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Commercial accounting practices used by traditional for-profit business are not adequate for nonprofit bookkeeping. Churches and other nonprofits need to adopt "fund accounting" practices. The difference, says Dan Busby, CPA and vice-president of Evangelical Council on Financial Accountability, is that fund accounting creates a distinction between restricted and unrestricted funds. Commercial practices make no allowance for such a distinction.

In a church or ministry, money is often given for specific purposes. These gifts are said to be "restricted." The nonprofit organization may have certain legal responsibilities to use the restricted funds as designated by the donors. At the very least, the organization must be accountable to the donors for how the funds are used. Owners of for-profit businesses are generally free to spend their earnings any way they see fit.

Funds given to a nonprofit organization for specific purposes are restricted to those defined needs. These gifts cannot be used for more immediate needs, such as paying salaries or basic operational expenses. Fund accounting techniques allow the organization to set up any number of restricted fund accounts, and ensure these funds are reserved for their restricted purposes.

A restricted fund can be established by a donor's request or by the organization, in our case, a church. In either case, the church is accountable for ensuring gifts designated for that fund are used according to the restrictions. When a church establishes a restricted fund, it communicates to potential donors how the funds will be used.

Restricted funds can be temporarily or permanently restricted. Funds intended for use in the near future are considered temporarily restricted. Funds intended to be used in the future or over a long period of time are permanently restricted. Funds are commonly restricted for the following purposes:

• To meet a specific physical need—anything from a single item to a general building program (usually a temporary restriction).
• To fund an endowment for a ministry position or program (permanent restriction).
• To provide scholarships for specific programs or general education (permanent restriction).

As an example, a church member donates $5,000 for the church to buy and install a new lighted outdoor sign. The church creates a restricted fund for the sign project, and records the gift as a contribution to that fund. The money does not yet move through the general books. When the sign needs to be paid for, the restricted gift is freed for use and the donation and payment are recorded in the general ledger. When possible, the donor is notified that the gift is being used. Often, when the item is installed, a plaque or other marker is placed nearby to indicate, with thanks, the source of the gift.

As another example, a foundation grants $35,000 to the church's educational arm for curriculum development, teacher recruitment and training, and some capital expenses to support teaching. The grant must follow a timeline and be used within a three-year period. Expenses charged to the grant must be documented so that the church can prove to the grant maker that the funds were used appropriately, and not to cover a shortfall in another area.

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