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Nonprofits, Are You Really Restricting Your Restricted Funds?

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Nonprofit accounting standards dictate that nonprofits must treat the gifts and donations they receive in specific ways. This includes making special accounting provisions for funds with donor restrictions and funds without donor restrictions.

However, due to the difficulty involved in complying with these accounting standards, nonprofits are understandably less than eager when it comes to restricting these funds. And this has led many to seek swift, effective, and stress-free ways of accounting for their restricted funds, including by using cutting-edge technology such as PreciseGrants.

How exactly are restricted funds meant to be handled and what are the methods open for nonprofits to manage these funds? Here’s all you should know.

What are restricted funds?

As the name suggests, restricted funds are gifts or donations that carry specific obligations or instructions relating to the use of the funds. The instruction may be to the extent that the fund can only be exhausted in a certain way or that it must be used on a specific project. In either case, when a donor specifies how they want the funds to be used, then the funds are restricted.

Under current accounting standards, these funds are referred to as “funds with donor restrictions.” The restrictions may be temporary or permanent. A temporarily restricted fund may specify that the money be used for a specific purpose within a particular timeframe. After the timeframe is over, the funds become unrestricted.

A permanently restricted fund, on the other hand, is expected to be put to the use specified by the donor in perpetuity. A common example of a permanently restricted fund is an endowment that requires the principal to be perpetually maintained in an investment fund, while the interest is applied to the donor’s instructions.

Essentially, restricted funds have specific purposes and cannot be co-mingled with other funds. In some ways, designated funds also behave in this manner. However, the difference between them is that designated funds are set aside for a specific end by the nonprofit itself, while restricted funds are restricted by the donor.

How should restricted funds be treated?

By their nature, restricted funds typically include large sums. Often, the larger the donation, the more likely that there will be donor-imposed restrictions. As a result, nonprofits that seek to attract gifts of this scale must be prepared to have robust accounting processes and procedures in place.

As a rule, restricted funds should be tracked separately from other fund assets. While most nonprofits would prefer a tidy balance sheet with a single neat column, they must be prepared to record restricted funds individually in grid-style sheets to properly track and account for the funds.

Each restricted fund is typically treated separately, almost like an independent business. Budgeting will be separate, so will expensing, and other aspects of the accounting process.

All of the income from restricted funds, including multi-year grants, are expected to be recorded on the nonprofit’s books in the year an irrevocable commitment to the funding was received. Even if the funds have not been received yet, the funds must be recorded.

These standards, and more, indicate how much work is involved in dealing properly with restricted funds. But why go through all of this trouble in the first place?

Why is it important to restrict these funds?

The primary, and possibly most important reason, for complying with requirements for restricted funds is trust. Donors usually want to deal with nonprofits that are trustworthy and accountable. When they donate to a specific cause or purpose, they want to be able to see that the nonprofit has followed the instructions properly.

However, even where an organization has carried out a donor’s instructions to the letter, it can be difficult to properly account for the funds without separate, and clear, financial statements backing this up. As a result, nonprofits that care about showing accountability and trustworthiness will need to ensure the appropriate accounting standards are followed.

Another important reason is to avoid potential liability arising from a breach of donor instructions. In some states, or in relation to certain government-funded donors, this may amount to legal liability, and in relation to private funders, it may cause the nonprofit to become non-compliant with the terms of the fund. The effects of this could range from illegibility to secure reimbursement for expenses, where the grant is reimbursable, to civil fines and penalties for unethical behavior.

Nonprofits with proper accounting procedures can also avoid the danger of co-mingling funds or even misappropriation. They can ensure that there is always an accurate record of what funds are available for what projects. This way, the organization will never run out of cash or find out that it has inadvertently restricted funds that were meant for general operations or vice versa.

Methods of accounting for restricted funds

Primarily, restricted funds are managed by nonprofits through fund accounting. This includes several accounting best practices from the FASB relating to the handling of donations. Nonprofits adopt several methods to achieve these, including recording donations relating to each restricted fund a:

  • Statement of financial position
  • Statement of activities
  • Statement of cash flow

Most nonprofits also have procedures that they apply to demarcate funds during the budget, and also assigning program codes to each restricted fund. Disbursements, expenses records, and other records will then be tied to the specific program code of each fund, making tracking easier.

Many nonprofits use spreadsheets to manage their restricted fund assets. While this can be labor-intensive, it may be useful for smaller nonprofits with only the odd restricted fund donation a year. However, larger nonprofits or those that see a steady stream of funds with donor restrictions may consider leveraging on fund accounting software like PreciseGrants.

Add precision to your fund accounting

PreciseGrants is the grant reporting and budgeting tool of choice for several US nonprofits receiving private support and funding from government agencies. Visit our website to learn how PreciseGrants can help simplify your restricted fund accounting process.

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  • Betty Lenzy

    An organization I am part of has restricted funds as part of the year to year budget. At the end of one year, if restricted funds remain, are those funds carried over into the next year for that year's budget use as it pertains to restricted funds allocation?
  • Ahmed Şihen

    What is the difference between restricted and unrestricted revenue?
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