How to Track Restricted Funds in Nonprofit Accounting

Why restricted fund tracking matters

Donors and grantors give money with conditions. A foundation awards $100,000 for after-school programs. A donor contributes $50,000 for the building campaign. The federal government funds a specific service delivery program.

These restrictions are legally binding. The money must go to the specified purpose. The organization must demonstrate compliance. Poor tracking exposes the organization to audit findings, grantor clawbacks, and legal action.

FASB ASC 958 formalizes this requirement. All nonprofits must classify net assets into two categories: with donor restrictions and without donor restrictions. Financial statements must show both classifications clearly.

Step 1: Define your fund categories

Start by listing every distinct restriction your organization manages. Group them into categories:

• Unrestricted operating fund. General donations, membership dues, unrestricted revenue.
• Time-restricted funds. Grants and donations restricted to specific fiscal periods.
• Purpose-restricted funds. Money restricted to specific programs, projects, or uses.
• Capital campaign funds. Building, renovation, or major equipment purchases.
• Endowment funds. Permanently restricted principal with spendable income.

Each category becomes a fund in your accounting system. Be specific enough to track restrictions but not so granular that fund management becomes unmanageable.

Step 2: Set up the chart of accounts

Your chart of accounts must support fund-level tracking. In dedicated fund accounting software, this is structural. Each fund has its own revenue accounts, expense accounts, and net asset balance.

If you’re using QuickBooks, you’ll create a Class for each fund and tag every transaction. This works but requires discipline. One untagged transaction corrupts your fund balances.

Step 3: Code transactions consistently

Every transaction needs a fund assignment. Train everyone who enters transactions to assign the correct fund every time. Create a reference document mapping common transaction types to their funds.

Common errors to watch for: payroll allocated entirely to the operating fund when staff time benefits restricted programs, shared expenses charged to one fund instead of allocated across funds, and revenue deposited without identifying the restriction.

Step 4: Monthly reconciliation

Check each fund balance at month-end. No restricted fund should have a negative balance. If one does, you’ve either overspent the restriction or miscoded a transaction. Investigate immediately.

Step 5: Release restrictions

When conditions are met, move amounts from restricted to unrestricted net assets. Document why the restriction was released. This documentation is critical for auditors.

Step 6: Report by fund

Your board, grantors, and auditors each need fund-level information. Build reporting templates that show each fund’s activity and balance. The time invested in templates pays off every reporting cycle.

DEFINITION

Restricted funds

Donations or grants with donor-imposed restrictions on their use. Temporarily restricted funds can be spent once the restriction is satisfied (a specific program completed, a time period passed). Permanently restricted funds — like endowments — cannot be spent; only the income generated can be used.

DEFINITION

Fund accounting

An accounting method that tracks each designated fund as a separate accounting entity with its own balance. Prevents commingling of restricted and unrestricted funds. Required for accurate FASB ASC 958 financial reporting.

DEFINITION

Release of restriction

The accounting transaction that moves funds from restricted to unrestricted status once the restriction is satisfied. For example, when grant funds are spent on the designated program, a journal entry releases the restriction. Fund accounting software handles this automatically with proper audit trails.

DEFINITION

Commingling

Using restricted funds for general operating expenses, or mixing funds in a way that obscures which money is restricted. Commingling violates donor intent, can result in grantor audits, and may constitute a breach of fiduciary duty for board members.