While many not-for-profits may consider it a luxury to have an endowment, the accounting aspects of dealing with one can be burdensome, particularly when it’s “underwater.” And while Accounting Standards Update (ASU) 2016-14, effective for fiscal years beginning after December 15, 2017, will help simplify that reporting, the classification of underwater endowments will still need to be addressed appropriately under the new rules.
 
In the context of this discussion, we are only addressing true endowments, not board-designated endowments. A true endowment is a gift in which a donor has instructed the not-for-profit to keep the principal in perpetuity and invest the gift for the purpose of producing present and future income. An endowment is underwater when the invested assets are less than the original amount of the gift, which typically occurs because of investment losses, poor spending policies or a combination of both. 

Classifying Underwater Endowments Under Prior GAAP

While recording the debits and credits for endowment activity is straight forward, the classification of net assets related to endowments can be tricky. Before ASU 2016-14 went into effect this year, not-for-profits had to determine which parts of the endowment to classify into which category:  permanently restricted, temporarily restricted and potentially unrestricted net assets.
 
Under prior GAAP, the portion of the endowment classified as permanently restricted will always be the original amount of the donor’s gift. As the gift is invested and begins to appreciate in value, that appreciated value was typically shown as temporarily restricted. This is because most endowments permit the spending of gift appreciation, either for general use or for a particular purpose, such as scholarships, program activity or research. These temporarily restricted amounts would then be appropriated for spending by a designated group within the organization, and those approved amounts would be removed from temporarily restricted net assets.
 
In a situation where investment losses or spending have reduced the invested assets below the amount of the original gift, becoming an underwater endowment, the difference would be shown in unrestricted net assets as a negative amount. 

New GAAP, New Disclosures

Under ASU 2016-14, now in effect for 2018 calendar year-ends, or “new GAAP,” the three net asset classes noted above will change to either net assets “with donor restrictions” or net assets “without donor restrictions.” One of the changes under ASU 2016-14 is that all endowments — whether underwater or not — will always be classified as with donor restrictions.
 
Read more about ASU 2016-14 in “ASU 2016-14 – Part I: Five Areas of NFP Financial Reporting That Will Be Impacted.”
 
While these new classifications will make the accounting easier to manage, there are a few new disclosure requirements to note. Namely, not-for-profits will need to disclose: 

• Their organization’s ability to spend from underwater endowments,
• Policies around appropriations from underwater endowments, and
• The fair value of underwater endowment funds and the original gifts required to be maintained by donor stipulations. 

To fulfill these requirements, a couple best practices of endowment reporting include the following: 

• If the endowment’s net assets are co-mingled with other investments, then the organization should track investment activity and spending separately to allow for the above reporting requirements.
• Not-for-profit management and boards should insure they are familiar with the requirements of their state’s enacted version of the Uniform Prudent Management of Institutional Funds Act (UPMIFA), which represents the state’s laws over management of endowments. 
• Every not-for-profit should have an UPMIFA compliant investment policy in place surrounding any endowments. That document should cover investment goals/metrics, spending policies (including policies for when an endowment is underwater) and the organization’s interpretation of applicable laws, such as UPMIFA. This policy will help in determining the proper treatment of endowments and help preserve the endowment for years to come in line with the donor’s stipulation. 

The new regulations will help simplify a portion of the accounting requirements for underwater endowments. However, putting the right policies and procedures in place will help ensure these funding sources are accounted for accurately. 

Please contact a member of your service team, or contact Brian Fiedler at bfiedler@cohencpa.com for further discussion.

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Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.