How Should Nonprofits Track Restricted Funds?

Nonprofits should track restricted funds in a way that clearly shows what the restriction is, how much was received, how much has been used, and how much remains available for the restricted purpose.

The best system is usually not the most complicated one.

In many organizations, restricted funding can be tracked within the existing accounting system using classes, projects, grants, departments, or other dimensions—without creating separate bank accounts or an entirely separate general ledger for every award.

The objective is clear, supportable accounting that allows management, the board, funders, and auditors to understand how restricted resources are being used.

Start With the Source Document

The first step is understanding the agreement that created the restriction.

That may be a:

donor letter;
contribution agreement;
grant agreement;
award notice;
pledge document;
endowment agreement; or
other written communication.

Management should identify:

who provided the funds;
the amount;
the purpose;
any time restriction;
any specific program requirement;
whether unused funds must be returned; and
any reporting requirements.

The accounting should reflect the actual terms of the arrangement rather than relying on a generic label such as “restricted grant.”

Understand What Creates a Donor Restriction

Under U.S. GAAP, nonprofit organizations distinguish between contributions with donor restrictions and contributions without donor restrictions. Donor restrictions arise from donor stipulations or circumstances surrounding a contribution that clearly restrict how or when the resources can be used.

Common restrictions may relate to:

a specific program;
a particular project;
a future time period;
purchase of equipment or other assets;
scholarships;
capital projects; or
endowment purposes.

Not every limitation on funding is necessarily a donor restriction for financial reporting purposes, so the underlying agreement matters.

Do Not Confuse Restrictions With Conditions

A restriction and a condition are not the same thing.

A restriction limits how or when contributed resources may be used.

A condition generally involves a barrier that must be overcome and a right of return or release from the provider’s obligation if the barrier is not met.

That distinction can affect when contribution revenue is recognized.

For example, a grant requiring funds to be used for a specific youth program may contain a purpose restriction.

A different grant may state that the nonprofit must first achieve specific measurable milestones and that funds must be returned if those conditions are not satisfied.

Those arrangements may require different accounting treatment.

Do Not Confuse Board Designations With Donor Restrictions

A board may choose to designate resources for a particular purpose.

That does not generally create a donor-imposed restriction.

For example, a board may designate $250,000 of unrestricted cash as an operating reserve.

That money may be presented internally as a reserve, but the board can generally reverse or modify its own designation.

A donor-imposed restriction is different because management and the board cannot simply decide to use the funds for another purpose.

This distinction is important for both financial reporting and liquidity analysis.

Build a Restricted-Funds Schedule

One of the simplest ways to maintain control over restricted funding is to keep a detailed restricted-funds schedule.

For each material restriction, track:

donor or funder;
grant or contribution name;
date received or awarded;
original amount;
nature of the restriction;
beginning restricted balance;
current-year additions;
qualifying expenditures;
releases from restriction;
remaining balance; and
supporting agreement.

The totals should reconcile to the organization’s accounting records.

Track Restrictions in the Accounting System

Whenever possible, the accounting system should carry the detail needed to support restricted-fund reporting.

Depending on the software, that may involve:

classes;
projects;
grants;
departments;
locations;
customer or donor records;
custom fields; or
another tracking dimension.

For example, an organization might use:

Natural account: Program Supplies
Department: Youth Services
Grant: Smith Foundation Grant
Restriction: Youth Program

That approach can provide meaningful reporting without creating hundreds of separate general ledger accounts.

Avoid an Overbuilt Chart of Accounts

A common mistake is creating a new income and expense account for every grant.

That can quickly produce a chart of accounts that is difficult to maintain.

For example, instead of creating:

Grant A Payroll;
Grant B Payroll;
Grant C Payroll;
Grant A Supplies;
Grant B Supplies;
Grant C Supplies;

the organization may be better served using common natural accounts such as:

Salaries;
Supplies;
Occupancy;
Travel;

and then tracking the grant through a separate dimension.

This keeps the financial statements cleaner while preserving grant-level detail.

Separate Bank Accounts Are Usually Not Necessary

A donor restriction does not automatically require a separate bank account.

Many nonprofits hold restricted and unrestricted cash in the same operating account while maintaining the necessary detail in the accounting records.

For example:

Cash in operating account: $900,000

Restricted resources represented within that cash: $550,000

Resources available for general operations may therefore be significantly less than the bank balance suggests.

Separate accounts may still be useful or required in certain situations, such as:

specific grant terms;
debt agreements;
endowments;
fiduciary arrangements; or
internal risk-management decisions.

But separate banking should not substitute for accurate accounting.

Reconcile Restricted Funds Regularly

Restricted balances should be reviewed throughout the year—not just during the annual audit.

At least monthly or quarterly, management should reconcile:

restricted-fund schedules;
grant reports;
qualifying expenditures;
contribution records;
amounts released from restriction; and
related general ledger balances.

Questions to ask include:

Does the remaining balance make sense?
Have qualifying costs been charged to the correct award?
Have restrictions been released appropriately?
Are any awards overspent?
Are any old restricted balances still sitting on the books?
Does the grant report agree with the accounting records?

Regular reconciliation makes year-end reporting much easier.

Document Releases From Restriction

When a donor restriction is satisfied, the organization should be able to explain why.

For example:

A donor provides $150,000 restricted to a food-access program.

During the year, the nonprofit incurs $90,000 of qualifying costs.

The organization should be able to support the $90,000 release from restriction with:

the original donor agreement;
the underlying expenses;
the program coding; and
the restricted-fund schedule.

Under nonprofit GAAP, donor-restricted contributions increase net assets with donor restrictions, and amounts are subsequently reclassified when the restrictions are satisfied.

Reconcile Grants to the General Ledger

Grant management records and accounting records should not operate as separate universes.

If the program team maintains a grant spreadsheet, it should periodically reconcile to the accounting system.

At minimum, management should be able to connect:

Grant agreement → accounting activity → grant report → remaining balance

If those four pieces do not agree, investigate the difference.

This becomes especially important for organizations with multiple government and foundation awards.

Track Shared Costs Consistently

Some costs relate to more than one program or grant.

Examples include:

administrative salaries;
occupancy;
information technology;
insurance;
finance staff;
payroll processing; and
general supplies.

The organization should use a reasonable, supportable, and consistently applied allocation methodology.

For example, costs might be allocated based on:

employee time;
square footage;
headcount;
direct program expenses; or
another reasonable measure.

The methodology should align with applicable grant terms and organizational policy.

Review Restrictions Before Budgeting Cash

Restricted resources can create a misleading picture of financial strength.

A nonprofit may have a large cash balance while still facing operating cash pressure.

Leadership should therefore distinguish between:

Total cash

and

Cash available for general operations.

This distinction is particularly important when preparing:

budgets;
cash-flow forecasts;
board dashboards;
reserve analyses; and
hiring decisions.

A strong restricted-fund process supports better forward-looking decisions, not just cleaner financial statements.

Common Restricted-Fund Tracking Mistakes

Common problems include:

relying entirely on spreadsheets outside the accounting system;
failing to maintain the original donor documentation;
confusing board-designated funds with donor-restricted funds;
treating every grant as restricted without analyzing the agreement;
failing to distinguish restrictions from conditions;
using the total bank balance as available operating cash;
releasing restrictions without support;
failing to reconcile grant reports to the general ledger;
creating an unnecessarily complicated chart of accounts; and
leaving old restricted balances unresolved for years.

Most of these problems are process issues rather than software issues.

A Practical Monthly Process

A simple monthly restricted-fund process can look like this:

Record new grants and contributions.
Review the underlying restrictions or conditions.
Code transactions to the appropriate grant or program.
Review qualifying expenditures.
Update the restricted-funds schedule.
Record appropriate releases from restriction.
Reconcile the schedule to the general ledger.
Review remaining balances with program leadership.
Investigate unusual or aging balances.
Incorporate available-resource information into management reporting.

That creates a repeatable process instead of a year-end reconstruction exercise.

The Bottom Line

Restricted-fund tracking should allow a nonprofit to answer three questions at any point in time:

What resources are restricted?

What can those resources be used for?

How much remains?

Organizations do not need dozens of bank accounts or an excessively complicated chart of accounts to answer those questions.

They do need clear source documentation, thoughtful accounting-system design, regular reconciliations, and consistent reporting.

Strong restricted-fund accounting helps support accurate financial statements, grant compliance, audit readiness, board oversight, and better cash-flow decisions.

How Bilotta & Company Can Help

Bilotta & Company, CPAs, LLC works with nonprofit organizations on accounting, financial reporting, audits, reviews, Single Audits, Form 990 compliance, and ongoing financial stewardship.

Through our Nonprofit Navigator® Financial Stewardship program, we help organizations design accounting structures and reporting processes that provide clearer visibility into grants, restricted resources, programs, and available cash.

The goal is not to make nonprofit accounting more complicated.

It is to make the organization’s financial information clearer, more reliable, and more useful for decision-making.

Explore Nonprofit Navigator® →

Visit the Nonprofit Financial Resource Center →

This article is provided for general educational purposes and should not be considered accounting, tax, legal, or grant-compliance advice for a specific organization or funding arrangement.