Fund-Based Accounting
Fund-based accounting is a system that segregates money into separate funds by the purpose or restriction attached to it, tracking each fund's income and spending on its own. It is used by non-profits, trusts, schools and colleges rather than commercial firms. It matters because donors and regulators need to see that restricted money was spent only on the purpose it was given for.
What Is Fund-Based Accounting?
Commercial accounting pools all money into one entity and measures profit. Fund-based accounting instead treats an organisation as a set of self-balancing funds — a general fund, a building fund, a scholarship fund, a specific grant — each with its own receipts, payments and balance. Money given for a stated purpose is a restricted fund and cannot be spent elsewhere; money with no strings is unrestricted. The focus is stewardship and accountability, not profit.
An Indian school, college, trust or NGO meets fund-based accounting because its grants and donations almost always carry conditions. A Pune education trust that receives ₹40,00,000 earmarked for a new library must account for it in a distinct fund and report that it was applied to the library, not to salaries. This segregation also underpins the income-tax tests for charitable bodies, where application of income to the stated objects is what preserves exemption.
Key terms
- Section 10(23C) Exemption Rules — Tax exemption for education and medical institutions.
- 85% Income Application Rule — The 85% application test for charitable trusts.
- Work-in-Progress (WIP) Valuation — A manufacturing inventory concept, unrelated to funds.
How Fund-Based Accounting Works
Money is tracked from receipt to reporting within its own fund:
- 1Identify the fund on receipt
Each donation or grant is classified as restricted or unrestricted and assigned to a fund — the founding record.
- 2Record income within the fund
Receipts are booked to that fund's income, keeping restricted money separate from general money.
- 3Spend against the fund
Payments are charged only to the fund whose purpose they serve, so a grant is not spent on unrelated costs.
- 4Maintain fund balances
Each fund carries its own surplus or deficit, and unspent restricted balances are visible at any time.
- 5Report fund-wise
The financial statements and the receipts-and-payments account present each fund, showing donors and regulators how their money was used.
Where Fund-Based Accounting Applies — Schools and Colleges
Fund-based accounting is the norm wherever money is held on trust for specified purposes:
- Schools and colleges — Institutions manage tuition, development, building and scholarship funds separately.
- Charitable and religious trusts — Trusts segregate corpus, restricted grants and general donations.
- NGOs on foreign and domestic grants — Grant-funded bodies must report each grant against its sanctioned purpose.
- Endowments and corpus funds — Permanent funds are ring-fenced so only their income, not the corpus, is spent.
- Bodies claiming tax exemption — Charitable entities rely on fund segregation to evidence application of income to their objects.
See also: Accounting Services for Schools & Colleges NGO & Non-Profit Accounting
Fund-Based Accounting: A Practical Example
| Particulars | Amount (INR) | Treatment |
|---|---|---|
| Library grant received | 40,00,000 | Restricted (Building/Library) fund |
| General donations | 15,00,000 | Unrestricted (General) fund |
| Spent on library construction | 28,00,000 | Charged to Library fund |
| Library fund balance carried | 12,00,000 | Restricted, unspent |
| General fund used for salaries | 15,00,000 | Charged to General fund |
A Pune education trust receives ₹40,00,000 earmarked for a library and ₹15,00,000 of general donations. It spends ₹28,00,000 on construction, charged to the Library fund, and carries the unspent ₹12,00,000 as a restricted balance. Salaries are met from the General fund. Because the funds are separate, the trust can show a donor exactly that the library money went to the library — and evidence application of income for its tax exemption.
Pooling restricted and general money: Mixing a grant into general funds breaches the donor condition → keep each restricted fund separate from receipt.
Common Mistakes With Fund-Based Accounting
Fund accounting fails when restrictions are not respected in the ledger:
- Pooling restricted and general money — Mixing a grant into general funds breaches the donor condition → keep each restricted fund separate from receipt.
- Spending a grant on other costs — Using earmarked money for unrelated expenses risks refund and loss of trust → charge payments only to the matching fund.
- Confusing corpus with income — Spending corpus as if it were income depletes the permanent fund → treat corpus donations as restricted capital.
- No fund-wise reporting — A single combined account hides how restricted money was used → present balances and utilisation fund by fund.
Fund-based accounting is a system that segregates money into separate funds by the purpose or restriction attached to it, tracking each fund's income and spending on its own. It is used by non-profits, trusts, schools and colleges rather than commercial firms. It matters because donors and regulators need to see that restricted money was spent only on the purpose it was given for.
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Applicable framework: Fund accounting practice; ICAI Technical Guide on NPOs; Income Tax Act 1961 (Sections 11–13, 10(23C)). For general information only, not professional advice. Verify the current position for your entity before acting.