Do restricted funds need to be kept in a separate bank account?

Question: We are a small but growing nonprofit organization. We just received notification of a restricted contribution from an estate. This will be our first significant restricted funding. A Board member suggested that we keep these funds in a separate bank account. Do we need to keep restricted funds in a separate bank account?

Answer: No, it is almost never required nor advisable for a nonprofit organization to keep restricted funds in one or more separate bank accounts, and this is not an accepted best practice. The reason is that using separate bank accounts for restricted funds makes managing these funds more difficult and does not enhance safeguards or strengthen internal accounting control systems. The opposite often results. Having unnecessary bank accounts can lead to operational inefficiencies and increased chances for errors.

It is common for nonprofit organizations to have accounting systems and manage annual operating budgets that rely on both restricted and unrestricted sources of funding. These organizations depend on established nonprofit accrual-based accounting systems, policies, and procedures to properly track receipt and use of restricted funds. These systems are designed to meet generally accepted accounting principles (GAAP) compliance requirements related to restricted funds.

Documentation is the key to verifying proper management and use of restricted funds. Robust timekeeping systems, approval of labor allocations, invoices for purchases of goods and services, contracts, and purchase orders are examples of strong internal control management practices and documentation.

Pushing restricted funds into separate bank accounts does not per se enhance compliance. In fact, this often provides a false sense of security that restricted use purposes have been met when funds are expended or transferred from these separate bank accounts.

Further, having additional bank accounts for restricted funds generally complicates cash management systems, increases the number of transactions, and burdens the accounting systems to record transfers and transactions between the two sets of bank accounts. This multiplies the chance for errors, leading to additional complex and time-consuming bank reconciliation procedures.

Planning Tip – If a donor stipulates that restricted funding must be kept in a separate bank account, you should pause and consider whether this requirement imposes an undue operational burden and increases compliance risks. If this is the case, you might want to consider not accepting these restricted funds.

Most nonprofits follow the best practice of having one main operating (business) bank account. Additional bank and investment accounts are added for safety and cash management purposes, i.e. separating intermediate and long-term funds not needed for current operations and to maximize earnings. Restricted and unrestricted funds are managed together within these cash management systems. Thus, a separate bank account for restricted funds is not needed.