Managing Nonprofit Donor-Restricted Funds
Nonprofit organizations deal primarily with two types of funding, donor-restricted funds and unrestricted funds.
Donor-restricted funds are donations given to your organization that have a pre-determined use provided by the donor, while unrestricted funds are donations that can be used in any manner the organization deems fitting.
It is important for nonprofit organizations to know how to differentiate between the two fund types and understand the accounting requirements in order to stay compliant and account for the funds correctly.
In this article, we will show you how to manage nonprofit donor-restricted funds with examples so that you can replicate it in your organization.
Key Takeaways
Restricted funds are funds given to the nonprofit for designated purposes.
Nonprofit organizations should have clear accounting practices and accurate recordkeeping to effectively manage donor-restricted funds.
Understanding the distinctions between unrestricted, temporarily restricted, and permanently restricted funds is important for effective management.
Transfer of excess funds strategically and training staff on fund allocation are important for maintaining transparency, accountability, and donor satisfaction.
What Are Donor Restricted Funds?
Donor-restricted funds are essentially funds provided to a nonprofit organization for designated purposes determined by the donor. In other words, these are funds that cannot be used outside of their intended purpose.
There are two primary types of restrictions imposed on these funds:
Time Restriction - The funds can be used after a defined period of time has passed
Purpose Restriction - The funds can be used only on defined activities
These funds can come from grants received for specific programs or individual contributions provided with the purpose of funding a specific program or project offered by your nonprofit.
Some nonprofits offer donors a few options for donation allocation in order to avoid any confusion on the use of the funds. For example, a cancer research nonprofit may give donors a choice between skin cancer, breast cancer, or brain cancer research.
Types of Nonprofit Restricted Funds
When a nonprofit receives funds from a donor, the donor may specify how the funds need to be used in 3 primary ways:
Unrestricted Funds - The donation can be used for any purpose by the organization. This means that the organization can use the funds to cover operating expenses, apply it to a program, kickstart a project, etc.
Temporarily Restricted Funds - The funds can only be used by the organization for a specific purpose stated by the donor as we discussed in the previous section.
Permanently Restricted Funds - These funds are unique in that they are held as principal in perpetuity, on which interest is earned and only the interest can be spent by the organization.
It is important that your organization understands the difference between these 3 primary restrictions that can be imposed by donors when they are providing funds to your nonprofit.
Later in this article, we will show you how to account between donor-restricted funds and unrestricted funds.
Nonprofit Donor Restricted Fund Management
When it comes to handling money donated with specific restrictions, your organization must make sure it is effectively overseeing the use of the funds and keeping the funds organized.
Although these funds do not need to be held in different bank accounts, it is important that your nonprofit understands exactly how much of the donated cash balance is restricted vs unrestricted. That is where having a well-built chart of accounts and keeping accurate books is important.
When creating a budget, it is important that your organization differentiates between the two types of funds to make sure that you use the funds correctly.
Now that we have covered the basics, let’s discuss how this plays out in the books.
Accounting Requirements
The accounting requirements for managing nonprofit donor-restricted funds are incredibly important due to the complexity of timing and recognition of the funding.
There are two key variables that make accounting for these funds more complex.
The first is that the income from the funds needs to be accounted for in your books in the period in which they were received or an unconditional commitment for the funds is received, regardless of when the expenses for the funds will occur.
The second variable is the timing of the funding. The funded amount will initially be placed in an account with donor restrictions while the unrestricted amount will be moved to the account without donor restrictions as the restrictions are satisfied.
We understand this may be confusing, so we have broken this down by income statement and balance sheet using a fictitious organization named “RPN” to walk you through the process.
Income Statement
The accounting of the restricted funds can be done in a few different ways depending on the accounting software your organization uses or the sophistication of your chart of accounts.
The technique we are going to use for this example is the two-column approach, where an additional column is created on the income statement and balance sheet to separate funds that are donor-restricted and unrestricted.
In the image below, you can see that the income from the restricted funds is first recorded in the “Donor-restricted” column.
When the time or purpose of the restriction has been satisfied as determined by the donor, the funds are moved over to the “Unrestricted” column using a new line item named “released from restrictions”.
In the example below, RPN (the fictitious organization we are using) received a five-year, $50,000 grant to fund a new project they are working on. The grant was received in 2023, meaning the grant will be fully unrestricted in 2028.
RPN records the entire $50,000 grant as income on the income statement under the “Donor-restricted” column. A portion of this grant ($10,000) will be released from restrictions every year since it has a five-year restriction. This means that in 2023, $10,000 will be released from restriction and that will be displayed in the Unrestricted column as shown in the example below.
After that is accounted for, the Donor-restricted column now shows how much of the grant is still restricted and can be expected to become unrestricted in the future. In this case, after 2023, the donor-restricted column will show $40,000.
Accounting rules require nonprofits to record the entirety of a grant as income when it is received, even if the restrictions are not satisfied until a later date.
Balance Sheet
Now that we have covered the income statement, let’s take a look at how this plays out on the balance sheet. The balance sheet provides a snapshot of your available net assets for decision-making and planning purposes.
You can use the same two-column approach on the balance sheet to separate restricted funds from unrestricted funds as you did on the income statement.
For the balance sheet, we are going to follow the same example as the income statement using RPN. On the balance sheet, RPN would have correctly recorded the $50,000 grant when it was received as an asset. Since $10,000 of the grant became unrestricted in 2023, only $40,000 would be remaining on the balance sheet at the end of the year.
The remaining $40,000 would still be an asset under the Donor-restricted column. That balance will remain until next year when another $10,000 becomes unrestricted. At that point, only $30,000 will remain as an asset under the Donor-restricted column.
It is highly recommended to report restricted dollars separately and pay close attention to unrestricted amounts when making operational decisions. Directors and managers should receive adequate training to navigate the unique financial management challenges presented by restricted funds in nonprofit organizations.
Need Help Managing Donor Restricted Funds?
We hope this guide was helpful and gave you a better understanding of how to manage donor-restricted funds provided to your organization.
In the case that you are still confused or would like some guidance on managing these funds properly, the team at RP Finance is here to help you. You can schedule a free consultation with one of our nonprofit accounting experts.
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