Assets are the things owned by an organization to generate value in the future by performing economic activities. A few examples of assets are property, machinery, or cash.
Net assets are the leftover assets in an organization once all its liabilities (or obligations or debt) have been paid off.
Net Assets for a Not-For-Profit Organization:
In a not-for-profit organization, assets can either be unrestricted or restricted. For financial reporting purposes, assets are categorized into three classifications for a non-profit organization.
It’s important to understand the difference between restricted and unrestricted net assets so you can have a better grasp of an organization’s finances.
- Unrestricted assets are those donations given to the organization that can be spent on any economic activity because it has no restrictions imposed by the donor
- Temporarily Restricted assets are those donations received that must be used by the organization to fulfill certain purpose specified by the donor. In other words, such donations have some kind of restriction placed on them by the donor, which are typically satisfied within one year.
- Permanently Restricted assets are those items that have been received with restrictions placed by the donor that require to be maintained permanently, but are usually permitted by the donor that the organization can use or spend part or all of the income derived by such assets. These restrictions are perpetual.
What Are Restricted Assets?
Restricted assets are the most common in non-profit organizations receiving assets like cash or anything with a monetary value from donors.
The party holding restricted assets is legally or contractually obliged to use the assets on certain previously agreed-upon activities only.
Restricted assets, due to specific accounting methods and principles, are separated from other assets to clearly outline or highlight their uses.
Only the donor decides whether the donations are to be restricted for specific purposes or can be spent by the not-for-profit entity for purposes it may deem best.
Typically, a restricted donation will be received by the not-for-profit organization with a contractual letter or will be restricted through an explicit agreement between the donor and acceptor. A gift received without any such restrictions automatically means that the asset is unrestricted.
Private sector companies, not-for-profit entities, and public sector organizations or government bodies all carry out transactions with different types of restricted assets.
Understanding Permanently Restricted Net Assets:
These are assets held by a not-for-profit entity that do not have any restrictions imposed on them by their donors.
These permanent restrictions are usually imposed when donors have contributed huge sums of money to these not-for-profit organizations and so they are more interested in deciding how these funds are to be used.
Permanently restricted net assets are the funds left with a not-for-profit organization that must be used in the chosen ways and whose principal amount cannot be expended.
The income that is generated on or through the principal amount is then to be spent for funding whatever the donor has contributed for.
Donations in the form of permanently restricted assets are not uncommon, as individuals, groups, or organizations making such donations might have specified preferences as to how these contributions are to be used by the not-for-profit entity.
Permanently restricted net assets are usually connected with a particularly large donation, and the donors most of the time explicitly state how the funds or donations are to be used. This is a meaningful amount and it has been intended to fund specified areas everlastingly.
A common example of a permanently restricted asset is real estate. For example, someone decides to donate a really large property to a nonprofit organization, like a public university, with the restriction imposed that the property can only be used for research purposes in perpetuity.
The university isn’t allowed to sell the property for any sort of capital gain.
For example, if someone is well known for making charitable donations in the form of stock, clearly specifying that only the dividends from the stock are to be used for funding by the not-for-profit organization.
The stock can not be sold as it should be allowed to grow and provide for funding in the form of dividends in perpetuity.
In such a case, the organization would state the donation as permanently restricted net assets on the balance sheet.
Using this same example, if the donor mentioned that the dividends earned from the donation were to be used for a particular purpose, then those dividends should be accounted for as temporarily restricted net assets.
If there were no specifications, the dividends would end up increasing unrestricted net assets. But regardless, the stock in itself would be accounted for as a permanently restricted net asset.
So whenever a donor may make a donation in perpetuity with certain restrictions, it is a permanently restricted asset.