Big Changes Coming for Financial Reporting of Not-for-Profit Organizations – Part 4: Accounting and Disclosures for Underwater Endowment Funds

Posted on Oct 17, 2016

By Andrew Prather, CPA

Recap

On August 18, 2016, the FASB issued Accounting Standards Update (ASU) No. 2016-14 “Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities.”  ASU 2016-14 requires a number of changes to the financial statements of NFPs.  These changes will be effective for fiscal years beginning on or after December 15, 2017.

This article is the fourth in a series discussing the changes required by ASU 2016-14.  In this article, we discuss new accounting and disclosure requirements for underwater endowment funds. 

Background

Endowments are established funds of cash, securities, or other assets to provide income for an NFP.  Endowment funds are generally established by gifts that are restricted by the donors.  Donors may restrict the endowment in perpetuity to provide a permanent source of income for the NFP, or they may restrict the endowment for only a specified time period.

Depending on the restrictions from the donor, an endowment fund may be created by a gift from a single donor or it may be created by combining the gifts of many donors that have the same restrictions on investment and use of income.  Either way, it is important for NFPs to keep track of each endowment fund individually – the assets and net assets — in order to carry out the NFPs obligation to use the endowed funds in accordance with the donor-imposed restrictions.

The FASB’s new standard for NFPs (ASU 2016-14) includes new accounting and disclosure requirements for endowment funds that are “underwater”.

What is an “Underwater” Endowment Fund?

The FASB defines an “underwater” endowment fund as follows:

A donor-restricted endowment fund for which the fair value of the fund at the reporting date is less than either the original gift amount or the amount required to be maintained by the donor or by law that extends donor restrictions.

The key points from this definition are as follows:

  • Applies only to donor-restricted endowment funds – Some NFPs establish board-designated endowment funds, sometimes referred to as “quasi-endowment funds”. The FASB’s definition does not include these quasi-endowment funds in the scope of the accounting and disclosure requirements for underwater endowment funds; the requirements only apply to donor-restricted endowment funds.
  • Asset fair value is less than donor/legal required amount – Endowment funds are generally invested in cash, securities, and/or other assets. These investments will fluctuate in value over time. An endowment fund is “underwater” when the fair value of the investment assets are less than the amount required to be maintained by the donor or by law.

Why Do Endowment Funds Go Underwater?

Endowment funds generally go underwater due to declines in the fair values of the investment assets and/or appropriations out of the funds that exceeds investment returns.

Most NFPs have endowment investment and spending policies that retain some investment return each year to provide a “cushion” for the routine ups and downs of market values.  However, significant declines in investment market values can cause the endowment investment’s fair value to drop, putting the endowment fund into an “underwater” position.

Additionally, some NFPs appropriate funds out of endowments over and above the amount of investment returns.  When this occurs, the endowment fund could go into an “underwater” position.  NFPs that are contemplating appropriating more than the investment return should consult the endowment donor gift instrument, the NFP’s endowment investment and spending policy, and the applicable state version of the Uniform Prudent Management of Institutional Funds Act (UPMIFA) to determine the allowability and prudence of such appropriations.

What is the New Accounting Requirement?

The FASB currently requires NFPs to report the underwater portion of an endowment fund in unrestricted net assets; that is, the deficit between asset fair value and the original gift (or other required amount) is a negative amount in unrestricted net assets.

With the issuance of ASU 2016-14, the FASB will now require the entire net balance of an underwater endowment fund, both the original gift (or other required amount) and the deficit, be accounted for within the “net assets with donor restrictions” class of net assets.

What are the New Disclosure Requirements?

The new ASU also includes more disclosures required when an NFP has an underwater endowment fund.  The NFP must disclose:

  • The NFP’s interpretation of the ability to spend from underwater endowment funds.
  • The NFP’s policy, and any actions taken during the period, concerning appropriation from underwater endowment funds.
  • For each period a statement of financial position is presented, each of the following, in the aggregate, for all underwater endowment funds must be disclosed:

1.The fair value of the underwater endowment funds,
2. The original endowment gift amount or level required to be maintained by donor stipulations or by law that extends donor restrictions, and
3. The amount of the deficiencies of the underwater endowment funds (1. less 2.)

Want to Learn More?

This article focuses on one of the key changes required by ASU 2016-14.  In future articles we will discuss other key changes in more detail along with practical guidance on implementation issues.  In the meantime, please contact your Clark Nuber service team or Andrew Prather if you would like to discuss how these changes will impact your NFP’s financial statements.

© Clark Nuber PS and Developing News, 2016. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to Clark Nuber PS and Developing News with appropriate and specific direction to the original content.

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