Assets are the things any organization has claim over- like property, machinery, or cash. Net assets mean anything that is leftover in an organization once all its liabilities (or obligations or debt) have been paid off.
So in a not-for-profit organization, there are net assets including unrestricted assets and restricted assets. For a non-profit organization, there are three classifications of assets for the purpose of financial reporting.
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 have no restrictions imposed by the donor
- Temporarily Restricted assets are those items donated to the organization that was received with some kind of restriction placed on them by the donor, that will be fulfilled in the near future (usually within one year). The donor’s restriction may differ depending on the purpose or program or for use in a specified time period.
- Permanently Restricted items are those 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.
Definition of Restricted assets:
Restricted assets can be defined as any gift or donation received by a not-for-profit organization that comes with a legal restriction from the donor on what activities the said donation can be spent on.
Most donations received by such organizations are usually restricted and hence, restricted assets are the most common in not-for-profit organizations.
A restricted asset can be cash or any other item with a monetary value. Restricted assets, because of specific accounting methods, are separated from other assets to clearly outline or highlight their uses.
Private sector companies, not for profit entities and public sector organizations or government bodies all carry out transactions with different types of restricted assets.
Whenever donations or contributions are received by a, not for profit entity, they should quickly identify if any restrictions have been imposed by the donor that would make the asset permanently or temporarily restricted. In the absence of any restrictions, the asset is automatically unrestricted.
Understanding Temporarily Restricted Net Assets:
A donor-imposed restriction limits how the entity makes use of the contribution and how they intended the contribution to be used for a specific purpose or in a specific time period rather than the freedom of making these decisions themselves, however, it is best suited for the organization.
For example, a donor may require that the contribution has to be used within a certain fiscal year, or it has to be used for purchasing new teaching equipment for the teachers working in a children’s summer camp. Or an organization has decided to raise funds for an old building’s renovation.
If someone decides to donate for this, they can impose the restriction that the funds have to be used for the building only. Another example of temporarily restricted net assets is long-term pledges.
The long-term section of pledges is already temporarily restricted because of their nature, as future payments support the future organizational activities planned.
This implies a time restriction. It is extremely important that an organization recognizes the nature of the donation to understand any restrictions imposed.
And once the restriction is complied with, whether it has been fulfilled or the time period has ended, then the restricted asset is released into unrestricted net assets. This allows temporarily restricted net assets to decrease and unrestricted net assets to increase.
A common misunderstanding that occurs is that the funds designated by the board are temporarily restricted assets. Once in a while, the board of directors of an organization may set aside some funds for a specific purpose or program, building project or any other kind of investment, etc.
However, this is not the same as restrictions being placed by a donor on their contribution, whereas the board can only label the unrestricted funds.
So whenever a donor makes a contribution marked for a specific use, the donation is to be used on a particular project or to pay for a certain need the non-profit organization has to fulfill.
For example, a school construction project in a rural area, the purchase of a vehicle or furniture, or for a specific program that is operating within the entity.
In all these cases, the contribution made by the donor is recorded as temporarily restricted net assets on the statement of financial position.
So we understand that the reason these donations are temporarily restricted is that they have a purpose to fulfill within a given period of time.