Nonprofit Grant Management: Restricted Funds, ASC 958, and Cost Allocation

A nonprofit that receives a $200,000 grant restricted to after-school tutoring cannot spend that money on a new roof. That sounds obvious, but the accounting mechanics behind it are not. Restricted funds must be classified separately on the balance sheet, tracked in dedicated general ledger accounts, released from restriction only when the donor’s conditions are satisfied, and reported to the grantor with enough detail to prove the money went where it was supposed to go. The framework governing all of this is ASC 958 (the FASB’s accounting standard for not-for-profit entities), and for organizations receiving federal awards, the compliance layer is OMB’s Uniform Guidance (2 CFR Part 200). Getting the classification wrong, releasing a restriction prematurely, or misallocating costs between grant-funded programs does not just create an audit finding. It can trigger clawback demands, jeopardize future funding, and, in extreme cases, threaten the organization’s tax-exempt status under IRC 501(c)(3).

What are restricted funds and why do they matter?

Restricted funds are contributions or grants that come with conditions attached by the donor or grantor. The conditions specify either what the money must be used for (a purpose restriction), when it can be used (a time restriction), or both. A foundation grant that says “for the purchase of science lab equipment” carries a purpose restriction. A bequest that says “to be used beginning in fiscal year 2028” carries a time restriction. A government grant that says “for workforce development services during the period July 1, 2026 through June 30, 2027” carries both.

The restrictions are legally binding. When an organization accepts a restricted gift, it accepts the obligation to use the funds in accordance with the donor’s stated intent. This is not a soft expectation or a best practice; it is a fiduciary duty that state attorneys general enforce under the Uniform Prudent Management of Institutional Funds Act (UPMIFA) and the terms of the grant agreement itself. The organization must be able to demonstrate, at any point, how much restricted money it holds, what each restriction requires, and whether those requirements have been met.

For nonprofits that depend on grant funding, restricted fund management is the core financial discipline. Foundations, government agencies, and corporate donors conduct their own audits and reviews. If they find that restricted funds were commingled with general operations, spent on disallowed costs, or reported inaccurately, the consequences are immediate: refund demands, suspension of future payments, and reputational damage that makes the next grant application harder.

How does ASC 958 classify net assets?

Before 2018, FASB’s framework (then SFAS 117) used three categories: unrestricted, temporarily restricted, and permanently restricted. ASU 2016-14 (now codified in ASC 958-205) collapsed these into two categories, effective for fiscal years beginning after December 15, 2017.

The two current categories are net assets without donor restrictions and net assets with donor restrictions. “Without donor restrictions” covers all net assets not subject to donor-imposed conditions. Board designations (a reserve earmarked by the board, for example) are not donor restrictions and do not change the classification. “With donor restrictions” covers all donor-imposed restrictions, whether they expire by passage of time, are fulfilled by the organization’s actions, or are permanent (as in an endowment where the principal must be maintained in perpetuity).

Because the two-category system no longer distinguishes temporary from permanent restrictions on the face of the statements, ASC 958 requires note disclosures explaining the nature and amounts of each type, including the composition of restricted net assets at period-end and amounts restricted in perpetuity.

For grant management, every restricted grant contribution is recorded as an increase in net assets with donor restrictions, and every release appears as a reclassification on the statement of activities (out of “with donor restrictions,” into “without donor restrictions”). The two-column presentation on the statement of activities makes this flow visible to anyone reading the financials.

What’s the difference between purpose and time restrictions?

A purpose restriction tells the organization what the money must be used for. A grant restricted to “mental health counseling services” cannot be spent on capital improvements or fundraising salaries. The restriction is satisfied when the organization incurs qualifying expenses for the stated purpose, at which point the funds are released from restriction.

A time restriction tells the organization when the money can be used. A multi-year pledge that specifies $50,000 per year for three years imposes a time restriction: the organization cannot recognize the second-year and third-year amounts as released from restriction until those periods begin. Similarly, a contribution received in December 2026 with the stipulation “for use in fiscal year 2027” carries a time restriction that prevents release until FY2027 begins.

Many grants carry both types simultaneously. A federal grant for “literacy program services during the period October 1, 2026 through September 30, 2027” is both purpose-restricted (literacy program) and time-restricted (the specified period). The restriction is not satisfied until both conditions are met: the organization must spend the money on literacy services and must do so during the grant period.

ASC 958-605-25 provides the recognition guidance. Contributions with donor restrictions are recognized as revenue in the period received (not the period spent), classified as increases in net assets with donor restrictions. When the restriction is satisfied, the organization records a reclassification: a decrease in net assets with donor restrictions and a corresponding increase in net assets without donor restrictions, reported on the statement of activities as “net assets released from restrictions.”

When are restricted funds “released from restriction”?

Release from restriction occurs when the donor’s conditions are met. For a purpose restriction, release happens when the organization incurs expenses that satisfy the purpose. For a time restriction, release happens when the specified time period arrives or elapses. For a combined restriction, both conditions must be met.

The release is an internal accounting entry (a reclassification between net asset classes), not a cash event. The money may have been spent weeks or months earlier; the release entry recognizes that the restriction has been satisfied. Organizations should establish a written policy for when and how release entries are recorded, because the timing of release directly affects the statement of activities. An organization that delays recording releases will overstate net assets with donor restrictions and understate net assets without donor restrictions, distorting the financial picture.

ASC 958 also permits a “simultaneous release” policy for contributions whose purpose restrictions are met in the same reporting period the contribution is received. Under this election, the organization recognizes the contribution directly in net assets without donor restrictions rather than recording it as restricted and immediately releasing it. The policy must be applied consistently and disclosed in the notes.

What are the grant compliance requirements?

Grant compliance depends on the grantor. Private foundations typically require a narrative and financial report at the end of the grant period, showing how the funds were used and what outcomes were achieved. Corporate funders vary widely. Government grants carry the heaviest compliance burden.

For federal awards, the compliance framework is the OMB Uniform Guidance (2 CFR Part 200), which applies to all non-federal entities that receive federal funds (directly or through a pass-through). The Uniform Guidance covers:

• Allowable costs (Subpart E): only costs that are reasonable, allocable to the award, and treated consistently with the organization’s cost accounting practices are chargeable to the grant. Certain costs are specifically disallowed (alcoholic beverages, entertainment, lobbying, fines and penalties, and others listed in the cost principles).
• Financial reporting: recipients must submit financial reports (typically the Federal Financial Report, SF-425) at intervals specified in the award terms, showing cumulative expenditures, unliquidated obligations, and the federal share.
• Record retention: financial records, supporting documents, and all records pertinent to a federal award must be retained for three years from the date of submission of the final expenditure report.
• Single Audit (Subpart F): organizations that expend $1,000,000 or more in federal awards during a fiscal year must have a Single Audit under the Uniform Guidance (the threshold was $750,000 for fiscal years that began before October 1, 2024). The Single Audit tests compliance with the terms of each major program and reports findings to the Federal Audit Clearinghouse.

State and local government grants often incorporate the Uniform Guidance by reference, even when the funds are not federal. Foundation grants that include “fund accounting” or “restricted fund” requirements in the grant agreement create contractual obligations that function similarly, even without the regulatory framework.

How does cost allocation work for grant-funded programs?

Most nonprofit programs do not operate in isolation. A youth education program funded by a restricted grant shares the building, the accounting staff, and the executive director with every other program. The question is how to divide those shared costs fairly, and the answer is the organization’s cost allocation methodology.

Direct costs can be identified specifically with a particular grant or program: the salary of a teacher who works exclusively on the grant-funded tutoring program, the textbooks purchased for that program. These are charged to the grant in full. Indirect costs benefit more than one program and cannot be assigned to a specific grant without effort disproportionate to the benefit. Rent, utilities, IT, accounting, insurance, and the executive director’s salary are typical indirect costs, allocated among programs using a reasonable, consistent methodology.

The most common allocation methods are direct labor hours or dollars (in proportion to each program’s share of total direct labor), modified total direct costs (MTDC, in proportion to each program’s share of total direct costs, excluding capital expenditures, pass-through funds, and participant support costs), and square footage (for facility costs). The method must be documented in a cost allocation plan and applied consistently.

For federal awards, organizations can negotiate an indirect cost rate with their cognizant federal agency. The negotiated indirect cost rate agreement (NICRA) establishes the percentage of direct costs chargeable to federal awards as indirect costs. Organizations that have never had a NICRA can use the de minimis rate of 10% of MTDC under 2 CFR 200.414(f), which does not require negotiation.

Many private foundation grants cap indirect costs (often at 10-15% of the direct grant amount, and some foundations do not allow indirect charges at all). When a grant caps or disallows indirect costs, the organization absorbs the unrecovered indirect costs from its unrestricted funds, which is why healthy unrestricted reserves matter for organizations that rely heavily on restricted grants.

What happens when restricted funds are misspent?

Spending restricted funds on purposes outside the restriction is a breach of the donor’s conditions. The consequences depend on who the grantor is and how the breach is discovered.

For private grants, the grantor can demand a refund of the misspent amount. Grant agreements typically include a clawback provision, and even without one, state law and the donor’s intent provide the legal basis for recovery.

For federal grants, the consequences are more structured. Disallowed costs must be repaid from non-federal funds. The awarding agency can suspend or terminate the grant, debar the organization from future federal funding, or refer the matter for investigation if fraud is suspected. Single Audit findings related to misspent funds are reported to the Federal Audit Clearinghouse and are visible to other federal agencies, creating a track record that follows the organization.

From a tax perspective, systematic misuse of restricted charitable funds can constitute private inurement or private benefit under IRC 501(c)(3), potentially jeopardizing the organization’s exempt status. Even short of revocation, the IRS can impose intermediate sanctions (excise taxes under IRC 4958) on organization managers who knowingly approve excess benefit transactions.

In extreme cases (intentional diversion of funds for personal use, submission of false reports to the funder), the individuals responsible can face criminal charges for fraud, embezzlement, or false statements, particularly for federal grants, where 18 USC 1001 and the False Claims Act apply.

The defense against all of these outcomes is straightforward: maintain separate tracking for each restricted fund, reconcile restricted fund balances monthly, and do not spend restricted money on anything other than its stated purpose.

How do restricted funds appear on the financial statements?

On the statement of financial position (the nonprofit balance sheet), net assets appear in two lines: without donor restrictions and with donor restrictions. The notes disclose the nature and amounts of each type of restriction, including endowments, purpose-restricted amounts, and time-restricted amounts.

On the statement of activities, revenue is presented in two columns. Restricted contributions are recorded in the “with donor restrictions” column when received. When a restriction is satisfied, the release appears as a reclassification: a positive amount in “without donor restrictions” and a corresponding negative in “with donor restrictions,” both labeled “net assets released from restrictions.”

On Form 990, restricted fund information appears in several places. Part X (Balance Sheet) reports total net assets but does not break out the two categories on the face of the form. Schedule D reconciles revenue and expenses between the financial statements and Form 990, and the differences often involve timing of restricted fund recognition. Part IX (Statement of Functional Expenses) reports expenses by both natural classification (salaries, occupancy, supplies) and functional classification (program services, management and general, fundraising), reflecting the cost allocation methodology. Schedule I reports grants made by the organization, including those funded from restricted sources.

What should I do next?

If your organization receives restricted grants, start by confirming that your chart of accounts supports fund-level tracking for each restriction. Every restricted grant should have its own fund code or project code in the general ledger, with all revenue, expenses, and reclassification entries recorded at that level. Establish a written policy for release from restriction (including whether you elect the simultaneous release option under ASC 958). Document your cost allocation methodology in a formal cost allocation plan, and review it annually to confirm the allocation base still reflects how shared resources are actually used. For federal awards, determine whether you need a negotiated indirect cost rate or whether the 10% de minimis rate is sufficient.

• Nonprofit Form 990 filing guide, how restricted fund classifications flow into the annual information return
• Starting a 501(c)(3): Form 1023 application, the exemption application process and the governance structure that supports grant compliance
• Nonprofit UBIT, the unrelated business income rules that can interact with grant-funded programs generating commercial revenue
• Nonprofit fiscal sponsorship, the alternative when a project needs grant funding without its own 501(c)(3) status

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.