Fund Accounting Basics: Managing Restricted and Unrestricted Funds
Fund accounting is the defining feature of nonprofit accounting. Unlike for-profit businesses that track owner's equity, nonprofits track "net assets" classified by donor restrictions. This guide explains how fund accounting works, how to track restrictions properly, and common pitfalls to avoid.
When donors give to nonprofits, they sometimes place restrictions on how their gifts can be used. Fund accounting ensures these restrictions are tracked and honored. It's not just good practice—it's a legal requirement. Misusing restricted funds can trigger serious consequences, from damaged donor relationships to regulatory action.
Understanding fund accounting is essential for anyone involved in nonprofit finance—executives, board members, accountants, and development staff alike.
Without Donor Restrictions
- Available for any organizational purpose
- Includes board-designated funds
- Released restricted funds
With Donor Restrictions
- Purpose restrictions (specific programs)
- Time restrictions (future periods)
- Perpetual restrictions (endowments)
Net Asset Classifications
Under current accounting standards (ASU 2016-14), nonprofit net assets are classified into two categories based on donor-imposed restrictions:
Net Assets Without Donor Restrictions
These are funds available for any purpose the organization's leadership chooses. They include:
- Unrestricted contributions
- Membership dues (unless restricted)
- Earned revenue from programs, services, sales
- Investment income (unless restricted by endowment terms)
- Released restricted funds (after purpose or time restriction is met)
Net Assets With Donor Restrictions
These funds have donor-imposed limitations on their use. Restrictions can be:
- Purpose restrictions: Must be used for specific programs, activities, or purposes
- Time restrictions: Cannot be used until a specific date or event
- Perpetual restrictions: Principal must be maintained forever (endowments)
Old vs. New Terminology
The old three-category system (unrestricted, temporarily restricted, permanently restricted) was replaced in 2018 by two categories (without donor restrictions, with donor restrictions). You may still see old terminology in older documents or systems.
Understanding Restriction Types
Purpose Restrictions
The most common type of restriction. Donors specify how funds must be used:
- "For the scholarship fund"
- "To support after-school programs"
- "For capital improvements to the facility"
- "To fund research in [specific area]"
Time Restrictions
Funds that cannot be spent until a future date or event:
- Multi-year pledges (not available until pledge payment received)
- Gifts specifying future use ("for use in fiscal year 2027")
- Contributed assets with implied time restrictions (like long-term pledges)
Perpetual Restrictions (Endowments)
Endowment gifts where the donor requires the principal to be maintained permanently. Only the investment earnings (and sometimes appreciation) can be spent, subject to the organization's spending policy.
- True endowments: Donor requires principal to be maintained forever
- Term endowments: Principal maintained for specified period
- Quasi-endowments: Board-designated, not donor-restricted (recorded as without restrictions)
Board Designations Are Different
When the board designates funds for a specific purpose (like a reserve fund or quasi-endowment), these are NOT donor-restricted. They remain "without donor restrictions" because the board can change its designation at any time. Disclose board-designated funds in financial statement notes.
Tracking Restrictions in Your System
Proper restriction tracking requires both accounting system setup and operational processes.
Accounting System Setup
- Fund codes: Create separate funds for each restriction category
- Grant/project codes: Track spending against specific grants or restricted gifts
- Department codes: Link spending to programs for functional expense allocation
- Class codes: Additional dimension for tracking by restriction type
Documentation Requirements
- Maintain original gift documentation (letters, grant agreements, donor communications)
- Record restriction terms at time of gift entry
- Create a tracking spreadsheet or database for all restricted gifts
- Document when restrictions are considered met (release criteria)
Restricted Fund Tracking Template
| Field | Purpose |
|---|---|
| Fund/Gift ID | Unique identifier linking to accounting system |
| Donor name | Source of restricted funds |
| Gift date/amount | When received and original amount |
| Restriction description | Exact terms from donor |
| Restriction type | Purpose, time, or perpetual |
| Spending to date | Cumulative spending against restriction |
| Remaining balance | Available funds still restricted |
Release from Restriction
When restricted funds are spent according to donor intent, they're "released" from restriction. This appears on the Statement of Activities as a transfer from "with restrictions" to "without restrictions."
Purpose Restrictions
Released when the funds are spent on the specified purpose:
- Record expense in the appropriate program/category
- Record corresponding release from restriction
- Revenue appears in "with restrictions," release appears as transfer
Time Restrictions
Released when the specified time period begins:
- On the specified date, release the funds
- Multi-year pledge payments released when received
- Time restrictions satisfied by passage of time
Simultaneous Release Policy
Organizations may adopt an accounting policy to immediately release purpose-restricted gifts when the restriction is met in the same period. For example, if you receive a gift restricted for "after-school programs" and you operate after-school programs, the gift can be shown directly in "without restrictions" revenue.
Disclose Your Policy
If you use the simultaneous release policy, disclose it in your financial statement notes. Be consistent—once adopted, apply it to all similar situations.
Common Fund Accounting Pitfalls
Misusing Restricted Funds
The most serious issue. Using restricted funds for purposes other than donor intent can result in:
- Requirement to return funds to donor
- Donor complaints and loss of future giving
- State attorney general investigation
- Audit findings and qualified opinions
Inadequate Tracking
- Losing documentation of restriction terms
- Failing to track spending against specific restrictions
- Not reconciling restricted fund balances regularly
- Accumulating old restricted balances without plan for use
Incorrect Classification
- Treating board designations as donor restrictions
- Missing implied restrictions (like gifts for "new building" during capital campaign)
- Incorrectly releasing funds before restrictions are met
When in Doubt, Contact the Donor
If restriction terms are unclear, reach out to the donor for clarification. It's better to ask than to guess wrong. Document the clarification for your records.
Financial Statement Presentation
Statement of Financial Position
Net assets section shows two categories:
- Net assets without donor restrictions
- Net assets with donor restrictions
- Total net assets
Statement of Activities
Shows revenues, expenses, and changes in each net asset category:
- Contributions and other revenue by restriction category
- Net assets released from restrictions (transfer line)
- Expenses (typically shown only in "without restrictions" column)
- Change in net assets by category
Note Disclosures
- Nature and amounts of donor restrictions
- Board-designated amounts within "without restrictions"
- Composition of net assets with donor restrictions
- Endowment policies and activity
Related Resources
Need Help with Fund Accounting?
Eagle Rock CFO helps nonprofits implement proper fund accounting practices. We ensure restricted funds are tracked correctly, reported accurately, and spent according to donor intent.
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