After watching the stock market — and their endowments — endure one heck of a roller coaster ride for the past 5 years, many nonprofit organizations are wondering how to properly account for their endowments in these up — and down — markets. In this issue of Nonprofit Fiscal Fitness, we'll answer all your questions about accounting for endowments. And for many of you, those end-of-the-quarter investment statements should provide the perfect opportunity to put your new knowledge to the test. Endowments not your thing? Feel free to forward it on to one of your co-workers that might find it useful. Many of our regular readers asked for information on endowment funds, so we asked FASB expert Susan Budak for help. The tone and content of this article is a bit more advanced than usual, so please let us know what you think. You are receiving this email because you are subscribed to Nonprofit Fiscal Fitness. If you do not wish to receive future issues of Nonprofit Fiscal Fitness, please click here. |
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Most of a nonprofit organization’s investments are held as endowment funds. Therefore, in order to discuss how to properly account for investments in a recovering market, it is first necessary to discuss how to account for investments of endowment funds and what happened to those investments in the falling market. Accounting for Endowment Funds What many organizations refer to as “the endowment fund” is actually a portfolio of multiple funds invested together. (To keep things clear, this article will use the term “endowment portfolio” to refer to the aggregate of all the individual endowment funds.) Each fund has its own specific instructions, which were provided by the donor or the governing board when the fund was established. In order to classify the net assets and changes in the net assets of an endowment portfolio, each of the individual funds must be analyzed to determine whether and how the funds are restricted. Each endowment fund is composed of three parts: its original amount, its net appreciation, and its income. The original amount is the gift or designation that created the fund. The net appreciation is the investment gains and losses accumulated since the fund was created. The income is the interest, dividends, rents, and royalties earned. When accounting for an endowment fund, each of its parts is unrestricted unless its use is permanently or temporarily restricted by a donor or by law. In the absence of explicit donor instructions, FASB Statement No. 117, Financial Statements of Not-for-Profit Organizations, states that law can influence the classification of gains and losses by extending the donor’s restriction to those net assets. In most states, the law is a version of the Uniform Management of Institutional Funds Act (UMIFA). (To find your state’s version of UMIFA, visit http://www.law.cornell.edu/uniform/vol7.html#infnd.) The relevant paragraph of UMIFA states:
In other words, net appreciation is not permanently restricted (because UMIFA states that it can be appropriated for expenditure). It is temporarily restricted if the fund’s income is restricted or unrestricted if the fund’s income is unrestricted (because UMIFA states that expenditure is for the uses and purposes for which the endowment fund is established). Classification of Losses During the Falling Market In a falling market, the organization must consider (at least) two things. First, can it continue to use its spending rate policy? Second, how will it restore the value of the endowment funds? In some cases, the falling market limits the organization’s ability to apply its spending rate. A spending rate policy is merely a method of implementing the power to appropriate net appreciation granted by UMIFA. Thus, any spending rate that an organization uses must be prudent and must not invade the historic dollar value of the fund. UMIFA defines historic dollar value; for most endowment funds, it is the amount of the original gift. The governing board compares the fair value of the fund’s assets to its historic dollar value. Only if there is an excess (net appreciation) is an organization able to spend more than the endowment fund’s allocation of dividends, interest, rents, and royalties. If an endowment fund is in a deficit position, the organization can still spend any income it earned (dividends, interest, rent, and royalties). But its governing board will want to consider whether doing so would be prudent considering market conditions and program needs. UMIFA is silent about an organization’s responsibility to restore a deficit in an endowment fund. Usually, donors also are silent about losses on investments of their endowment funds. Many organizations simply wait for the fair value of the assets to recover — as it slowly has been doing since the fall of 2002. Others choose to add the income back to the fund assets to help the fund get out of the deficit position sooner. Paragraphs 12, 13, 73, 74, 76, and 77 of FASB Statement No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations, form the principal guidance for accounting for endowment funds whose market value has declined. Paragraph 12 of FASB Statement No. 124 states:
A loss on the endowment portfolio’s assets is prorated to each individual fund based upon that fund’s ownership. The classification of the loss within each individual endowment fund depends on whether there is net appreciation from prior periods that is classified as temporarily restricted. If so, the allocated losses of that fund are recorded as reductions in temporarily restricted net assets to the extent that that endowment fund has net appreciation in that net asset class. Once the losses exceed the accumulated net appreciation that is classified as temporarily restricted, any additional losses reduce unrestricted net assets. Classification of Gains During a Recovering Market Since the fall of 2002, the market has slowly been recovering. Paragraph 13 of FASB Statement No. 124 states that:
Thus, in a year of recovery, the fair value of an endowment fund’s assets is compared to its historic dollar value (the amount required by UMIFA to be maintained). If the fair value is less, the investment gains allocated to that fund are classified as increases in unrestricted net assets. If the fair value is greater than historic dollar value but the fund was in a deficit position in the prior period, gains equal to the deficit amount are classified as an increase in unrestricted net assets. Any excess gains are classified as increases in temporarily restricted net assets if the donor restricted the use of the endowment’s income or unrestricted if the donor did not restrict the income’s use. If the fair value is greater than historic dollar value and the fund was not in a deficit position in the prior period, the classification of the gains is the same as the classification of the fund’s income. An Example Charitable Organization has an endowment portfolio of 32 endowment funds. One of those funds is a donor-restricted permanent endowment fund that has investments worth $135,000. The initial gift that created the fund was $100,000, and that historic dollar value is unchanged. The net assets of that endowment fund are classified as $100,000 permanently restricted (the historic dollar value), $25,000 of temporarily restricted net assets (net appreciation on which the restrictions have not been met), and $10,000 of unrestricted net assets (net appreciation on which the restrictions have been met). By the end of the year, the endowment fund’s share of the investments has fallen in value to $95,000. There are no donor instructions relating to losses. There was no spending for the restricted purpose during the year. The loss, which is $40,000, would first reduce temporarily restricted net assets to zero ($25,000). The remaining loss ($15,000) reduces unrestricted net assets, which could be viewed as $10,000 as a reduction in the unrestricted net appreciation, and $5,000 for the deficiency when compared to the historic dollar value. During the next year, Charitable Organization, which uses a 5% spending rate, has no net appreciation to spend from this fund. Therefore, it cannot apply its spending rate. It can spend only the $2,000 dividends and interest that the investments earned. It chooses to do so rather than adding the income to the fund to reduce the deficit. At the end of the year, the fair value of the investments is $102,000. The $7,000 gain is classified as a $5,000 increase in unrestricted net assets (the restoration of the deficit amount) and $2,000 as an increase in temporarily restricted net assets (because the use of endowment fund’s income is restricted). Charitable Organization similarly analyzes the 31 other funds each year as it classifies the income and gains on its endowment portfolio. What to Do Now When classifying the gains that (we hope) result from the recovering market, an organization needs to consider whether it properly accounted for its losses during the years of the market downturn. If it did, the procedures described above should be used to account for those gains. If the organization did not properly account for its losses, it needs to compare what it did to what it should have done. Any classification of gains should bring the final classification of each endowment fund’s net assets to the same position it would have been in if the losses had been properly classified in prior years. About the Author Susan Budak, CPA, is a consultant working primarily with the Financial Accounting Standards Board (FASB) and the American Institute of Certified Public Accountants (AICPA). She is also an author of three Practitioner's Publishing Company Guides. Before joining FASB, she held positions as assistant controller and director of accounting services at Northwestern University and senior accountant at Deloitte & Touche in Chicago.
February 14, 2005 at 2:00 p.m. EST You received this email because you are subscribed to Fiscal Fitness. If you would like to unsubscribe, please click here and you will be removed immediately. If this email was forwarded to you, and you would like to receive a free subscription, please visit http://www.blackbaud.com/support/register.asp and log on to our Web site. Once logged on, click the Manage Subscriptions button to choose which Blackbaud publications you'd like to receive. The information contained herein should not be construed as legal or professional advice. If you have questions about how this newsletter's content applies to your organization, you should seek advice from appropriate professional counsel. © 2005 Blackbaud, Inc. All rights reserved.
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From a high of almost 12,000 in January 2000, the Dow Jones Industrial Average (DJIA) dropped to 7,500 on September 30, 2002 — a fall of more than 35%. Then, it climbed 39 percent from that low, and now is hovering around 10,500. That roller coaster ride left nonprofit governing boards and investment managers queasy, to say nothing of the accountants who tried to report the changes. Because FASB Statement No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations, requires that most stocks and bonds be reported in the balance sheet at fair value, with changes in fair value shown in the statement of activities, the drops and rolls of the DJIA have been reproduced in nonprofits’ financial statements.
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