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UPMIFA vs. FASB – Compatibility Issues

K.B. Parrish & Co. Certified Public Accountants. UPMIFA vs. FASB – Compatibility Issues. FASB FSP 117-1, UPMIFA and Community Foundations. Ryan W. Keith, CPA, K.B. Parrish & Co. LLP, rkeith@kbparrish.com. K.B. Parrish & Co. Certified Public Accountants. Agenda

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UPMIFA vs. FASB – Compatibility Issues

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  1. K.B. Parrish & Co. Certified Public Accountants UPMIFA vs. FASB – Compatibility Issues FASB FSP 117-1, UPMIFA and Community Foundations Ryan W. Keith, CPA, K.B. Parrish & Co. LLP, rkeith@kbparrish.com

  2. K.B. Parrish & Co.Certified Public Accountants • Agenda • Identification of endowment funds • Fund agreements and accounting treatment under the new accounting standards • Board interpretation of the UPMIFA law • Endowment fund accounting and related disclosures

  3. K.B. Parrish & Co.Certified Public Accountants • FSP 117-1 • Financial Accounting Standards Board Staff Position 117-1 • Issued August 6, 2008 • Effective for all fiscal years ending after December 15, 2008

  4. K.B. Parrish & Co.Certified Public Accountants • FSP 117-1 • Which funds does it impact? • Endowment funds • Identification of endowment funds (per FASB) • An established fund of cash, securities, or other assets to provide income for the maintenance of a not-for-profit organization. • The use of the assets of the fund may be permanently restricted, temporarily restricted, or unrestricted. • Generally established by donor-restricted gifts and bequests to provide a permanent endowment to provide a permanent source of income or a term endowment which is to provide income for a specified period.

  5. K.B. Parrish & Co.Certified Public Accountants • FSP 117-1 • Identification of endowment funds - continued • Portion that must be maintained permanently is classified as permanently restricted net assets • Portion of term endowment that must be maintained for a specified term is classified as temporarily restricted net assets

  6. K.B. Parrish & Co.Certified Public Accountants • FSP 117-1 • Identification of endowment funds - continued • Two types of endowment funds • Donor-restricted endowment funds • Endowed funds that are established by donor-restricted gifts for that purpose • Board-designated endowment funds • Earmarked by governing board to be invested to provide income for a long but unspecified period

  7. K.B. Parrish & Co.Certified Public Accountants • FSP 117-1 • Identification of endowment funds - continued • Definitions of endowment funds differ between FASB and UPMIFA • This allows for endowments that legally fail to meet the definition to be treated as endowments for accounting purposes under the FASB guidance

  8. K.B. Parrish & Co.Certified Public Accountants • FSP 117-1 • So what’s the problem? • There are inconsistencies between the UPMIFA and FSP 117-1 which make it very difficult to determine which funds are endowment funds and how those funds are to be treated • Subject to interpretation • Variance power issues

  9. K.B. Parrish & Co.Certified Public Accountants • FSP 117-1 • Fund Agreements • Common wording • “Distributions – the ordinary income, capital appreciation (realized and unrealized), and principal (both historic dollar value and any principal contributions, accumulations, additions, or reinvestments) allocable to the Fund, net of the fees and expenses set forth in this Agreement, may be committed, granted, or expended pursuant to the distribution (or spending) policy of the Community Foundation, as such policy ……………..

  10. K.B. Parrish & Co.Certified Public Accountants • FSP 117-1 • Fund Agreements • Common wording • “Continuity of the Fund – The Fund shall continue so long as assets are available in the Fund and the purposes of the Fund can be served by its continuation. If the Fund is terminated………..” • This language dictates that there isn’t a requirement from the donor for any component to be held in perpetuity, thus eliminating the permanently restricted component of the endowment fund • Basically, we are left a with temporarily restricted endowment, until appropriations exhaust the fund balance

  11. K.B. Parrish & Co.Certified Public Accountants • FSP 117-1 • Fund Agreements • Theory of an endowment is a fund not fully expendable on a current basis • Define “current basis” • Are there limits on what we can spend right now? • Look to spending policies, fund agreements, and organizing documents

  12. K.B. Parrish & Co.Certified Public Accountants • FSP 117-1 • Fund Agreements • Under UMIFA/UPMIFA, funds which are not wholly expendable on a current basis to be endowment funds and doesn’t include board designated assets • FSP 117-1, however, considers all funds that are maintained to preserve income to be endowment funds • Board interpretation and consistency is very important until further application guidance is available

  13. K.B. Parrish & Co.Certified Public Accountants • FSP 117-1 • Board interpretation of enacted law • Two interpretations available • Must maintain the “fair value” of the original gift absent donor stipulations to the contrary • Must preserve the “purchasing power” of the fund absent donor stipulations to the contrary • What’s the difference?

  14. K.B. Parrish & Co.Certified Public Accountants • FSP 117-1 • Difference between maintaining fair value and purchasing power • Fair value – permanent portion includes: • Original value of gifts donated to the permanent endowment • Original value of subsequent gifts • Accumulations made in accordance with the direction of applicable gift instrument

  15. K.B. Parrish & Co.Certified Public Accountants • FSP 117-1 • Difference between maintaining fair value and purchasing power (continued) • Purchasing power – permanent portion includes: • The same first three as the fair value treatment plus: • The portion of investment return added to the permanent endowment to maintain its purchasing power. • So how is this determined?

  16. K.B. Parrish & Co.Certified Public Accountants • FSP 117-1 • Difference between maintaining fair value and purchasing power (continued) • Purchasing power – investment return component: • Each year, the permanent portion of the endowment funds are increased by some measure of inflation • Consumer Price Index • Be consistent

  17. K.B. Parrish & Co.Certified Public Accountants • FSP 117-1 • Difference between maintaining fair value and purchasing power (continued) • The inflation rate increase comes from unrestricted net assets if the rate of return is less than the inflation adjustment • If the actual rate of return is greater than the inflation adjustment, the excess becomes available for appropriation and is classified as temporarily restricted net assets until appropriated

  18. K.B. Parrish & Co.Certified Public Accountants • FSP 117-1 • Difference between maintaining fair value and purchasing power (continued) • So how will your organization interpret the law? • Factors • Ease of implementation • True interpretation • Cost/benefit

  19. K.B. Parrish & Co.Certified Public Accountants • FSP 117-1 • Variance Power • How does this affect endowments? • Organizing documents or specific fund agreements often grant variance power • Does this variance power automatically make the fund unrestricted? • Not necessarily – case-by-case basis • Need to carefully examine wording to determine extent of power • Potentially an agency fund instead of net assets

  20. K.B. Parrish & Co.Certified Public Accountants So what do we do?

  21. K.B. Parrish & Co.Certified Public Accountants • Consult your attorney • Board interpretation • Be consistent • Continually evaluate documents, agreements and implementation • Watch for court cases! • The new guidance is so new, there isn’t much precedence at this point, but it’s coming.

  22. K.B. Parrish & Co.Certified Public Accountants • FSP 117-1 • Accounting treatment • Unrestricted, Temporarily Restricted or Permanently Restricted • Reclassifications • Financial statement disclosure

  23. K.B. Parrish & Co.Certified Public Accountants • Accounting treatment • Determining which of your funds are truly endowments • Donor-restricted endowments • Board-designated endowments

  24. K.B. Parrish & Co.Certified Public Accountants • Accounting treatment • Donor-restricted endowments • Unrestricted • Includes amounts not specifically dictated by donor as well as reductions in the endowment below the original principal • Temporarily restricted • Includes cumulative appreciation on the original principal of the endowment less appropriated expenditures and depreciation to the extent that the temporarily restricted portion is greater than zero • Permanently restricted • Includes the original principal of the endowment that must be retained permanently in accordance with explicit donor stipulations or the amount the governing board determines must be preserved in the absence or such stipulations consistent with the relevant state law

  25. K.B. Parrish & Co.Certified Public Accountants • Accounting treatment • Donor-restricted endowments (continued) • Investment losses • The application of FASB No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations is not changed by FSP 117-1 • Investment losses do not reduce the portion of the endowment fund classified as permanently restricted • At the point that investment losses have reduced the temporarily restricted endowment component to zero, any remaining losses are shown as a reduction to the unrestricted portion of the endowment fund

  26. K.B. Parrish & Co.Certified Public Accountants • Accounting treatment • Donor-restricted endowments (continued) • The portion of an endowment fund not classified as permanently restricted is classified as temporarily restricted net assets, until appropriated for expenditure • Appropriation • Deemed to occur upon approval for expenditure, unless approved for future period • Appropriation can occur as part of formal annual budget or specifically approved as needs arise

  27. K.B. Parrish & Co.Certified Public Accountants • Accounting treatment • Donor-restricted endowments (continued) • Appropriation (continued) • Absent a purpose restriction, appropriation eliminates time restriction and appropriated amount is reclassified to unrestricted net assets • For purpose restrictions not met, the appropriation is not reclassified as unrestricted net assets until met

  28. K.B. Parrish & Co.Certified Public Accountants • Accounting treatment • Board-designated endowments • The portion of an organization’s unrestricted net assets earmarked by the governing board to be invested to provide income for a long but unspecified period. • Not subject to UPMIFA • Internal designations are not restricted and are, therefore, classified as unrestricted net assets

  29. K.B. Parrish & Co.Certified Public Accountants • Accounting treatment • Board-designated endowments (continued) • Board-designated endowments are subject to the reporting disclosures required by FSP 117-1 • No reclassification between net asset classes is necessary as the funds are always a component of unrestricted • Shift from the endowment to non-endowment unrestricted operating assets

  30. K.B. Parrish & Co.Certified Public Accountants • Accounting treatment • Reclassifications • Under FAS116 – “If an expense is incurred for a purpose for which both unrestricted and temporarily restricted net assets are available, a donor-imposed restriction is fulfilled to the extent of the expense incurred unless the expense if for a purpose that is directly attributable to another specific external source of revenue.” • Any amounts previously determined to be available to meet a purpose restriction, but that haven’t been appropriated for expenditure are now considered unavailable until appropriated and the purpose restriction is reinstated

  31. K.B. Parrish & Co.Certified Public Accountants • Accounting treatment • Reclassifications • Net asset reclassifications in first year are cumulative change adjustments • Reported in separate line in statement of activities • Possible to have reclassification from unrestricted to temporarily restricted net assets in year of adoption

  32. K.B. Parrish & Co.Certified Public Accountants • Accounting treatment • Disclosures • Increased disclosure under FSP 117-1 regardless of enactment of state UPMIFA law • Applicable for all endowment types • Intention is to enable readers to understand the classification of net assets • Is it working? • Investment and spending policy information

  33. K.B. Parrish & Co.Certified Public Accountants • Accounting treatment • Disclosures (continued) • Board interpretation • Appropriation policies • Investment policies • Return objectives • Risk tolerance • Strategies • Relation to spending policy

  34. K.B. Parrish & Co.Certified Public Accountants • Accounting treatment • Disclosures (continued) • Composition of endowments by net asset class • Potential for disconnect • Historic Dollar Value for permanently restricted net assets, but not for endowment fund • Reconciliation, in total and by type, from beginning of year to end of year

  35. K.B. Parrish & Co.Certified Public Accountants • Accounting treatment • Disclosures (continued) • Continued disclosure of temporarily restricted and permanently restricted net assets as required by SFAS 117 • Fund deficiencies – “under water” funds

  36. K.B. Parrish & Co.Certified Public Accountants • Accounting treatment • Disclosures (continued) • Sample disclosure 2009 Endowment net asset composition by type of fund is as follows as of June 30, 2009: Temporarily Permanently Unrestricted Restricted Restricted Total Donor-restricted endowment funds $ (32,000) $ 520,000 $ 1,500,000 $ 1,988,000 Board-designated endowment funds 25,000 - - 25,000 Total funds $ (7,000) $ 520,000$ 1,500,000$ 2,013,000

  37. K.B. Parrish & Co.Certified Public Accountants • Accounting treatment • Disclosures (continued) 2009 Changes in endowment net assets are as follows for the year ended June 30: Temporarily Permanently Unrestricted Restricted Restricted Total Endowment net assets, beginning $ 1,000 $ 950,000 $ 1,380,000 $ 2,331,000 Investment return: Investment income 2,000 50,000 - 52,000 Net depreciation (10,000) (420,000) - (430,000) Total investment return (8,000) (370,000) - (378,000) Contributions - - 120,000 120,000 Appropriation of endowment assets for expenditure - (60,000) - (60,000) Total funds $ (7,000) $ 520,000$ 1,500,000$ 2,013,000

  38. K.B. Parrish & Co.Certified Public Accountants • Accounting treatment • Disclosures (continued) 2009 Permanently restricted net assets (1) The portion of perpetual endowment funds that is required to be retained permanently either by explicit donor stipulation or by UPMIFA $ 1,500,000 Total endowment funds classified as permanently restricted net assets $ 1,500,000 Temporarily restricted net assets (1) Term endowment funds $ 5,000 (2) The portion of perpetual endowment funds subject to a time restriction under UPMIFA: Without purpose restrictions 70,000 With purpose restrictions 445,000 Total endowment funds classified as temporarily restricted net assets $ 520,000

  39. K.B. Parrish & Co.Certified Public Accountants • Other Issues • What else does the UPMIFA law bring to the table? • Every organization subject to the new law must adopt a prudent spending policy • Investment policies become even more important as they, in conjunction with the spending policy, dictate the treatment of all endowment funds

  40. K.B. Parrish & Co.Certified Public Accountants • Other Issues • What else does the UPMIFA law bring to the table? • Per Indiana law – “In determining to appropriate or accumulate endowment funds, an institution shall (1) act in good faith and with the care of a prudent person acting in a like position would use under similar circumstances; and (2) consider the following factors: • Duration and preservation of the endowment fund • Purposes of the institution and the endowment fund • General economic conditions • Possible effects of inflation or deflation • Expected total return from income and the appreciation of investments • Other resources of the institution • The investment policy of the institution”

  41. K.B. Parrish & Co.Certified Public Accountants • Other Issues • What else does the UPMIFA law bring to the table? • What is prudent? • Needs to be determined by the governing board and adhered to. • UPMIFA allows for optional 7% provision that creates a presumption that expenditure appropriations in excess of 7% of the fair market value of an endowment fund is imprudent. • Indiana has not adopted this provision, however it does give a good reference point of “crossing the line”. • Less than 7% not necessarily prudent

  42. K.B. Parrish & Co.Certified Public Accountants • Other Issues • What else does the UPMIFA law bring to the table? • How does the thought of prudent spending apply to accounting theory? • Imprudent appropriations and expenditures generally are a reduction of unrestricted general operating assets. • You can spend it, but it isn’t coming from an endowment fund! • Besides the accounting treatment, other consideration should be given to what imprudent spending says about the organization as a whole.

  43. K.B. Parrish & Co.Certified Public Accountants • Questions??? • Ryan Keith, CPA K.B. Parrish & Co. LLP 6840 Eagle Highlands Way Indianapolis, IN 46254 (317) 347-5200

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