Tracking restricted funds is essential for organizations, especially nonprofits, to ensure compliance with donor intent and maintain financial transparency. It primarily involves specific accounting practices that categorize and monitor these funds separately from unrestricted resources.
What Are Restricted Funds?
Restricted funds are donations or grants that come with specific conditions or purposes set by the donor. Unlike unrestricted funds, which an organization can use at its discretion, restricted funds must be used exactly as specified. They are generally categorized into two main types:
- Temporarily Restricted Funds: These funds have donor-imposed restrictions that will eventually expire (e.g., after a certain time period passes) or can be satisfied by the organization meeting a specific purpose (e.g., spending the funds on a particular program).
- Permanently Restricted Funds: These funds have donor-imposed restrictions that never expire. The principal amount must be maintained in perpetuity, though the income generated from investing these funds may be available for use (often subject to additional restrictions).
Key Principles for Tracking Restricted Funds
Effective tracking of restricted funds centers on clear categorization, meticulous record-keeping, and appropriate financial reporting.
1. Integrate into Financial Statements
Within a reporting or accounting period, all revenue and expenses, including restricted funds, are tracked in your statement of activities. Restricted funds are included under revenue and must be specified as either permanently or temporarily restricted. This distinction is critical for accurate financial reporting and demonstrating accountability to donors.
2. Utilize Fund Accounting
Nonprofits often employ fund accounting, a system that categorizes financial resources into different "funds" based on their purpose or restriction. This method helps maintain segregation between unrestricted funds and those with donor-imposed restrictions.
- Purpose of Fund Accounting: It allows an organization to clearly demonstrate how restricted donations are being used in accordance with donor stipulations, enhancing transparency and trust.
3. Chart of Accounts Structure
A well-designed chart of accounts is the backbone of tracking restricted funds. It should include distinct accounts that clearly differentiate between unrestricted, temporarily restricted, and permanently restricted net assets.
- Example Account Structure:
- Assets: Cash - Unrestricted, Cash - Temporarily Restricted, Investments - Permanently Restricted
- Revenue: Contributions - Unrestricted, Contributions - Program A Restricted, Contributions - Endowment
- Net Assets: Net Assets Without Donor Restrictions, Net Assets With Donor Restrictions (Temporarily), Net Assets With Donor Restrictions (Permanently)
4. General Ledger Entries
Every transaction related to restricted funds, from receipt to expenditure, should be meticulously recorded in the general ledger.
- Recording Restricted Revenue: When a restricted donation is received, it is recorded as revenue specific to its restriction type.
- Example: Debit Cash - Temporarily Restricted, Credit Contributions - Program B Restricted.
- Releasing Restrictions: When the conditions for temporarily restricted funds are met (e.g., the money is spent on the designated program or the time restriction expires), the funds are "released" from restriction. This involves a reclassification in the accounting system.
- Example: Debit Net Assets With Donor Restrictions (Temporarily), Credit Net Assets Without Donor Restrictions. This reclassification occurs on the statement of activities.
5. Financial Reporting
Restricted funds have a significant impact on an organization's primary financial statements, particularly for nonprofits.
-
Statement of Activities: This statement shows the changes in an organization's net assets over a period, categorizing revenue and expenses by restriction type. It highlights how restricted funds are received and how restrictions are satisfied.
-
Statement of Financial Position (Balance Sheet): This statement reports the organization's assets, liabilities, and net assets at a specific point in time. Net assets are presented in three categories as per FASB ASC 958:
- Net Assets Without Donor Restrictions
- Net Assets With Donor Restrictions (combining temporarily and permanently restricted funds)
Fund Type Description Example Reporting Location (Statement of Financial Position) Unrestricted Funds Funds that can be used for any purpose determined by the organization's governing body. General operating support, membership dues. Net Assets Without Donor Restrictions Temporarily Restricted Funds that have donor-imposed conditions or time restrictions that will eventually be met or expire. Grant for a specific program (e.g., after-school tutoring), donation for a capital campaign that ends next year, funds designated for use in a specific fiscal year. Net Assets With Donor Restrictions Permanently Restricted Funds where the principal must be maintained indefinitely, with only the income or a portion of the income available for use (often in endowments). The restriction never expires. Endowment donation where the principal is invested forever, and only the investment earnings can be used for scholarships; a gift to maintain a historic building in perpetuity, with interest from the investment used for upkeep. Net Assets With Donor Restrictions
6. Accounting Software and Tools
Utilizing specialized accounting software designed for nonprofits or robust general ledger systems with strong tracking capabilities is crucial.
- Features to look for:
- Ability to create custom funds or classes for different restrictions.
- Robust reporting features that can generate statements by fund.
- Audit trails to track every transaction.
- Grant management modules for complex restricted grants.
Best Practices for Managing Restricted Funds
To ensure accurate and compliant tracking, consider these practical insights:
- Clear Documentation: Maintain comprehensive records for every restricted gift, including donor agreements, letters of intent, and internal memos outlining the specific restrictions.
- Regular Reconciliation: Reconcile restricted fund balances monthly or quarterly to ensure that reported balances match actual usage and remaining funds.
- Segregation of Duties: Implement internal controls that separate the responsibilities for receiving, recording, and expending funds to prevent errors and fraud.
- Policy & Procedure Manual: Develop clear internal policies for how restricted funds are accepted, tracked, released, and reported.
- Staff Training: Ensure all staff involved in financial management understand the nuances of restricted funds and their specific roles in tracking them.
- Communication with Donors: Maintain open communication with donors, providing updates on how their restricted funds are being utilized, which reinforces trust and encourages future giving.
- External Audits: Regular external audits can verify the accuracy of your financial statements and your compliance with restricted fund usage.
By adhering to these principles and employing robust accounting practices, organizations can effectively track restricted funds, uphold donor trust, and ensure long-term financial health.
