Not-for-Profit Endowment Accounting: UPMIFA and Net Asset Classification
Understand endowment accounting for not-for-profit organizations on the CPA FAR exam. Covers donor restrictions, UPMIFA, underwater endowments, and net asset classification with practical examples.
Endowment Fundamentals for NFPs
Endowments are a critical topic for not-for-profit (NFP) accounting on the CPA FAR exam. An endowment is a fund in which the donor stipulates that the principal be maintained either permanently or for a specified period, with investment returns used for a designated purpose. Understanding how endowments are classified, invested, and reported requires knowledge of both accounting standards (ASC 958) and the Uniform Prudent Management of Institutional Funds Act (UPMIFA), which governs spending decisions.
Types of Endowments
Donor-Restricted (True) Endowments
A true endowment arises when a donor stipulates that the gift be held permanently or for a specified period. The original gift amount is classified as net assets with donor restrictions. These restrictions never expire as long as the endowment exists (permanent restrictions under legacy terminology). Investment returns on the endowment may be unrestricted or restricted depending on donor stipulations.
Term Endowments
A term endowment requires the principal to be maintained for a specified time period or until a specific event occurs. Once the time or event condition is met, the funds become available for spending and are reclassified.
Board-Designated (Quasi) Endowments
These are funds that the organization's governing board has designated to function as an endowment. Because the restriction is internal rather than donor-imposed, these funds are classified as net assets without donor restrictions. The board can reverse its designation at any time.
Net Asset Classification of Endowment Activity
Example: Initial Gift and Investment Returns
A university receives a $1,000,000 cash gift with donor stipulations that the principal be held in perpetuity and investment income be used for scholarships.
Initial recording:
- Debit: Cash $1,000,000
- Credit: Contributions - With Donor Restrictions $1,000,000
Year 1: The endowment earns $60,000 in interest and dividends and $40,000 in unrealized gains, totaling $100,000 in investment return. Since the donor restricted income to scholarships, the returns are initially with donor restrictions:
- Debit: Investments $100,000
- Credit: Investment Return - With Donor Restrictions $100,000
When $50,000 is spent on scholarships, the purpose restriction is satisfied:
- Debit: Net Assets Released from Restrictions $50,000
- Credit: Net Assets With Donor Restrictions $50,000
- Debit: Scholarship Expense $50,000
- Credit: Cash $50,000
UPMIFA and Spending Policies
UPMIFA, adopted by most states, provides guidance on how much an NFP may prudently spend from an endowment fund. UPMIFA replaced the historical dollar value maintenance concept with a prudence standard. Rather than requiring that spending never reduce the fund below the original gift amount, UPMIFA allows the governing board to spend amounts it deems prudent, considering factors such as the duration and preservation of the fund, the purposes of the organization, general economic conditions, the effect of inflation or deflation, the expected total return from income and appreciation, other resources of the organization, and the investment policy.
Most organizations adopt a spending rate policy, commonly 4% to 5% of a rolling average of the endowment's market value over the preceding 12 to 20 quarters. This smoothing mechanism reduces the impact of market volatility on annual spending.
Underwater Endowments
An endowment is considered underwater when its fair value falls below the original gift amount (or the amount required to be maintained by donor stipulation or law). Under ASU 2016-14, NFPs must disclose the aggregate fair value of underwater endowments, the original endowment gift amounts, and the aggregate amount by which they are underwater.
Example
An endowment was established with a $500,000 gift. Due to market losses and spending, the fair value is now $460,000. The endowment is underwater by $40,000. This $40,000 is reported as a reduction of net assets with donor restrictions. The NFP does not reclassify any portion to net assets without donor restrictions. Under UPMIFA, the organization may still spend from the fund if it is prudent to do so, though many boards adopt a policy of reduced or suspended spending for underwater endowments.
Investment Return Reporting
ASU 2016-14 requires NFPs to report investment return net of external and direct internal investment expenses on the statement of activities. The components of investment return (interest, dividends, realized gains and losses, unrealized gains and losses) may be presented separately or in a single line item. Investment return is classified based on the existence and nature of donor restrictions on the endowment and its income.
Key Exam Tips
- Donor-restricted endowments are classified as net assets with donor restrictions; board-designated endowments are without donor restrictions.
- Investment returns on endowments are classified based on donor stipulations about the use of income.
- Underwater endowments reduce net assets with donor restrictions and require specific disclosures.
- UPMIFA uses a prudence standard, not a strict historical dollar value maintenance requirement.
- Know the difference between permanent and term endowments and how net asset reclassification works when restrictions are satisfied.
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