If you manage finances for a church or nonprofit, you have probably heard the terms "restricted" and "unrestricted" used to describe different types of money. These terms are not just accounting jargon. They represent one of the most important concepts in nonprofit financial management, and getting them right is essential for legal compliance, donor trust, and organizational integrity.
The good news is that the concept is not nearly as complicated as it might sound. Once you understand the basic principles and see a few real-world examples, the distinction becomes intuitive. This guide will walk you through everything you need to know, from clear definitions to practical application to the common mistakes that trip people up.
The Fundamental Concept
At the heart of fund accounting is a simple idea: not all money is the same. When someone donates to a church or nonprofit, their gift may come with specific intentions about how it should be used. The organization has a legal and ethical obligation to honor those intentions.
This is fundamentally different from how a business operates. When a customer pays a business for a product, that revenue belongs to the business to use however it sees fit. But when a donor gives a restricted gift to a nonprofit, the organization becomes a steward of that money, not the owner in the traditional sense.
Understanding and respecting this distinction is the foundation of everything else in nonprofit accounting.
Unrestricted Funds: The Flexible Foundation
Unrestricted funds (also called "without donor restrictions" under current accounting standards) are exactly what they sound like: money that your organization can use for any legitimate purpose that supports its mission.
What Makes a Fund Unrestricted?
A contribution is unrestricted when the donor does not place any conditions on how it can be used. The most common examples include:
- General tithes and offerings at a church, dropped in the offering plate or given online without specifying a purpose
- Annual membership dues at a nonprofit organization
- Unrestricted annual fund gifts where donors give to support the organization's overall work
- Fundraiser proceeds from events like dinners or auctions, unless the event was promoted for a specific purpose
- Interest income earned on unrestricted bank accounts
How Unrestricted Funds Are Used
Your leadership team has discretion over how unrestricted funds are spent. These funds typically cover:
- Staff salaries and benefits
- Facility costs (rent, mortgage, utilities, maintenance)
- Office supplies and equipment
- Insurance
- General ministry or program expenses
- Administrative costs
Example: First Community Church receives $15,000 in general tithes and offerings during the month of March. None of the donors specified a particular purpose for their gifts. This $15,000 is unrestricted. The church treasurer records it in the general fund and it can be used to pay the pastor's salary, the electric bill, or any other budgeted expense.
Why Unrestricted Funds Matter
Unrestricted funds are the lifeblood of any organization. They provide the flexibility to cover essential operating costs, respond to unexpected needs, and keep the lights on. Many churches and nonprofits find that while restricted gifts fund exciting projects and programs, it is the unrestricted giving that sustains day-to-day operations.
Encouraging unrestricted giving is a healthy financial practice. Organizations that are overly dependent on restricted funds can find themselves in the awkward position of having money in the bank that they cannot use to pay their bills.
Restricted Funds: Honoring Donor Intent
Restricted funds (or "with donor restrictions") are contributions where the donor has specified how the money should be used. The restriction can be based on purpose, time, or both.
What Creates a Restriction?
A restriction exists when:
- The donor explicitly states a purpose for their gift (purpose restriction)
- The donor specifies that the gift should be used after a certain date or event (time restriction)
- The organization solicits funds for a specific purpose, such as a building campaign (the solicitation itself creates the restriction)
This last point is important and often overlooked. If your church promotes a "roof repair fund" and collects donations for it, those donations are restricted to roof repair, even if individual donors did not write "roof repair" on their check. The act of soliciting for a specific purpose creates the restriction.
Types of Restricted Funds
Under current accounting standards (ASU 2016-14), there are two categories:
With Donor Restrictions encompasses what used to be two separate categories:
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Purpose-restricted funds -- The donor specifies what the money should be used for, but there is no time limitation. Once the money is spent on its designated purpose, the restriction is considered met.
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Time-restricted funds -- The donor specifies that the money should not be used until a future date or event. Once that date arrives or the event occurs, the restriction is released.
Some gifts have both purpose and time restrictions. For example, a donor might give $10,000 to be used for a new playground, but not until the church completes its building expansion next year. Both conditions must be met before the funds can be used.
Real-World Examples of Restricted Funds
Purpose-restricted examples:
- A donor gives $5,000 to the church's missions fund, designated specifically for supporting overseas missionaries
- A foundation awards a $20,000 grant to a nonprofit for its after-school tutoring program
- Church members contribute to a building fund for a new sanctuary
- A family donates $3,000 to the youth scholarship fund to help students attend summer camp
Time-restricted examples:
- A donor pledges $50,000 to an endowment, stipulating that only the investment income can be used (the principal is permanently restricted)
- A foundation gives a two-year grant, releasing $25,000 per year
- A donor contributes to a capital campaign with the condition that funds not be spent until the campaign reaches its goal
Example in practice: Grace Nonprofit receives a $10,000 grant from a local foundation, restricted to its food pantry program. The nonprofit must track this $10,000 in a separate restricted fund. When the nonprofit purchases food, pays food pantry volunteers' mileage, or covers other food pantry costs, those expenses are charged against this restricted fund. The money cannot be used to pay rent on the main office or cover the executive director's salary, even if the general fund is running low.
The Critical Rule: Restrictions Must Be Honored
This is not optional. When a donor places a restriction on a gift, the organization is legally and ethically required to use those funds only for the specified purpose. Using restricted funds for other purposes, even with good intentions, can result in:
- Legal liability. Donors can take legal action if their restricted gifts are misused.
- Loss of tax-exempt status. Mismanagement of restricted funds can attract IRS scrutiny.
- Loss of donor trust. Once donors learn that their designated gifts were not used as intended, future giving suffers.
- Board liability. Board members can be held personally responsible for financial mismanagement in some cases.
The stakes are real. That is why proper tracking is so important.
Tracking Requirements: What You Need in Place
Properly managing restricted and unrestricted funds requires a system that keeps them separate at every level. Here is what that looks like in practice:
Separate Fund Tracking
Each restricted purpose should have its own fund in your accounting system. This means:
- A separate fund for the building campaign
- A separate fund for the missions offering
- A separate fund for the youth scholarship program
- A separate fund for each restricted grant
When income comes in, it is recorded in the appropriate fund. When expenses are paid from that fund, they are recorded against that fund. The fund balance at any point tells you exactly how much restricted money remains for that purpose.
Clear Documentation
For every restricted gift, you need documentation of the restriction. This might be:
- The donor's written designation on a check or giving form
- A grant agreement from a foundation
- The solicitation language from a fundraising campaign
- Meeting minutes where the board formally designated funds
Keep this documentation organized and accessible. If anyone questions how restricted funds were used, you need to be able to show the paper trail.
Regular Reporting
Your financial reports should clearly distinguish between restricted and unrestricted activity. Key reports include:
- Fund balance reports showing each fund's current balance
- Statement of Activities with separate columns for restricted and unrestricted revenue and expenses
- Statement of Financial Position showing net assets with and without donor restrictions
These reports should be generated regularly, at minimum quarterly, and reviewed by your board or finance committee.
Common Mistakes and How to Avoid Them
Even well-intentioned organizations make mistakes with fund tracking. Here are the most common ones:
Mistake 1: Commingling Funds
The problem: Depositing restricted and unrestricted funds into the same bank account without tracking them separately in the accounting system.
The fix: You do not necessarily need separate bank accounts for each fund (though some organizations prefer this). What you absolutely need is separate tracking in your accounting software. A good fund accounting system lets you track multiple funds through a single bank account while maintaining complete separation in your books.
Mistake 2: Borrowing from Restricted Funds
The problem: Using restricted fund money to cover general operating expenses, with the intention of paying it back later.
The fix: Do not do this. Even with the best intentions, "borrowing" from restricted funds creates legal risk and, if the money is not repaid, constitutes misuse. If your general fund is short, the solution is to reduce expenses, increase unrestricted fundraising, or discuss the situation openly with your board. Quietly redirecting restricted funds is never the answer.
Mistake 3: Failing to Release Restrictions
The problem: When a purpose has been fulfilled or a time restriction has passed, failing to reclassify the funds from restricted to unrestricted.
The fix: When you spend restricted funds on their designated purpose, the restriction is considered satisfied. Your accounting entries should reflect this release. Periodically review your restricted funds to ensure that any met restrictions have been properly recorded.
Mistake 4: Creating Restrictions That Do Not Exist
The problem: Treating internally designated funds (where the board has earmarked money for a specific purpose) as if they were donor-restricted.
The fix: Understand the difference between donor-imposed restrictions and board designations. If your board decides to set aside $20,000 from the general fund for building maintenance, that is a board designation, not a donor restriction. The board can change its mind at any time. Only donors (external parties) can create true restrictions. Board-designated funds should be tracked separately for management purposes but reported as unrestricted net assets.
Mistake 5: Using Spreadsheets to Track Funds
The problem: Trying to manage multiple restricted funds in a spreadsheet or general accounting software that was not designed for fund accounting.
The fix: Use software specifically built for nonprofit accounting. Fund accounting is complex enough that manual tracking and workarounds inevitably lead to errors. Purpose-built software keeps each fund's activity clean and generates accurate reports without the risk of formula errors or missed entries.
How Proper Software Makes Fund Tracking Manageable
Managing restricted and unrestricted funds does not have to be overwhelming, but it does require the right tools. Software designed for fund accounting provides:
- Built-in fund structure that enforces separation between restricted and unrestricted money
- Automatic fund balancing that ensures every transaction is properly assigned to a fund
- Fund-level reporting that shows income, expenses, and balance for each fund at a glance
- Inter-fund transfer tracking that creates a clear audit trail when money moves between funds
- Restricted fund alerts that help prevent overspending or misuse
When your software handles the structural complexity, you can focus on the decisions, not the data entry.
Bringing It All Together
Understanding restricted and unrestricted funds is not just an accounting exercise. It is about stewardship, accountability, and trust. When donors give to your church or nonprofit, they are entrusting you with their resources. Honoring the intentions behind those gifts is a fundamental responsibility of nonprofit financial management.
The key principles are straightforward:
- Unrestricted funds can be used for any purpose that supports your mission
- Restricted funds must be used only for the purpose the donor specified
- Restrictions must be honored -- there are no exceptions
- Proper tracking requires proper tools -- fund accounting software, not spreadsheets
When you get this right, you build the kind of financial integrity that earns donor confidence, satisfies auditors, and lets your board lead with full knowledge of where the organization stands.
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