Verdict: Restricted funds are legally binding donor promises, not flexible cash. The systems that keep you out of trouble are simpler than you think.
What works: Capturing donor intent at the source (separate donation forms per purpose, written restriction language, monthly reconciliation) solves 90% of the problem before any accounting software is involved.
What doesn't: One checking account for everything. When restricted and unrestricted dollars look identical at the bank, you will spend restricted money without meaning to.
Best for: Any nonprofit that accepts even one restricted gift per year, from a $50 check with "food pantry" in the memo to a six-figure foundation grant.
Worth considering if: You are approaching $100K in restricted revenue, your first federal grant, or an upcoming audit and need to formalize your gift acceptance and reconciliation process.
Table of contents
A donor hands you a $10,000 check and says, "this is for the after-school tutoring program." Six months later, your single checking account is low, payroll is due, and that $10,000 looks like cash. It isn't. It is a promise with legal teeth, and spending it on rent can trigger a donor lawsuit or a state attorney general inquiry.
That is the practical heart of restricted funds for a small nonprofit. The accounting rules and the GAAP language matter for your auditor. The daily discipline that keeps you out of trouble starts at the moment the gift arrives: capture the restriction in writing, tag it, and track it as a separate line forever after.
This guide is written for small and mid-sized nonprofits (roughly $0 to $2M in annual revenue) running QuickBooks Online or a spreadsheet, without a dedicated CFO or fund-accounting software. We will cover what restricted funds are, how they differ from designated and unrestricted funds, the GAAP reporting rules under ASU 2016-14, an 8-step management process you can actually run, and the common mistakes that quietly sink small orgs.
What are restricted funds in nonprofit accounting?
A restricted fund is money a donor or grantor gives your nonprofit with a specific use attached. The donor names the purpose, and you agree to use the gift only for that purpose. Once you accept the gift, the restriction is binding.
A simple example: a donor gives $10,000 specifically for your after-school tutoring program. That money can only be spent on tutoring. Not rent. Not salaries for unrelated staff. Not next year's gala. Only tutoring.
Under U.S. Generally Accepted Accounting Principles (GAAP), this idea is codified in Accounting Standards Codification (ASC) Topic 958, as updated by ASU 2016-14. Under ASC 958, a donor restriction can arise two ways: from the donor's explicit stipulation (a written agreement, a grant contract, an earmarked check memo), or from the circumstances of the gift (for example, you ran a purpose-specific appeal and the donor responded to it). A vague preference ("I hope you use this on the kids") is not binding. A specific designation is.
For a small nonprofit, the verdict is this: the legal weight of a restricted gift does not depend on whether you have fund-accounting software. The moment you accept the money, the obligation exists. The systems are how you keep the promise.
Restricted vs. unrestricted funds: the key differences
The difference comes down to who decides how the money is spent.
|
| Who sets the use | The donor or grantor | Your organization |
| Flexibility | Locked to the stated purpose | Spend on any mission-aligned need |
| Reporting on financial statements | Reported as net assets with donor restrictions | Reported as net assets without donor restrictions |
| Who can release the restriction | The donor, or a court | No restriction to release |
| Typical examples | Program grants, capital campaign gifts, endowments, scholarships | General operating donations, annual fund gifts |
The one-line version: Restricted = donor decides. Unrestricted = you decide.
For a small nonprofit: unrestricted dollars are your most valuable money because they pay rent, salaries, and the unsexy infrastructure that keeps the lights on. Restricted dollars are valuable too, but they are program fuel, not flexibility. A healthy fundraising mix has enough unrestricted revenue to cover operations even if every restricted dollar arrived tomorrow with strings attached.
Designated funds vs. restricted funds: why they are different
This is the distinction that trips up the most boards, and it matters legally.
- Restricted funds are set by the donor. The restriction is external, legally enforceable, and only the donor (or, in narrow cases, a court) can release it.
- Designated funds (also called board-designated or board-restricted funds) are set by your own board. The restriction is internal and reversible. The same board that designated the money can undesignate it with a vote.
|
| Who imposes it | The donor or grantor | Your board of directors |
| Reversible? | No, only the donor can release it | Yes, by board resolution |
| Who enforces it | The donor; in most states, the state attorney general | The board itself |
| GAAP classification | Net assets with donor restrictions | Net assets without donor restrictions (with internal note) |
A common example: your board votes to set aside $50,000 from the annual surplus as a "reserve fund." That is designated, not restricted. If a roof leak forces an emergency next year, the board can vote to release the reserve and spend it. By contrast, if a donor wrote a $50,000 check earmarked for "facility reserves," you cannot touch it for any other purpose without going back to that donor.
For a small nonprofit: when a board member proposes "let's restrict that money for the youth program," correct them gently. They mean designate. The legal stakes are very different, and so is how it appears on your financial statements.
Types of restricted funds
Operationally, nonprofits and accountants still talk about two flavors of restriction, even though GAAP no longer separates them on the financial statements (more on that in a moment).
Temporarily restricted (purpose- or time-bound)
These funds are restricted to a specific purpose or a specific time window. Once you meet the condition or the time passes, the restriction is released and the money becomes available for general use.
Example: A foundation gives you a $75,000 grant for a two-year youth mentorship program. The funds must be spent on that program within two years. Year three, anything left over (if the grant agreement allows) becomes unrestricted.
Permanently restricted (endowments)
These funds are restricted forever. The principal is invested and must be preserved; only the investment income can be spent, usually on a purpose the donor named.
Example: A donor establishes a $200,000 endowment for scholarships. The $200,000 is invested in perpetuity. Each year, a portion of the investment earnings funds scholarships. The original $200,000 is never spent.
Important under current GAAP: ASU 2016-14 collapsed temporarily restricted and permanently restricted into a single financial-statement class called net assets with donor restrictions. The temporary vs. permanent distinction is still useful for internal tracking and donor communication, but on your Statement of Financial Position, both show up under one line.
Grants as restricted funds
Most grants from foundations, corporations, and government agencies are restricted by definition. A grant agreement is a legally binding contract. Signing it obligates you to use the funds only for the stated purpose, follow the budget you proposed, and report back on schedule with financial and programmatic outcomes.
If your nonprofit expends $1,000,000 or more in federal funds in a single fiscal year, you are subject to the Uniform Guidance at 2 CFR Part 200 and must obtain a Single Audit. The threshold rose from $750,000 effective for fiscal years beginning on or after October 1, 2024. For grant fundamentals, see our guide to grant management.
How restricted funds are designated
Restrictions show up in a few predictable ways. Recognizing them early is half the battle.
- Donor intent in writing. A donor signs a gift agreement, writes a memo line ("for tutoring program"), or responds to a purpose-specific appeal. Each of these creates an enforceable restriction under ASC 958.
- Grant requirements. Foundation and government grant agreements spell out allowed uses, reporting deadlines, and what happens if you do not comply.
- Purpose-specific appeals. If you run a campaign that says "donate to feed 100 families this winter," donations to that appeal are restricted to that purpose, even if no individual donor wrote a memo. The circumstance of the appeal creates the restriction.
- Legal frameworks. Endowment law (UPMIFA in most states) restricts how endowment principal and income can be used.
- Board designation. As covered above, this is internal and reversible, not a true restriction, but it should still be tracked separately so the picture is honest.
GAAP and ASU 2016-14: what nonprofits are required to report
If a CPA prepares your financial statements or you have an audit, your books must comply with GAAP. For nonprofits, the relevant section is ASC Topic 958, as updated by ASU 2016-14 (effective for fiscal years beginning after December 15, 2017).
The two-class model
Before ASU 2016-14, nonprofits reported three classes of net assets: unrestricted, temporarily restricted, and permanently restricted. The update collapsed these into two classes:
- Net assets without donor restrictions
- Net assets with donor restrictions
Temporary and permanent restrictions still exist in real life, but on the face of the financial statements they are now combined. Details about the nature, amount, and timing of restrictions are disclosed in the notes.
The four required statements
Under GAAP (ASC 958), most nonprofits are required to present:
- 1. Statement of Financial Position (the nonprofit balance sheet), showing net assets in the two restriction classes.
- 2. Statement of Activities (the nonprofit income statement), showing revenue and expense activity by restriction class.
- 3. Statement of Cash Flows.
- 4. Statement of Functional Expenses, which breaks expenses out by program, management/general, and fundraising. Required for many nonprofits.
How restricted funds look on the Statement of Activities
On the Statement of Activities, restricted revenue is recognized when received (not when spent). When the restriction is satisfied, the money moves from "with donor restrictions" to "without donor restrictions" through a line called net assets released from restrictions. This release line is one of the most useful internal signals you have: if it is small or zero, your restricted dollars are piling up unused, which can be its own problem.
For a small nonprofit: you do not need to memorize ASC 958. You do need to know that your auditor or accountant will ask you to classify every gift as with or without donor restrictions, and that they cannot do that job for you. The classification depends on what the donor said at the moment of the gift, which only your records can tell them. If those records do not exist, the classification gets reconstructed (poorly) at year-end.
Legal considerations: what happens if restrictions are violated
Restricted funds are not a soft norm. They are a legal obligation, and breaches have real consequences.
Donor lawsuits. A donor (or their estate) can sue to enforce the restriction. The remedy is usually that the nonprofit must return the funds or redirect them to the stated purpose.
State attorney general enforcement. In most states, the state attorney general has authority over donor-intent violations in charitable gifts and restricted funds, grounded in common law and statutes like the Uniform Trust Code (UTC) and UPMIFA. An August 2025 multistate guidance letter signed by the attorneys general of New York, California, Connecticut, Delaware, Maryland, Minnesota, Nevada, Oregon, Vermont, and Washington reaffirmed this authority. Scope varies by state, but the general rule holds: AGs can investigate, demand corrective action, and bring enforcement proceedings. (See the multistate guidance letter.)
Grant consequences. Misusing or under-reporting on a grant may result in repayment of misused funds, loss of any remaining award, ineligibility for future grants from that funder, an audit, and reputational damage.
This is general information, not legal advice. If you discover that restricted funds have been misused, or you are unsure whether a planned expenditure complies with a restriction, consult a nonprofit attorney in your state before taking action.
For a small nonprofit: the realistic enforcement risk is rarely a federal lawsuit. It is a donor who notices that the program they funded never happened, asks for an accounting, and either takes it to your board, the press, or the state AG's charity bureau. Reputational damage compounds fastest in small communities. The fix is upstream: never let restricted money look the same as general money in any system you touch.
8 steps to manage restricted funds correctly
Most small-nonprofit advice on restricted funds assumes you have fund-accounting software, a controller, and class tracking turned on. Most readers of this article have none of that. Here is the version that works at the kitchen-table scale, then scales up.
Step 1: Document the restriction in writing the day the gift arrives
Every restricted gift needs a written record of donor intent created at the moment it arrives, not reconstructed six months later. For online gifts, the cleanest version of "in writing" is letting the donation form do it for you: use a per-purpose donation form so the restriction is captured at the source. The form itself becomes the documentation. For mailed checks, scan the memo line and save it. For grants, file the signed agreement. For pledges and major gifts, send a written confirmation back to the donor stating the restriction in plain language and ask them to confirm.
Step 2: Set up separate tracking
Every restricted purpose needs its own line in some system. In QuickBooks Online without class tracking, this often means a unique income account or a customer/sub-customer for each restricted purpose. In a spreadsheet, it means a tab per restriction. The point is not the tool. The point is that "restricted for tutoring" is never visually identical to "general operating" in any view you look at.
Pair this with your donor records. You can tag, segment, and note donor intent in a free donor CRM so that intent and history live in the same place. Categorized gifts can then be pushed into QuickBooks for the formal accounting side.
Step 3: Acknowledge the restriction in your receipt
Your donation receipt should name the restricted purpose. This serves two functions: it gives the donor a written record that you understood their intent, and it locks in the restriction language for your own records. Automated, IRS-compliant donation receipts that document the gift purpose make this a non-task.
Step 4: Recognize revenue when received, not when spent
Under GAAP, restricted revenue is recorded when the contribution is received (or when an unconditional pledge is made), not when the money is eventually spent. If a donor promises a $20,000 gift restricted to scholarships, you record it as restricted revenue now. The "release from restriction" happens later, as scholarships are awarded. If revenue is received for multiple programs or purposes, allocate it based on the donor's intent or the purpose specified in the grant agreement.
Note on conditional gifts. A conditional contribution has a barrier between the promise of funding and the actual transfer (for example, "we will give you $50,000 if you raise $50,000 in matching funds by December"). Conditional gifts are not recognized as revenue until the condition is met. Mark each gift as conditional or unconditional when it arrives.
Step 5: Spend strictly within the restriction
When you pay an expense, ask the upstream question: which fund is paying for this, and does the restriction cover it? Tutoring program payroll? Yes, the tutoring restriction covers it. Office rent allocated to the tutoring program's share of square footage? Maybe, if the grant allows indirect costs. General overhead? Almost never, unless the grant explicitly funds it.
Step 6: Release restrictions when they are met
When you have spent restricted dollars on their intended purpose, the restriction is released. Record a release-from-restriction entry that moves the matching amount from "with donor restrictions" to "without donor restrictions." For time-restricted gifts, the release happens when the time passes. Build a recurring monthly task to look at every open restricted fund and ask: did we satisfy any of this restriction this month?
Step 7: Report back to donors and grantors
For grants, the reporting schedule is in your agreement, usually a mix of interim and closeout reports covering spend-vs-budget and programmatic outcomes. For individual restricted gifts, send an annual or end-of-program update telling the donor what their money funded and what it accomplished. The donor management tool that holds intent and history is where this report gets built.
Step 8: Reconcile restricted balances monthly
The single most important habit. Every month, total the unspent restricted balance for each fund and confirm that your total cash on hand is at least that amount. If your bank balance is lower than your total restricted obligations, you have already spent restricted dollars on general operations, and you have a problem to solve before it gets bigger.
Common mistakes nonprofits make with restricted funds
Mistake 1: One bank account, one bucket
The most common failure mode for small nonprofits. All gifts land in one checking account, restricted and unrestricted look identical at the bank, and routine expenses quietly draw down restricted balances. You only notice when an audit, a grant report, or a donor question forces a reconciliation. The fix is not a second bank account (although larger orgs sometimes do this for major restricted gifts). It is making sure restricted dollars are visually and structurally separated in your accounting records and reconciled monthly.
Mistake 2: Treating cash and check gifts as "untracked"
Online gifts are easy to tag. The cash dropped in the offering plate or the check mailed in with "scholarship fund" written on the memo line is where small orgs lose discipline. These offline gifts need to land in the same system as online gifts, with the same restriction tags. You can log cash, check, and in-kind restricted gifts in Zeffy's donor management tool in the same ledger as online ones so nothing falls through the cracks.
Mistake 3: Confusing designated with restricted
Covered above, but worth repeating. When the board "restricts" money, they almost always mean designate. Using the wrong word in your financial statements can mislead donors, auditors, and the next executive director who reads the file.
Mistake 4: Skipping the written record on small gifts
A $50 check with "for the food pantry" in the memo is still a restricted gift. The dollar amount does not change the legal obligation. Small restricted gifts in volume add up, and at audit time you cannot tell your auditor "we figured it was too small to track."
Mistake 5: Letting restricted funds pile up unspent
If your release-from-restrictions line is near zero year after year, restricted dollars are sitting on your balance sheet doing no programmatic work. Donors did not give you that money to hold it. Restricted balances should turn over as programs run.
Mistake 6: Spending first, classifying later
The instinct in a cash-tight month is to pay the bill now and figure out which fund it belongs to at month-end. By month-end, the reasoning is fuzzy, and the easiest answer (general fund) wins. Classify the expense at the moment you authorize it, not in retrospect.
Restricted funds and your financial statements
Once gifts are captured and tagged correctly at the source, presenting them on financial statements is mostly a matter of mapping. Here is the basic shape of how restricted activity flows through the two key statements under ASU 2016-14.
|
| General operating donations received | Revenue | |
| Grant restricted to a 2-year program, received | | Revenue |
| Endowment gift received | | Revenue |
| Program expenses paid from the restricted grant | Expense | |
| Release from restriction (as program is delivered) | + Net assets released | - Net assets released |
| Ending balance reported on Statement of Financial Position | Net assets without donor restrictions | Net assets with donor restrictions |
If you keep books in QuickBooks Online, Zeffy's free QuickBooks integration pushes every payout into QuickBooks already sorted by campaign and fund, so each restricted gift lands in the right income account automatically. At month-end your treasurer opens the deposit, sees it already categorized, and clicks Match instead of hand-coding every line. That is what turns restricted-fund reconciliation from an afternoon of re-tagging into a few minutes. Use classes (in QuickBooks Online Plus and higher) or sub-customers to hold the restricted-vs-unrestricted split, and your accountant maps the categories to the correct net-asset class at period-end. (Setup takes a few minutes, and refunds are still recorded manually.) Pair this with a clean nonprofit budget template that tracks restricted and unrestricted lines separately, and you will spend far less time at year-end untangling what should have been tagged in real time.
For a small nonprofit: the goal is not to produce GAAP-compliant statements yourself. It is to hand your accountant or auditor a transaction record so clean that they can produce GAAP-compliant statements without guessing what the donor meant.
When restricted-fund discipline is worth the effort
The discipline described in this article is right-sized for any nonprofit that accepts even one restricted gift per year. The amount of tooling scales:
- Under about $100K/year in restricted revenue: a separate donation form per restricted purpose, written intent in your donor CRM, and a monthly reconciliation will cover you. QuickBooks Online with classes (or even sub-customers) is usually enough.
- $100K to $500K/year in restricted revenue, or your first significant federal grant: formalize a written gift acceptance policy, document restriction-release procedures, and schedule an annual review with your accountant. Many orgs at this stage are still in QuickBooks Online with disciplined class tracking.
- $500K+ in restricted revenue, multiple federal grants, or an upcoming Single Audit: graduate to a dedicated fund-accounting system and engage a CPA with nonprofit specialization. At this scale, the cost of the wrong system exceeds the cost of the right one.
The mistake is buying enterprise tooling before the workflow exists. The discipline beats the tool, and a small org with good intake habits and monthly reconciliation is in better shape than a mid-size org with expensive software and sloppy classification.
Capture restricted gifts at the source
Every restricted gift starts as a promise to a donor. Zeffy is the free fundraising platform used by 100,000+ nonprofits and has helped them raise $2B+. No platform fee, no transaction fee, no credit card fee. Ever.
What are restricted funds examples?
Common examples include endowment funds (where the principal is invested and only earnings can be spent on a named purpose such as scholarships), capital campaign contributions (restricted to building projects or equipment), scholarship funds (designated for students based on need or merit), and program grants from foundations or government agencies (restricted to a specific initiative over a defined period).
What is the difference between restricted and unrestricted funds?
Restricted funds are designated for specific purposes by donors, grantors, or legal requirements, and must be used solely for those purposes. Unrestricted funds can be used at the organization's discretion for any mission-aligned need, including operations and overhead.
Is interest earned on restricted funds also restricted?
It depends on the gift instrument. For most endowments, yes: the gift agreement typically specifies how investment income (interest, dividends, gains) can be used, and that use is itself restricted. For shorter-term restricted gifts held in an operating account, interest earned is often treated as unrestricted unless the donor's documentation says otherwise. When in doubt, look at the original gift agreement first, then apply your state's UPMIFA rules for endowment income, and ask the donor for clarification on ambiguous cases.
What is the difference between designated funds and restricted funds?
Designated funds (sometimes called board-designated or board-restricted) are set aside by your board of directors for a specific purpose. The restriction is internal, and the board can reverse it with another vote. Restricted funds are set by the donor or grantor, and the restriction is external and legally enforceable. Only the donor (or, in narrow cases, a court) can release a true donor restriction.
Can a nonprofit use donor-restricted funds for other purposes?
No, not without first obtaining a release from the donor or, in some cases, a court. Spending restricted funds outside the stated purpose may result in donor lawsuits and, in most states, enforcement action by the state attorney general. If circumstances change and a restriction becomes impractical, the right path is to contact the donor (or their estate) in writing and request a formal modification before spending the money differently. Consult a nonprofit attorney in your state before acting.
How do you record restricted funds in accounting?
Under GAAP (ASC 958, as updated by ASU 2016-14), restricted contributions are recognized as revenue when received and classified as "net assets with donor restrictions" on the Statement of Financial Position. When the restriction is satisfied (the program is delivered, the time period passes), an entry called "net assets released from restrictions" moves the matching amount into "net assets without donor restrictions." Day-to-day, most small nonprofits track restricted funds by tagging each gift to a purpose at intake (via the donation form or donor management tool) and mapping those tags to QuickBooks classes or accounts for formal accounting.
Do restricted funds need to be in a separate bank account?
Not legally, in most cases. What is required is that they be tracked separately in your accounting records and that the cash to satisfy them is on hand. Many small nonprofits keep all funds in a single operating account and rely on accounting-system separation. Larger restricted gifts (endowments, major capital campaign holds) are often moved to a separate investment or savings account to make the separation physical, but this is a best practice, not a universal requirement.
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