Deferral vs. Restricted Fund Method For NPOs

Omar Visram
Deferral vs. Restricted Fund Method For NPOs
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Accounting isn't always easy to master, especially for those who don't live and breathe the specifics of accounting rules and regulations. However, some policies are more important than others, especially for non-profit organizations. If you own, operate, or work for an NPO, reviewing the differences between deferral and restricted fund contribution revenue recognition may be worthwhile.

The Ins and Outs of Accounting for NPOs

Due to the difference in tax status of not-for-profit organizations, accounting revenue recognition standards are a little different. In most business situations, revenue comes largely from business and investing activities, but NPOs have an additional element to worry about: charitable contributions.

A charitable contribution is a payment of cash or other assets provided with no expectation of service or valuable consideration from the giver. A component of revenue wholly unique to non-profits, this form of income requires a unique approach to recognition.

When accounting for charitable contributions for Canadian non-profits, accountants have two choices: the deferral method or the restricted fund method. While the pros and cons of each option are important for all charitable contributions, they become more so when considering the ramifications of restricted contributions.

What Are Restricted Contributions?

Restricted contributions are similar to any other contribution, with one key difference: funds are earmarked for a specific purpose and cannot be used for additional expenses or costs of doing business.

For example, if a youth-oriented charity is provided money to build a new playground by community members, this capital can only be invested in playground construction and should not be used for things like after-school program funding. If the restricted requirement is not fulfilled, funds must be returned to the donor.

Evaluating Accounting Options

Under Part III of NPO standards, not-for-profit organizations can choose between the deferral method and restricted fund method for revenue recognition.

Deferral Method

When using the deferral method of accounting for restricted contributions, revenue is not recognized when it is received but rather in the period that corresponds to related expenses. This is due to the refundable nature of restricted giving; as there are terms involved in using such revenue, it's not recognized until the conditions of use have been carried out.

For example, suppose a donor provides money specifically to build a playground in November, but the construction does not begin until March. In that case, no revenue will be recognized until equipment is purchased and the ground is broken.

Restricted Fund Method

Under the restricted option, revenue is recognized when received regardless of when it is used. So, suppose the aforementioned donor provides money for the playground in July. In that case, the revenue will be recognized in July and accounted for in the year of receipt in a playground-specific fund.

This method is named as such because it uses a separate fund to manage the contributions and expenses associated with an external restriction. This allows for restricted and unrestricted fund activities to be separated in an income statement.

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Choosing the Right Path Forward

The differences between restricted and deferral methods are apparent, but which do you choose?

While there's not always one correct answer, most companies base their decision on factors that include the number of restricted contributions received and reporting objectives. Organizations that receive minimal restricted contributions may prefer the deferral method, choosing to show amounts on a statement of operations as expenses are incurred.

On the other hand, organizations that receive many restricted contributions often choose to use the restricted method of accounting to add more value to financial statements. Instead of just providing a high-level summary, the breakdown of fund activity under the restricted fund method offers more insight, painting a clearer picture of an organization's use of funds.

While each method of fund accounting for restricted contributions has pros and cons, it is ultimately up to each organization to weigh the options available, identify needs and objectives, and make a decision accordingly.

Accounting for NPOs doesn't have to leave you scratching your head. With nonprofit bookkeeping services from Enkel, you can guarantee every contribution is realized and recognized. Contact us today to learn more about our nonprofit bookkeeping services!

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