Contributions have one of three levels of restriction. Unrestricted contributions can be spent on any activity and in any time period the recipient organization chooses. Temporarily restricted contributions have to be spent on specific activities and/or in a particular time period as stipulated by the contributor. Permanently restricted contributions are to be held in perpetuity, usually as an endowment.
Treatment of Restricted Contributions
The first accounting practice you'll need to become familiar with is the presentation of restricted contributions on your financial statements. As you know, many contributors place a programmatic and/or time restriction on how their contributions may be used. It is a leadership function - and a key element in non-profit accountability - to ensure that restricted contributions are spent according to their donors' intent. If your financial statements don't convey that funds you have on hand carry a restriction, you might inadvertently spend the funds elsewhere and be unable to perform the grant or contract deliverables in the time frame required.
Once a non-profit receives a temporarily restricted contribution, it has to monitor expenses according to the budget approved by the donor. As a non-profit spends money according to the budget, it is releasing funds from restriction. In other words, it is the act of doing the promised work that allows a non-profit to consider the funds unrestricted and available to cover expenses.
In monitoring the release from restriction, readers of financial statements are monitoring the organization's fulfillment of its promise to spend funds in prescribed ways or time frames. The essential accounting practice behind this concept is the tracking of expenses by activity, so that the fulfillment of promises to spend can be tracked and reported on a monthly or quarterly basis.
A related accounting practice concerns the presentation of the organization's net assets by level of restriction. Because net assets are where readers of financial statements look to determine the reserve of the organization (funds it could use to start a new program or buy a building), it is critical that they not blend unrestricted and restricted amounts in the presentation.