A donor gives $50,000 to a charity specifically to fund a counseling program for low-income families. The charity cannot use that money to pay general administration costs, fund an unrelated outreach event, or cover a shortfall in another project. This charity restricted fund example illustrates a basic but critical point: a donation’s stated purpose can create a binding obligation for the charity.

For treasurers, board members, and finance teams, restricted funds are not just a presentation issue in the annual financial statements. They affect how donations are accepted, coded, spent, monitored, reported, and audited. Getting this wrong can weaken donor confidence, create governance concerns, and lead to avoidable questions during an external audit.

What Is a Restricted Fund?

A restricted fund is money or other assets that a charity must use only for a particular purpose. The restriction usually comes from an external party, such as an individual donor, corporate sponsor, foundation, government agency, or a fundraising appeal that clearly promises a defined use of proceeds.

The restriction may be broad or narrow. A gift for “education programs” allows more flexibility than a gift for “scholarships for students at a named school during the 2026 academic year.” The exact wording matters. The charity should refer to the donation letter, grant agreement, appeal materials, correspondence, or other evidence that establishes the donor’s intention.

A restricted fund is different from a designated fund. A board may decide to set aside unrestricted reserves for a future building project or emergency relief work. That internal decision is a designation, not a donor restriction. The board can usually change the designation through proper approval. It cannot simply redirect externally restricted donations because another need has become more urgent.

A Practical Charity Restricted Fund Example

Consider a Singapore-based charity that provides services for seniors. It receives three inflows during the year:

• $80,000 from a foundation for a dementia support program
• $25,000 from public donations collected through an appeal for subsidized transport
• $40,000 in general donations with no stated purpose

The first $80,000 and the $25,000 appeal proceeds should generally be tracked as restricted funds because each amount carries a stated purpose. The $40,000 general donation is unrestricted and may be used to support the charity’s overall activities, subject to the board’s approved budget and applicable requirements.

During the year, the charity spends $55,000 on qualified dementia support program costs and $18,000 on subsidized transport. At year-end, $25,000 remains in the dementia support fund and $7,000 remains in the transport fund. These balances do not become unrestricted merely because the reporting period has ended. They remain available only for their intended purposes until the restriction is fulfilled, expires, is amended with appropriate authority, or another lawful outcome applies.

The accounting records should allow management and the auditor to trace this clearly. A sensible fund schedule may show the opening balance, income received, expenses applied, transfers where permitted, and closing balance for each restricted fund. The general ledger should also identify the program or fund attached to each relevant transaction.

How Restricted Fund Accounting Works in Practice

The accounting treatment must follow the charity’s applicable financial reporting framework and the facts of the donation. However, the operational principle is straightforward: record restricted income separately and apply related expenditure only to the fund that is permitted to bear it.

Using the example above, when the $80,000 foundation grant is received, the charity records the income in the restricted dementia support fund. When it pays for program staff, approved therapy sessions, venue costs, or other eligible items, those costs are charged against that same fund. The finance team should retain supporting invoices, payroll records, program reports, and approval documents.

Not every cost connected to the charity can be charged automatically. Shared expenses such as rent, finance staff salaries, information technology, or management time may be recoverable from a restricted fund only if the grant terms allow it and the allocation method is reasonable. If the donor agreement is silent or restrictive, the charity should avoid assuming that overhead costs are permitted.

This is where small errors can become significant. Charging an ineligible expense to a restricted fund can overstate the funds available for unrestricted operations and may mean the charity needs to replenish the restricted fund from unrestricted resources. A timely review during the year is usually far less disruptive than correcting multiple entries shortly before the audit or annual general meeting.

When a Grant Is Received Before the Work Is Done

A grant received in advance may require separate consideration. The charity should review whether the amount is income immediately or whether a liability or deferred income treatment is more appropriate until specified conditions are met. Labels such as “restricted” and “deferred” are not interchangeable.

A restriction tells the charity how resources may be used. A condition may require the charity to achieve a particular milestone, submit reports, or meet eligibility criteria before it is entitled to retain the money. The agreement’s wording, including any repayment clause, should be reviewed carefully.

Documents That Support a Restricted Fund

Good records reduce audit delays and help the board make informed decisions. For each material restricted fund, finance teams should maintain a complete file from receipt through utilization.

Useful supporting documents commonly include:

• The donor letter, grant agreement, appeal terms, or email confirming the intended purpose
• Evidence of receipt, such as bank statements, remittance advice, and donation records
• An approved budget or program plan showing how the funds will be used
• Invoices, payroll records, contracts, and payment approvals for expenses charged to the fund
• Progress reports, claims, or donor reports required under the funding agreement
• A year-end reconciliation of opening balance, receipts, expenditure, and closing balance

The purpose is not unnecessary paperwork. It is to create a reliable audit trail. If a different staff member takes over, or a donor asks how the funds were used, the charity should be able to provide a clear answer without reconstructing the history from scattered emails.

What Auditors Review

During a charity audit, auditors will seek evidence that restricted funds have been identified, accounted for, and applied in line with donor intentions. The depth of testing depends on the charity’s size, risk profile, materiality, internal controls, and nature of funding.

Auditors may inspect grant agreements and fundraising communications to understand the restrictions. They may test selected receipts to bank records, review whether expenditure is eligible, assess the basis for allocating shared costs, and reconcile fund balances to the accounting records and financial statements.

They also consider whether restricted fund disclosures are clear and whether management has identified unspent balances, possible breaches, related commitments, or grants received subject to conditions. Where a fund is overspent or money has been used outside its intended purpose, management should address the issue promptly rather than waiting for the audit to identify it.

An audit does not replace management’s responsibility for fund stewardship. The board and finance team remain responsible for maintaining controls, reviewing fund reports, and escalating exceptions. A responsive audit process works best when schedules and source documents are prepared early.

Common Problems to Avoid

One frequent issue is treating every donation as unrestricted because the payment reference is vague. If the charity ran a campaign promising that donations would support a specific cause, the campaign materials may establish a restriction even when individual donors do not repeat that wording in each transfer.

Another issue is combining several restricted projects in one ledger code. This may appear efficient at first, but it becomes difficult to demonstrate whether each donor’s money was used as intended. Separate fund or project codes provide clearer accountability, particularly where grants have different reporting dates or eligible-cost rules.

Charities should also be careful with transfers. Moving money from a restricted fund to general operations to manage cash flow is not a harmless bookkeeping entry. Unless the restriction permits the use, the funds remain restricted even if the charity expects to replace them later.

Finally, do not assume that an old balance can be redirected because the original project is no longer active. Review the donor terms and obtain appropriate advice before changing the purpose or closing the fund. The correct approach depends on the legal documentation, the amount involved, and whether the donor or grant-maker can be contacted.

A Practical Year-End Review

Before year-end, management should review every restricted fund with a positive or negative balance. Confirm the original purpose, compare actual spending against the approved budget, identify unused funds, and check whether any reporting or refund obligations are approaching. This review should be documented and presented to the board or relevant finance committee where appropriate.

For charities managing multiple grants, a monthly restricted-fund report can prevent year-end surprises. It should show available balances, spending to date, upcoming deadlines, and exceptions requiring management attention. Clear reporting supports better decisions and reduces the pressure on staff when audit schedules are requested.

Koh & Lim Audit PAC can help charities approach their annual audit with clear schedules, practical questions, and focused attention on compliance. Sound restricted fund records do more than support accurate financial statements. They show donors, beneficiaries, and the board that every promised dollar is being treated with the care it deserves.