so document your basis (time studies, square footage, FTE counts) and apply it consistently.
This data maps closely to IRS Form 990:
- Part IX — Statement of Functional Expenses. Section 501(c)(3) and 501(c)(4) organizations filing the full 990 complete all functional columns (total, program, management, fundraising) across roughly two dozen expense lines (as of 2026 — verify).
- Part X — Balance Sheet. Reports assets, liabilities, and net assets at beginning and end of year — the 990's version of your Statement of Financial Position.
Two cautions. First, the 990 is filed on a tax basis that can differ from your GAAP audit in classification and timing, so the numbers won't always match line-for-line. Second, "overhead ratios" derived from Part IX are an imperfect proxy for effectiveness — chronic underinvestment in management and fundraising (the "nonprofit starvation cycle") often weakens organizations. Report honestly rather than starving infrastructure to flatter a ratio. For benchmarks that put your ratios in context, see nonprofit financial benchmarks.
Why funders read each statement
Different readers open to different pages. Knowing what each is looking for helps you present cleanly and answer questions before they're asked.
| Reader | Statement they focus on | What they're checking |
|---|---|---|
| Foundation program officer | Statement of Activities + functional expenses | Was the restricted grant spent on the funded program? How much reaches the mission? |
| Bank / lender | Financial Position + Cash Flows + liquidity note | Can the org cover obligations and debt service? How much truly available cash exists? |
| Major donor | Functional expenses + net asset trend | Is the organization efficient and financially stable over time? |
| Auditor / IRS | All four + notes | Do the statements tie out, follow GAAP, and reconcile to the 990? |
| Board treasurer | Statement of Activities (unrestricted column) | Is the operating budget sustainable, separate from restricted swings? |
The practical takeaway: a single "total" surplus can hide an unrestricted deficit, and a healthy-looking balance sheet can hide locked-up restricted cash. Strong organizations present both columns clearly and pair the statements with a short narrative. This same transparency is what earns repeat funding — a theme we explore in grant management and reporting and in donor stewardship.
Make your statements funder-ready
- Show both net asset columns — never collapse to a single total.
- Disclose your liquidity policy and one-year availability figure.
- Document and footnote your cost-allocation method.
- Reconcile GAAP statements to the Form 990 before filing.
- Pair the numbers with a one-page plain-English narrative for non-finance readers.
Getting your books audit-ready
You don't need to be an accountant to keep clean fund-accounting records — you need the right setup and the discipline to maintain it. A realistic path for a small or growing nonprofit:
- Use real fund-accounting software. Tools that support classes, locations, or true fund tracking let you tag every transaction to a net asset class and program. This is the single biggest time-saver at audit.
- Track restrictions at the moment of the gift. When a grant arrives, record the restriction and the release conditions immediately — not at year-end when memories fade.
- Reconcile monthly. Bank, restricted balances, and the Statement of Activities should tie out every month, so the annual audit holds no surprises.
- Adopt the required policies. A liquidity/availability policy and a cost-allocation method are now expected disclosures; pair them with an investment and reserve policy if you hold reserves or endowment.
- Bring in a CPA for the GAAP statements. Whether or not you're legally required to have an audit (thresholds vary by state and funder — verify), a nonprofit CPA converts your bookkeeping into GAAP-compliant statements and catches restriction errors. Prepare with the audit preparation guide.
Most early-stage organizations can self-manage day-to-day bookkeeping in software like QuickBooks for Nonprofits or Aplos, then engage a CPA annually for the formal statements and 990. As restricted grants and complexity grow, that CPA relationship becomes essential rather than optional. For a step back to the fundamentals underneath all of this, the operations and finance hub links the full sequence.
Turn everyday local spending into recurring, unrestricted support
Clean financial statements are easier to keep when revenue is recurring and unrestricted. With Good Circles, supporters pick your cause once, then a share of their everyday local spending funds you automatically — about $72 per active supporter per year (roughly $36,000/yr from 500 supporters). It's recurring, unrestricted, and free to join. This is an estimate, not a guarantee.
Claim a Founding Nonprofit spot →Sources & tools
Free first
- Propel Nonprofits — Resource Library — Practical guides, sample financial statements, and tools on nonprofit finance and fund accounting written for small organizations.
- FASB ASU 2016-14 Overview — The authoritative standard behind the two-class net asset model and the liquidity and functional-expense disclosures.
- IRS Form 990 (Parts IX & X) — The annual information return; Part IX is functional expenses and Part X is the balance sheet, both mirroring your GAAP statements.
- National Council of Nonprofits — Financial Management — Plain-language overviews of financial management, internal controls, and the policies funders expect.
Paid — optional labor-savers
- QuickBooks for Nonprofits / Aplos — Accounting software with class- or fund-level tracking so each transaction ties to a net asset class and program. Worth it when You manage multiple restricted grants and need clean fund tracking without a full-time accountant.
- Nonprofit CPA firm — A CPA experienced in nonprofits who produces GAAP-compliant statements, prepares the 990, and catches restriction errors. Worth it when You need an audit or review, hold restricted grants or endowment, or any funder requires audited statements.
Last verified 2026-06-16. Figures and rules change — verify at the source before you act.
FAQ
What's the difference between restricted and board-designated funds?
Restricted funds carry limits imposed externally by a donor or grantor — on purpose, time, or perpetuity — and only that source can lift them. Board-designated funds are set aside by your own board for an intended use, but they remain legally unrestricted ("without donor restrictions") because the board can reverse the designation. On your statements, donor-restricted gifts appear in the "with donor restrictions" class; board designations stay in the "without" class.
How many net asset classes do nonprofits report now?
Two: net assets without donor restrictions and net assets with donor restrictions. FASB ASU 2016-14 replaced the old three-class model (unrestricted, temporarily restricted, permanently restricted) effective for fiscal years beginning after December 15, 2017 (as of 2026 — verify). The permanent/temporary distinction now appears in the notes rather than on the face of the statements.
Is the Statement of Functional Expenses required?
An analysis of expenses by both natural category and function is required under GAAP, but you can present it as a separate Statement of Functional Expenses, as a schedule within the Statement of Activities, or in the notes. Most nonprofits use a standalone statement because it maps cleanly to Form 990 Part IX and is what watchdogs and funders expect to see.
Do GAAP financial statements match the Form 990?
They report much of the same information but won't always tie line-for-line. The 990 uses a tax basis with its own format and timing rules, so classification and certain figures can differ from your GAAP audit. Best practice is to prepare both from the same underlying books and reconcile them before filing, so you can explain any differences if asked.