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9.10 Endowment funds
Publication date: 27 May 2020
us NFP guide
In large NFPs, e.g., universities, the majority of investments will typically be associated with the institution’s endowment funds. Endowment funds are defined in the ASC Master Glossary.
Endowment funds: An established fund of cash, securities, or other assets to provide income for the maintenance of a not-for-profit entity (NFP). The use of the assets of the fund may be with or without donor-imposed restrictions. Endowment funds generally are established by donor-restricted gifts and bequests to provide a source of income in perpetuity or for a specified period. See Donor-Restricted Endowment Fund. Alternatively, an NFP’s governing board may earmark a portion of its net assets as a Board-Designated Endowment Fund. See Funds Functioning as Endowment.
This section focuses on “true endowments,” which are endowments established by donor-restricted gifts to provide a source of income in perpetuity. Boards can also set aside an institution’s own funds to be invested, managed, and spent in a manner that resembles a true endowment. Board-designated endowments (sometimes called “quasi-endowments” or “funds functioning as endowments”) are discussed in NP 2.3.1.3.
True endowments arise when a donor makes a gift and requires that the gift be invested in perpetuity. Such gifts are pooled and invested to provide an ongoing source of cash flow to support the NFP’s operations. Endowments are typically invested with an objective of maximizing total return—that is, the highest combination of current income (for example, dividends and interest) and capital appreciation. Only a portion of the total return will be spent; the remainder will be reinvested to ensure that the endowment keeps pace with inflation.
Endowments give rise to questions about how the funds should be invested, how the accumulated fund should be displayed within net assets, and how much of the total return can be spent in a year in order to ensure it lasts in perpetuity. The general accounting and reporting requirements are codified in ASC 958-205-45-13 through ASC 958-205-45-13J and ASC 958-205-50-1A through ASC 958-205-50-2, and are illustrated in ASC 958-205-55-31 through ASC 958-205-55-52.
9.10.1 Uniform Prudent Management of Institutional Funds Act
The Uniform Prudent Management of Institutional Funds Act (UPMIFA) is a model rule setting out principles for the manner in which institutions should administer their endowments. Laws requiring application of UPMIFA principles have been enacted in most, but not all, states. The state laws provide guidance on the management and investment of charitable funds such as endowments. In addition, they guide board decision-making on how much of the total return should be distributed (that is, “appropriated for spending”) and how much should be reinvested to ensure that the fund will last in perpetuity.
A donor that makes a gift to create an endowment fund is instructing an NFP to invest the funds, spend the income therefrom, and preserve the principal for either a specified period or in perpetuity. An NFP must comply with a donor’s specific instructions set forth in the gift instrument with respect to spending vs. accumulation of the return on the invested funds (which includes net appreciation). If a donor's intent with respect to spending versus accumulation of the income is not clearly expressed, however, laws such as UPMIFA provide a "rule of construction" to guide an NFP's decision-making regarding distributions to be made from a donor-restricted fund under a total-return spending policy.
For accounting and financial reporting purposes, UPMIFA's standards governing expenditure from donor-restricted endowment funds in such cases are considered to be extensions of the donor's original instructions. Consequently, ASC 958-205-45-13D states that the original gift amount, any additional gifts to that fund, and any resulting investment returns must be reported as net assets with donor restrictions until appropriated for expenditure by the organization.
The requirement to classify investment return as net assets with donor restrictions until it is appropriated for spending results in an implied time restriction on that portion of the endowment. According to ASC 958-205-45-13E, the implied time restriction lapses only when and to the degree that a governing board appropriates an amount for expenditure from the fund after weighing the factors detailed in UPMIFA's “prudent spending” guidelines. If a donor-restricted endowment also carries a purpose restriction (that is, the return must be used for purposes stipulated by the donor), the implied time restriction must be met (through appropriation for spending) before the purpose restriction can be considered to be met in order to comply with the requirements of ASC 958-205-45-9 (discussed in NP 6.7.2) for reporting releases of restrictions when two or more restrictions have been imposed on a single gift.
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