Endowments may seem intimidating, with complex rules, long-term commitments and high stakes. But when the right steps are taken, endowments can unlock powerful possibilities for not-for-profit and higher education organizations.
Endowments are a cornerstone of financial sustainability, providing perpetual funding for mission-critical programs and enabling long-term strategic planning. For nonprofit finance professionals, understanding the nuances of endowment accounting, governance, and best practices is essential to maintaining donor trust and regulatory compliance.
Understanding the Types of Endowments
Endowments come in several forms, each with distinct accounting and governance implications:
Donor-restricted Endowments
Donor-restricted endowments are established through gifts or bequests with stipulations, which typically require the principal (usually the original gift amount) to be maintained in perpetuity. The income or earnings generated may be used for specific purposes defined by the donor, or the income may be used to support general operations. It all comes down to donor intent.
Board-designated Endowments (Quasi-endowments)
These endowments are created when a nonprofit’s governing board earmarks a portion of net assets for long-term investment. These funds are not subject to donor restrictions and can be repurposed by board action. The funds could be established for things like a capital campaign, institutional scholarships or a strategic reserve for an upcoming initiative.
Both types of endowments have wide-ranging impacts. In higher education, they fund scholarships, faculty positions and research initiatives. In public charities, they can support programs like art conservation, staff development and community outreach, among a variety of other uses.
Net Asset Classification and Financial Reporting
Proper classification and reporting of endowed assets is essential for transparency, compliance and strategic financial management. Endowed funds, whether donor-restricted or board-designated, must be carefully tracked and disclosed in financial statements.
Donor-restricted Endowments
These are classified as net assets with donor restrictions. Within this category, organizations must distinguish between:
- Permanent Restrictions: The principal must be maintained in perpetuity
- Temporary Restrictions: Earnings may be restricted for specific purposes or time periods (Note: some earnings may be available within net assets without donor restrictions)
Financial reporting should include:
- A roll forward of beginning and ending endowment balances
- Contributions, investment returns, appropriations and other changes
- Disclosure of spending policies and how they align with donor intent
- Identification and disclosure of any underwater endowments
Board-designated (Quasi) Endowments
Board-designated endowments are classified as net assets without donor restrictions, since the board has discretion to redirect the funds. However, they should still be tracked separately to ensure clarity and accountability.
Reporting should include:
- Segregation of board-designated funds from other unrestricted net assets
- Documentation of board actions establishing or modifying designations
- Disclosure of investment and spending policies applicable to these funds
By clearly distinguishing between donor-restricted and board-designated endowments, organizations can provide stakeholders with a transparent view of how funds are managed and used, in alignment with both donor intent and strategic priorities.
UPMIFA: The Regulatory Backbone
The Uniform Prudent Management of Institutional Funds Act (UPMIFA), adopted in nearly every U.S. state, governs the management and investment of endowment funds. Key principles include:
- Prudent Spending: Balancing current needs with long-term preservation
- Preservation of Purchasing Power: Maintaining the real value of the endowment over time
- Oversight: Investment committees play a vital role in governance
- Annual Reporting: UPMIFA requires organizations with endowed gifts to submit annually to an independent audit
A notable UPMIFA concept is the treatment of underwater endowments — funds whose fair value falls below the original gift amount. These must be tracked at the fund level, with disclosures on their status and spending policies.
Managing Underwater Endowments
Underwater endowments require special attention and careful management. These situations often arise during market downturns or periods of poor investment performance.
What You Need To Know
- UPMIFA Guidance: Organizations are permitted to continue spending from underwater funds but must do so prudently and disclose the rationale
- Donor Communication: Transparency with donors about status and plans for recovery is essential to maintaining trust
How To Manage Them
- Track at the Fund Level: Maintain detailed records of original gift amounts, current fair value and spending activity
- Review Spending Policies: Consider temporarily reducing or suspending spending from underwater funds to preserve principal
- Engage Investment Committees: Reassess investment strategies and risk tolerance to support recovery
- Document Decisions: Ensure board and committee decisions regarding underwater funds are well-documented and align with UPMIFA
What To Report
- Disclosure in Financial Statements: Include the number of underwater funds, aggregate original gift amounts, current fair values and any spending from these funds
- Narrative Explanation: Describe the organization’s approach to managing underwater endowments, including any changes to spending policies
Proactive management and transparent reporting of underwater endowments demonstrate responsible stewardship and help preserve donor confidence.
Quick Guide To Managing Endowment Funds
To navigate the complexities of endowment accounting and uphold strong financial stewardship, consider the following.
- Develop Clear Investment Policy Statements: This means defining your organization’s asset allocation, risk tolerance and spending criteria.
- Coordinate With Fundraisers: Partner with development/advancement teams to ensure that gift acceptance policies, donor documentation and informational workflow support management of endowed funds.
- Maintain Robust Internal Controls: Ensure board and management oversight, enforce spending policies and communicate routinely with donors.
- Conduct Regular Reviews and Audits: At least annually, validate compliance and refine policies and procedures to ensure that your endowment management adheres to your organization's policies, mission and local regulations.
Tip: Consider implementing fund accounting software, endowment subledgers and donor management tools. These can make tracking simpler but also allow for reporting and analytics that enhance transparency and support strategic decision-making. Having a trusted advisor review your situation and the best tools to meet your needs is critical.
Common Pitfalls To Avoid When Managing Endowments
Even well-intentioned organizations can stumble when managing endowments. Here are some frequent missteps:
- Misclassifying Net Assets: Confusing donor-restricted and board-designated funds can lead to inaccurate reporting, or worse, misallocation of donor-restricted funds
- Neglecting Donor Intent: Failing to adhere to donor restrictions can damage trust and lead to legal consequences
- Overlooking UPMIFA Requirements: Not understanding state-specific regulations can result in noncompliance
- Inadequate Documentation: Missing or vague endowment agreements make it difficult to enforce spending policies
- Weak Internal Controls: Lack of oversight can lead to mismanagement or misuse of funds
- Poor Communication: Not keeping donors informed about fund performance and impact can hinder future giving
Endowment Readiness Checklist
Before launching or expanding an endowment, consider the following:
- Do you have a clear investment and spending policy?
- Are donor restrictions documented and understood?
- Is your accounting system equipped to track endowment funds?
- Have you established oversight through a finance or investment committee?
- Are internal controls in place to manage spending and reporting?
- Do you have a plan for communicating with donors and stakeholders?
- Have you reviewed UPMIFA requirements for your state?
Your Guide Forward
Managing endowments requires a thoughtful approach to compliance, transparency and long-term planning. Whether your organization is establishing its first endowment or optimizing existing funds, strong governance and sound accounting practices are key.
At Cherry Bekaert, we collaborate with nonprofit and higher education institutions to:
- Develop and refine investment and spending policies
- Implement tracking and reporting systems
- Address donor restrictions and underwater endowments
- Strengthen internal controls and governance through training and advisory support
Advance your mission with confidence and connect with our not-for-profit advisory team to learn more.
