Restricted and unrestricted gifts

This guide is for treasurers, bookkeepers and leaders of small charities who receive gifts "for" something: a grant for a specific program, a donation for a new van, a memorial gift for scholarships. Those gifts come with promises. After reading, you'll understand the difference between restricted and unrestricted money, how to track restricted gifts in simple books, how a restriction is "released," and why this is one of the fastest ways to earn, or lose, a donor's trust.

Two kinds of money

Unrestricted money can be spent on anything that serves your mission: programs, rent, salaries, insurance, the phone bill. Most small individual gifts are unrestricted unless the donor says otherwise.

Restricted money comes with a condition set by the donor about how or when it can be used. Common restrictions:

• Purpose: "for the summer camp," "for the food pantry's freezer."
• Time: "for use next year," or a pledge paid over three years.
• Permanent: an endowment gift where the donor asks that the original amount be kept and only the earnings spent.

Only a donor (or a grantmaker) can create a donor restriction. If your board decides to set money aside for a reserve or a future project, that's a board designation. It's still unrestricted money in the accounting sense, because the board can change its mind. The Form 990 instructions say all funds without donor-imposed restrictions are reported as unrestricted, whatever the board has designated.

Modern nonprofit financial statements, and IRS Form 990, use the terms net assets without donor restrictions and net assets with donor restrictions. "Net assets" means what you own minus what you owe. You'll see these labels on your balance sheet.

How a gift becomes restricted

A gift is generally treated as restricted when the donor makes it clear that it's for a particular purpose or time. That can come from the donor's own words or from what you asked for. Watch for:

• the memo line on a check,
• a note on an online donation form,
• an appeal letter that asked for money for one specific thing,
• a grant agreement or award letter.

That third point catches many charities. If you send a letter saying "help us buy a new van," gifts in response may be restricted to the van. If you might raise more than you need, add a line such as: "Gifts above what's needed for the van will support our other programs." Then you're being clear from the start.

Tracking restricted gifts

You don't need special software. You need a consistent system.

1. Record the restriction when the gift arrives. In your donor list and your books, note the amount, the donor, the restriction and any deadline.
2. Use classes, tags or separate accounts. Most accounting software lets you tag income and expenses by fund or program. In a spreadsheet, keep a tab for each restricted fund.
3. Track spending against it. When you buy the freezer, tag that expense to the freezer fund.
4. Keep a running balance. For each restricted fund: money received, money spent, money remaining.
5. Report it monthly. Show restricted balances in your board report. See our guide on financial controls.

You don't usually need a separate bank account for each restricted gift. Some grants require one, so read the agreement. What matters is that your records show clearly how much restricted money you're holding and that you have enough cash to honor it.

Releasing a restriction

A restriction is "released" when the condition is met. If a donor gives $2,000 for the summer camp and you spend $2,000 on the camp, the restriction has been met. In your books, the money moves from "with donor restrictions" to "without donor restrictions" as it's spent on the purpose. Your accountant or software handles the entry. Your job is to record the spending against the right fund.

Time restrictions are released when the time arrives. A gift "for next year" becomes available next year.

When you can't use a gift as the donor asked

Sometimes plans change. The camp is canceled, or the van costs less than expected.

• Talk to the donor first. Explain honestly and ask whether they'd like the gift used for something else, or returned. Get their answer in writing.
• For grants, contact the funder before making any change. Most grant agreements require approval for budget changes.
• If the donor can't be reached, get legal advice before changing the use. State law controls this, and in some states changing a restriction can involve the courts and the Attorney General.

In New York, for example, the Attorney General's guide to the state's Prudent Management of Institutional Funds Act explains that a charity may get the donor's written consent to release or change a restriction. If the donor isn't available or won't consent, the charity may ask a court to release or change a use restriction that has become impossible, impracticable, unlawful or wasteful, with notice to the Attorney General. Other states have their own rules.

Why this matters for trust

Donors who give for a specific purpose are trusting you to keep your word. Funders check. Auditors test restricted funds closely. State regulators expect it: the New York Attorney General's internal controls guidance lists ensuring that restrictions on the use of funds are obeyed as part of a charity's basic financial procedures.

When you report back to a donor, "your gift bought the freezer, and here's a photo of it full of fresh vegetables," you prove that giving to you is safe. That donor is likely to give again.

Restricted funds checklist

• Every restricted gift is recorded with its purpose and any deadline
• Our appeals say what happens to extra money
• Income and spending are tagged by fund
• Each restricted fund has a running balance
• Our board report shows restricted balances
• We never use restricted money for general bills
• We ask donors in writing before changing how a gift is used

If you want help setting up fund tracking in your books, ask a member charity for help through the Exchange.