Nonprofit Net Assets: Classes, Disclosures, and Reporting

Nonprofit net assets classification and reporting is governed by FASB’s Accounting Standards Update 2016-14, which requires organizations to sort net assets into two classes — with donor restrictions and without donor restrictions — and to present those balances on the face of the financial statements with supporting footnote disclosures, functional expense reporting, and liquidity information. Those same figures then flow through to Form 990 and any required audits. The two-class framework replaced the older system of unrestricted, temporarily restricted, and permanently restricted net assets, and it now governs every GAAP-compliant nonprofit financial statement.

What Net Assets Are

Net assets equal total assets minus total liabilities. For-profit businesses call the same figure owner’s equity or shareholders’ equity because it belongs to investors. Nonprofits have no shareholders, so the residual belongs to the mission.

The figure is cumulative across the life of the organization. Every year’s surplus adds to it; every year’s deficit reduces it. The Statement of Financial Position shows the running total at a point in time, and the Statement of Activities shows how that total changed during the reporting period.

The Two Required Classes

Every dollar of net assets falls into one of two buckets based on a single question: has an outside donor placed conditions on how the money can be used?

If no external donor has limited the money, it belongs in net assets without donor restrictions. If a donor has attached conditions, it belongs in net assets with donor restrictions. ASU 2016-14 collapsed the older three-category system into these two. Purpose restrictions and time restrictions now sit together in the restricted class, and perpetual restrictions live there too but with separate footnote disclosure explaining that the principal must be maintained indefinitely.¹

Net Assets Without Donor Restrictions

These are the flexible dollars. They come from fees for services, general donations, membership dues, and investment gains that carry no external strings. Leadership can spend them on anything that advances the mission, from staff salaries to building repairs to launching a new program. When finance committees ask whether the organization can weather a slow fundraising quarter, they are really asking how large this balance is relative to monthly operating costs.

Board-Designated Funds

A governing board can earmark a portion of unrestricted net assets for a specific internal purpose, such as a capital project, a technology upgrade, or an operating reserve. These board-designated funds look restricted on internal reports, but they remain legally unrestricted because no outside donor imposed the limitation. The board can reverse the designation by formal vote whenever priorities shift.

Industry benchmarks suggest nonprofits target operating reserves equal to three to six months of expenses, with the low end covering at least one full payroll cycle including taxes. Organizations relying on seasonal fundraising or periodic grants often need reserves closer to the high end. Reserves exceeding two years of budget can invite questions from donors and regulators about whether resources are being hoarded rather than deployed.

Financial statements must disclose the purpose and amount of board-designated funds in the footnotes, giving readers a clear picture of self-imposed commitments even though the law treats those dollars as unrestricted.¹

Net Assets With Donor Restrictions

When a contributor attaches conditions to a gift, those conditions are legally binding. The organization accepts not just the money but a duty to follow the donor’s instructions. Under trust law, that obligation resembles a trustee’s duty of obedience.

Donor-restricted net assets generally fall into three patterns:

Purpose restrictions. The gift funds a specific activity, like a scholarship program, a building renovation, or a particular research initiative. The money cannot be spent on anything else.
Time restrictions. The gift cannot be spent until a specified date or event. A pledge payable over five years creates a time restriction until each installment comes due.
Perpetual restrictions. The donor requires the original gift amount to remain invested indefinitely. Only the investment income can be spent, and sometimes even that income carries its own purpose restriction.

All three now sit in a single class on the face of the financial statements, but the footnotes must distinguish among them.

Releasing Restrictions

When a nonprofit satisfies a donor’s conditions, the funds are reclassified through an accounting entry called a release from restriction. For a purpose restriction, the release happens when the money is spent on the specified activity. For a time restriction, it happens when the clock runs out. For an endowment generating spendable income, earnings are released according to the terms of the gift and the organization’s spending policy.

On the Statement of Activities, released funds appear as a decrease in net assets with donor restrictions and a corresponding increase in net assets without donor restrictions. Total net assets do not change; dollars simply move between columns. Reclassifications should be processed at least whenever financial statements are prepared. Auditors will flag stale balances sitting in the restricted column long after the conditions have been met.

Endowments and Underwater Funds

Perpetually restricted endowments carry their own spending framework. The Uniform Prudent Management of Institutional Funds Act, adopted by every state and the District of Columbia except Pennsylvania, requires boards to set a prudent spending level after weighing seven factors covering the fund’s duration, the institution’s purposes, economic conditions, inflation, expected total return, other available resources, and the investment policy. Many states include an optional provision creating a rebuttable presumption of imprudence if spending exceeds 7% of the fund’s fair market value, averaged over at least the preceding three to five years depending on the state. If a gift agreement sets a lower rate, that donor restriction controls.

An endowment is underwater when its current fair market value drops below the original gift amount or a required minimum. In UPMIFA states, underwater status does not automatically freeze spending; the board can still authorize prudent withdrawals. In the few remaining states operating under the older Uniform Management of Institutional Funds Act, spending cannot go below the fund’s historic dollar value.

Underwater endowments remain classified as net assets with donor restrictions. Organizations must assess each fund individually rather than netting gains in one fund against losses in another. The footnotes must disclose the board’s interpretation of applicable law, the spending policy for underwater funds, the aggregate fair value of all underwater funds, the aggregate original gift amounts, and the total deficiency.¹

What Must Appear on the Financial Statements

ASU 2016-14 standardized presentation and added disclosure requirements that apply to every nonprofit issuing GAAP-compliant financial statements.

Statement of Financial Position

The nonprofit balance sheet must report total assets, total liabilities, and total net assets, with net assets broken out into the two required classes.¹ Organizations can disaggregate further within either class. A nonprofit might separate perpetually restricted endowment funds from time-restricted grants inside the “with donor restrictions” line. The two-class minimum is mandatory, and the totals for each class must appear on the face of the statement.

Statement of Activities

This statement reports the change in net assets over the reporting period. Revenues are recorded in the “without donor restrictions” column unless the gift carries a donor limitation, and all expenses reduce net assets without donor restrictions. Reclassifications from restricted to unrestricted appear as a separate line item, making it easy to see how much restricted funding was unlocked during the period.¹

Functional Expense Reporting

ASU 2016-14 extended to all nonprofits a requirement that previously applied only to voluntary health and welfare organizations: reporting expenses by both their natural classification (salaries, rent, supplies) and their functional classification (program services, management, fundraising). The analysis can appear on the face of the Statement of Activities, in a separate schedule, or in the footnotes, but it must be presented in one location.¹ This breakdown shows how much goes to mission delivery versus overhead.

Footnote and Liquidity Disclosures

The numbers on the face of the statements tell only part of the story. For net assets with donor restrictions, the notes must describe the nature and amounts of the different types of restrictions, including when time-restricted funds become available and what purpose-restricted funds must be spent on. For net assets without donor restrictions, the notes must describe any board designations, including amounts and purposes. Contractual limitations on the use of certain assets, such as cash held as collateral or compensating balances required by a bank, must be disclosed as well.¹

ASU 2016-14 also added a liquidity disclosure requirement that is now closely read. Organizations must provide both quantitative and qualitative information about the financial assets available to meet general expenditures within one year of the balance sheet date. The quantitative piece identifies assets that are both current and unrestricted, such as cash, receivables, and short-term investments. The qualitative piece explains how the organization manages its liquid resources, including credit facilities, lines of credit, and the board’s approach to maintaining operating reserves. Supplemental information can note assets expected to be released from restriction during the coming year.¹

Form 990 and Audit Reporting

The same net asset figures then feed federal and state reporting.

Most tax-exempt organizations file Form 990 annually. Part XI reconciles beginning and ending net asset balances by walking through total revenue, total expenses, and other changes during the year. Organizations with endowment funds must also complete Part V of Schedule D, which tracks beginning balances, contributions, investment earnings, losses, distributions, and ending balances for permanent endowments, term endowments, and board-designated quasi-endowments separately.²

Nonprofits that expend $1 million or more in federal funds during a fiscal year must undergo a Single Audit under the federal Uniform Guidance. The audit evaluates the financial statements and compliance with the terms and conditions of federal awards, including proper tracking of restricted grant funds. State charitable solicitation laws in many jurisdictions impose independent audit requirements tied to annual revenue, with common triggers falling between $750,000 and $2 million. Some states require a less expensive financial review at lower thresholds and a full audit only above the higher mark. A handful have no state-level audit mandate at all. Organizations soliciting in multiple states may need to comply with the strictest applicable threshold.

Why Correct Classification Matters

Misusing restricted funds is one of the fastest ways for a nonprofit to face legal trouble. The donor can sue to enforce the original terms of the gift. The state attorney general, who has broad authority to oversee charitable assets, can open an investigation and pursue enforcement actions. Board members who authorized the misuse may face personal liability for breach of fiduciary duty or fraud.

In the most serious cases, the IRS can revoke the organization’s tax-exempt status, particularly where the diversion of restricted funds amounts to private inurement or an excess benefit transaction. Even short of revocation, the reputational damage from a publicized enforcement action can dry up future donations. Restricted dollars should be tracked in separate accounts or subaccounts, and no expenditure from those accounts should occur without verifying it matches the donor’s stated purpose.

1
Financial Accounting Standards Board (FASB). Accounting Standards Update No. 2016-14 – Presentation of Financial Statements of Not-for-Profit Entities
2
Internal Revenue Service. Instructions for Schedule D (Form 990)