Unlike traditional businesses, nonprofits often handle funds designated for specific purposes, introducing us to terms such as “restricted” and “unrestricted” net assets. These classifications are critical in ensuring transparency and accountability in nonprofit operations. What if we need to release the funds from restrictions? Let’s go through the basics with a journal entry example.
Please note that this article follows the latest guidance ASU 2016-04.
Understanding Restricted Net Assets
In nonprofit accounting, it’s common for funds to come with specific guidelines or conditions. These can be categorized into two main types:
- Temporarily Restricted Assets: These funds come with clear direction or restriction, either based on purpose or time.
- Purpose-based: For example, a donation is given solely to buy books for a community library. These funds are reserved solely for the purchase of books and nothing else.
- Time-based: For example, funds are provided to support a research project for exactly three years. Funds must either be spent within three years or become unrestricted after three years, depending on the condition.
- Permanently Restricted Assets: Funds in this category are set aside indefinitely. For instance, a large donation was made to create a scholarship fund. The principal remains untouched forever, but the interest it generates every year is used to grant scholarships to students. This way, the donor’s gift continues to benefit students year after year.
Definition of Net Assets Released from Restrictions
When funds designated for a specific purpose or time frame are used as intended, we consider them as having moved from a “restricted” to “unrestricted” status. Or, in accounting terms, the funds were released from restriction.
For instance, a local library receives a donation of $10,000 specifically to fund its English as a Second Language program. This donation is a “restricted” fund in the beginning since it’s meant for a particular purpose. When the library spends the full $10,000 to pay the English teachers, the fund will be released from restriction or moved from the “restricted” to the “unrestricted” category since the money was used for its designated purpose. The section below will present a journal entry example.
Net Assets Released from Restrictions – Journal Entry Example
A donation of $10,000 was made to the local library to fund its English as a Second Language Program. The fund will be restricted to hiring English teachers.
Journal Entry – Receiving Donation
Similar to the regular GAAP, we will debit Cash for $10,000 for receiving the fund and credit Revenue for $10,000. Note the account we use here is called “Contribution Revenue – Restricted.” Some nonprofits also call it “Donated Revenue – Restricted” or “Operating Revenue – Restricted”. They all mean the same account. The key here is that this revenue account is restricted.
Journal Entry – Paying for the Hiring Expense and Reclassification
The 1st entry is to record the cash payment for hiring the teachers. We debit Program Expenses and credit cash for the payment of $10,000.
The 2nd entry is the key – as it records how we shifted the fund from the “restricted” to the “unrestricted” category. Or, in accounting terms, funds released from restriction. We would debit “Reclassification – Net Asset with Donor Restrictions” and credit “Reclassification – Net Asset without Donor Restrictions.” for $10,000.
Consider the reclassification as an “Income Statement” or P&L entry in the regular business world, where debit means expense and credit means revenue. When we debit the Net Asset with Donor Restrictions, we reduce the funds available for that category (like expense). And when we credit the Net Asset without Donor Restrictions, we give more funds to that category (like revenue).
Are you curious about what these accounts mean on the Statement of Activities? See the section below.
Net Assets Released from Restrictions – Statement of Activities Presentation
The Statement of Activities in the nonprofit world is similar to the Income Statement or Profit & Loss Statement in for-profit businesses, except it further illustrates changes in its net asset categories. Namely, “Net Assets without Donor Restrictions” and “Net Assets with Donor Restrictions.”
Here’s how the accounts and activities from the above example would appear:
- Contribution Revenue – Restricted: This line item will show the $10,000 that was donated specifically for the ESL program. It increases the “Contribution” in the Net Assets with Donor Restrictions on the Statement of Activities.
- Program Expenses: Under the expenses section, you’d see an increase of $10,000, indicating the amount utilized to pay the teacher for the program. This expense will appear in the Net Assets without Donor Restrictions on the Statement of Activities.
Tip: All expenses are taken from ‘Net Assets without Donor Restrictions’ because restricted assets cannot be expensed.
- Reclassifications from Net Assets with Donor Restrictions: This represents the decrease in the Net Assets with Donor Restrictions. In our example, once the teachers are paid, the restriction on the use of the $10,000 is satisfied. This line item would show the $10,000 moving out of this category as “ESL Program Release.”
- Reclassifications to Net Assets without Donor Restrictions: Correspondingly, this line reflects the increase in Net Assets without Donor Restrictions. It’s the other side of the previous entry, indicating that those funds have satisfied the requirement. This line item would show the $10,000 moving into this category as “Satisfaction of Program Restrictions.”
Combining them, here is the overall presentation of Net Assets Released from Restriction on the Statement of Activities.
To summarize, on the Statement of Activities, you’ll observe:
- An increase in revenue under the restricted category. (Note D)
- An increase in program expenses. (Note B)
- A reclassification from “with Donor Restrictions” to “without Donor Restrictions” indicating the restriction has been met. (Note A & E)
- No net impact on either of the two categories. (Note C & F)
Note at the end, the net asset change is zero. This is consistent with the fact that the library has responsibly spent all of the designated funds on the English as a Second Language program, leaving no profit or loss after all.
This entire process promotes clarity, transparency, and trust in nonprofit financial reporting. Donors can see that their contributions are being used for the intended purposes, and the organization ensures that funds are handled responsibly and in compliance with donor wishes.
- Unlike traditional businesses, nonprofits manage funds often designated for specific causes or projects, creating temporarily and permanently restricted assets.
- When restricted funds are used as intended, they “move” from restricted to unrestricted categories. The journal entry is debiting a reclass account for Net Asset with Donor Restrictions and crediting a reclass account for Net Asset without Donor Restrictions.
- Net assets released from restriction do not have a net impact on the Statement of Activities. It is merely a reclass from “Net Assets with Donor Restrictions” to “Net Assets without Donor Restrictions” category.