Not-for-Profit Endowment Accounting: A Guide to Effective Fund Management

HOST: Welcome and thanks for listening to Cherry Bekaert's not-for-profit podcast series. In each episode, we hear from the best in the business on the latest challenges, trends, and opportunities affecting not-for-profit organizations and educational institutions. I hope you enjoy and thanks for listening.

JASON STURDIVANT: Welcome everyone to another not-for-profit podcast in Cherry Bekaert's not-for-profit industry podcast series. My name is Jason Sturdivant. I'm a senior manager in Cherry Bekaert's CFO advisory services, working exclusively with not-for-profit organizations.

JASON STURDIVANT: I've been working with not-for-profits in various capacities, including as an auditor and now as a consultant with Cherry Bekaert. Joining me today is Blakeley Richard. Blakeley.

BLAKELEY RICHARD: Hi. My name is Blakeley. I'm also a prior auditor who works alongside Jason within our GPS advisory group that works specifically in not-for-profits. That ranges from K–12s, private colleges and universities, religious organizations, and various other entity types.

JASON STURDIVANT: Today's topic, which is particularly significant for many of those organizations you mentioned, is endowments. To set the table, Blakeley, when we say endowments, what are we really talking about? Is it just a big pot of money for operating reserves or something else?

BLAKELEY RICHARD: Not quite. An endowment is more of a long-term investment fund with a purpose, and it is wrapped in restrictions and expectations. The purpose of an endowment is that a donor gives an organization money to be invested to earn money that can then be used for that specific purpose or the donor's intention.

JASON STURDIVANT: So endowments can be used for operating purposes to support an organization overall, but often they are for more specific purposes than that. They may fund particular programs that are not the organization's general mission. I think the best thing to do is start with some definitions.

BLAKELEY RICHARD: We'll use a lot of terms throughout this podcast, so we want to go over some quick ones. If there are any other terms we use during the podcast that anyone has questions about, don't hesitate to reach out.

BLAKELEY RICHARD: Corpus is the original gift that comes from a donor and is supposed to be held in perpetuity as permanently restricted. It is the value that is invested to generate earnings. Earnings are the returns that the investment produces over time, whether a high return or a low return depending on how it is invested.

BLAKELEY RICHARD: I'll also talk about unitization and allocation. Unitization is where you take those earnings and allocate them across the different funds. We will use the term funds during this podcast to refer to the donor's intended purpose, such as a scholarship fund, and that's where you will unitize earnings.

BLAKELEY RICHARD: We will also refer to different restrictions: unrestricted, temporarily restricted, purpose restricted, board designated, and permanently restricted. Endowments are mostly perpetual in nature and permanently restricted or temporarily restricted. Perpetual in nature refers to the corpus, which is also known as permanently restricted. Purpose restricted is a type of temporarily restricted fund; it is restricted to a purpose but not held in perpetuity.

BLAKELEY RICHARD: Board designated funds are those given to the board to designate spending. The key difference is board designation versus donor designation. The donor creates the purpose for the funds, whereas board designation is where the board directs how the funds are used.

BLAKELEY RICHARD: An endowment pool is when you invest multiple corpuses and gifts into one investment account. It might include endowment money, scholarship gifts, or gifts for events, all pooled into the same investment account. The earnings accrue to the pool, and then unitization is used to allocate those earnings across the individual funds.

BLAKELEY RICHARD: The last thing I'll define is spend policy. A spend policy is a guideline, often set by the donor or organization, that specifies how much can be spent from earnings each year—for example, 4% annually. Not all endowments have a spend policy, but many large endowments do.

JASON STURDIVANT: There are a lot of definitions, which means there can be a lot of potential confusion. Let's talk about some misconceptions. What's one thing that accountants usually get wrong with endowment accounting?

BLAKELEY RICHARD: It's not just accountants; many people misunderstand endowments because of the nuance. If you don't know what you mean by corpus, earnings, or spending policy, you can go down the wrong path. One common misconception is that organizations can use endowments for whatever they want, as if it is free money. The biggest challenge organizations face is adequately tracking restricted funds.

BLAKELEY RICHARD: When we talk about a restricted endowment, there's the corpus and then the earnings. Organizations need to ensure they are restricting the corpus as permanently restricted, held in perpetuity. When you unitize earnings monthly, quarterly, or annually, you must allocate those earnings to the appropriate purpose restriction.

BLAKELEY RICHARD: The key distinction is between temporarily restricted or purpose restricted funds and permanently restricted, perpetual funds. You cannot spend the corpus that is held in perpetuity; you use the earnings for the donor's specified purpose.

JASON STURDIVANT: Let's talk a bit more about donor intent. When a donor gives money and specifies donor intent, what does that mean?

BLAKELEY RICHARD: Donor intent defines the restrictions: what you can and cannot do with the endowed gift. Donor intent is the last word on what restrictions apply. It's important to document and track donor intent throughout the life of an endowment, since many endowments are intended to fund organizations in perpetuity.

BLAKELEY RICHARD: Donor intent also governs how much of the earnings may be spent in any given year. Organizations can renegotiate donor intent with living donors or trustees, but if you don't document the original intent or any changes, you will be lost and stuck regarding how to track and manage the endowment.

JASON STURDIVANT: Given the complexity, how can accounting for endowments go sideways? What messy situations have you seen?

BLAKELEY RICHARD: I've seen issues at multiple points in the timeline. One major point is investment accounting. If investment accounting is messy or delayed, that will affect endowment accounting. Some organizations wait until year-end to record investment activity, creating a large pool of earnings that must then be unitized across funds.

BLAKELEY RICHARD: Unitization itself can go wrong. There are software solutions that handle unitization, but many organizations use Excel. If you don't have a good template or if you perform unitization only at year-end, allocation for gifts received midyear can be inaccurate.

BLAKELEY RICHARD: Restriction classifications can be incorrect. If you misclassify endowment funds between perpetual in nature and purpose restricted, you may inappropriately restrict or allow spending. Accurate restriction accounting in your software is essential.

BLAKELEY RICHARD: Donor intent again matters. If you don't track donor intent or obtain the right information from the donor, you might overrelease or underrelease funds when attempting to make releases.

BLAKELEY RICHARD: Fund accounting is critical. Even if funds are part of a larger endowment pool, you must track each fund individually to know the corpus, the earnings, what you can spend, when you can release it, and how much you can release in a given year.

JASON STURDIVANT: We also see organizations struggle with underwater endowments. What does that mean?

BLAKELEY RICHARD: An underwater endowment occurs when the market value of a fund drops below the original gift or corpus value. There are rules about when you can spend in those situations.

JASON STURDIVANT: With underwater endowments, donor intent matters first. Some donors explicitly allow spending of corpus in the original gift, which is rare. Organizational spending policy should guide what to do when funds are underwater. Spending part of the corpus without adequate earnings to replenish it can leave the fund below its original value.

JASON STURDIVANT: If a fund is underwater, it must be made whole by pulling funds from somewhere else, often operating funds. A fund that remains underwater for multiple years can raise compliance and regulatory concerns.

BLAKELEY RICHARD: Why does endowment accounting matter? What's at stake when it goes wrong?

JASON STURDIVANT: Endowments are about trust. Donors trust organizations with their gifts. Beneficiaries, such as students relying on scholarship endowments or faculty supported by endowed chairs, depend on proper handling so that funding continues in perpetuity. Internal departments may rely on endowment earnings for operations.

JASON STURDIVANT: Public trust is also at stake. Missteps with endowments can damage reputations and lead to serious legal trouble. Mismanagement can also affect future fundraising if donors lose confidence that their gifts will be used as intended.

BLAKELEY RICHARD: Mismanagement can impact budgeting. If you count on endowment earnings to fund programs or overhead, you need to know how much is available. Poor management can undercut an organization's long-term sustainability.

JASON STURDIVANT: Who is responsible for ensuring endowment accounting is done right—the CFO, the board, the finance team, the development team?

BLAKELEY RICHARD: Responsibility is shared. The finance team does the actual accounting, ensures restrictions are applied, and unitizes earnings. The development team handles donor relations and documentation of donor intent. The CFO oversees finance and development inputs, and the board has fiduciary responsibility to understand finances and ensure donor intent is met.

JASON STURDIVANT: If responsibility fails and someone drops the ball, serious consequences follow. There can be civil penalties if a donor alleges mismanagement, and individuals with fiduciary responsibility could face professional impacts, including effects on CPA licensure. In extreme cases of gross negligence or malfeasance, legal penalties could include fines or jail time.

JASON STURDIVANT: If oversight fails, remediation is costly in time and money. Fixing issues may require hiring staff, investing in software, or engaging consultants. The best time to have fixed it was yesterday; the next best time is today.

BLAKELEY RICHARD: If you are advising a not-for-profit, foundation, university, or other not-for-profit, what's your top tip for avoiding endowment accounting pitfalls?

JASON STURDIVANT: My top tip is to have a plan. Document donor intent, donor restrictions, spending policies, and related procedures. Be transparent and able to respond quickly if a donor asks about the impact of their endowed gift. Invest in tracking software if possible—many endowment systems are more affordable than organizations expect.

JASON STURDIVANT: Ensure your finance team and other parties, including the board and development team, understand the legal and GAAP nuances of endowment accounting. Having these elements in place helps avoid many of the issues we've discussed.

BLAKELEY RICHARD: Endowments are powerful when managed with care. When accounted for correctly, they support organizational sustainability; when mismanaged, they can cause significant damage to trust and operations.

JASON STURDIVANT: If your organization needs accounting assistance, the Cherry Bekaert advisory team can help with investment and endowment cleanup, audit preparation, roll-forward assistance, and template building.

JASON STURDIVANT: Thank you, Blakeley, for joining me today and sharing your insights and experiences.

BLAKELEY RICHARD: Thank you. It's been my pleasure.

JASON STURDIVANT: For not-for-profits that want to see how our not-for-profit accounting advisory team can help, visit cbh.com and search "NFP accounting as a service" or "NFP advisory" in the search bar, or reach out to our team via the links in the episode notes.

HOST: I hope you enjoyed this episode and look forward to our next one. Don't forget to subscribe.