Restricted funds in a charity, explained

That one rule sounds simple. In practice it is where a lot of well-meaning charities get into difficulty, because restricted money has to be tracked separately all year, shown separately in the accounts, and spent within a reasonable time for the purpose it was given.

This page explains what a restricted fund is, how it differs from the other kinds of charity fund, and what the Charity Commission rules actually say.

Always check GOV.UK for the current position.

What is a restricted fund?

A restricted fund is money that must be spent on a purpose narrower than your charity's general aims. The restriction is set by whoever gave the money, usually in one of two ways:

• The donor said so. Someone gives you £5,000 "for the youth club," and that is what it is for.
• You said so when you asked for it. You launch an appeal "to build a wheelchair ramp," and everything given to that appeal is restricted to the ramp.

Once money is restricted, it is restricted. The trustees cannot simply decide to use it for something else, even something equally worthy, without going through a proper process (more on that below).

There is also a positive duty to actually spend it. You cannot sit on a restricted fund indefinitely. The Charity Commission expects trustees to spend restricted money on its purpose within a reasonable time of receiving it. Holding it too long can itself be a breach of trust.

Restricted, unrestricted, designated: the difference that trips people up

There are three terms that get muddled, and the difference is legal, not just bookkeeping.

Unrestricted funds. The charity's general money. The trustees can spend it on anything that furthers the charity's purposes. This is what pays the rent, the salaries, the day-to-day.

Restricted funds. Money tied to a narrower purpose by the donor or the appeal, as above. Not the trustees' to redirect.

Designated funds. This is the one that catches people out. A designated fund is unrestricted money that the trustees have set aside for a particular plan, say, earmarking £10,000 towards a future building project. It looks restricted, but it legally is not. Because the trustees imposed the earmark themselves, the trustees can also cancel it. If circumstances change, they can bring that money back into general funds.

The practical point: a restriction imposed from outside (a donor, an appeal) is binding. A designation the trustees made themselves is not. Mislabel one as the other in your accounts and you either tie up money you did not need to, or spend money you were not allowed to.

Endowment funds, briefly

Some charities also hold endowment funds, which the trustees are required to keep and invest rather than spend freely. There are two kinds:

• Permanent endowment must be kept, not spent. The charity uses the income it generates, but the capital stays put. Spending it usually needs the Commission's authority.
• Expendable endowment is capital the trustees have the power to convert into income and spend, if they choose.

Most small charities do not have endowment funds. If yours does, the rules are stricter and worth proper advice.

The Charity Commission rules on spending a restricted fund

Three rules matter most, and they are all about not treating restricted money as if it were yours to allocate.

1. Spend it on its purpose. That is the whole point of the restriction. Using restricted money for anything else, even briefly to cover a cashflow gap, is a breach of trust.

2. Spend it within a reasonable time. The duty is not only to spend it correctly but to spend it. A restricted fund left untouched for years is a problem, not a safety net.

3. You need Charity Commission authority to change what a restricted fund is for. If you genuinely cannot use the money for its original purpose, you cannot just decide on a new one. Changing the purpose of a restricted fund means changing the terms it was given under, and that generally requires the Commission's agreement.

What if you cannot use the money for its purpose?

This happens more than people expect. An appeal raises money for a project that then falls through. A restricted donation arrives for something the charity has since stopped doing.

You cannot simply move the money to general funds. What you can do depends on the situation:

• Go back to the donor if you can identify them, and ask whether they will agree to the money being used differently.
• If the donor cannot be traced, or it was a public appeal, you will usually need the Charity Commission to make a scheme redirecting the funds to a similar purpose.

This is exactly the kind of thing to get right rather than guess at, because getting it wrong is a breach of trust that falls on the trustees personally. If you are stuck with a restricted fund you cannot use, talk to us or contact the Commission before you move a penny of it.

Why restricted funds matter in your accounts

This is not just a governance point. It is an accounting one, and it is where charity accounts differ most from company accounts.

Under the Charities SORP, restricted and unrestricted funds must be shown separately in the accounts. Every pound of income and expenditure has to be allocated to the right fund, all year, not reconstructed at the year end. If the coding is wrong during the year, no amount of work at year end will properly unpick it.

This is the single most common reason charity bookkeeping goes wrong, and it is why charity accounting is a specialism rather than ordinary bookkeeping with a charity's name on it. A charity juggling several restricted funds, each with its own conditions, needs those tracked properly from day one.

How we help

We do charity fund accounting properly, from the start of the year. Restricted and unrestricted funds tracked separately and correctly, so your accounts show the true picture and your trustees can see, at any point, exactly what each fund holds and what it can be spent on.

We also prepare charity accounts to the SORP and act as independent examiners (though not for a charity whose books we keep, that is the independence rule, and we will always be straight about it).