Commercial accounting practices used by traditional for-profit business are not adequate for nonprofit bookkeeping. Churches and other nonprofits need to adopt "fund accounting" practices. The difference, says Dan Busby, CPA and vice-president of Evangelical Council on Financial Accountability, is that fund accounting creates a distinction between restricted and unrestricted funds. Commercial practices make no allowance for such a distinction.

In a church or ministry, money is often given for specific purposes. These gifts are said to be "restricted." The nonprofit organization may have certain legal responsibilities to use the restricted funds as designated by the donors. At the very least, the organization must be accountable to the donors for how the funds are used. Owners of for-profit businesses are generally free to spend their earnings any way they see fit.

Funds given to a nonprofit organization for specific purposes are restricted to those defined needs. These gifts cannot be used for more immediate needs, such as paying salaries or basic operational expenses. Fund accounting techniques allow the organization to set up any number of restricted fund accounts, and ensure these funds are reserved for their restricted purposes.

A restricted fund can be established by a donor's request or by the organization, in our case, a church. In either case, the church is accountable for ensuring gifts designated for that fund are used according to the restrictions. When a church establishes a restricted fund, it communicates to potential donors how the funds will be used.

Examples of Restricted Funds
Restricted funds can be temporarily or permanently restricted. Funds intended for use in the near future are considered temporarily restricted. Funds intended to be used in the future or over a long period of time are permanently restricted. Funds are commonly restricted for the following purposes:

• To meet a specific physical need—anything from a single item to a general building program (usually a temporary restriction).
• To fund an endowment for a ministry position or program (permanent restriction).
• To provide scholarships for specific programs or general education (permanent restriction).

As an example, a church member donates $5,000 for the church to buy and install a new lighted outdoor sign. The church creates a restricted fund for the sign project, and records the gift as a contribution to that fund. The money does not yet move through the general books. When the sign needs to be paid for, the restricted gift is freed for use and the donation and payment are recorded in the general ledger. When possible, the donor is notified that the gift is being used. Often, when the item is installed, a plaque or other marker is placed nearby to indicate, with thanks, the source of the gift.

As another example, a foundation grants $35,000 to the church's educational arm for curriculum development, teacher recruitment and training, and some capital expenses to support teaching. The grant must follow a timeline and be used within a three-year period. Expenses charged to the grant must be documented so that the church can prove to the grant maker that the funds were used appropriately, and not to cover a shortfall in another area.

In another example, each year a church sponsors a vacation Bible school program, and pays the up-front preparation cost of about $2,000. Voluntary donations from parents during the vbs recapture the $2,000, sometimes even more. Without fund accounting, the church would simply see the expense of the vbs program out of the general fund, and the vbs-specific donations would be accumulated with other donations. The church would not be able to document the net cost of the vbs program.

Too Little or Too Much
Sometimes a gift is not sufficient to pay the entire expense, so operational funds or other contributions can make up the difference. On the other hand, if the amount in the named fund exceeds the expense, the church should consult with the donor about how to use the remaining restricted funds. The funds can be freed for general use, pooled with other restricted funds, or left in the original restricted fund without redirection or recommitment—an undesirable option.

Financial managers must remember that they cannot transfer restricted funds to other uses without consent of the donor. Greg Capin, CPA and partner at Capin Crouse LLP, says that it is important to clearly segregate restricted funds from operational funds. Transfers of funds from restricted to operational must be clearly documented. That way, donors and grant makers will be assured that funds are being used for their designated purposes.

One Account, Multiple Funds
Treasurers or church business administrators may think that the best way to handle restricted funds is to open a separate checking account for each fund. This approach multiplies paperwork and makes determination of a balance sheet more difficult. All funds can be invested or accumulated in one pool as long as the accounting system clearly documents net assets and liabilities in each fund apart from operational cash flow.

Nick Nicholaou, president of Ministry Business Services, says the primary difference between fund accounting and non-fund accounting software is that fund accounting software balances income/expense transactions within multiple funds while maintaining the overall balance sheet. Most business accounting programs have only one equity line, while fund accounting requires multiple equity accounts. Fund accounting software is essential for the church or ministry that has (or will have) restricted gifts.

Pay-as-you-go Software
The upfront program costs and the administrative burden of updating and maintaining software prevent some churches from buying fund accounting software. With application service provider (ASP) programs, these barriers are going away. An ASP is a program that resides on the service provider's Internet server. Program users pay a monthly fee to access the program through an Internet connection. The church does not need to spend hundreds or thousands of dollars to buy a program outright, and the service provider maintains the program, so there is no administrative burden on the church.

Although today only a few companies offer ASP fund accounting solutions, Nicholaou observes that it's the wave of the future. An additional benefit is that program access can be granted to several people, if needed, and the data and program can be accessed from any Internet-ready computer.

Churches and ministries have wonderful opportunities to encourage people to give beyond their regular tithing to unique needs and opportunities. Such gifts require increased levels of stewardship from both the donor and the church. Donors want accountability in the use of these funds. Fund accounting lets them know their financial support is making a difference in practical ways that glorify God.

John R. Throop is a contributing editor to Your Church magazine and a management consultant and Episcopal clergyman (throop@consultsummit.com).