Conditional Love: Dealing With Donor Restricted Funds

Great news – your nonprofit has received a huge donation! The catch? They’re in the form of donor restricted funds earmarked for a specific purpose.

It’s certainly an understandable precaution. Givers often want to make sure their money is used responsibly or betters a project close to their hearts. And it might make a donor feel good to say they’re funding a specific building or project. But for a nonprofit, that well-meaning gesture can also create unexpected burdens.

We most often see donor restricted funds given in response to large capital campaigns for specific purposes (e.g., a “Save the Gymnasium” campaign). These funds are generally set up for a specific purpose, and the organization has decided to designate them separately. Organizations can also be approached by well-intentioned donors with specific areas they want to fund. For example, money is given to a youth sports program specifically to purchase new football helmets and shoulder pads.

Regardless of the purpose, by law donor restrictions must be honored if a donation is accepted with any of these attached stipulations. Here’s what you need to know about the accounting impact of accepting donor restricted funds — and how to encourage unrestricted donations.

Difficulties in Accounting, Reporting and Usability

Donor restricted funds present a few accounting-based wrinkles. First, you must list them separately in financial statements. Specifically, your Statement of Activities separately lists support and revenues with restrictions, as well as the expenditures that have been used on these activities (and therefore, released from restriction).

When restricted contributions are not fully spent in the year they’re received, they convert to net assets with donor restrictions at the end of the year. Net assets are then shown on your Statement of Net Position as either “net assets without donor restrictions” or “net assets with donor restrictions.” (The latter category was created by FASB’s Update 2016-14, Topic 958. Previously, these funds had to be further divided into “temporarily restricted” and “permanently restricted.”).

If you can, we generally suggest trying to spend the restricted money first so that your liquid assets without donor restrictions are available for any expenses as they arise. The longer that it takes you to spend these funds on their specific restricted purpose, the longer you must keep track of them.

You must also separate donor restricted funds in your budget to make sure they’re spent as intended. Not only does this follow reporting rules, it reminds you to not spend this money for other purposes. While having one or two restricted categories for large projects seems reasonable, keeping track of dozens can be much more cumbersome for your accounting team and can increase outsourced accounting and audit/compliance costs considerably.

In addition to these accounting and reporting hurdles, donor restricted also present an operational challenge. While an earmarked donation is usually made with good intentions, it prevents you from using these funds elsewhere when an urgent need arises.

Imagine that the youth sports example cited earlier happened at the outset of COVID-19. Let’s say the donation for helmets and pads was $50,000. Then before the equipment could be purchased, COVID hits and all sports are shut down for months. But rent on their facilities is still due, and utilities need to be paid. Because the $50,000 donation is in donor restricted funds, the program can’t divert that money to help keep the center going.

The moral: Needs of an organization can shift rapidly. Depending on how donor agreements are written, funds may not always be available to meet those needs, even with money in the bank account.

Your Best Workarounds

To avoid these difficulties, some organizations only accept unrestricted donations. While that helps, it can also be off-putting to donors and potentially reduce incoming funds.

If you’re worried about the requirements of donor restricted funds, have a conversation with donors who approach you with this kind of gift. Explain that while you’re grateful for their generosity, such a donation comes with bookkeeping challenges and additional costs. This is especially the case if the money is used over more than one year.

It’s also important to maintain a good ratio of program expenses vs. general and administrative costs. Sometimes donors provide conditions because they’re worried the money will be spent on executive salaries or other costs they deem frivolous.

Demonstrating that your administrative costs are low compared to program costs will reassure donors of your good stewardship of their generous contributions. A good ratio is at least 75% on the portion that covers program expenses. (Ideally, aim for above 90% to be exceptionally impressive.)

Your nonprofit CPA can help you with these workarounds and advise you on the accounting and use of donor restricted funds.

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