NonprofitsExplainer

Fund Accounting for Nonprofits, Explained (2026)

How fund accounting for nonprofits works: restricted funds, net assets with and without donor restrictions, releasing restrictions, and a worked grant example.

A nonprofit’s money is not one pot. A foundation grant for your literacy program, a bequest that must be invested forever, and an unrestricted gift from a regular donor all land in the same bank account, but they come with different promises. Fund accounting for nonprofits is how you keep those promises visible on your books, so you can tell a funder, your board or an auditor exactly where their money went.

This guide explains the core ideas in plain English: the two classes of net assets, how restrictions are released, a worked example of a restricted grant, how to set it up in your software, and the mistakes that cause the most trouble.

This is general information, not accounting, tax or legal advice. For your organization’s statements, work with a CPA who knows nonprofit accounting.

The words you need

  • Fund: a group of money tracked for one purpose, such as a specific grant, a building campaign or general operations.
  • Net assets: what a nonprofit owns minus what it owes. It is the nonprofit version of “equity.”
  • Donor restriction: a limit the donor puts on a gift. It can be about purpose (use it for the food pantry), time (use it next year) or both. Some restrictions are meant to last forever, such as an endowment where the donor requires the gift to be invested and the principal kept.
  • Board designation: a limit your own board sets, such as an operating reserve. It is not a donor restriction, because the board can reverse it.
  • Release from restriction: moving money from restricted to unrestricted once the restriction has been met.

Two classes of net assets

In 2016 the Financial Accounting Standards Board (FASB), which sets US accounting standards, issued Accounting Standards Update (ASU) 2016-14. It replaced the old three classes (unrestricted, temporarily restricted and permanently restricted) with two:

  1. Net assets without donor restrictions: everything the organization can use as the board sees fit, including board-designated funds.
  2. Net assets with donor restrictions: everything a donor has limited by purpose or time, including gifts that must be held permanently.

The statement of financial position (the nonprofit balance sheet) shows each class and total net assets. The update took effect for annual statements for fiscal years beginning after December 15, 2017.

ASU 2016-14 also requires nonprofits that follow US GAAP to:

  • Disclose board designations: the amounts and purposes of limits the board has placed on unrestricted money.
  • Explain liquidity: describe how the organization manages cash to meet general expenses within one year, and show how much of its financial assets are available for that within one year of the balance sheet date.
  • Report expenses by nature and function in one place: for example, salaries, rent and supplies (nature) split across programs, management and general, and fundraising (function).

The IRS Form 990 follows the same two classes. In Part X, an organization that follows FASB’s nonprofit standards reports net assets without donor restrictions on line 27 and net assets with donor restrictions on line 28. The IRS instructions are explicit that all money without donor restrictions goes on line 27, even if the board has designated it.

How restrictions are released

A restricted gift is recorded as revenue in the with donor restrictions column when you receive it (or when an unconditional promise to give is made). Spending it does not happen in that column. Instead:

  1. You spend money on the restricted purpose, or the time restriction passes.
  2. You record a reclassification: a decrease in net assets with donor restrictions and an equal increase in net assets without donor restrictions.
  3. The statement of activities (the nonprofit income statement) shows this reclassification as its own line, usually labeled net assets released from restrictions.
  4. The expense itself appears in the without donor restrictions column, where the released money now sits.

Buildings and equipment: if a donor gives money to buy or build a long-lived asset and does not say otherwise, ASU 2016-14 requires the placed-in-service approach. The restriction is released when the asset is placed in service, not gradually over its useful life.

Restricted or conditional? Not every grant with strings is a restricted gift. Some grants are conditional: you only earn the money if you clear a barrier, such as matching funds or a performance target, and the funder can take it back otherwise. Conditional grants are not recorded as revenue until the condition is met. FASB’s ASU 2018-08 explains how to tell the two apart; ask your accountant to review any grant agreement where it is unclear.

Worked example: a restricted program grant

Hillside Youth Center runs on a calendar year. On January 10, 2026, a community foundation pays it a $60,000 grant restricted to its after-school tutoring program. By December 31, the center has spent $45,000 on tutoring: tutor wages, books and snacks.

When the grant arrives (January 10):

  • Debit cash $60,000.
  • Credit contribution revenue, with donor restrictions, $60,000.

Each time it spends on tutoring (shown here as one year-end total):

  • Debit program expenses $45,000; credit cash $45,000. This expense sits in the without donor restrictions column.
  • Reclassify $45,000 out of with donor restrictions and into without donor restrictions (net assets released from restrictions).

The grant’s lines on the 2026 statement of activities:

Without donor restrictions With donor restrictions Total
Contributions $0 $60,000 $60,000
Net assets released from restrictions $45,000 ($45,000) $0
Program expenses: tutoring ($45,000) $0 ($45,000)
Change in net assets $0 $15,000 $15,000

The $15,000 left over stays in net assets with donor restrictions on the year-end balance sheet. It is still promised to tutoring, and it is released in 2027 when the center spends it. The board cannot use it for rent, even if cash is tight. That is exactly what fund accounting is meant to make obvious.

On the Form 990, the $60,000 shows up as contribution revenue, the $45,000 as program service expenses, and the $15,000 is part of net assets with donor restrictions on Part X, line 28.

Setting it up in your software

You need two things: a way to record each restricted gift separately, and a way to split income and expenses by program and function.

  1. Create a fund, class or tag for each restricted source. One for each restricted grant or campaign, and one for general operations. Dedicated nonprofit systems call these funds. General tools use other names: QuickBooks Online uses classes, and Xero uses tracking categories.
  2. Add net asset accounts for both classes. Use “Net assets without donor restrictions” and “Net assets with donor restrictions” in your equity section, replacing the generic “retained earnings.”
  3. Tag every restricted transaction. Income and every expense paid from a grant should carry that grant’s fund, class or tag.
  4. Set a release routine. Monthly, compare spending on each restricted purpose to the restricted balance and record the release entry. Many grant budgets require monthly or quarterly reporting anyway.
  5. Track function, too. Tag expenses as program, management and general, or fundraising. The full Form 990 asks for expenses split this way, and the IRS says shared costs like a salary must be allocated by time spent: an employee who spends 40% of the time on fundraising and 60% on programs is split 40/60.
  6. Keep the grant agreement with the records. The agreement defines the restriction. Your auditor will ask for it.

Common mistakes

  • Treating a board designation as a donor restriction. Board reserves stay in net assets without donor restrictions. Show them in a note, not in the restricted column.
  • Recording expenses in the restricted column. Expenses go in without donor restrictions; the release entry is what moves the money there. Skipping the release overstates restricted net assets year after year.
  • Never releasing time restrictions. A gift “for use in 2026” should be released in 2026, even if no specific expense is tied to it.
  • Depreciating a restricted building gift as the release. Unless the donor says otherwise, release the restriction when the asset is placed in service.
  • Booking a conditional grant as revenue too early. If the funder can claw it back until you hit a milestone, read the agreement with your accountant before recording it.
  • One “grants” class for everything. You cannot report to five funders from one bucket. Track each restricted grant separately.
  • Spending restricted cash to cover payroll. Even if it is temporary, using restricted money for another purpose breaks the donor’s terms. If you have to borrow internally, document it and get advice first.

Tools that make fund accounting easier

The right software turns fund accounting from a side spreadsheet into something that happens as you record each transaction:

Frequently asked questions

What is fund accounting for nonprofits?

It is a way of tracking money by the purpose it must be used for. Each grant, donor-restricted gift or program can be followed separately, so you can show a funder exactly how their money was spent. In external financial statements, US nonprofits report the result as two classes of net assets: with donor restrictions and without donor restrictions.

What are restricted funds in a nonprofit?

Restricted funds are gifts or grants a donor has limited to a specific purpose, a specific time period, or both. Some restrictions are meant to last forever, such as an endowment whose principal must be invested and kept. Limits set by your own board are not donor restrictions.

What does "released from restriction" mean?

When you meet a donor restriction, for example by spending a program grant on that program, you move that amount from net assets with donor restrictions to net assets without donor restrictions. The statement of activities shows this as a separate line, often called net assets released from restrictions.

Is a board-designated fund restricted?

No. If your board sets money aside, for example as a reserve or a quasi-endowment, it stays in net assets without donor restrictions, because the board can change its mind. You can disclose the designation, but you do not classify it as donor-restricted.

Do I need special software for fund accounting?

Not always. Small nonprofits with a few restricted grants often manage with classes or tracking categories in general accounting software. Dedicated nonprofit systems track funds natively and save time once you have many grants.

Sources and updates

Facts in this article were last checked against the official sources below on . Rules and thresholds change, so confirm anything you act on with the official source or a qualified professional. Spot something out of date? Tell us and we will re-check it. How we work: editorial policy.