When charities receive donations with specific instructions from donors, they must handle these restricted funds differently from regular donations.
Restricted funds require separate tracking, careful documentation, and precise reporting to ensure every dollar goes exactly where the donor intended. Mismanaging these funds can lead to serious problems, including fines, lawsuits, or loss of charitable status.
This guide walks through the essential steps for handling restricted fund accounting properly. We’ll cover the core principles you need to know, different types of restrictions you might encounter, and practical systems for tracking and reporting on these funds. You’ll also learn about internal controls that protect your organization and ensure compliance with accounting standards.
Core Principles of Restricted Fund Accounting
Restricted fund accounting operates on three key foundations.
First, we must clearly separate funds with and without donor limitations.
Second, we need systematic tracking methods that honor donor wishes.
Third, we must strictly follow how donors intend their gifts to be used.
Definition of Restricted and Unrestricted Funds
Restricted funds are donations that donors have designated for specific purposes.
We cannot use these funds for any other activities without the donor’s permission.
These funds come with clear instructions.
A donor might give money for building repairs, youth programs, or medical equipment.
Unrestricted funds have no donor-imposed limitations.
We can use these donations for any legitimate organizational purpose.
Unrestricted funds help cover general expenses like staff salaries, utilities, rent, office supplies, and emergency needs.
The key difference lies in flexibility.
Restricted funds must follow donor rules exactly, while unrestricted funds let us address our most pressing needs.
Both types are important.
Restricted funds often support specific programs, and unrestricted funds keep our operations running smoothly.
Purpose and Significance of Fund Accounting
Fund accounting helps us track different types of donations separately.
This system ensures we use each gift according to donor wishes.
We must report restricted and unrestricted funds in different categories.
This separation shows donors and regulators how we manage their contributions.
Financial statements require three main sections:
- Without donor restrictions (unrestricted funds)
- With donor restrictions (temporarily restricted)
- With donor restrictions (permanently restricted)
This accounting method builds trust with donors.
They can see exactly how we used their specific gifts.
Fund accounting also protects our organization legally.
Mixing restricted funds with general funds can lead to fines, lawsuits, or loss of charitable status.
The system helps us plan better budgets.
We know which funds are available for general use and which have specific purposes.
Donor Intent and Donor Restrictions
Donor intent represents the specific purpose a donor had in mind when making their gift.
We must understand and document these intentions clearly.
Common types of donor restrictions include:
- Time restrictions (use funds within certain dates)
- Purpose restrictions (specific programs or projects)
- Geographic restrictions (serve particular locations)
- Beneficiary restrictions (help specific groups)
We cannot change donor restrictions without written permission.
If a project costs less than expected, we cannot automatically use leftover funds elsewhere.
Documentation is crucial.
We must keep records of all donor communications and agreements, including emails, letters, and grant agreements.
When restrictions become impossible to follow, we must contact the donor.
Sometimes circumstances change and original plans no longer work.
Clear communication prevents problems.
We should discuss any concerns about restrictions before accepting large gifts.
Types of Restricted Funds in Charities
Charities receive donations with different types of restrictions that affect how and when funds can be used.
These restrictions fall into three main categories based on time limits, permanence, and specific purposes outlined by donors.
Temporarily Restricted Funds
Temporarily restricted funds have donor-imposed limitations that expire over time or when certain conditions are met.
These restrictions typically involve time restrictions or specific project completion requirements.
Common examples include donations for annual programs or multi-year initiatives.
A donor might give $25,000 for youth programs to be spent over three years.
Once we use the funds according to the donor’s wishes, the restrictions are released.
Time restrictions are the most frequent type of temporary restriction.
Donors specify when funds must be used, such as “for the 2026 summer camp program” or “to be spent within five years of receipt.”
We must track these funds carefully in our financial records.
When restrictions are satisfied, we transfer the funds from temporarily restricted to unrestricted net assets on our statement of activities.
Temporary restrictions will eventually be lifted.
This gives us more flexibility in long-term planning once conditions are met.
Permanently Restricted Funds
Permanently restricted funds maintain donor restrictions that never expire.
The principal amount must remain intact forever, though we can often use investment earnings according to donor specifications.
Endowments are the most common type of permanently restricted funds.
Donors create endowments to provide ongoing income for specific purposes while preserving the original gift amount.
For example, a $100,000 endowment for scholarships means we keep the $100,000 invested permanently.
We can use the annual investment earnings to fund scholarships, but the original amount stays untouched.
These funds require special investment management and accounting treatment.
We must maintain detailed records showing the original gift amount and any accumulated earnings or losses.
Legacy gifts often come with permanent restrictions.
Donors want their contributions to support our mission indefinitely, creating lasting impact beyond their lifetime.
Purpose-Restricted Funds
Purpose-restricted funds must be used for specific programs, activities, or expenses as designated by the donor.
These restrictions focus on how funds are spent rather than when they’re spent.
Purpose restrictions can be narrow or broad.
A donor might restrict funds for “veterinary supplies” (narrow) or “animal care programs” (broad).
We must honor the exact wording of the restriction.
Common categories include:
- Program-specific donations for particular services
- Capital campaigns for buildings or equipment
- Operating expenses like rent or utilities
- Staff salaries for specific positions
We need separate tracking systems for each purpose-restricted fund.
Our accounting records must clearly show which expenses are charged against which restricted funds.
Some donors combine purpose and time restrictions.
A gift might be restricted for “education programs in 2025 only,” creating both purpose and temporary restrictions we must manage at the same time.
Establishing and Tracking Restricted Income
Proper income identification and tracking systems ensure compliance with donor restrictions while maintaining accurate financial records.
Clear documentation and systematic tracking prevent misuse of restricted funds and support transparent reporting.
Identifying Restricted vs. Unrestricted Donations
We must clearly distinguish between restricted and unrestricted donations at the point of receipt.
Restricted income comes with specific donor-imposed limitations on how we can use the funds.
Unrestricted funds have no donor restrictions.
We can use these donations for any legitimate organizational purpose, including general operating expenses, administrative costs, or program activities.
Common types of restricted donations include:
- Program-specific gifts for particular projects
- Capital campaign contributions for buildings or equipment
- Endowment funds with spending restrictions
- Operating expense donations for specific costs like utilities
Time restrictions also matter.
Some donations must be used within specific timeframes, while others may be restricted until certain conditions are met.
We should document the restriction type immediately when receiving each donation.
This prevents confusion later and ensures proper accounting treatment.
Gift Instruments and Documentation
Every restricted donation requires proper documentation to capture donor intent accurately.
Gift instruments serve as legal proof of the donor’s wishes and restriction terms.
Key documentation includes:
- Written donor correspondence stating restrictions
- Grant agreements outlining fund usage requirements
- Pledge cards with specific designation fields
- Donation receipts noting any restrictions
We must review all gift documentation carefully before accepting restricted funds.
If restrictions conflict with our mission or capacity, we should discuss modifications with the donor or decline the gift.
Store original documentation in secure files linked to our accounting system.
Digital copies provide backup access while keeping organized records for audits.
Essential information to capture:
- Exact restriction language from the donor
- Start and end dates for time-restricted funds
- Spending requirements or limitations
- Reporting obligations to the donor
Clear documentation protects our organization and honors the donor’s wishes.
Implementing a Tracking Process
Our accounting system must separate restricted and unrestricted funds from the moment we receive them.
This requires specific procedures and internal controls.
Set up separate fund codes or accounts for each type of restriction.
Use distinct numbering systems that clearly identify the fund purpose and restriction type.
Tracking requirements include:
| Fund Type | Account Setup | Reporting Needs |
|---|---|---|
| Unrestricted | General operating accounts | Statement of activities |
| Temporarily restricted | Separate fund codes | Restriction tracking reports |
| Permanently restricted | Endowment accounts | Investment performance reports |
Record all restricted income in the appropriate fund account immediately upon receipt.
Never deposit restricted funds into general unrestricted accounts, even temporarily.
Monthly reconciliation ensures restricted fund balances match donor restrictions.
Compare actual spending against allowable uses for each restricted fund.
We should generate regular reports showing restricted fund activity.
These reports help management monitor compliance and provide transparency to donors about how we use their gifts.
Train all staff who handle donations on proper restriction identification and recording procedures.
Consistent processes prevent errors that could lead to compliance issues.
Need a clearer process for tracking restricted funds?Discover our step-by-step guide on handling restricted funds in the general ledger to strengthen your charity’s financial accuracy and compliance.
Accounting and Allocating Restricted Funds
Proper accounting for restricted funds requires careful tracking and allocation methods that maintain donor restrictions and ensure accurate financial reporting.
We must record these funds separately from unrestricted donations and allocate expenses according to specific guidelines.
Recording Restricted Funds
We need to set up our accounting system to track restricted funds separately from unrestricted donations.
This starts with creating distinct accounting codes or fund accounts for each type of restriction.
Our chart of accounts should include separate categories for temporarily restricted and permanently restricted net assets.
We record restricted donations in these specific accounts when we receive them.
The balance sheet must show restricted funds as separate line items.
We cannot mix restricted and unrestricted net assets together on our financial statements.
We should establish separate bank accounts for major restricted funds when possible.
This makes tracking easier and reduces the risk of accidentally spending restricted money on the wrong purpose.
Our accounting system needs to track each restriction’s purpose, timeline, and remaining balance.
We must document exactly what each donor specified when they made their gift.
When we spend restricted funds, we move the money from restricted net assets to unrestricted net assets.
This shows that we have met the donor’s requirements.
Expense Allocation and Indirect Costs
We can only charge expenses to restricted funds if they directly relate to the restricted purpose.
Direct costs like program supplies or staff salaries for specific projects are usually acceptable.
Indirect costs require more careful handling.
We can allocate administrative expenses like rent or utilities to restricted funds only if our organization has an approved indirect cost rate.
Many donors limit how much we can spend on overhead costs.
We need to check each restriction to see what percentage can go toward administrative expenses versus program costs.
We should create allocation formulas based on reasonable methods like staff time, square footage, or program budgets.
These formulas must be consistent and well-documented.
Our financial statements must show how we allocated expenses between restricted and unrestricted activities.
This transparency helps donors see how we used their gifts.
Financial Reporting and Compliance
Charities must follow specific reporting standards when handling restricted funds. This helps maintain donor trust and meet legal requirements.
Proper financial statements separate restricted and unrestricted net assets. Regulatory bodies require detailed documentation of how we use these funds.
Reporting in Financial Statements
We must clearly separate restricted and unrestricted funds in our financial statements. The statement of financial position shows net assets with donor restrictions and net assets without donor restrictions as distinct categories.
Our balance sheet displays restricted funds as separate line items. This separation helps readers understand which assets we can use freely and which have limitations.
The statement of activities breaks down revenue and expenses by restriction type. We list temporarily restricted funds that will become available when conditions are met.
Permanently restricted funds appear separately since these restrictions never expire.
Key Financial Statement Elements:
- Statement of financial position with separated net assets
- Statement of activities showing restricted revenue
- Cash flow statements track restricted fund movements
- Notes explaining restriction details and purposes
We must document all restriction details in the notes to the financial statements. These notes explain the nature of restrictions and when temporarily restricted funds might become available.
Regulatory Requirements for Charities
Charities face strict rules about restricted fund management from multiple regulatory bodies. We must maintain accurate records that prove we’re using restricted funds according to donor wishes.
Revenue agencies require us to file annual returns that detail our restricted fund activities. These filings must show how we’ve used restricted donations and whether we’ve met all donor conditions.
Provincial charity regulators often have additional reporting requirements. We may need to submit detailed financial reports that break down restricted fund usage by program or purpose.
New to restricted fund accounting? Understanding what qualifies as a Canadian registered charity is a good place to start. Learn more in this external guide on Canadian registered charities.
Common Regulatory Requirements:
- Annual information returns with restricted fund details
- Quarterly reports for large restricted donations
- Special reporting for government grants
- Documentation of donor communications and agreements
Failure to meet these requirements can result in penalties, loss of charitable status, or legal action. We must keep detailed records of all restricted fund transactions and decisions.
Producing Donor Reports
Donor reports build trust by showing exactly how we’ve used restricted funds. We should create clear, specific reports that demonstrate the impact of restricted donations.
Our donor reports include financial summaries showing how much we’ve spent and what remains. We provide program updates that connect spending to actual outcomes and beneficiaries.
Effective Donor Report Elements:
- Financial breakdown of fund usage
- Program outcomes and beneficiary stories
- Photos or evidence of funded activities
- Timeline of fund expenditure and remaining balance
We send reports at agreed intervals, typically quarterly or annually. Some donors require approval before we spend restricted funds, so we include spending plans in our reports.
Large restricted donations often need special reporting arrangements. We work with major donors to create custom reports that meet their specific information needs while protecting beneficiary privacy.
Effective Management and Internal Controls
Strong internal controls and proper management systems help charities track restricted funds accurately. The right technology and clear procedures make compliance easier while reducing the risk of fund misuse.
Best Practices for Managing Restricted Funds
We need to separate restricted funds from unrestricted money right from the start. This means creating different accounts or fund codes in our accounting system for each type of restriction.
Documentation is critical. We should record every detail about donor restrictions when we receive the gift.
This includes the specific purpose, any time limits, and what happens if we can’t use all the money.
Our team needs clear roles for who can approve spending from restricted funds. We recommend having at least two people review each expense before we pay it.
Regular monitoring keeps us on track. We should check our restricted fund balances monthly to make sure we’re not overspending.
This also helps us spot problems early.
We need to train our staff on the rules for restricted funds. Everyone who handles money should understand why we can’t move funds between different restrictions.
Implementing Internal Controls
Strong internal controls start with separating duties. We should have different people who receive donations, record them, and approve spending from restricted accounts.
Our approval process needs multiple levels. Small expenses might need one signature, but larger amounts should require two or more approvals from senior staff or board members.
We need regular reconciliation of our accounts. Someone who doesn’t handle the daily bookkeeping should review our restricted fund records each month.
Written policies protect our organisation. We should document exactly how we handle restricted funds, who can make decisions, and what steps we follow for different situations.
Our board should review restricted fund reports at each meeting. This oversight helps catch mistakes and shows donors we take their restrictions seriously.
Technology Solutions for Charities
Nonprofit accounting software makes managing restricted funds much easier than basic bookkeeping programs. These systems let us tag each donation with its specific restrictions automatically.
Fund accounting features are essential. We need software that can track multiple funds separately while still giving us organisation-wide financial reports.
Cloud-based systems help our team access restricted fund information from anywhere. This is especially helpful when multiple staff members need to check fund balances before making spending decisions.
Integration saves time and reduces errors. Our donation platform should connect directly to our accounting system so restricted gifts get coded properly from the start.
We should look for software that generates compliance reports automatically. This makes it easier to show donors and auditors how we’ve used their restricted gifts properly.
Conclusion
Managing restricted funds requires careful attention to detail and strong systems. When we track these donations properly, we build trust with donors and stay compliant with regulations.
The key steps are simple but important: understand donor rules, track funds separately, and budget carefully. Transparency helps us show donors how their money makes a difference.
Good restricted fund management protects our charity’s reputation and mission. It also helps us use every dollar the way donors intended. Ready to improve your charity’s fund accounting?
Book a free call with us for expert help with restricted funds and compliance.
Navigating director compensation rules can be complex.
Contact Northfield & Associates for expert guidance on compliance requirements. Our team understands Canadian charity law and can help ensure your organisation follows proper procedures.
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Frequently Asked Questions
Managing restricted funds raises many practical questions about proper accounting methods and compliance requirements. These common concerns focus on recording procedures, classification differences, and financial statement presentation.
What is a restricted account in accounting?
A restricted account holds donations that must be used for specific purposes set by the donor. We cannot use these funds for general operating expenses or other activities.
How do I record restricted funds?
Record restricted funds separately from unrestricted donations in your accounting system. Each restricted gift gets its own tracking code or fund designation, and your income statement must show restricted and unrestricted revenue in different categories.
What is the difference between restricted and unrestricted accounting?
Unrestricted funds have no donor limitations on how you use them. Restricted funds come with specific donor instructions that you must follow exactly. Your financial statements must separate these two types clearly.
Is restricted cash a liability or asset?
Restricted cash is an asset on your balance sheet. You own the money, but must use it according to donor instructions. Show restricted cash separately from unrestricted cash on your financial statements.
How do you show restricted funds on a balance sheet?
List restricted cash as a separate line item under assets. Your net assets section shows funds with donor restrictions separately from unrestricted net assets, as required by accounting standards.
What is an example of a restricted account?
A building fund where donors give money specifically for facility improvements. An endowment fund where you keep the original donation intact and only spend investment earnings. Program-specific donations like “for animal care only” must be tracked separately.
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