Nonprofit Grant Management: Restricted Funds, Compliance Reporting, and What Happens When You Misspend

A grant restricted to youth literacy can’t pay the rent, and the accounting has to prove it didn’t. Under the FASB standard for nonprofits (ASC 958), an unconditional restricted grant is recorded as revenue when it arrives (a grant with a condition still to clear is a refundable advance until then), in the “with donor restrictions” class, and moves to “without donor restrictions” only as the organization spends it on the stated purpose. Every restricted grant gets its own fund code so the unspent balance is visible at any moment. Federal awards add the Uniform Guidance on top: allowable costs, reports at least once a year, an indirect cost rate, and a Single Audit once you spend $1,000,000 of federal money in a year. Misspend, and the funder can take the money back.

What are restricted funds, and how does ASC 958 classify them?

Money a donor or grantor gave with strings attached. The FASB standard uses two classes of net assets: without donor restrictions, which the board can spend on anything within the mission, and with donor restrictions, which carry a purpose, a time, or both, plus endowments held in perpetuity. The Form 990 instructions build the balance sheet on exactly these two lines: “Organizations that follow ASC 958. Line 27. Net assets without donor restrictions. Line 28. Net assets with donor restrictions.”

Kind of money	Who set the limit	Net-asset class	When it becomes spendable	Example
Unrestricted gift, program fees	Nobody beyond the mission	Without donor restrictions	Immediately	General donation, class fees
Board-designated reserve	The board	Without donor restrictions (the board can undo it)	Whenever the board votes	Operating reserve
Purpose-restricted grant	The donor or grantor	With donor restrictions	As qualifying expenses are incurred	”For after-school tutoring”
Time-restricted gift	The donor	With donor restrictions	When the period arrives	”For use beginning fiscal 2027”; year two of a pledge
Endowment principal	The donor, in perpetuity	With donor restrictions	Never (income spendable under the spending policy)	Named scholarship endowment

• The restriction is legally binding on the organization once it accepts the gift. Funders audit; state attorneys general enforce donor intent under state charitable law; the grant agreement itself usually carries a clawback clause.
• A board designation is a plan, and the board can reverse it. A donor restriction is a promise, and only the donor can lift it. The two go in different classes for that reason.
• The classes replaced the older three-way split (unrestricted, temporarily restricted, permanently restricted); the notes to the financial statements now explain what sits inside the restricted class, including amounts held in perpetuity.

How is a restricted grant recorded and released from restriction?

Recognized as revenue when received or unconditionally promised, in the restricted class, and released as the money is spent on the purpose. A $200,000 grant that lands in December 2026 for 2027 tutoring is 2026 revenue, all of it restricted. As tutors are paid in 2027, the organization posts a reclassification, “net assets released from restrictions,” moving the spent amount out of the restricted class and into the unrestricted one. The cash may have moved months earlier; the release entry records that the condition was met.

• Fund codes. Each grant with its own restrictions gets its own fund, class or project code in the ledger, and every dollar of related revenue and expense carries it. The fund balance at any date is the unspent restricted money. The fund accounting guide covers the mechanics.
• Conditional grants are different. A grant that depends on a barrier the organization hasn’t cleared yet (matching funds raised, a milestone hit) isn’t revenue until the condition is met; until then it’s a refundable advance. Read the agreement for conditions before you book it.
• Time restrictions release on the calendar. Year two of a three-year $50,000-a-year pledge releases when year two begins, whatever was spent.
• Post releases monthly. An organization that waits until year end to record releases overstates restricted net assets all year and hands the auditor a reconstruction project.
• The acknowledgment should name the restriction. The donor acknowledgment letter describes the gift; for a restricted gift, describing the purpose the donor set is how you and the donor agree on what the strings are.

What do federal grants require under the Uniform Guidance?

Allowable costs, regular financial reports, an indirect cost rate, and an audit above a spending threshold, all in 2 CFR Part 200. 2 CFR 200.403 makes a cost chargeable only if it’s “necessary and reasonable for the performance of the Federal award,” conforms to the award’s limits, follows policies “that apply uniformly to both federally financed and other activities,” and gets “consistent treatment.” Under 200.501, an entity “that expends $1,000,000 or more during the non-Federal entity’s fiscal year in Federal awards must have a single or program-specific audit.”

• Records. 2 CFR 200.334: the recipient “must retain all Federal award records for three years from the date of submission of their final financial report,” and longer if litigation, a claim or an audit finding is still open.
• Reports. 2 CFR 200.328: the agency “must collect financial reports no less than annually” and “may not collect financial reports more frequently than quarterly” without a specific condition. Annual reports are due “no later than 90 calendar days after the reporting period”; quarterly or semiannual ones “no later than 30 calendar days.”
• Consistent treatment. The regulation’s own example: “a cost must not be assigned to a Federal award as a direct cost if any other cost incurred for the same purpose in like circumstances has been allocated to the Federal award as an indirect cost.” Rent charged direct to one grant and indirect to another is the classic finding.
• The Single Audit. Once federal spending in a year reaches $1,000,000, an independent auditor tests the financial statements and compliance with each major program and files with the Federal Audit Clearinghouse, where other agencies can read the findings. The threshold was $750,000 before the 2024 revision of Part 200.
• State pass-throughs. State and local agencies that regrant federal money pass these rules down by reference, and many attach them to state-funded grants too.
• Foundation grants have no regulatory layer, but a grant agreement that requires fund accounting, a budget and reports creates the same obligations by contract.

How do you allocate indirect costs to a grant?

Direct costs go to the grant in full; shared costs go in by a written method, up to whatever the funder allows. A tutor paid only to run the grant-funded program is a direct cost. Rent, IT, bookkeeping and the executive director’s time serve every program and are indirect. For federal awards, 2 CFR 200.414(f) lets a recipient without a negotiated rate “elect to charge a de minimis rate of up to 15 percent of modified total direct costs (MTDC),” and an agency “may not require recipients … to use a de minimis rate lower than” that election.

• MTDC under 2 CFR 200.1 is “all direct salaries and wages, applicable fringe benefits, materials and supplies, services, travel, and up to the first $50,000 of each subaward,” and it “excludes equipment, capital expenditures, charges for patient care, rental costs, tuition remission, scholarships and fellowships, participant support costs, and the portion of each subaward in excess of $50,000.”
• A negotiated indirect cost rate agreement (NICRA) with your cognizant agency replaces the de minimis rate whenever the organization chooses to negotiate one; 200.414(f) says the de minimis rate
• Common allocation bases: direct labor hours or dollars, MTDC, and square footage for facility costs. Pick one per cost pool, write it into a cost allocation plan, and apply it the same way every year. The FAR 31 guide covers the parallel rules for government contractors.
• Foundation grants often cap indirect costs at a low percentage or exclude them. Whatever the cap doesn’t cover comes out of unrestricted funds, which is why an organization living on restricted grants needs an unrestricted reserve.

What happens when restricted funds are misspent?

The funder takes the money back first, and the rest depends on who the funder is and whether anyone lied about it. A private grantor demands a refund under the agreement’s clawback clause and stops funding. On a federal award, costs found unallowable If a report to the funder misstated where the money went, the individuals involved have their own exposure.

• False statements. 18 U.S.C. 1001 makes it a crime, in a matter within federal jurisdiction, to “knowingly and willfully” make “any materially false, fictitious, or fraudulent statement or representation,” punishable by a fine and imprisonment of “not more than 5 years.”
• False claims. Under 31 U.S.C. 3729(a)(1), a person who “knowingly presents, or causes to be presented, a false or fraudulent claim for payment or approval” is liable for a civil penalty “plus 3 times the amount of damages which the Government sustains.”
• The exemption. IRC 501(c)(3) requires that “no part of the net earnings of which inures to the benefit of any private shareholder or individual.” Restricted money diverted to an insider is inurement, and where the insider is a disqualified person, IRC 4958 adds “a tax equal to 25 percent of the excess benefit,” 200% if not corrected, and 10% on a manager who knowingly approved it. The executive compensation guide covers those rules.
• The board. Directors have a fiduciary duty to see restricted funds used as promised, and knowingly approving a diversion is a personal-liability question under state law. It belongs on the same agenda as the conflict-of-interest policy.
• Bridging. Borrowing restricted cash to make payroll in a thin month, with every intention of putting it back, is still spending restricted funds on something else. If it happens, document it, restore it, and tell the funder before the funder finds it.

How do restricted funds show on the financial statements and Form 990?

On the statement of financial position as the two net-asset lines, and on the statement of activities as two columns with the releases crossing between them. On Form 990 the same two figures go on Part X, lines 27 and 28. Part IX spreads expenses across program services, management and general, and fundraising, which is where the cost allocation plan becomes visible to the reader, and Schedule I picks up grants the organization itself made once they pass $5,000 to any one domestic organization.

• The statement of activities shows restricted contributions in the “with donor restrictions” column when received and a “net assets released from restrictions” line moving the spent amount to the other column, so a reader can see how much restricted money came in, how much was used, and how much is still owed to a purpose.
• Grant revenue on the 990 is reported when recognized, so a large December grant inflates one year and the spending shows in the next. The functional expense allocation in Part IX should match the cost allocation plan you use for the grants, because a funder comparing the two will notice if it doesn’t.
• The Form 990 guide covers the return; if a grant-funded program starts selling services, the UBIT guide covers when that income becomes taxable.

What should I do next?

Open the chart of accounts and check that every restricted grant has its own fund or project code with the grant budget loaded against it. Write down the release policy and the cost allocation method, with the base for each cost pool. If you take federal money, check this year’s expected federal spending against the $1,000,000 Single Audit line and decide between the 15% de minimis rate and a negotiated one. Then reconcile each restricted fund balance to the funder’s record of what it sent you.

• Nonprofit Form 990 filing guide, where the two net-asset classes and the functional expenses are reported
• Church bookkeeping and fund accounting, the same fund structure for designated giving
• Governance and conflict of interest, the board’s oversight of restricted funds
• Donor acknowledgment letters, naming the restriction in the letter
• Fiscal sponsorship, where the grant agreement and reports do the same job for a sponsored project
• Government contract direct and indirect costs under FAR 31, the contractor version of the cost principles

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