Fund Accounting: Investment Management's Crucial Component

Fund accounting is a system of accounting used by non-profit entities, governments, and investment funds to track the amount of cash assigned to different purposes and the usage of that cash. It is also referred to as partnership accounting, as it involves the management of investors' funds. The focus of fund accounting is on accountability and compliance rather than profitability. This method of accounting is especially useful for non-profits and governments, as it allows them to demonstrate how money is spent and how well they are preserving and using their resources.

Fund accounting is also used in the investment world, particularly for alternative investments such as private equity, venture capital, and mutual funds. In this context, fund accounting involves tracking the financial inflows and outflows, identifying income and expenses, and verifying accounting records. It is a critical function for the financial system, as an increasing number of individual investors and retail clients hold the majority of their savings in mutual funds.

Investment funds vs. traditional corporate accounting

Investment funds and traditional corporate accounting are distinct but related concepts. Investment funds refer to financial instruments like mutual funds or hedge funds, which pool money from investors to purchase a diversified portfolio of securities, commodities, and/or real estate. Traditional corporate accounting, on the other hand, involves managing the financial operations and capital of a company, focusing on profitability and adhering to accounting standards like GAAP or IFRS.

Investment Funds Accounting:

Investment funds accounting involves managing and tracking the performance of investment funds. This includes calculating the net asset value (NAV) of the fund's portfolio, recording income and expenses, and monitoring security transactions. Investment funds accounting is subject to regulatory requirements and must provide accurate pricing and reporting to investors. The end goal is to provide accurate pricing of investment vehicles and correctly assign investment income.

Traditional Corporate Accounting:

Traditional corporate accounting, as practised in corporate finance, deals with the day-to-day financial operations of a company. This includes budgeting, cash management, accounting, and financial reporting. Corporate accountants produce financial statements, track revenue and expenses, and ensure compliance with accounting standards and tax regulations. Their focus is on profitability and providing financial information to stakeholders, including shareholders and investors.

Key Differences:

While both deal with financial management, investment funds accounting is more focused on the performance and valuation of investment portfolios, whereas traditional corporate accounting deals with the broader financial operations and capital management of a company. Investment funds accounting is specific to the investment industry, while traditional corporate accounting is applicable to a wider range of businesses. Additionally, investment funds accounting may involve more complex calculations and analysis due to the dynamic nature of investment portfolios.

In summary, investment funds accounting and traditional corporate accounting serve different purposes within the financial ecosystem. Investment funds accounting ensures accurate valuation and reporting for investment vehicles, while traditional corporate accounting provides financial insights and compliance for a company's operations and capital management.

Fund accounting for non-profit entities

Fund accounting is a system used by non-profit organisations to maintain accountability and transparency for money received from donors and grants. It is a method of accounting that emphasises accountability rather than profitability. It is used to track and report on funds based on donor restrictions, ensuring that money is spent in alignment with donor preferences.

Non-profit organisations use fund accounting to segregate their financial activities into different funds, each with its own set of financial statements. Fund segregation helps organisations manage and report on specific activities or programs. This system enables non-profits to maintain transparency and accountability, providing clear financial reports to stakeholders.

Fund accounting categorises funds into restricted and unrestricted categories or classes, allowing for precise tracking and reporting. Restricted funds are meant to be maintained intact in perpetuity, often in the form of endowments. Unrestricted funds can be used for any of the organisation's purposes and provide flexibility and adaptability for non-profits.

Non-profit fund accounting is a vital part of financial management, helping organisations ensure compliance with donor restrictions and legal obligations. It provides valuable insights into the financial health of the organisation and enables the preparation of financial statements that reflect the organisation's financial activities and fund balances accurately.

To set up a fund accounting system for a non-profit organisation, separate funds or accounts are created for various programs and outreach efforts. A chart of accounts is used to establish categories of expenses and revenues, and donations or grants are allocated accordingly. It is recommended that non-profits use accounting software specifically designed for non-profit needs to ensure accurate record-keeping and reporting.

Mutual fund accounting

• Calculating the daily value of its investment portfolio, referred to as the net asset value (NAV).
• Anticipating and recording all income, including dividends and interest.
• Recording accruing interest on fixed-income securities like bonds.
• Properly amortizing any discounts or premiums on bond purchases.
• Recording all securities transactions, such as purchases and sales of portfolio investments.
• Recording all capital gains, both short-term and long-term, arising from securities transactions.
• Maintaining records of shares owned and transactions made by each shareholder.
• Tracking income and capital gains distributions to shareholders.

The end goal of mutual fund accounting is to ensure accurate pricing of these investment vehicles and the correct allocation of investment income to their holders. This information is vital for investors as it enables them to calculate gains or losses and compare the fund's performance to its peers.

Private equity fund accounting

Private equity funds typically invest in mature companies directly, often purchasing private companies and sometimes buying the stock shares of publicly-traded companies. They seek to acquire a controlling interest in a company, improve its management and operations, and then sell their interest for a profit once the company becomes more valuable. This process can also result in an initial public offering (IPO), where a private company issues equity shares to the public to raise capital.

Private equity funds are structured as limited partnership agreements (LPAs) with several classes of partners, including founder partners (FPs), general partners (GPs), and limited partners (LPs). The LPA details the roles, responsibilities, fee structures, and distribution policies of each class, and these have profound implications for accounting practices.

One of the key differentiators of private equity fund accounting is allocation. Transactions need to be tracked at the partner level so they can be allocated correctly according to partner levels of ownership, function, and responsibility. For example, the LP who contributes the most to a fund may negotiate a lower management fee percentage than other LPs.

Another challenge of private equity fund accounting is managing complex distribution waterfalls. Waterfall calculations ensure that everyone involved in an investment, including general partners, receives their fair share of the returns. Customised LP agreements often lead to a wide variety of waterfall structures, and calculating distributions can become extremely complex when factoring in tiers, catch-up calculations, and other nuances.

The country of jurisdiction can also impact the structure and accounting of private equity funds. Most US private equity funds are based in Delaware, but funds may also be located offshore or in other countries.

Private equity funds often create complex investment structures to limit the tax burdens of their investments, which complicates accounting practices. Controls may need to be put in place to reduce tax risk, and structures may need to be adjusted over time due to changing legislation or interpretations of tax laws.

The agreements that private equity funds have with the companies they invest in also affect accounting practices. For example, if a fund invests in a business through both equity and debt, interest payments must be reconciled.

Overall, private equity fund accounting is a complex and specialised field that requires a detailed understanding of private equity funds and their unique characteristics.

Fund accounting software

The software can include a range of features, such as:

• Streamlined workflows and automated complex processes
• Comprehensive investor reporting and data sharing
• A general ledger with a library of financial reports
• Automated waterfall calculations
• Cloud-based architecture
• Integration with other business processes and systems
• Advanced security and fraud protection
• Budgeting, payroll, and HR management tools
• Grant and donation management

Some examples of fund accounting software include:

• Allvue
• MIP Fund Accounting
• Aplos
• Blackbaud Financial Edge NXT
• FundCount
• AccuFund Accounting Suite
• DLS Financials
• Certent Equity Management
• Endowment Manager
• Tangicloud Fundamentals
• QuickBooks Online
• IconCMO Fund Accounting
• MoneyMinder
• FastFund Software Suite
• MIP Fund Accounting
• Faithlife Giving
• Juniper Square

Frequently asked questions