How to Track and Use Restricted vs. Unrestricted Funds in Your Nonprofit Bookkeeping
- rebekaheliasllc
- Nov 16, 2025
- 3 min read
Hello its your bookkeeper - Rebekah! If you run a nonprofit organization, you know that every donation counts — but not every donation can be spent the same way. Understanding the difference between restricted and unrestricted funds is crucial for accurate nonprofit bookkeeping, compliance, and donor trust.
In this post, we’ll explain what restricted and unrestricted funds are, why they matter, and how to track them correctly in your accounting system.
What Are Restricted Funds?
Restricted funds are donations or grants that come with specific instructions from the donor. These restrictions limit how your nonprofit can use the money.
Examples include:
A $10,000 donation to fund youth scholarships.
A grant that can only be used for building renovations.
Money earmarked for a specific program or outreach event.
These funds must be tracked separately and used only for their intended purpose. Misusing restricted donations can lead to compliance issues, damaged relationships, or even loss of future funding.
What Are Unrestricted Funds
Unrestricted funds are donations that your nonprofit can use for any operational need.
Examples include:
General donations from fundraising events
Membership dues
Sponsorships with no attached conditions
Unrestricted funds keep your nonprofit running — covering expenses like payroll, rent, supplies, and administrative costs. They give your organization the flexibility to adapt and grow.
Why Nonprofits Must Track Restricted and Unrestricted Funds Separately
Accurate fund accounting helps nonprofits:
Stay compliant with IRS and FASB reporting standards.
Maintain donor trust by using funds exactly as promised.
Prepare accurate financial statements and grant reports.
Simplify audits and annual reviews.
Failing to separate restricted and unrestricted funds can make your books inaccurate and put your nonprofit at risk of mismanagement.
How to Track Restricted and Unrestricted Funds in Nonprofit Bookkeeping
Here’s how to manage these funds correctly in your accounting system:
1. Use Fund Accounting Software
Choose software that supports fund accounting, such as QuickBooks Online for Nonprofits, Aplos, or Xero. These platforms allow you to track multiple fund categories within one chart of accounts.
2. Create Classes or Tags for Each Fund Type
Set up classes or tracking tags for restricted and unrestricted income and expenses. This ensures your reports clearly show how money flows in and out of each category without needing multiple banks accounts for tracking.
3. Record Donations With Documentation
Always record the restriction details (purpose, donor, date, and terms) in your accounting software. Attach supporting documents like grant agreements or donor letters to maintain a clear audit trail.
4. Reconcile Restricted Funds Regularly
Run monthly or quarterly reports showing:
Beginning restricted fund balance
New restricted income
Program expenses paid from restricted funds
Remaining restricted balance
This helps ensure you never overspend restricted money and remain in compliance with donor requirements.
5. Release Restrictions When Conditions Are Met
Once the project or purpose is complete, mark the funds as released from restriction and move them to your unrestricted balance. Keep detailed notes for transparency and audit support.
Best Practices for Managing Nonprofit Funds
Educate your team on the importance of donor restrictions.
Build unrestricted reserves to support operations.
Communicate with donors about the benefits of giving general support.
Hire a nonprofit bookkeeper or CPA to ensure accurate fund tracking.
Strengthen Your Nonprofit With Clean, Accurate Books
Properly tracking restricted and unrestricted funds keeps your nonprofit compliant, transparent, and financially healthy. With the right bookkeeping system in place, you can focus more on your mission and less on financial stress.
If your nonprofit’s books feel confusing or outdated, it may be time for a bookkeeping clean-up.
Need help organizing your nonprofit’s restricted and unrestricted funds? We specialize in nonprofit bookkeeping, fund tracking, and accounting clean-ups. Let your bookkeeper Rebekah get your books donor-ready and audit-proof.
Book a consultation today!
Comments