Endowment Updates

Nonprofits dream of substantial endowments to allay rising operating costs and for greater flexibility to pursue new programs and ideas. Nonprofits such as prestigious universities, have often achieved this goal. Endowments generally involve donations to nonprofits whereby the corpus or principal of the gift are to remain intact and the “earnings” on the corpus can be used to fund programs.

In practice, arrangements can be diverse based on the donor’s specific wishes regarding the endowment. For example, a donor could stipulate the principal of the endowment be spent over a certain time or conversely that the “corpus” of the gift be increased by some percentage anually to account for the loss of purchasing power. Endowments are different from a nonprofit’s reserve funds that have accumulated over time to cover unforeseen pressing financial needs. Some organizations designate their reserve funds to function as a quasi-endowment to manage long-term finances.

However, many nonprofits never achieve a true or quasi-endowment accumulation because current need surpasses long-term dreams and operating reserves can be difficult to come by. Similarly, the average donor lacks the financial wherewithal to make a significant endowment gift and may prefer to see their gift assist with current needs, and/or receive the benefits of an annual donation. Donors of significant means may have different motivations to make an endowment gift. They may be concerned about the operational impact of a large one-time gift and the use of the funds. A sense of permanence may also motivate larger donors to make a named gift so that future generations are aware of their philanthropy. This sense of permanence guides many to establish a named private foundation for the same reasons.

Furthermore, organizations with endowments are required to record transactions a certain way and to provide disclosures about their endowments by financial reporting standards. The accounting standards are influenced by “endowment law” and known as the Uniform Prudent Management of Institutional Funds Act (UPMIFA), which has been adopted by all states except Pennsylvania. UPMIFA replaced the prior standard that was in place since 1972, the Uniform Management of Institutional Funds Act (UMIFA). In addition to a law change, accounting standards are evolving with the issuance of ASU 2016-14, Not-for-Profit Entities: Presentation of Financial Statements of Not-for-Profit Entities.  Early adoption is permitted; these amendments are effective for years beginning after December 15, 2017.

Under both present and future GAAP, contributions are restricted only upon a donor’s designation. If the donor creates a true endowment fund, the contributions are permanently restricted net assets under current GAAP or net assets with donor restrictions under the latest changes. A board-designated endowment fund is created when a governing board designates or earmarks a portion of its net assets without donor restriction to be invested, generally for a long but possibly unspecified period. When classifying a donor restricted endowment fund, consideration is given to both the donor’s explicit instructions and the applicable laws (usually UPMIFA) that extend donor restrictions. Investment returns are recorded in accordance with any donor stipulation such as for use in a particular program, and in this case would be considered restricted until the amounts are spent on the specific program or otherwise considered restricted until appropriated for expenditure by the nonprofit’s governing board.

One of the major changes to both governing law (UPMIFA vs UMIFA) and in the recent accounting update is the treatment of “underwater endowments”. Under UMIFA, there was a concept of the historical dollar value of an endowment consisting of the original gift plus any additions to the fund made by the donor, which constituted a floor that the value of the fund should not fall below. Regardless of interpretation, in practice the accounting guidance followed the prescription that the historic dollar value and recorded permanently restricted net asset was fixed. Therefore, any decrease in fair market value below this had to be covered by otherwise unrestricted net assets creating a loss in that column, assuming there was no temporarily restricted net assets on net appreciation of the fund that was unspent. UPMIFA eliminated the concept of historic dollar value and applied prudent man standards to how an endowment fund may be spent over time. As a result, the new accounting standards are a significant change that would treat a drop in fair market value of a restricted donor endowment as a loss in the donor restrictions column.

There are specific financial statement disclosures related to endowment funds as stated in the new standards ASU 2016-14, Not-for-Profit Entities: Presentation of Financial Statements of Not-for-Profit Entities. A nonprofit will disclose information to enable users of financial statements to understand all of the following about its endowment funds both donor-restricted and board-designated:

• Net asset classification such as net assets with donor restrictions or net assets without donor restrictions.
• Net asset composition such as board-designated endowment funds or donor-restricted endowment funds.
• Changes in net asset composition
• Spending policies
• Related investment policies

At a minimum, a nonprofit shall disclose all of the following information for each period that it presents financial statements:

• A description of the governing board’s interpretation of the laws that underlie the nonprofit’s net asset classification of donor-restricted endowment funds, including its interpretation of the ability to spend from underwater endowment funds.
  • A description of the nonprofit’s policy or policies for the appropriation of endowment assets for expenditure (its endowment spending policy or policies) including its policy and any actions taken during the period concerning appropriation from underwater endowment funds.
  • A description of the nonprofit’s endowment investment policies including their return objectives and risk parameters, how return objectives relate to the nonprofit’s endowment policy or policies and the strategy for achieving return objectives.
• The composition of the nonprofit’s endowment by net asset class at the end of the period, in total and by type of endowment fund, showing donor-restricted endowment funds separately from board-designated endowment funds.
• A reconciliation of the beginning and ending balance of the nonprofit’s endowment in total and by net asset class including, if applicable 1) investment return 2) contributions 3) amounts appropriated for expenditure that contain no purpose restrictions and other changes.

If a nonprofit is subject to a donor restriction or applicable law that its governing board interprets as requiring the maintenance of purchasing power for donor-restricted endowment funds, they should periodically adjust the disclosed amount that is required to be maintained either by the donor or by law.

Furthermore, for each period that a statement of financial position is presented, a nonprofit shall disclose each of the following, in the aggregate, for all underwater endowment funds:

• The fair value of the underwater endowment funds.
• The original endowment gift amount or level required to be maintained by donor stipulations or by law, which extends donor restrictions.
• The amount of the deficiencies of the underwater endowment funds.

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