Restricted Fund

A restricted fund is money the organization holds but does not own in the full sense — the donor or funder retains control over how it may be used by imposing conditions on its purpose, timing, or permanence.

This distinction — between holding funds and controlling them — is the foundation of nonprofit fund accounting. An organization that receives a $100,000 restricted grant has $100,000 more in its bank account. It does not have $100,000 more in freely available resources. The money is obligated before it arrives.

The three types of restrictions

Under FASB ASC 958, donor-imposed restrictions fall into three categories.

Purpose restrictions limit spending to a specific program, activity, or geographic area. A grant restricted to “after-school tutoring for at-risk youth in the Riverside service area” cannot be used for administration, other programs, or activities outside the service area. The restriction is released when qualifying expenditures — tutoring program costs within the Riverside area — are incurred and documented.

Time restrictions make funds unavailable until a future date or event. The most common example is a multi-year pledge: a donor commits $50,000 per year for three years. The pledges for years two and three are time-restricted until those years arrive. At the pledge’s present value, they appear in restricted net assets until the time restriction expires.

Perpetual restrictions require the principal of a contribution to be held in perpetuity. A true endowment gift — where the donor specifies that the principal must be maintained permanently and only investment income may be spent — creates a perpetual restriction. The principal never leaves the restricted class; only the income generated by investing it can be released.

FASB ASU 2016-14, effective for fiscal years beginning after December 15, 2017, consolidated the prior three-class system (unrestricted, temporarily restricted, permanently restricted) into two classes. All three restriction types above now appear in the single “net assets with donor restrictions” class on the balance sheet, with footnote disclosure about the composition.

How restricted funds differ from board designations

Board designations look similar from the outside — money set aside for a specific purpose — but they are fundamentally different.

A board designation is created by internal policy. The board resolves to set aside $100,000 as an operating reserve or technology fund. That designation lives within net assets without donor restrictions. The board can rescind it at the next meeting if circumstances change.

A donor restriction is created by external conditions imposed by the person who contributed the funds. The organization cannot unilaterally remove it. Only the donor can release a restriction, typically in writing.

Misclassifying board designations as donor-restricted overstates restricted net assets. Auditors test for this. The test is simple: where did the condition come from? If it came from the board, it is a designation. If it came from the donor, it is a restriction.

What restricted fund tracking requires in practice

The compliance obligation is operational, not just conceptual.

For each restricted fund, the organization must: record the award or contribution with the specific restriction terms; assign a fund code so that expenses can be charged to the correct fund; post expenses against the fund as they are incurred; verify that every expense is within the restriction scope; and document the release from restriction when the conditions are satisfied.

This documentation chain — from the award letter or contribution agreement to the final expense and release documentation — is what an auditor will review when testing restricted fund compliance. Organizations that maintain this chain as a byproduct of normal accounting have clean files. Organizations that reconstruct it at year-end or at audit time have gaps.

How restrictions are released

The release-from-restriction event is the moment when restricted net assets become unrestricted. It is recorded on the statement of activities as “net assets released from restrictions” — a decrease in the restricted class and an equal increase in the unrestricted class.

For purpose restrictions, the release happens when qualifying expenditures are incurred. When a restricted grant funds a specific program, each allowable expense charged to the grant releases a corresponding amount from restriction. At the end of the grant period, if all funds were correctly expended, the restricted balance reaches zero and the full grant award has been released.

For time restrictions, the release happens automatically with the passage of time or the occurrence of the specified event. When a future-year pledge installment becomes due, the time restriction releases and the pledge moves from restricted to unrestricted revenue.

The documentation that the restriction was satisfied — expenditure reports, time records, program documentation — is the audit trail. Without it, the release is an assertion rather than a verified fact.