FASB’s Accounting Standards Update 2016-14 will be effective for calendar year-end entities in 2018 and fiscal year-end entities in 2019. Non-profit organizations will see changes in how they must present net assets on their statement of financial position. An important area of change will be the presentation and disclosure of underwater endowments.
Endowments are established funds of cash, securities, or other assets to provide on-going income for a non-profit organization. Endowment funds are generally established by gifts that are restricted by the donors. Donors may restrict an endowment in perpetuity to provide a permanent source of income for the non-profit, or they may restrict an endowment for only a specified time period. Income generated from endowment funds can either be with restriction (to be used for a specific purpose, such as scholarships) or without restriction. However, when an endowment fund falls below the original value restricted by the donor, it becomes an “underwater” endowment.
According to FASB, an underwater endowment fund is defined as: “A donor-restricted fund for which the fair value of the fund at the reporting date is less than either the original gift amount or the amount required to be maintained by the donor or by law that extends donor restrictions.” Additionally, it should be noted that underwater endowments only apply to donor-restricted endowment funds. FASB’s requirements for underwater endowment funds do not apply to board designated endowment funds or “quasi-endowment funds.”
To explain the new changes for underwater endowments, we also need to clarify a change to the classification of net assets on the financial statements. With ASU 2016-14, net assets will be classified under two types; with donor restriction and without donor restriction. Temporarily restricted and permanently restricted net assets will no longer be presented on the financial statements. They are now classified as “net assets with donor restriction.” Unrestricted net assets, including Board designated funds, are now classified as “net assets without donor restriction.”
The presentation of underwater endowments will be as follows: the original amount of the endowment and the amount the endowment is underwater (deficiency) will both be included in net assets with donor restriction. In the past, the unrestricted net assets bore the risk of endowment losses.
Under the new standards, there are four disclosures that must be included in the notes to the financial statements for underwater endowments:
- The fair value of the underwater endowment funds.
- The original gift amount of the endowment or level required to be maintained by donor stipulations or by law.
- The aggregate amount that endowment funds are underwater (deficiencies).
- Any governing board policy or decisions to spend, or not spend, from such funds.
The problem for organizations with underwater endowments is the classification of the net assets, as with or without restriction requires retroactive treatment of any previous losses. In other words, you would need to analyze the history of your endowments to ensure that they are properly valued as previous losses on endowments went to assets without restrictions and the new ASU requires the restatement of net assets to reflect the historical investment results as part of the endowment.
James Laino, CPA
James is a member of Cerini & Associates’ senior audit staff where he works with our education and school district clients. James conducts claims audits at various school districts on Long Island.