Restricted Funds

Restricted Funds

What are restricted funds?

In the non-profit sector, restricted funds refer to a cash reserve that can only be used for specific projects or purposes. Funds may be restricted because the donor wants the money to go to a particular program or the donor wants the money to be used after a certain time or event, such as a birthday. Restricted funds ensure donors use their money the way they want it.

When a donor makes a donation to a non-profit organization, they can specify whether their donation is restricted or can be used in any way the organization deems appropriate. If the donor temporarily restricts the use of funds, the organization must use the funds for the intended purpose. If funds are permanently restricted, the donation is the principal amount, and only the interest earned can be spent on charitable activities. There may also be certain restrictions on how the interest can be spent. If the non-profit does not follow the donor's instructions, the donor can sue the organization or request a full refund of the donation.

Designation of restricted fund

The decision to donate, restricted or unrestricted, rests with the donor. The donor makes this designation by letter of intent to donate or by explicit agreement with the association. Nonprofits can avoid confusion by offering sponsorship when requesting donations by direct mail or email. This can be done by appending a clause to this effect, both in the donation form and in the acknowledgment of receipt. For example, the American Red Cross Society offers donors the option to donate to Disaster Relief, the local Red Cross, or wherever they are needed. The designation reduces confusion when donors do not explicitly state the designation of the funds.

However, most non-profits require unrestricted funding when requesting donations. Include an email or direct mail statement that the donor is making an unrestricted donation to the organization. This gives them the ability to allocate funds to specific programs where they are needed most. An exemption is when the non-profit organization requests funds for a specific purpose, such as a scholarship or construction fund.


Types of restricted funds

The name that specifies the type of donation is contained in a document called the "gift instrument." A gift instrument is a grant document written by a foundation or individual donor that describes how funds will be used. Restricted funds are grouped into two main categories:

1. Temporarily restricted

A temporarily restricted fund usually has a time limit and can be used for specific purposes over a period of time. When the goal is reached or the allotted time expires, the money becomes unrestricted or ceases. For example, a grant for a scholarship fund is canceled when the recipient completes the university program. Likewise, if donors have contributed to the construction of a building, the fund is canceled upon completion of the construction project.

2. Permanently restricted

This fund invests the gift and then uses the interest earned to fund specific goals designated by the donor. The funds are deposited into a financing fund that supports the the non-profit organization or specific projects in general. The non-profit organization can only use the interest and return on investment to support specific activities of the organization. Permanently restricted funds do not expire.

Accounting for restricted funds

Recording of Donation 

The Financial Accounting Standards Board (also called the FASB) issued guidance on recording income generated by non-profit organizations in 1996. The guidance is contained in FASB 116, which requires that all contributions received from donors be aggregated as unrestricted, temporarily restricted, or permanently restricted. Valuations should also be recorded separately in the organization's financial statements. This makes it much easier to keep track of each donation and how it was used. A journal entry is made when the goal or deadlines are met, and the funds remaining in these accounts can be moved to an unrestricted funds account.


A non-profit organization should maintain separate, unrestricted, temporarily restricted, and permanently restricted funds during the budgeting process. If the funds are managed as a single fund, the non-profit can make decisions based on the number of designated donors. For example, if the fund is $500,000 and the fund allocated is $300,000, the non-profit cannot use the funds for unrestricted purposes.


Internal Control System

A non-profit organization can set up an internal control system that tracks how donations are spent and alerts management as soon as the fund's time and purpose constraints are met. The funds are then transferred to unallocated fund accounts to fulfill the donor's wishes. The organization should also endeavour to train its staff on how to identify and record the expenses to be allocated to the corresponding funds. The right allocation of funds for the right purposes makes donors happy and helps the organization avoid legal problems due to embezzlement.


Legal obligations of Restricted Funds

When requesting donations, nonprofits should offer donors the option of designating their contributions as restricted or unrestricted funds. If donors state that their donation is restricted, the organization has a moral obligation to honor the donor's wishes.

There is also a legal obligation, as the law requires non-profits to use donations for the purposes proposed by donors. Suppose, for some reason, the non-profit organization does not comply with the donor's wishes and uses the funds for other unforeseen purposes. In that case, the donor may request a refund of their donation. The donor is also free to sue the organization for embezzlement or to file a complaint against the charity with the government department of the state where the non-profit is located.


  • A restricted fund is any cash balance that has been set aside for a specific or restricted use.

  • Often associated with funds held by donations to non-profit organizations or donations, restricted funds ensure that only donors can direct the use of those resources.

  • Failure to adhere to restrictions or unauthorized use of restricted funds may result in legal action.



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