What Is the Difference Between Funds With Donor Restrictions and Without Donor Restrictions?
Nonprofits have a unique accounting standard that differs from other types of businesses. Nonprofits have two categories for funds received: 1) funds with donor restrictions, and 2) funds without donor restrictions.
These used to be called unrestricted, temporarily restricted, and permanently restricted funds, but their names recently changed.
The two categories describe the presence or absence of restrictions imposed by a donor. Only a donor can legally impose restrictions on funds. Donors impose restrictions by creating a condition (either time or purpose) that must be met before the funds can be released. Donors communicate their conditions in the document used to award the funds, often referred to as an “award letter,” and technically known as a “gift instrument.”
If a donor does not pose a restriction, the donation is considered to be funds without donor restrictions. In this case, the nonprofit can use the donation where it is needed most.
How to Manage Funds with Donor Restrictions
Restrictions are conditions such as time and purpose. Time conditions might include a multi-year grant where the funds granted are distributed across a period of three years. Though the nonprofit may receive the full grant in year one, they cannot use the funds for years two and three until the time restriction is lifted. Purpose conditions might include funds intended for one specific program. Under “purpose” a donor can impose a condition that funds should be invested permanently, creating a condition that will never be met (therefore, the funds will always have donor restrictions). An example of this is an endowment.
Nonprofits should separate income with donor restrictions and without on their balance sheets and P&Ls. When the conditions of the restriction have been met, (the timeframe is right, or the program is happening) funds move from the “with restrictions” column to the “without restrictions” column. Once moved, the nonprofit can use the funds. This allows nonprofits to transparently report funds with and without donor restrictions.
Nonprofits are always legally obligated to meet the conditions of a donor-imposed restriction before spending the funds. That’s why funds without donor restrictions are always the best kind of funding a nonprofit can receive.