A restricted asset is an item of value that can only be used for a specified purpose. Failure to use the asset according to the attached limitations has contractual or legal consequences that can include having the asset revert to a prior owner. The restrictions on an asset can be permanent or temporary. Both require special accounting procedures to properly value the asset in light of the limitations on its use and to track the compliance with the restrictions in the business records.
The notion of restricting an asset was developed as a way to assure a party to a transaction that certain requirements would be met and continue in effect as long as necessary to honor the underlying intent of a party. Restrictions tend to concern use of the asset but can also involve related issues, such as continued ownership by a particular party or an owner maintaining a specific status. There are no limits on the nature of the restrictions that can be placed on an asset when it is transferred to another party. As long as the receiving party accepts the asset with knowledge of the restrictions, he must abide by them or forfeit the asset.
Nonprofits and educational institutions are the most common types of entities that will accept a restricted asset. Donations are often made with specific stipulations regarding use. Institutions are required by law to honor those stipulations or risk being forced to return the donation. For example, a university might receive a donation that is specifically earmarked by the donor for a new building. Likewise, a youth organization might receive a donation specifically to fund a scholarship.
A restricted asset is carried on the books in a separate section. The asset section of the financial statements for these types of entities will show two separate categories, labeled restricted assets and unrestricted assets. An accountant has to apply special valuation rules to the restricted assets because the limitation on use affects transferability and worth.
Another circumstance that typically involves a restricted asset is the sale of municipal bonds. A municipality offers bonds for sale to the public to raise funds for specific projects, such as building a new convention center. This creates an implied contract that the funds raised will be used for that purpose alone. The government cannot simply reallocate those funds to a different project.
Sometimes, a person will restrict an asset in a will. For example, a person might restrict the transfer of assets into the name of a minor child until he reaches the age of majority. This is a temporary restriction. Comparatively, a will might restrict the ownership of an asset to a son-in-law for as long as he remains married to the person’s daughter. This is a permanent restriction, and failure to comply will cause the asset to revert back to the estate.