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The Ultimate Guide to Restricted Funds for Your Nonprofit

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Eva

Accounting for donations to nonprofit organizations involves a unique set of principles. The types of transactions that nonprofits encounter give rise to certain legalities — and sometimes, expectations. Such is the case with restricted funds

Our guide will introduce you to restricted funds, giving you an explanation of what these donations look like and how to account for them.

Here is where we are headed today: 

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What Are Restricted Funds?

Nonprofits receive two types of funds: restricted and unrestricted. As you might infer from the name, restricted funds are meant for a specific purpose of the donor’s choosing. These funds must be used for that purpose and that purpose only. Failure to do so can result in litigation and even the loss of nonprofit status. 

In contrast to restricted funds, your nonprofit can use unrestricted funds for any purpose. They often help organizations with administrative expenses, such as payroll and rent. Restricted funds are frequently not endowed to cover these costs, so unrestricted donations can be a welcome departure from that level of oversight. 

restricted-funds-nonprofit-benefitEmily is ready to learn all about restricted funds!

Most donations that organizations receive from individual donors are unrestricted. The higher the dollar amount, the greater the likelihood that a contribution will hold a stipulated purpose.

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The Benefit of Restricted Funds

Restricted funds can benefit both your nonprofit and its donors. Donors that restrict their funds know exactly where their donations are going. Thus, they are able to directly target a cause or program that is of personal value to them. 

Restricted funds endow donors with the feeling that they can make a greater impact in the areas of your nonprofit that mean the most to them. This makes supporters more inclined to give in the first place, which is a major plus for nonprofits. 

And, when that money goes toward something your nonprofit itself would allocate money to, there is little difference between a restricted and unrestricted fund; they each bring about the same end. This is not always the case, however. While most nonprofits would prefer to receive unrestricted funds, restricted donations are only a nuisance when you cannot make them work within the context of your budget and goals.

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Types of Restricted Funds

There are two types of restrictions: permanently restricted and temporarily restricted. These restrictions have to do with the timeframe for using the funds. 

Permanently Restricted

Permanently restricted funds carry with them requirements that last for their lifetime. Organizations cannot put these funds toward just anything; they must allocate them toward their specified purpose. 

For example, if someone contributes to an elephant sanctuary with the stipulation that that money go toward food, it cannot be put toward anything else, even medical care or another expense related to the wellbeing of the elephants.

Temporarily Restricted

A temporarily restricted fund has a time limit or specific goal, known as a limiting factor. Once that goal has been achieved or that time limit has expired, any remaining funds are classified as unrestricted.

Let’s say that a donor contributes a large sum of money to a nonprofit that provides full-ride scholarships to underprivileged students. This donor specifies that the money should fund scholarships for students to attend college in the same state in which the nonprofit resides for the upcoming school year. 

The nonprofit awards a student a scholarship who later chooses to go to a university in a different state, so the funds go back to the nonprofit. If the school year starts before the nonprofit can find another student to give the funds to, then the nonprofit gets to use the funds in whatever manner it sees fit. 

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How Do Restricted Funds Work?

Restricted funds can be somewhat of a nuisance. They can alter how you carry out your objectives and, even in some cases, what objectives you target and achieve. This is why you must be careful when you accept the terms of a restricted fund, especially if it is a large one. 

restricted-funds-nonprofit-accountingSadie is deep in thought on the complexities of restricted funds.

To start, your donor must specify what their contribution is for. Whether or not this involves a formal contract, there will at least be a mutual understanding, in writing, that the funding is restricted in a certain way. 

The financiers that provide nonprofits with restricted funds may want updates on how the nonprofits are using those funds. These updates may take the form of legal documentation. This is frequently the case when a private foundation or endowment supplies a restricted grant.

If a nonprofit were to use a restricted fund for anything other than its intended purpose, the nonprofit could face serious legal action. Not only that, abiding by the stipulations of restricted funds instills trust in your organization, and removing that trust can have devastating effects — on both your donor pool and your community at large.

Pro Tip: If someone does approach you with a restricted donation, it is within your right to deny it. Of course, you want to let them down easily by thanking them for their support. But, you do not have to accept a gift if you cannot use it in the way that they want.

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Accounting for Restricted Donations

You must track restricted donations via various financial statements, including a statement of activities, statement of financial position, and budget. You will do the same when you account for grants, account for stock donations, and account for in-kind donations in addition to account for any other funding.

Statement of Activities

In your statement of activities, you track all of your revenue and expenses within a reporting or accounting period. Include your restricted funds under revenue, and specify them as permanently or temporarily restricted. Then, tally everything up — by subtracting your liabilities from your gross assets — to arrive at your net assets.

Statement of Financial Position

Your statement of financial position is a snapshot of your organization’s financials on any given day. This document displays three categories:

  • Gross assets

  • Liabilities

  • Net assets 

Place your restricted funds within the assets category along with your unrestricted funds. 

Budget

Your nonprofit budget acts as your working template for the year, from which you finance projects and programs. If your ledger shows, for example, that your organization has $200,000 in restricted funds that you must use to finance activities for children, you can allocate a part or all of this funding accordingly. 

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What About Restricted Gifts?

Restricted gifts resemble restricted funds — your donor makes the purpose of these items clear before you accept them, and you legally abide by this purpose.

restricted-funds-nonprofit-final-thoughtsCorinne is feeling confident with all this newfound knowledge!

For example, maybe you help women in need. Instead of giving you money to buy feminine hygiene products for these women, a donor gives you those feminine hygiene products.

It is not that common for donors to put restrictions on in-kind donations, as the purpose of those resources is usually clear. To continue with the above example, what else are you going to do with the feminine hygiene products? I guess you could keep them for the office, but the donor is probably going to assume that you understand what to use them for given what your mission is and how many products they provide.

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Final Thoughts

So, what are the biggest takeaways from this long article with new terminology and information? Practice diligent financial management by keeping track of where you are getting contributions and how you are spending them. If a donation comes with a restriction clause, follow this guidance to avoid legal action, loss of public trust, and/or loss of nonprofit status. And that is it! We just summed up this whole article in a few sentences.

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FAQ

💡Can a nonprofit borrow from restricted funds?

No. A nonprofit cannot borrow from restricted funds. The nonprofit must use these funds for their corresponding purposes. Find out more. 

🔑 What is the difference between permanently and temporarily restricted funds?

Permanently restricted funds carry with them requirements that last forever. Temporarily restricted funds, on the other hand, have temporary guidelines. Once those temporary restrictions expire, the nonprofit can use them as it sees fit. Find out more. 

📝 Do restricted funds appear on financial statements?

Yes. Restricted funds appear on financial statements with labels that specify their purposes. Find out more.

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Eva
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