Fund Accounting for Nonprofits & Charities

The negative relationships between restricted donations and program outputs “are mostly derived from permanently restricted donations. This may be due to the relative size of these donations and that they are typically restricted in perpetuity, leaving little flexibility to the organization,” according to the authors. The revenues from payroll taxes are used to fund public programs; as such, the funds collected go directly to those programs instead of the Internal Revenue Service (IRS). The principal cannot be spent and only a specified percent of the interest can be used.

In this article, we will show you how to manage nonprofit donor-restricted funds with examples so that you can replicate it in your organization. Knowing what constitutes restricted funds (and then handling them correctly) is crucial to staying out of trouble with your donors…and the law. In a situation where it’s too late for a disclaimer, you can go back to donors and ask permission to re-purpose their gift. Keep in mind that donors have the legal right to say no, and we have seen donors refuse to allow such.

Types of Restricted Funds

We’re going to focus specifically on how it’s applied to small and mid-sized nonprofits and charities. If you’re looking for info on fund accounting in government here is a great resource for you. The funds are restricted by law, so if they are not used for the designated purpose, a donor can initiate legal action and demand their return. Consider, for example, a temporarily restricted donation made for a capital campaign.

  • They allow the organization the freedom of discretionary spending, and they are essential financial resources contributing to the effective operation of a nonprofit organization.
  • To nonprofits, restricted funds are important because many major donations that help fund large initiatives are restricted by the contributor.
  • Start by deciding whether your nonprofit can accept restricted gifts, and communicate your plans to your donors as they support your cause.
  • Having consistent processes in place to navigate budgets aids in both making the most out of the funds available and aiding with financial transparency.
  • Restricted and unrestricted funds refer to the different types of money non-profit organizations receive and how they can use them.

And this has led many to seek swift, effective, and stress-free ways of accounting for their restricted funds, including by using cutting-edge technology such as PreciseGrants. A restricted fund contains money that is earmarked for use only for a specific stated purpose. If the money is temporarily restricted, any excess can become unrestricted once the purpose is fulfilled. If the money is permanently restricted, it must be kept intact in the form of an endowment, usually in perpetuity, and only the interest earned by investing the endowment may be spent in service of the purpose.

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To nonprofits, restricted funds are important because many major donations that help fund large initiatives are restricted by the contributor. For example, a major donor might decide to give a gift of $650,000 to an organization but require the funds be placed in an endowment. That donor may further restrict the interest made off of the contribution and require it to be used for a scholarship program. For the balance sheet, we are going to follow the same example as the income statement using RPN. On the balance sheet, RPN would have correctly recorded the $50,000 grant when it was received as an asset.

Nonprofit Donor Restricted Fund Management

You could allocate all of your nonprofit’s funds exactly where you deemed them most important, whether that was to overhead expenses or to your latest programs. Even if this example nonprofit runs into financial difficulties, they cannot use these funds to support other programs or pay for overhead expenses. This is why it’s so important for nonprofits to allocate some of their unrestricted funds to a reserve fund in case of future economic turbulence.

Add precision to your fund accounting

Nonprofit organizations must maintain a healthy unrestricted fund balance, as it provides a cushion for unforeseen expenses and allows the organization to respond to new opportunities or challenges. Five types of fund balances are commonly used in accounting for government and nonprofit organizations. If too much funding is restricted and designated for program use only, the organization might not have enough to put toward fundraising expenses, according to the authors. Now new research suggests that donor-restricted gifts have a negative impact on charities. For years, nonprofit advocates have been suggesting that restricted funding misses the point. In an effort to create a “more equitable nonprofit sector,” organizations like the Trust-Based Philanthropy Project have been working to encourage grant makers to rethink how their donations are structured.

More and more, donors are paying special attention to how their contributions are used, and many have shown that they are willing to take whatever steps might be necessary to ensure that their wishes are fulfilled. When soliciting donations on your website, via mail, or at events, you may choose to include a clause that specifies that the donations will go to wherever the organization best sees fit. This will provide restricted funds, but as mentioned earlier, you may find that donors are more generous when they can easily see the tangible results of their contributions.

About the Author: Nonprofit Megaphone

To aid your grant and fund allocations, develop guidelines and procedures for expense allocation and implement fund accounting software. It’s also important to train finance and program staff to ensure allocation processes are consistently followed, and regularly review expense allocations to identify errors or discrepancies. A non-profit should maintain separate unrestricted, temporarily restricted, and permanently restricted funds during the budgeting process.