For not-for-profit organizations, a commitment by a donor to support a specific project can make it a reality. The assets can be used to support the not-for-profit’s mission and provide much-needed services.

These contributions – donor restricted assets – come, though, with very specific requirements and legal stipulations that not-for-profits must adhere to. By not using the funds for the stated purpose, an organization runs the risk of significant financial penalties and, possibly, the loss of its tax-exempt status.

Restricted vs. Designated Assets

The terms “restricted” and “designated” assets might sound similar, but they’re different. Restricted assets are assets given by a donor with specific restrictions on how they can be used. For example, a donor might give $100,000 to a not-for-profit with the stipulation that the funds only be used to construct a new building or fund a specific program.

Designated assets are assets that have been designated by the not-for-profit’s governing board for a specific purpose. Unlike restricted assets, the governing board can reverse designations on assets at any time. This is why designated assets are classified as net assets without donor restrictions, even though the board has designated them for a specific use.

Here’s an example: a major donor gives $500,000 to a not-for-profit and stipulates that the gift be placed in an endowment. This donor-restricted designation means the organization can not use those funds for any other purpose. The donor could even require that the earnings received on the gift be used for a specific purpose, such as to fund a scholarship program.

Letting Donors Call the Shots

Restricted assets account for the largest donations to not-for-profits. Many donors prefer them because they can mandate how their gifts are used. This is especially true for major donors who are contributing large sums and want some level of control over how the not-for-profit utilizes their gift. Grants may also be restricted to specific purposes.

Restricted assets can be perpetual or temporary in nature. Net assets with donor restrictions that are perpetual in nature cannot be spent directly on a project or initiative. Instead, they are placed in an endowment and the earnings received are used by the organization to fund programs or initiatives.

Donor-restricted assets that are temporary in nature are bound by time or a specific purpose. Once the time has expired or the purpose has been fulfilled, the assets are reclassified to net assets without donor restrictions. For example, suppose a donor gifted a not-for-profit $100,000 to fund a new wing for their building. If the project was completed for just $90,000, the not-for-profit could ask the donor to release the extra $10,000 as without donor restrictions.

Accounting for Restricted Assets

Not-for-profits must use care when accounting for restricted assets to make sure that the funds are used for the purpose stipulated by the donor and not misallocated. Specifically, donor restrictions should be noted in the statement of activities and statement of financial position, as well as reflected in the budget.

The statement of activities is divided into three sections—revenue, expenses, and a reconciliation of net assets—to show how a not-for-profit is allocating resources and how funding helps advance its core initiatives. The statement is further divided into three more columns—without donor restrictions, with donor restrictions, and a total column—to show which net assets the organization can use for operations and which net assets are restricted by donors.

The statement of financial position shows a not-for-profit’s assets, liabilities, and net assets. The net assets section separates funding into assets with and without donor restrictions. Based on this, an organization can calculate the number of months of liquid net assets available for use by subtracting non-liquid assets (e.g., property and equipment) from net assets without donor restrictions, and thus take restricted assets out of the equation.

When creating a budget, allocate funds based on restrictions and exempt any assets that are perpetual in nature. Otherwise, the organization could end up with a revenue shortfall at the end of the year.

Achieving the Right Balance

It’s important to monitor a not-for-profit’s percentage of net assets with and without donor restrictions in order to remain nimble. If too many assets are restricted, this could place severe limits on financial flexibility. One benchmark is to strive for no more than 50 percent of total assets to be restricted at any given time.

To avoid any problems and to make sure that generous donors remain so, not-for-profits should collaborate with major donors to explore how their gifts – restricted or not – will be used to best support the organization’s mission and constituents.

Interested in learning more about the opportunities and pitfalls of donor restricted assets? We’re ready to answer your questions! Give us a call.