What it means
When a donor gives money to a charity for a specific purpose, such as building a school or funding a research project, the charity receives it with a condition attached. The money may be used only for that purpose, and the charity must be able to show that it was.
Accounting standards require such funds to be reported separately. In many systems the accounts show net assets with donor restrictions apart from net assets without donor restrictions, and the notes describe the nature of each restriction.
Some restrictions are temporary, such as spending on a named programme or waiting until a date, and others are permanent, as with an endowment where only the investment income may be spent. When the purpose is met or the time passes, the money is released from restriction and becomes available for general use.
A restricted fund is different from a designated fund, which is set aside by the organisation's own board for a purpose that the board can later change. A restriction imposed by a donor cannot be undone by the board alone.
Good controls are important. A charity should record each restricted gift, track the spending against it in a separate account or code, and report to the donor as agreed, and the cash can be held in the same bank account provided the records show clearly how much belongs to each fund.
The risk is cash flow. A charity can have healthy-looking bank balances while most of the money is restricted, and spending it on running costs would be a breach, so management should plan using the unrestricted funds only.
In practice
Real-world examples.
Example
A hospital foundation receives a $1,000,000 gift to buy imaging equipment. It records the gift in a restricted fund and uses it only for the purchase, then reports the spending to the donor.
Example
A university receives a $5,000,000 endowment where only the investment income can be spent on scholarships. The principal is held permanently, and each year the income is released to fund student awards.
Example
An animal rescue charity runs a public appeal to build a new shelter wing. All the money raised is restricted to the building project, and the finance manager keeps a separate ledger to show every dollar is accounted for. When the wing opens, any unspent balance is returned to donors or used as the appeal terms allow.
Formula
Calculation
Closing restricted balance = opening restricted balance + new restricted gifts and income - amounts spent on the restricted purpose (released from restriction).
Suppose a charity received a $200,000 grant restricted to a literacy programme, with no opening balance. During the year it spent $50,000 on programme costs. Closing balance = 0 + 200,000 - 50,000 = $150,000. The $50,000 spent is released from restriction and the remaining $150,000 stays restricted for future literacy programme costs.Case study
Seen in the real world.
Riverside Youth Trust is an illustrative, fictional charity with a bank balance of $900,000, which the board believed was enough to cover a year of running costs. The new finance manager analysed the balance and found that $620,000 of it was restricted to specific programmes.
Only $280,000 was unrestricted, which covered about three months of core costs such as rent and salaries. The earlier plan to use the full balance to cover a funding gap would have breached donor terms.
The charity cut costs, applied for new unrestricted funding and began to include a modest contribution to overhead in each grant application. The illustrative lesson is that a large bank balance can be misleading, and a charity should always know how much of it is free to use. The board now sees a monthly report that splits cash between restricted and unrestricted funds.
Watch out
Common mistakes.
- Treating the total bank balance as available cash, when much of it may be restricted to specific purposes.
- Spending restricted money on unrelated costs, which can breach the donor's terms and trigger a demand for repayment.
- Confusing board-designated funds with donor-restricted funds, since the board can change its own designation but cannot override a donor's restriction.
Questions
People also ask.
Can a charity use restricted funds for overheads?
Only if the donor's terms allow it, so many grants permit a fair share of indirect costs and others do not.
What happens when a restriction is met?
The amount is released from restriction, which means it moves into unrestricted funds and may be used for any purpose of the organisation.
Do for-profit companies have restricted funds?
The term is mainly used by non-profits and governments, though companies may hold restricted cash, such as money held in escrow, with similar limits on use, and the accounts then show it apart from ordinary cash.
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