February 22, 2016

Managing Restricted Contributions: How to Keep Your Nonprofit Organization Out of Trouble

Managing Restricted Contributions: How to Keep Your Nonprofit Organization Out of Trouble

For nonprofit organizations that receive contributions from private donors, there can be a variety of risks, including tracking and expending contributions as well as accounting and reporting for such funds. Whether donors are individuals or corporations, the exposure can be significant when donor-imposed restrictions are associated with the contributions received. There have been multiple cases of donors who have sued nonprofit organizations over how their contributed funds are used.

Given the risks, nonprofits must recognize the need to carefully account for how they spend contributed funds. This is especially important when donors include private individuals or organizations that make significant contributions that come with restrictions. More and more, donors are paying special attention to how their contributions are used, and many have shown that they are willing to take whatever steps might be necessary to ensure that their wishes are fulfilled. Properly managing restricted contributions can prove to be challenging for some nonprofits, and having a well-defined approach and a set of consistently applied procedures are critical for effectively managing such contributions.

Nonprofit executives must ask themselves what key controls are in place to avoid costly missteps when managing restricted contributions.

The first step is to make sure that incoming contributions are properly assessed and labeled from the moment they are identified and the appropriate information is received. Managers and their staffs must be aware that any paperwork or other correspondence in connection with a contribution needs to be immediately communicated to the appropriate teams, including finance and accounting. This way, contributions can be properly recorded into one of the three acceptable categories: Unrestricted, Temporarily Restricted, or Permanently Restricted. More importantly, any contribution with a restriction should have that restriction documented, including the nature or the restriction and what constitutes “satisfaction” of that restriction. Keep in mind that restrictions will generally be satisfied by spending funds for a specific purpose, completion of a stated activity or the passage of time. Additionally, once restrictions are met, GAAP allows restricted funds to be reclassified as unrestricted funds.

This initial tracking is critical, because the consequences for misuse of restricted funds can be significant. Technically, such misuse is considered criminal conduct and, depending on the circumstances and the extent of the misuse, nonprofit executives can face charges, conviction and potentially jail time. The mere perception of misuse of funds can also be a problem because a nonprofit’s reputation is arguably one of its most important assets. Word generally travels fast within local nonprofit communities, and any such negative publicity often translates to diminished contributions, not only from new donors but also from existing key donors on whom the organization may rely for support each year.

So what else should a nonprofit do to support its all-important function of tracking restricted contributions? As a best practice and to keep risks at a minimum, nonprofit organizations should implement a system to review all restricted contributions on a regular basis, and more importantly, correct any mistakes as soon as they are identified or as soon as reasonably possible. Inadvertent mistakes can occasionally happen, and any good system will include a process to regularly review, identify and correct them. In some cases, it may be necessary to communicate errors to donors, including corrective measures that were taken.

Nonprofit organizations should also ensure that any donor-imposed reporting requirements are consistently met and that such reporting is delivered within established deadlines. However, any required reporting to donors associated with restricted contributions should be carefully balanced against the nonprofit’s own internal reporting needs. Proper management of the organization involves regular reporting of activities by function and other internal financial reporting. Nonprofit executives should ensure that donor-imposed reporting requirements do not limit the organization’s ability to generate necessary internal reports, whether this reporting is for department managers, senior leadership, the board or others.

Ultimately, the board is responsible for a nonprofit. Organizations must ensure that their boards have a good understanding of restricted funds. What restricted funds are in hand, what are the nature of the restrictions, how are restricted funds being used, and is the tracking and reporting to the board adequate? These are all critical questions. Boards must have enough quality information to gain an understanding and a high level of comfort that restricted funds are being properly managed.

Avoiding potential problems with managing restricted contributions is generally much easier than it may sometimes appear. Implementing basic internal controls that include identification, tracking and any reporting associated with restricted contributions can often mean the difference between unwanted negative publicity, loss of funding and, in the more extreme cases, legal action from unhappy donors who make restricted contributions.

Related Industry

Nonprofit & Social Sector