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The Ins and Outs of Endowments

For nearly 35 years the Uniform Management of Institutional Fund Act (UMIFA) outlined the laws regarding the management and investment of institutional funds and permanent endowments in 47 states. In 2006, the Uniform Prudent Management of Institutional Funds Act (UPMIFA) was created. It has slowly been adopted by most states to provide guidance regarding endowments.

Although UPMIFA has been around for over half a decade, understanding and implementing its provisions have often proved challenging for nonprofit management and governing boards. This article outlines who is affected by UPMIFA, what UPMIFA does, and accounting and reporting requirements under it. If your organization already has an endowment or is thinking about establishing one, you need to take these factors into consideration.

What Is an Endowment?

An endowment comprises gifts that the donor requires to be invested in perpetuity or for a specific period of time. An endowment can also represent amounts segregated or designated by the governing board for a length of time to provide income for maintaining the nonprofit organization. Since board designations are voluntary and may be reversed at any time, an endowment established by a board is not considered restricted and is sometimes referred to as quasi-endowments.

Who Is Affected by UPMIFA?

UPMIFA applies to nonprofit charitable entities as well as all institutional funds, whether created before or after the enactment of the statute. UPMIFA sets standards for endowment spending and preservation of the original gift in accordance with donor intent.

Whether or not your organization is affected by UPMIFA, it will be affected by the technical guidance issued by the Financial Accounting Standards Board (FASB) in response to UPMIFA. FASB Accounting Standards Codification (ASC) 958-205 (formerly FSP FAS 117-1) was issued in August 2008 and is effective for fiscal years ending after December 15, 2008.

What UPMIFA Does

Building on the principles established by the previous guidelines (UMIFA), UPMIFA:

  • provides consistent investment and spending standards to all forms of charitable funds, excluding all trusts;
  • strengthens the concept of prudent investing by creating more exact rules for investing prudently;
  • abandons the use of historic dollar value (HDV) as a floor for spending and provides organizations with more flexibility in deciding whether to expend any portion of an endowment fund; and
  • provides a process for the release or modification of restrictions on a gift.

Accounting and Reporting Requirements

The elimination of the HDV concept increases an organization's ability to apply a total-return spending rate to its donor-restricted endowment funds. This new standard of prudence places responsibility on the organization's governing board when it comes to investing and spending policies.

Eliminating the HDV concept also helps alleviate short-term barriers to spending, such as poor market performance, in favor of a more long-term approach toward preserving the endowment. Spending policies affect endowment duration and performance and also the ability to fulfill gift intent. UPMIFA contains guidelines for governing boards to consider in establishing safe harbors for spending and investing.

UPMIFA mandates that earnings, unless otherwise instructed, be classified as donor restricted for legal purposes until they are appropriated for expenditure. Under UPMIFA, donor intent extends not just to the original gift but also to earnings on the related investments as well. Therefore, earnings are donor restricted until the governing board provides approval to use the funds.

The FASB decided to improve on the accounting and disclosures related to endowments. This subsequent guidance changes the accounting requirements to conform to UPMIFA with regard to the preservation of purchasing power and the classification of earnings. Additionally, this guidance requires that certain disclosures be included for all donor restricted and board designated endowments, regardless of whether UPMIFA affects them or not.

Nonprofits are also required to disclose a description of their governing board's interpretation of applicable law governing net asset classification for donor restricted endowments, endowment spending policies, and investment policies. The ultimate purpose of the enhanced disclosure requirements is to improve transparency, making underwater endowments more evident. (An underwater endowment is one whose fair market value is less than its historic dollar value.)

Investment losses associated with underwater endowments are to be recorded as temporarily or unrestricted activity and not as a decrease in the permanently restricted endowment.

Conclusion

The bottom line: handling your endowments correctly involves examining your gift documentation carefully, analyzing the donor's intent for each fund, and understanding current laws that apply to those funds in order to develop policies to preserve endowments. In short, when establishing or planning for an endowment, or quasi-endowment, management and the governing board must consider a variety of factors.

Lee T. Sullivan, CPA, CGMA, is a manager at Witt Mares, PLC and leads the firm's Not-For-Profit team. Witt Mares, PLC is a regional accounting and consulting firm serving clients throughout the Mid-Atlantic.

Topics: Fundraising
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