The accounting entries for restricted funds in nonprofits follow a two-step pattern: record the incoming gift as revenue in “Net Assets With Donor Restrictions” when the donor’s promise is unconditional, then, when you satisfy the restriction, post the expense in the usual way and add a separate reclassification entry that moves the same dollar amount from restricted to unrestricted net assets. The reclassification is what most organizations get wrong, and it has to happen as its own journal entry alongside the expenditure.
The Two Net Asset Categories Behind Every Entry
Under current GAAP, every nonprofit splits equity into exactly two buckets: Net Assets Without Donor Restrictions and Net Assets With Donor Restrictions.1Financial Accounting Standards Board. Accounting Standards Update 2016-14 – Presentation of Financial Statements of Not-for-Profit Entities The old three-category system (unrestricted, temporarily restricted, permanently restricted) was eliminated by ASU 2016-14, though the underlying concepts still exist inside the two-category framework.
Restrictions come from donors in two basic forms. A purpose restriction says the money must fund a specific program, project, or initiative. A time restriction says the funds are held until a certain date or event, such as a grant designated for next fiscal year’s operations. Endowment gifts carry a third flavor, requiring the original principal to be maintained in perpetuity; these still sit within “Net Assets With Donor Restrictions” and get their own treatment below.
Check for a Condition Before You Book Anything
Before recording any contribution, determine whether the donor’s terms create a restriction or a condition. The entries are completely different.
A restricted contribution has limits on how or when you spend, but you’re entitled to the money. Revenue is recognized immediately. A conditional contribution requires you to overcome a specific barrier before you’re entitled to the funds at all, and the donor keeps a right to take the money back if the barrier isn’t met. Revenue recognition is deferred until the barrier is satisfied.2Financial Accounting Standards Board. FASB Staff QA – Subtopic 958-605 Application
The test under FASB Subtopic 958-605 is whether the agreement contains both a barrier to overcome (delivering specific services, meeting a matching requirement) and a right of return if the barrier isn’t met.3Financial Accounting Standards Board. Accounting Standards Update 2018-08 – Clarifying the Scope and Accounting Guidance for Contributions Received and Made If both exist, the gift is conditional. If a donor merely says “use this for our literacy program” with no barrier or return right, that’s a restriction.
In practice: a foundation promises $100,000 for tutoring services and requires unused funds be returned. On receipt, you record nothing as revenue. You debit Cash and credit Refundable Advance (a liability). As you deliver services and overcome the barrier, you reclassify the liability into contribution revenue. A match requirement works the same way. For an unconditional restricted gift, the treatment is the opposite: revenue is recognized immediately in the restricted category, whenever you plan to spend.
Recording the Initial Receipt
Cash Gifts
For a cash gift with donor restrictions, the entry is:
- Debit: Cash
- Credit: Contribution Revenue — With Donor Restrictions
A $50,000 donation restricted to a building project increases cash and simultaneously creates revenue in the restricted column of the Statement of Activities. The money is in your bank account, but it isn’t available for general operations. Contributions are recognized when the unconditional commitment is made, not when the cash arrives or when the funds are spent.3Financial Accounting Standards Board. Accounting Standards Update 2018-08 – Clarifying the Scope and Accounting Guidance for Contributions Received and Made
Pledges Receivable
When a donor promises a restricted gift but hasn’t transferred funds yet:
- Debit: Pledges Receivable
- Credit: Contribution Revenue — With Donor Restrictions
For multi-year pledges, GAAP requires the receivable to be recorded at present value, discounting future cash flows using a risk-adjusted rate appropriate at the time the pledge is made. The discount amortizes as additional contribution revenue over the life of the pledge. Establish an allowance for uncollectible pledges as well, so the receivable reflects net realizable value. A $300,000 pledge payable over three years won’t sit on the books at $300,000.
Non-Cash Contributions
For securities, real estate, equipment, or other donated assets carrying restrictions, record the asset at fair market value on the gift date:
- Debit: Investments (for donated securities) or Property/Equipment (for tangible assets)
- Credit: Contribution Revenue — With Donor Restrictions
Publicly traded securities use the market price on the donation date. Real estate or closely held stock requires an independent appraisal. ASU 2020-07 adds a separate requirement: contributed nonfinancial assets appear on their own line on the Statement of Activities, apart from cash and financial asset contributions, with enhanced disclosures on valuation methods and any donor restrictions.4Financial Accounting Standards Board. Accounting Standards Update 2020-07 – Presentation and Disclosures by Not-for-Profit Entities for Contributed Nonfinancial Assets
Board-Designated Funds Are Not Restricted
When the governing board earmarks funds for a future purpose, say $200,000 for a technology upgrade, those funds are board-designated, not donor-restricted. Because the board can reverse its own designation at any time, the money stays in the “Without Donor Restrictions” category.
No reclassification journal entry moves board-designated dollars into the restricted column. Track them internally. ASU 2016-14 requires the nature and amount of board designations to be disclosed in the financial statement footnotes.1Financial Accounting Standards Board. Accounting Standards Update 2016-14 – Presentation of Financial Statements of Not-for-Profit Entities Many organizations put board-designated funds in a separate bank or investment account to avoid comingling with operating cash, but that’s a management practice, not an accounting requirement.
The test is always who imposed the limitation. Outside (donor): restricted. Inside (board): designated, and unrestricted for accounting purposes.
Releasing Restrictions: The Two-Step Entry
Spending restricted money takes two journal entries, not one. This is where the accounting gets distinctive and where mistakes cluster.
Step One: Record the Expense
- Debit: Program Expense (or the appropriate expense account)
- Credit: Cash (or Accounts Payable)
The expense lands in the “Without Donor Restrictions” column of the Statement of Activities. That looks wrong at first: you spent restricted money, so why does the expense show up in the unrestricted column? Because the release entry in Step Two is what moves restricted dollars over to cover it.
Step Two: Release the Restriction
- Debit: Net Assets Released from Restrictions — With Donor Restrictions
- Credit: Net Assets Released from Restrictions — Without Donor Restrictions
The debit reduces restricted net assets. The credit increases unrestricted net assets by the same amount, offsetting the expense. The release must match the qualifying expenditure exactly.
On the Statement of Activities, “Net Assets Released from Restrictions” appears as a negative in the restricted column and a positive in the unrestricted column. The two entries net to zero across total net assets, which is correct: you haven’t created or destroyed resources, you’ve fulfilled a donor’s terms.
Time Restrictions
For time-restricted funds, the release happens when the stipulated period begins, not when you spend. If a donor gave $120,000 restricted for next fiscal year’s operations, record the full release on the first day of that fiscal year:
- Debit: Net Assets Released from Restrictions — With Donor Restrictions: $120,000
- Credit: Net Assets Released from Restrictions — Without Donor Restrictions: $120,000
After that entry, the dollars sit in unrestricted and can be spent on operations through the year, with expenses recorded normally.
Endowment Entries
Endowments are the most complex form of restricted contribution. The donor requires the original gift amount (the corpus) to be invested in perpetuity, with only investment returns available for spending. The corpus is classified within “Net Assets With Donor Restrictions” and stays there indefinitely.
The initial entry:
- Debit: Investments
- Credit: Contribution Revenue — With Donor Restrictions
Investment returns raise a classification question. If the gift instrument specifies that income must be used for a particular purpose, returns are classified “With Donor Restrictions” until spent on that purpose. If the instrument is silent on returns, investment income is generally classified “Without Donor Restrictions” when earned.
Most nonprofits adopt a spending policy that appropriates a percentage of the endowment’s average market value each year (commonly 4–5%). When the board formally appropriates endowment returns for expenditure, record a release from restrictions for the appropriated amount, making those dollars available to spend.
If an endowment’s fair value drops below the original gift amount, the loss reduces the balance within the restricted category rather than triggering a reclassification out of it. GAAP requires specific disclosures for underwater endowments, including original gift value, current fair value, and the organization’s policy on continued spending.
How the Entries Flow to the Financial Statements
The Statement of Financial Position splits total net assets into the two categories, so a reader can immediately see how much equity is locked into donor-specified uses.1Financial Accounting Standards Board. Accounting Standards Update 2016-14 – Presentation of Financial Statements of Not-for-Profit Entities Footnotes describe how much is purpose-restricted, time-restricted, and perpetual endowment corpus.
The Statement of Activities reports revenues and expenses with separate columns for each net asset category. Restricted contributions appear as revenue in the restricted column. “Net Assets Released from Restrictions” appears as a subtraction in the restricted column and an addition in the unrestricted column, so both sides of the reclassification are visible. Contributed nonfinancial assets sit on a separate line from cash contributions.4Financial Accounting Standards Board. Accounting Standards Update 2020-07 – Presentation and Disclosures by Not-for-Profit Entities for Contributed Nonfinancial Assets
Form 990 Tie-Out
Part X of Form 990 (Balance Sheet) requires organizations following ASC 958 to report net assets on two lines: Line 27 for net assets without donor restrictions and Line 28 for net assets with donor restrictions.5Internal Revenue Service. 2025 Instructions for Form 990 These balances should tie directly to the audited Statement of Financial Position.
If the organization holds any endowment funds (donor-restricted, board-designated, or quasi), answer “Yes” to Part IV, Line 10 and complete Schedule D, Part V with endowment activity for the year, including beginning and ending balances, contributions, investment returns, and amounts appropriated for expenditure.5Internal Revenue Service. 2025 Instructions for Form 990 Discrepancies between the financial statements and Form 990 are audit red flags, so reconcile before filing.
Why the Entries Matter
Spending restricted funds on unauthorized purposes isn’t only an accounting error. The IRS treats diversion of grant funds as a taxable expenditure. If a grantor foundation discovers a recipient has misused restricted grant funds, the foundation itself faces penalties unless it takes immediate steps to recover the diverted amount, ensures remaining funds are redirected to the intended purpose, and withholds future payments until receiving adequate assurances.6Internal Revenue Service. Violations of Expenditure Responsibility Requirements – Private Foundations Repeated or egregious violations can jeopardize tax-exempt status.
The accounting system is the first line of defense. Properly tracking restricted balances, documenting restriction releases, and keeping a clear audit trail shows donor intent is being honored. Organizations that comingle restricted and unrestricted cash in one account with no internal tracking are the ones that end up defending themselves.