On August 6, 2008, the Financial Accounting Standards Board (FASB) issued FASB Staff Position No. 117-1 (FSP 117-1). This pronouncement clarifies various financial reporting matters related to donor-restricted endowments held by not-for-profit organizations operating in states that have enacted the Uniform Prudent Management of Institutional Funds Act of 2006. FSP 117-1 modifies the manner in which not-for-profit organizations determine permanently restricted, temporarily restricted, and unrestricted net assets resulting from their donor-restricted endowments, and requires additional financial statement disclosures. Accordingly, it is imperative that not-for-profit organizations familiarize themselves with the requirements of FSP 117-1 and take the action steps discussed at the conclusion of this article.
The Uniform Prudent Management of Institutional Funds Act
The Uniform Prudent Management of Institutional Funds Act of 2006 (UPMIFA) is a model act developed by the Uniform Law Commission which regulates the manner in which not-for-profit organizations invest and manage donor-restricted endowment funds. According to the UPMIFA’s website, as of April 15, 2009, 30 states and the District of Columbia have enacted the UPMIFA. Missouri House Bill 1055, which is currently under consideration by the Missouri State Legislature, would adopt UPMIFA for Missouri effective August 28, 2009. Illinois House Bill 0811, which proposes enactment of the UPMIFA, is currently being considered by the Illinois State Legislature. Kansas enacted the UPMIFA in 2007.
The UPMIFA is a revision of a 1972 model act entitled the Uniform Management of Institutional Funds Act (UMIFA), which was adopted by 46 states and the District of Columbia. Kansas and Illinois each adopted the UMIFA in 1973; Missouri enacted the UMIFA in 1976.
Historical Endowment Management Requirements (under the UMIFA)
Under the UMIFA, unless the donor’s gift instrument contained provisions to the contrary, not-for-profit organizations were required to retain and invest into perpetuity the “historic dollar value” of donor-restricted endowments. Essentially, the historic dollar value was defined as the original amount of the donor’s endowment gift plus any accumulated appreciation or income required by the gift instrument to be retained as part of the endowment corpus. Apart from this, not-for-profit organizations were permitted to spend both the income and the appreciation on donor-restricted endowments as they saw fit, unless the terms of the gift instrument specified otherwise.
The financial reporting treatment for donor-restricted endowments required by FASB Statement No. 117 (FASB 117) was derived from the requirements of the UMIFA. FASB 117 stated that the balance of donor-restricted endowments required by the gift instrument or state law to be invested into perpetuity was to be presented as permanently restricted net assets. Any appreciation and income on donor-restricted endowments were to be presented as increases in unrestricted net assets, unless the gift instrument imposed further time or purpose restrictions on their use.
New Endowment Management Requirements (under the UPMIFA)
The UPMIFA revises the requirements of the UMIFA in several significant ways. First, the UPMIFA abandons the historic dollar value approach for determining the balance of donor-restricted endowments that not-for-profits must invest into perpetuity. In its place, Section 4(a) of the UPMIFA establishes the “prudent person” standard, stating that “the institution shall act in good faith, with the care that an ordinarily prudent person in a like position would exercise under similar circumstances.” To assist in determining the corpus balance for a donor-restricted endowment fund, UPMIFA identifies seven factors that a not-for-profit organization should consider.
These factors are:
- the duration and preservation of the endowment fund;
- the purposes of the institution and the endowment fund;
- general economic conditions;
- the possible effect of inflation or deflation;
- the expected total return from income and appreciation of investments;
- other resources of the institution;
- and the investment policy of the institution.
The application of these factors might result in a larger or smaller balance of a donor-restricted endowment being invested into perpetuity than under the historic dollar value approach. UPMIFA also allows states, if they so choose, to incorporate a rebuttable presumption that the spending of more than seven percent of the fair market value of an endowment fund in a given year is imprudent.
Additionally, Section 4(a) of the UPMIFA provides that “unless stated otherwise in the gift instrument, the assets in an endowment fund are donor-restricted until appropriated for expenditure by the institution.” This means that the appreciation and income on a donor-restricted endowment may not immediately be expended by a not-for-profit organization as was previously the case. Instead, formal appropriation of these earnings by the institution must first take place. As was the case under the UMIFA, any provisions regarding the investment and expenditure of endowment funds contained in a donor’s gift agreement supersede the provisions of the UPMIFA.
Requirements of FSP 117-1
FSP 117-1 updates the requirements of FASB 117 to account for the provisions of the UPMIFA. Paragraph 5 of FSP 117-1 states that not-for-profit organizations operating in states where the UPMIFA has been enacted should record as permanently restricted net assets the portion of a donor-restricted endowment required to be invested into perpetuity by the gift agreement or by the UPMIFA. As stated above, the application of the seven factors enumerated by Section 4(a) of the UPMIFA may result in the permanently restricted net asset balance associated with a donor-restricted endowment being larger or smaller than was the case under the previous regulations.
Additionally, paragraph 8 of FSP 117-1 states that, when the provisions of UPMIFA are applicable to a not-for-profit organization, the appreciation and income on a donor-restricted endowment should be reported as temporarily restricted net assets until these funds are appropriated for expenditure by the organization. Appropriation for expenditure may occur as part of a formal, annual budget, or as a supplementary appropriation occurring when the need arises. Once appropriation has occurred, these temporarily restricted earnings should be released to unrestricted net assets. Finally, paragraph 11 of FSP 117-1 describes several additional footnote disclosures related to donor-restricted endowments that are applicable regardless of whether or not the not-for-profit organization is subject to the provisions of UPMIFA. The new disclosures required are:
- A description of the not-for-profit organization’s governing board’s interpretation of the law(s) that underlies the organization’s net asset classification of donor-restricted endowment funds;
- A description of the organization’s policy(ies) for the appropriation of endowment assets for expenditure;
- A description of the organization’s endowment investment policies, including the organization’s return objectives and risk parameters; how those objectives relate to the organization’s endowment spending policy(ies); and the strategies employed for achieving those objectives;
- The composition of the organization’s endowment by net asset class at the end of the period, in total and by type of endowment fund, showing donor-restricted endowment funds separately from board-designated endowment funds; and
- A reconciliation of the beginning and ending balance of the organization’s endowment, in total and by net asset class, including, at a minimum, the following line items (as applicable): investment return, separated into investment income (for example, interest, dividends, rents) and net appreciation or depreciation of investments; contributions; amounts appropriated for expenditure; reclassifications; and other changes.
FSP 117-1 also reminds not-for-profit organizations of two disclosure requirements of FASB Statements No. 117 and No. 124 that remain in effect. These are:
- The nature and types of permanent restrictions or temporary restrictions on net assets;
- The aggregate amount of the deficiencies for all donor-restricted endowment funds for which the fair value of the assets at the reporting date is less than the level required by donor stipulations or by law.
FSP 117-1 is effective for fiscal years ending after December 15, 2008.
Action Steps for Not-For-Profits
In order to comply with both the UPMIFA and FSP 117-1, not-for-profit organizations should take the following action steps:
- If the UPMIFA has not already been enacted in the state in which the not-for-profit organization operates, the organization should monitor the status of UPMIFA legislation within the state’s legislature. This may be done by checking the UPMIFA website, or by checking the website for the state legislature (Missouri; Illinois).
- The not-for-profit organization should review the gift agreements associated with each of its donor-restricted endowments, and document whether the agreements contain specific donor restrictions on the spending of the principal, appreciation, and/or income on these endowment funds. If the agreements do not contain restrictions over one or more of these components of donor-restricted endowment assets, the endowment spending restrictions of the UPMIFA (or existing state law) will be applicable.
- The not-for-profit organization’s governing board (working in conjunction with the organization’s legal counsel) should develop an interpretation of the UPMIFA’s endowment maintenance requirements as applied to the organization’s donor-restricted endowments, and the resulting balance of these endowments that the organization will be required to invest into perpetuity and report as permanently restricted net assets.
- The not-for-profit organization should adopt a formal policy for the appropriation of appreciation and income on donor-restricted endowments for expenditure. If the not-for-profit organization does not already budget for the expenditure of appreciation and income on donor-restricted endowments as part of the annual budget, the organization may wish to consider doing so.
- The not-for-profit organization should establish mechanisms to track and summarize the information necessary to prepare the new footnote disclosures required by FSP 117-1.
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