Donor restricted assets present a good news-bad news scenario for nonprofit organizations. The good news is that these assets are real donations that your organization can use to further its mission.
The bad news is that the assets must be used for the specific purpose stated by the donor. Donors have the legal right to require that their gifts be used for limited and specific purposes. Once your organization accepts the assets, the donor stipulation is inviolate. If you accept the gift, you are legally required to follow the stipulation. Failure to do so could lead to financial penalties or even the loss of your tax-exempt status.
For example, suppose a major donor gives $500,000 to a nonprofit but stipulates that the gift be placed in an endowment. This money would be considered donor-restricted that is perpetual in nature and the organization couldn’t use it 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 nonprofits. Many donors prefer them because it lets them call the shots in terms of 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 nonprofit 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 any 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 nonprofit $100,000 to fund a new wing for their building. If the project was completed for just $90,000, the nonprofit could ask the donor to release the extra $10,000 as without donor restrictions.
Accounting for Restricted Assets
Nonprofits 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 your budget.
The statement of activities is divided into three sections—revenue, expenses, and a reconciliation of net assets—to show how a nonprofit 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 nonprofit’s assets, liabilities, and net assets. The net assets section separates funding into assets with and without donor restrictions. Based on this, you 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, you should allocate funds based on restrictions and exempt any assets that are perpetual in nature. Otherwise, you could end up with a revenue shortfall at the end of the year.
Achieving the Right Balance
It’s important to monitor your nonprofit’s percentage of net assets with and without donor restrictions in order to remain nimble. If too many of your assets are restricted, this could place severe limits on your financial flexibility. One benchmark is to strive for no more than 50 percent of total assets to be restricted at any given time.
Work closely with your major donors to let them know how their gifts, whether donor restricted or not, can best support your organization. For example, you could create a wish list of needs that they could donate assets to support, such as new computers, vehicles, or buildings.
Contact our Nonprofit Group if you have questions about donor restricted assets.
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 nonprofit 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 nonprofit’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.