This post was last updated on March 25th, 2021 at 09:47 am.
Church accounting software must obey fund accounting principles. These principles are non-negotiable if the church wants the accounting books correct. Before looking at accounting software, you must understand this fund accounting principle. Without it, when you review software, you won’t know if the accounting software packages can accomplish it. Many folks will ask “but if they advertise proper church accounting, doesn’t that mean they are following fund accounting principles?” NO, it doesn’t. There are some very well known packages that don’t follow this principle, including QB (Quickbooks) and QBO (Quickbooks Online). In many instances these packages use things like classes or projects. Other workarounds include sub-accounts in checkbooks or using liability for funds. These last two are especially troubling. Why? Because accounting should follow what happens in real life. Why are these workarounds used? Because the system doesn’t obey the fund accounting principle and doesn’t follow FASB guidelines.
Why are churches required to use “fund accounting”? Unlike for-profit accounting for businesses, a church must focus on accountability and stewardship. A for-profit business only cares about the accountability portion. Some may say this is unfair. Well may be it is, but donors, auditors, and the government want to ensure the not-for-profits are using the money as intended. The for-profit business has no such requirements as it reports to its shareholders and owners, what the profit or loss is. They can spend their money any way they wish, to the point of bankruptcy.
These additional not-for-profit requirements may seem like a burden, however many would quickly point out the church’s tax exemption status. No matter what side of the fence you may be on, the rules and requirements are there for a reason. These additional requirements allow the church to prove that the money was judiciously spent on what they said it would be.
Church Accounting History Lesson Introduction
It would be impossible to go over all the ways churches, in the past, recorded accounting transactions. Let’s just say there were many creative structures that never answered all the questions for church leaders. Let’s review one of the methods with the understanding that it doesn’t cover every situation, historically.
Creative church accounting example in the past – in depth
In the good ole days, some churches would have a revenue and expense account they used to get a balance. For example, to find the balance for missions, they would subtract the mission expenses from the mission revenue. Let’s walk through an example. The mission revenue receives $2,400.00 for the year, $200.00 per month. Only if things were this simple, but we digress. The church decides it will send $150.00 per month to the missionary family for living expenses.
In this example, the church would take the revenues and subtract the expenses. For January it would be $200.00 minus $150.00 that equals $50.00 remaining in the checkbook. In February the remaining amount will grow to $100.00. The equation would be $400.00 in revenues (Jan thru Feb) minus $300.00 expenses (Jan thru Feb) which equals $100.00 staying in the checkbook. Sounds good so far, right?
Accounting history lesson goes awry
Now let’s throw a wrench into this easy example. The church decides that at the end of the year they want to purchase a home for them which cost exactly $600.00. They are going to use the remaining $50.00 each month until they have the entire $600.00 at the end of the year. How are you going to track that using only revenues and expenses? A better question is do you really have $100.00 or not in the checkbook in February? What is your true balance if it’s not the $100.00? What would keep the $100.00 and the future contributions coming into the checkbook from being spent elsewhere? Are you going to keep a nice little spreadsheet off to the side to track it? Many questions come up using this method and then more creative ways were invented to handle those questions.
The nightmare unfolds as time passes
Can you see how a simple decision of saving money for a house, turned into an accounting nightmare? All those questions above and no way of getting answers when using only revenues and expenses. What this creative method fails to do when using only revenues and expenses, is to figure out a balance when a liabilities may come up. A proper church accounting software, would show you that you don’t even have a positive balance. In fact its negative for this fund the entire year. Why? You see that $600.00 promise would translate to a $600.00 liability. At the end of February it would be $100.00 (assets) minus $600.00 (liability) which is -$500.00 (net asset).
Who owns the debt?
Now how do you know if its the Mission or Youth ministries that owes that housing debt? That is where fund accounting comes in. Because tagging the transaction with the fund “Missions” associates the liability to it. Thus the liability is the Mission fund’s responsibility. Additionally the Mission fund has no money in February, although the checkbook has that $100.00 in it! Many would be led to believe they could spend that $100.00, because it’s in the checkbook. Without using a liability account and what fund owes the money, the church may spend the money not even realizing it.
We should further note that the missions ministry will break even in December, after receiving the final monthly donation. In other words it has zero money to spend or use in the next year. For December it will be at $0.00 after writing the check for the full amount of the house and the final missionary expense. Some folks may say — but it has money in the checkbook of $100.00 in February. Yes it does, but that $100.00 is ear marked for a house, not for spending elsewhere. Welcome to the complicated subject of accounting, and more precisely church accounting with funds. Keeping in mind this is a very simple example. What happens when you start doing things like payroll, complex grants, recording donations and monthly bills for each ministry. It will overwhelm you, and fast. No spreadsheet is going to save you.
Church Accounting Software Standards
FASB (Financial Accounting Standards Board) is the organization that all entities look to for their accounting standards. These standards are the designated standard from the Security and Exchange Commission (SEC). The American Institute of Certified Public Accountants (AICPA) also follow FASB.
FASB has codified the older not-for-profit standards (SFAS 95, 116, 117, and 124) into what they call the Not-for-Profit Entities (Topic 958). What this means is the Topic 958 is the standard at this time for not-for-profits. It supersedes all other mentioned standards. They also issued a clarification on the Topic 958 in 2018. Keep in mind the clarification series isn’t the complete guide so don’t get them confused. They are used together as an authoritative guide for not-for-profit accounting.
Fund Accounting vs Profit Accounting Methods
Fund accounting is a different type of animal, to say the least. One major differences is the main accounting equation. Going back to accounting 101, it states, Assets minus Liabilities equals Owner’s Equity. More precisely stated:
Assets - Liabilities = Owner's Equity
What happens in a for-profit is at the end of the year the retained earnings move into owner’s equity, via a journal entry. Retained earnings essentially zeroes out so it can account for the new year’s income or loss. This end of year transaction tells the company how much income or loss accumulated for the year. Retained earnings is only affected by revenue and expense accounts. This process is like accounting funds, where revenues and expenses move the fund balance. This is where the similarities end between retained earnings and accounting funds.
The only other transaction that uses retained earnings is at the end of the year in a for-profit system. Where the for-profit and not-for-profit differ, is funds never have a year end transaction moving the money out into another account. In other words there’s no such movement of unused monies out of funds to another account such as owner’s equity. Why? In the not-for-profit world, there is no such thing as Owner’s Equity. Churches aren’t owned by anyone. Because there is no owner’s equity the funds keep the monies from one year to the next — always. If your current church accounting software moves money at the end of the year, it’s wrong. The software is not suited for not-for-profits organizations.
The not-for-profit accounting equation
The not-for-profit equation is as follows — Assets minus Liabilities equals Net Assets. More precisely it would look like this:
Assets - Liabilities = Net Assets
While this appears to only be a verbiage difference — ie. using Net Assets instead of Owner’s Equity, it’s more than that. It’s an important distinction. Why? Because the net assets are the various funds’ equity accounts. These accounts can’t be directly debited or credited using journal entries. Their balances go up an down as a side affect to crediting and debiting other GL accounts. For example, a GL transaction for revenue would increase the fund’s equity account. As stated earlier the fund equity accounts work similarly to for-profit retained earnings.
Now, let’s go over a what exactly is an accounting fund.
What are church accounting funds?
Because churches want to be good stewards of resources, not-for-profit accounting gets complicated. When paying for expenses, a church must know who (the fund) paid for that expense. Was it the General fund or the Youth fund? Knowing the expense account isn’t enough as in a for-profit organization. A not-for-profit needs the ability to look at each funds’ financial health — separately. If that isn’t complicated enough, they also need the ability combine the funds into one report. We call this an “All Funds” report. An all funds report gives you a thirty thousand foot view of the entire organization. Where as a one fund report gives you the twenty foot view of that fund. The one fund report is a close up snap shot of that fund only.
If funds are important then what do funds look like? Well they can include restricted or unrestricted net assets. Funds could be various ministries or grants. What aren’t funds? Funds aren’t liabilities in the COA (chart of accounts)! Funds aren’t many sub accounts in checkbooks! The funds aren’t the “difference” between revenues and expenses. If any of these are true, then your software isn’t fund based. When the software isn’t fund based then it can’t handle the organization’s needs. And more than likely your church accounting software is inadequate.
Deciding what is an accounting fund…
So how do you decide what a fund is and what isn’t? Start with this question. “Should I know how much money (the balance) I have set aside for (fill in the blank here)?” If you need to know a balance, then you need a fund. Funds enable you to have what we call mini organizations within the larger not-for-profit. A fund allows the creation of assets, liabilities, expenses, and revenues within each mini organization. Thus funds allow the ability to have one full set of COA per fund. The more funds you have the more separate COA you have. A church accounting software keeps each mini organizations separate within the larger not-for-profit COA. Some other noteworthy questions to ask might be:
- is this a one time event or an annual event, like a turkey dinner. If so you probably don’t need a fund as you can probably use one revenue and one expense account.
- is this a pass through type of situation? If so it’s probably best to use a liability account, and bring the money into one pass through fund (or General) for all pass through type situations.
- is the donations restricted in some fashion? If so, you will need a fund.
NOTE: Temporarily restricted funds aren’t allowed any more as per the FASB guidelines.
NOTE: Churches should try to limit how many restricted funds they allow their donors to donate too.
Reporting Differences in Church Accounting Software
Now that we understand what a fund is, let’s move on to reporting differences. The reporting differences are subtle, but have vast consequences when ignored. The two main reports are the balance sheet report and the profit and loss statement. The Statement of Financial Position is the equivalent to the for-profit balance sheet. And the common profit and loss statement is the Statement of Financial Activities. You may find these terms used interchangeably in conversation. But they have subtle differences and your responsibility is to know what they are.
Balance sheet differences – Statement of Financial Position
First, a for profit organization has owner’s equity. It also has a report called the balance sheet, showing the owner’s equity. A for-profit also has retained earnings. Since no one owns a church, there isn’t an owner’s equity or retained earnings in the chart of accounts, ever! Thus the reports should never show it either. This report will show “Net Assets” instead of “Owner’s Equity”. Does your software show owner’s equity or require you to move money out of retained earnings? If so the software isn’t made for not-for-profit organizations.
Churches are suppose to use any remaining resources for the following year. Thus they shouldn’t pull money out or move it like a for-profit system. It simply rolls over within each fund. If your current church accounting software uses a date range for the balance sheet, it would show the system isn’t fund based. Balance sheets go by an end date, not a date range. They go all the way back to the very beginning to calculate the balances for assets and liabilities. Statement of Financial Position report only has assets and liabilities.
Income statement differences – Statement of Financial Activities
The statement of financial activities report goes by a date range unlike the balance sheet’s end date. For the most part the report is the same as its for profit version. It has a net revenue at the bottom that shows revenues minus expenses, which can be zero, negative, or positive. The report could have no activity reported for the date range selected. What is important to know is — this report does NOT carry balances, ever! They only show what came in and what went out during a period of time. A quick illustration of not carrying a balance is to run the report for a month that has no activity in any revenue or expense. The report would be blank, right? However I bet you still have money in your checkbook, correct? Thus this shows that assets and liabilities hold balances while revenues and expenses don’t.
Summary of Church Accounting
We hope you have learned the various reasons churches need a proper church accounting software. Here’s a condensed list of the most important points.
- Not all systems that promise they do not-for-profit account can actually do it. It’s up to you to review and ensure they follow the FASB guidelines and other accounting rules like GAAP.
- The FASB guidelines for not-for-profits is the Topic 958 published in 2016. A shorter clarification version was published in 2018, but both are considered as one.
- Understanding the differences between for-profit and not-for-profit accounting in regards to owner’s equity and net assets, respectively. It’s not only a verbiage difference. Because for-profit has retained earnings which moves to owner’s equity. This doesn’t happen in a not-for-profit system.
- What exactly are church funds and a few questions to ask yourself before making them. Church funds aren’t sub accounts of checkbooks. They aren’t liability accounts, either. Do you need to separate the assets, liability, revenue, equity, and expenses from other areas of the organization? If so you need a fund.
- And finally what are the differences between the reports for a for-profit vs. a not-for-profit? There are different names for the balance sheet and profit and loss statement (P&L). They are called the Statement of Financial Position and Statement of Activities, respectively. Additionally these reports need to be able to break funds out on their own or roll them up into on grand report for the entire organization.