Nonprofit donations are classified into two categories for accounting and tracking purposes. Donations are given with instructions to either be used for specific programs (restricted), or for any programs the nonprofit sees fit (unrestricted). Nonprofits are required by law to use donations for the purposes specified.
It is important to understand the differences between the two designations if you are beginning nonprofit work or thinking of donating to one. The difference between the two can help you decide whether to give or use donations for specific or general purposes.
What Are the Nonprofit Fund Types?
Donors to a nonprofit organization may designate—or restrict—the use of their donations to a particular purpose or project. An example is a gift to a special scholarship fund at a university.
Unrestricted funds are donations the nonprofit may use for any purpose. Unrestricted funds usually go toward the operating expenses of the organization or to a particular project that the nonprofit picks.
How Do the Nonprofit Fund Types Work?
While many nonprofits prefer to receive donations that they can put to use as they see fit, it is not always possible to do so. Many donors prefer to give money and know that the program they are giving to is receiving it. Unrestricted donations are very simple for a nonprofit to use and account for. Restricted funds are much more complicated to use and account for.
One way some nonprofits avoid confusion and complications is to give donors a choice of designation at the time of the donation. For instance, the American Red Cross, on its online donation page, offers several options for the donor to direct their donations, such as “Disaster Relief,” “Where it is needed most,” and “Your Local Red Cross.”
Nonprofits are required to us accounting standards set by the Federal Accounting Standards Board (FASB); for unrestricted donations, they can be used for any purpose and accounted for under whichever program they were used for.
Most nonprofits ask for unrestricted funds when they solicit donors by email or direct mail. A clause often states this on the donation form and in the gift acknowledgment.
These donations are classified as restricted when donors are asked to give to a capital campaign, a building fund, or a scholarship fund, or if the donor wishes the donation to be used for only one purpose.
The designation is either made by a letter from the donor or through an explicit agreement with the nonprofit. Often, grants from foundations are restricted to a particular program or purpose, and that restriction is set out in the documentation that accompanies the award.
Restricted donations fall into two categories, specified in the “gift instrument.” This is the document that determines how the donated funds will be used. The gift instrument might be an award letter from a foundation or a letter from an individual donor.
Donors sometimes impose time-limited restrictions. Time-restricted means that the donation can be used for a particular purpose, or it must support a specific program or campaign for a limited amount of time.
There are two types of restrictions: temporary and permanent. If a donation is time-restricted, or the project is done on a time-limited donation, the funds become unrestricted or are stopped. Examples might include a grant, graduation of a scholarship recipient, or the completion of a building project.
Permanently restricted funds never expire. Usually, this means that the charity invests the gift and then uses the interest and investment returns in perpetuity. Permanently restricted funds often go into an endowment that supports a particular activity or the organization in general.
Whatever type of restricted fund is set up, the nonprofit must keep track of it and report it appropriately in its financial statements. This can be complex, so it might be best to use an accountant experienced with nonprofits to make sure all the accounts are balanced and accurate.
It's a good idea to revisit any restricted funds on your books. If many years have passed, or the fund is no longer relevant, consider your options for changing the status of the fund—in all but a few states, there is legislation governing the management of funds under guidance from the Uniform Law Commission. You'll need to ensure you're following the law if a donation classification needs to change.
Nonprofits receive donations from many different entities. These donations are classified into two categories: restricted or unrestricted.
- Restricted donations can only be used for the designated purpose.
- Restricted donations are either temporary or permanent in nature.
- Unrestricted donations can be used for any purpose.
- Generally accepted accounting procedures must be followed when using donations.
- Donation classifications and use are guided by legislation that governs nonprofits.