Changing Times for Endowment Management

By R. Russell Coleman, Jr., Cherry, Bekaert & Holland, L.L.P. (CB&H)
Email: rcoleman@cbh.com

On August 6, 2008, the Financial Accounting Standards Board (FASB) issued new accounting and disclosure guidance intended to improve the quality and consistency of financial reporting for endowment funds held by not-for-profit organizations.

Background
The laws under which charitable organizations in most states manage endowment funds are modeled after the Uniform Management of Institutional Funds Act (UMIFA) of 1972. Drafted by the National Conference of Commissioners on Uniform State Laws (now know as the Uniform Law Commission or ULC), UMIFA was intended to provide guidelines to institutional managers in the management of donor-restricted funds. There was also a need at the time to address a lack of legal guidance applicable to the management of institutional funds.

Acts of the ULC are not binding for each state until that state’s respective legislature enacts a version of the uniform law. In addition, most acts of the ULC provide for some variation or options within the act itself. UMIFA did not receive immediate acceptance by state legislatures, and many states did not enact a version for over 20 years. However, by 1996, 46 states and the District of Columbia had enacted a version.

The Financial Accounting Standards Board (FASB) also issued Statements of Financial Accounting Standards (SFAS) Nos. 116 and 117 at about this same time, followed shortly thereafter by SFAS No. 124. Combined with UMIFA, these accounting pronouncements have guided the manner in which not-for-profit organizations have accepted donor-restricted endowment contributions for the last 12 years.

The financial and investment markets have changed significantly during that time, and the types of investment vehicles and the strategies used by managers have also changed. As with many laws, UMIFA contained provisions that no longer fit the objectives of the institutional managers or provided adequate guidance to protect the intentions of the donors.

In response to changing times, the ULC developed and passed the Uniform Prudent Management of Institutional Fund Act (UPMIFA) in July 2006. With a wider scope than UMIFA, UPMIFA addresses investment and expenditure of funds accumulated and streamlines the process of dealing with an obsolete charitable purpose. UPMIFA has received wide support, and is being enacted by the states much faster than UMIFA. Currently, 24 states, including Virginia, West Virginia, Georgia, South Carolina, Tennessee and Alabama, plus the District of Columbia, have enacted a version of UPMIFA and eight more states, including Maryland and Mississippi, have introduced legislation to do so.

FASB Staff Position 117-1
UPMIFA presented the differences between the legal guidance for management of institutional funds and accounting and disclosure guidance under generally accepted accounting principles. In response, FASB recently issued FASB Staff Position 117-1, Endowments of Not-for-Profit Organizations: Net Asset Classification of Funds Subject to an Enacted Version of the Prudent Management of Institutional Funds Act, and Enhanced Disclosures for All Endowment Funds (FSP 117-1). FSP 117-1’s enhanced disclosure requirements are effective for years ending after December 15, 2008. However, the net asset classification of donor-restricted endowment funds and the related accumulated investment return are not affected until the after the effective date of enacting legislation in the relevant state.

The enhanced disclosure requirements of FSP 117-1 apply to both the legally defined endowment funds and all quasi-endowment funds. These disclosures are designed to help a reader of financial statements understand the classification and composition of net assets. In addition, the disclosures provide information on investment and spending policies and the governing board’s interpretation of the applicable state law governing endowment management. The required disclosures are as follows:

1. A description of the governing board’s underlying legal interpretation that determines how the organization classifies donor-restricted endowment funds
2. A description of the organization’s policies governing appropriation of endowment assets for expenditure
3. A description of the organization’s endowment investment policies (This must include the organization’s return objectives and risk parameters and how these objectives relate to spending policy, as well as the strategies used to achieve those objectives.)
4. The composition of the organization’s endowment by net asset classification at the end of the period, in total and by type of fund, showing donor-restricted and board-designated funds separately
5. A reconciliation of the beginning and the ending balances for the period, by net asset classification, showing, at a minimum, investment income, realized and unrealized gains and losses, contributions, amounts appropriated for expenditure, reclassifications and other changes
6. The nature and types of temporary and permanent restrictions
7. The aggregate amount of deficiencies for all donor-restricted endowment funds for which the fair value of assets at the end of the period is less the donor stipulated amount or the amount required by law

The changes to net asset classification required by FSP 117-1 will become effective in the year in which the relevant state enacts a version of UPMIFA. There may be interpretational differences from state to state regarding the classification between temporarily and permanently restricted net assets. Consequently, the accounting treatment may differ depending on whether the state adopts UPMIFA in whole or in part, and the interpretation by each state’s attorney general.

For example, based on a state’s interpretation of provisions in UPMIFA related to the preservation and duration of the funds, a not-for-profit organization may be restricted from spending a portion of the appreciation of the endowment. Institutions in all states should expect a change in the classification of accumulated appreciation related to the temporarily restricted component of the funds.

FASB has concluded that the appropriation provisions of UPMIFA extend a time restriction on accumulated appreciation of funds until the governing body appropriates the funds for expenditure. This is a reversal of the position taken by the FASB with regards to accumulated appreciation. It is expected that, upon implementation of this part of FSP 117-1, there will be a reclassification of unrestricted net assets to temporarily restricted net assets for a portion of the accumulated appreciation as a result. Accordingly, a careful analysis of the respective state’s enacted version of UPMIFA will be required.

Conclusion
UPMIFA and FSP 117-1 present significant changes in endowment management and accounting. These changes will permit management to manage endowment funds more consistent with a donor’s intent and the mission of the institution. The accounting and reporting changes will more clearly reflect the activities of all endowment funds and the institution’s policies and practices to meet the intentions of donors and serve the community in which it operates.

Please do not hesitate to contact your not-for-profit and tax specialists for further information and guidance on the implementation of FSP 117-1, and any questions you may have regarding the accounting application of UPMIFA.

Russell is a Partner with CB&H and Director of the Firm’s College & University Industry Group.