Restricted Fund Accounting Basics for Nonprofits

Understanding how restricted funds work in nonprofit accounting is not optional for organizations that receive grants. It is the accounting foundation on which compliance reporting, audit defense, and funder relationships rest. Get it wrong, and the financial statements misrepresent the organization’s position; get it right, and the same financial statements become a management tool for understanding what resources are available and where they are committed.

The Net Asset Framework Under ASU 2016-14

The Financial Accounting Standards Board’s ASU 2016-14, effective for most nonprofits in fiscal years beginning after December 15, 2017, restructured how nonprofits classify net assets. The previous three-class system (unrestricted, temporarily restricted, permanently restricted) was simplified to two classes:

With-donor-restrictions: Resources subject to donor-imposed conditions that have not yet been met. This includes:

Purpose restrictions (funds restricted to a specific program or activity)
Time restrictions (funds that cannot be spent until a future date)
Endowment funds where the principal is permanently restricted

Without-donor-restrictions: Resources the governing board can direct to any organizational purpose. This includes:

General operating funds
Funds the board has internally designated for specific purposes (board designations are internal actions, not donor restrictions)
Net assets released from donor restriction after conditions are met

The change from three to two classes was meant to simplify reporting while retaining the essential distinction between funds the organization controls freely and funds subject to external conditions.

Recording a Restricted Contribution

When a grant award letter is received or a restricted donation is collected, the accounting entry is:

Debit:   Cash (or Pledge Receivable)              $X
Credit:  Contribution Revenue — With Restrictions  $X

This entry increases the with-donor-restrictions net asset class. The contribution appears as revenue in the with-donor-restrictions column of the Statement of Activities.

For multi-year grants, record revenue only when a contribution is unconditional. If a grant is awarded as a two-year commitment with the second year contingent on the first year’s performance, the second year payment is conditional and should not be recorded as revenue until the condition is met (or unless the conditions are so unlikely to fail that they are treated as administrative formalities under ASC 958 guidance).

The Journal Entry to Release a Restriction

When restricted funds are spent on the specified purpose (or when a time restriction expires), the restriction is released. The entry:

Debit:   Net Assets Released — With Restrictions    $X
Credit:  Net Assets Released — Without Restrictions  $X

Simultaneously, record the actual program expense in the without-donor-restrictions class:

Debit:   Program Expense                            $X
Credit:  Cash (or Accounts Payable)                  $X

In practice, many accounting systems handle this with a single entry that directly reduces the restricted fund balance and records the expense, but the conceptual flow — first release the restriction, then record the expenditure — is important for understanding how the Statement of Activities reflects grant spending.

How This Flows to Financial Statements

Statement of Financial Position (Balance Sheet):

With-donor-restrictions net assets appear as a separate line from without-donor-restrictions net assets
The balance in with-donor-restrictions represents unspent restricted funds, not yet eligible for general use
A high restricted net asset balance is normal for grant-heavy organizations; it does not indicate cash availability for operations

Statement of Activities (Income Statement):

Restricted contributions appear as revenue in the with-donor-restrictions column
Net asset releases appear as a reduction in the with-donor-restrictions column and an addition in the without-donor-restrictions column (not as revenue — they are transfers between classes)
Program expenses appear in the without-donor-restrictions column

Liquidity and Availability Note (Required by ASU 2016-14):

Organizations must disclose how much of their financial assets are available for general expenditure within one year of the balance sheet date
With-donor-restrictions assets are typically excluded from this availability calculation because they are not available for general use

Common Bookkeeping Mistakes

Recording restricted contributions as unrestricted revenue. The most consequential error. If a $100,000 grant is recorded as unrestricted contribution income, it shows up as available for any organizational purpose. The board may approve spending from it on general operations. When the grant is audited, the restricted use violations become apparent and must be resolved — sometimes requiring repayment to the grantor.

Releasing restrictions before conditions are met. Some organizations release the restriction as soon as they spend money, without verifying that the spending meets the restriction’s terms. A grant restricted to youth tutoring programs cannot be released by spending money on staff training that benefits the whole organization, even if some of those staff members work on the youth tutoring program.

Not tracking restrictions at the program level. Recording all restricted funds as a single with-donor-restrictions balance without sub-accounts by grant or purpose makes it impossible to know which restrictions have been met, which are partially met, and which are fully unspent. Each grant or restriction should have its own sub-account or project code.

Releasing permanently restricted endowment principal. Permanently restricted endowment principal (the corpus) is never released — only the investment income generated by the endowment may be spent, and only according to the endowment’s terms. Treating endowment principal as a spendable with-donor-restrictions fund is a significant accounting error.

Year-end errors. At fiscal year-end, review every restricted fund balance. Any unspent grant funds where the grant period has ended should prompt a determination: has the restriction been met and the close-out process completed? If not, the balance remains in with-donor-restrictions even across fiscal years until the grantor formally closes the award.

Practical Tracking Infrastructure

Clean restricted fund accounting requires a chart of accounts structure that supports it:

Create a sub-account for each active grant within the with-donor-restrictions net asset class
Code every expense charged to a grant to the corresponding grant project in your accounting system
Run monthly reports showing the opening restricted balance, contributions received, expenditures charged, and closing restricted balance for each active grant
Reconcile the accounting system grant balances against your grant management tracking records at least quarterly

Organizations that maintain this tracking continuously can produce a restricted fund reconciliation in minutes. Organizations that reconstruct it at year-end or at audit spend days on the same task.

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Frequently asked

Frequently Asked Questions

What are restricted funds in nonprofit accounting?

Restricted funds are contributions (grants, donations, or other gifts) that come with donor or grantor conditions specifying how, when, or for what purpose the money may be spent. A restricted fund must be tracked separately from the organization's general operating funds and may only be used for the stipulated purpose. When the restriction is met, the funds are released to the without-donor-restrictions category through a net asset release entry.

How do you record a restricted contribution?

When a restricted contribution is received, debit Cash (or Accounts Receivable if pledged) and credit Contribution Revenue — With Donor Restrictions. Do not record it as operating revenue or general contribution income. The contribution sits in the with-donor-restrictions net asset class until the restriction is satisfied — either a purpose restriction (the funds are spent on the specified program) or a time restriction (the specified date arrives). Commingling restricted contributions with unrestricted revenue is a common bookkeeping error that creates compliance exposure.

What is a net asset release?

A net asset release is the accounting entry that moves funds from the with-donor-restrictions class to the without-donor-restrictions class when a restriction is satisfied. The entry debits Net Assets Released from Restrictions — With Donor Restrictions and credits Net Assets Released from Restrictions — Without Donor Restrictions (or directly to the relevant program expense account). Releasing a restriction before the restriction is actually met — such as releasing grant funds before the grant period ends — is an accounting error that misrepresents the organization's financial position.

What's the difference between with-donor-restriction and without-donor-restriction net assets?

With-donor-restrictions net assets are resources that donors or grantors have restricted to a specified purpose, time period, or both. The organization cannot spend these funds on anything other than the stipulated use until the restriction is satisfied. Without-donor-restrictions net assets are resources the board can direct to any organizational purpose — including funds the board has internally designated (though internal designations do not create donor restrictions). The distinction was simplified by ASU 2016-14 from the previous three-class system (unrestricted, temporarily restricted, permanently restricted).

How does restricted fund accounting affect financial statements?

On the Statement of Financial Position, with-donor-restrictions and without-donor-restrictions net assets are reported as separate line items. On the Statement of Activities, restricted contributions are shown in the with-donor-restrictions column, and net asset releases are shown as a deduction in the with-donor-restrictions column and an addition in the without-donor-restrictions column. Organizations with significant grant revenue will show large inflows into restricted net assets in years when grants are received and large releases in years when grant programs are delivered.