Nonprofit fund accounting is a way of keeping a nonprofit's accounts in separate funds, so that money given for one purpose is spent only on that purpose. A fund is a separate set of accounts, with its own income, its own spending and its own balance. Money that a donor gives for a named purpose is called a restricted fund. Money that may be spent on anything the organisation needs is called unrestricted.
A company keeps one set of accounts, because all its money belongs to the company. A nonprofit cannot do this. A donor who gives for scholarships expects the money to pay for scholarships, not for the office rent. A company that gives CSR money for a water project expects a report that shows what the money bought. CSR, corporate social responsibility, is the money that large Indian companies must spend on social projects by law. And in India, foreign money received under the Foreign Contribution (Regulation) Act (FCRA) must stay in its own bank account, and be spent only on the purposes approved for it.
Here is how it works. Every rupee that comes in is tagged with a fund. Every expense, from a teacher's salary to a water pump, is tagged with the fund that pays for it. The software keeps a balance for each fund. It blocks, or sends for approval, any expense that breaks a fund's rules. Shared costs, such as rent and the accounts staff, are divided across the funds by a rule agreed in advance. At the end of the year, the software produces a separate report for each funder.
Consider a rural development NGO in Jodhpur with three funds this year. A cement company has given ₹40 lakh of CSR money for 20 village water tanks. Small donors have given ₹12 lakh with no conditions. A foundation abroad has given ₹15 lakh for a women's health programme, received in the NGO's FCRA account. In June, an employee in the accounts team enters a bill of ₹1.9 lakh for the first tank. It is charged to the CSR fund, whose balance falls to ₹38.1 lakh. Next, he charges the month's office rent of ₹60,000 to the FCRA fund. The software flags it. The agreed rule says that the health programme uses a quarter of the office, so the FCRA fund may pay only a quarter of the rent. He charges ₹15,000 to the FCRA fund and ₹45,000 to the unrestricted fund. In March, after all 20 tanks are built, the software prints the report for the cement company: 20 tanks, ₹38 lakh spent and ₹2 lakh unspent.
Fund accounting works inside donor management software, or is connected to it, so a gift tagged "scholarships" there arrives here already tagged. Nonprofits that charge fees, such as a community centre that runs on membership management software, also put their fee income into funds. Governments keep their accounts in funds too, in their government ERP.
How is it different from the cost centres in an ordinary ERP? A cost centre shows where a company spent its money, but all of that money still belongs to the company. A restricted fund belongs to its purpose. Spending it on something else breaks a promise to a donor, and sometimes the law.