Restricted Funds

A restricted fund segregates certain assets that have been earmarked for a specific, limited use, often directed by a particular donor.
Restricted Funds
3 min
06-June-2024

A restricted fund is a designated account holding funds reserved for specific purposes. It offers donors assurance that their contributions are allocated as intended. Non-profit organisations are significant contributors to the society and economic well-being of a nation, as they work to improve the lives of people in need of help and upliftment. These organisations mainly depend on donations, which can be designated to fund their operations or for specific purposes only. These donations serve as an important source of income—sometimes the only source of income—for these organisations.

A non-profit organisation can run out of money for its operational requirements even though it may have quite a significant amount in its accounts, which it cannot use for general requirements but only for specific purposes as proposed by the donor. Such funds are called restricted funds.

Let us understand the importance of a restricted fund, its types, and its importance for non-profit organisations and donors.

Also read: How do mutual funds work

What is a restricted fund?

A restricted fund is a donation made for a specific purpose, limiting its spending on other non-profit organisation requirements. These funds can only be spent on specific projects or programs that have been predesignated. The organisation that receives the restricted funds is not authorised to spend them for any other purpose.

The donor determines how the donation is to be spent, thereby deciding its nature as a restricted or unrestricted fund. A subtype of a restricted fund is a permanently restricted fund, where the donations are put in an endowment fund, and the interest is then spent for specific purposes.

Importance of restricted funds

A restricted fund is significant to a non-profit organisation as it allows the organisation to continue working in an earmarked sector. Here is how the restricted fund benefits both the non-profit organisation and the donors.

  • A restricted fund allows donors to fund a project or program about which they are passionate. These projects or programs are usually close to a donor's heart.
  • It lets donors know precisely where and how their money is being spent, and it allows them to track the progress of the project or program.
  • A restricted fund allows non-profit organisations to start or continue specific projects and programs with the assurance that they have the required funds.
  • It lets a non-profit organisation work on multiple projects and decide the scale of operations of each project.

Types of restricted funds

Now that you know what restricted funds are, you must also understand the types of these funds and why they are classified differently.

Permanently restricted funds

A permanently restricted fund is a subtype of restricted fund, which are donations that a non-profit organisation cannot spend directly. Instead, a permanently restricted fund is kept as an endowment fund, and the interest gained is used as the actual funding for specific purposes as chosen by the donor. In other words, the principal amount of the donation is perpetually off-limits to the organisation; however, the interest amount is available to fund specifically earmarked projects.

Temporarily restricted funds

Another subtype of restricted fund is a temporarily restricted fund. In this case, there is a time limit or specific purpose for the fund. Once it is achieved, the fund becomes unrestricted and can be used for other purposes. The time limit or purpose is chosen by the donor in agreement with the organisation.

Also read: How to choose mutual funds

How are restricted funds designated?

An organisation would usually prefer funds to come in an unrestricted manner so they can be used as per the requirement at the time. The restricted funds, however, are decided by the donor, who chooses the purpose of the fund. Donors do so for a variety of reasons, be it a personal preference or their sense of urgency about a particular project.

Restricted fund management for non-profit organisations

Non-profit organisations manage restricted funds by spending them for specific purposes as intended by the donor. They do so by maintaining a proper record of their spending, which is available to the scrutiny of the donor.

Challenges and opportunities of restricted funds

Restricted funds come with their own set of challenges and opportunities. Here is a quick look at the challenges and opportunities that come with these funds:

  • A challenge with a restricted fund is that the donor decides its utility, even though the organisational urgency may be regarding some other project.
  • Restricted funds can dilute or divert the focus of an organisation from more pressing issues.
  • The opportunity offered by restricted funds is that the non-profit organisation can expand its scope.
  • Also, restricted funds let the non-profit organisation work on projects or programs beyond its existing sources of funding.

Temporarily restricted net assets vs. Deferred revenue

Temporarily restricted net assets and deferred revenue are two distinct financial concepts used by non-profit organisations to manage and report their funds. Understanding the differences between these terms is crucial for accurate financial reporting and compliance with accounting standards.

Temporarily restricted net assets

Temporarily restricted net assets refer to funds that are restricted by donors or grantmakers for a specific purpose or period. These funds are typically used for a particular project or initiative and are only released from restriction once the specified conditions are met. Examples of temporarily restricted net assets include grant funding, major and planned gifts, and corporate sponsorship revenue.

Deferred revenue

Deferred revenue, on the other hand, refers to funds received in advance for goods or services that have not yet been provided. This type of revenue is recorded as a liability until the goods or services are delivered, at which point it is recognised as revenue. For example, if a science museum receives registration fees for summer camps in advance, these fees would be recorded as deferred revenue until the camps take place.

Key differences

The primary distinction between temporarily restricted net assets and deferred revenue lies in the nature of the restrictions and the timing of recognition. Temporarily restricted net assets are restricted by purpose or time, whereas deferred revenue is restricted by the timing of the goods or services provided. Additionally, temporarily restricted net assets are recognised as revenue at the time of receipt, whereas deferred revenue is recognised as revenue when the goods or services are delivered.

Conclusion

Restricted funds are an important source for non-profit organisations to continue their work and expand their scope of work. Tax deductions are allowed under the Income Tax Act on donations made to eligible non-profit organisations.

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Frequently asked questions

What are restricted funds examples?

An example of a restricted fund is when a donor funds an orphanage managed by a non-profit organisation but wants the donation to be specifically spent on educating orphans.

What does it mean when a fund is restricted?

When a fund is restricted, it cannot be used for any purpose or program other than the designated one.

What is the difference between restricted funds and unrestricted funds?

Restricted funds can only be spent for specific purposes. Unrestricted funds do not have a purpose limitation.

What is the restricted fund method?

The donor of the fund can decide whether it is a restricted fund or an unrestricted fund.

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Bajaj Finance Limited (“BFL”) is an NBFC offering loans, deposits and third-party wealth management products.

The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

This information should not be relied upon as the sole basis for any investment decisions. Hence, User is advised to independently exercise diligence by verifying complete information, including by consulting independent financial experts, if any, and the investor shall be the sole owner of the decision taken, if any, about suitability of the same.