An endowment fund is an established fund of cash, securities or other assets held to provide income for the maintenance of a not-for-profit entity, and the use of its assets may be with or without donor-imposed restrictions (FASB, Accounting Standards Update 2016-14, Master Glossary). Endowment funds are established either by a donor or by a governing board. That origin, rather than the size of the pool or the way it is invested, decides how the fund is classified and reported (FASB, Accounting Standards Update 2016-14, paragraph 958-205-45-13).
The Three Types, and What Separates Them
The federal return names all three in one place. Schedule D of Form 990 asks an organization to split its year-end endowment balance across board designated or quasi-endowment, permanent endowment, and term endowment, and the three estimated percentages should equal 100% (IRS, Schedule D (Form 990), Part V, line 2).
Permanent Endowment
A permanent endowment is established by donor-restricted gifts and maintained to provide a permanent source of income, with the stipulation that principal must be invested and kept intact in perpetuity while only the income generated can be used by the organization (IRS, Instructions for Schedule D (Form 990), Part V).
Term Endowment
A term endowment is also established by donor-restricted gifts, but it is maintained to provide a source of income for either a specified period of time or until a specific event occurs (IRS, Instructions for Schedule D (Form 990), Part V). Its restrictions are temporary in nature, so once the term is served the fund is no longer donor restricted and a reclassification of net assets is reported (FASB, Accounting Standards Update 2016-14, paragraph 958-205-45-10).
Board-Designated or Quasi-Endowment
A board-designated endowment fund is created when a governing board designates a portion of its net assets without donor restrictions to be invested, generally for a long but not necessarily specified period, and it is sometimes called funds functioning as endowment or a quasi-endowment (FASB, Accounting Standards Update 2016-14, Master Glossary). Because a board designation is internal rather than donor-imposed, the governing board has the right to decide at any time to expend the principal of such funds (FASB, Accounting Standards Update 2016-14, Master Glossary). In rare circumstances a board-designated endowment fund can also include a portion of net assets with donor restrictions, for example where a not-for-profit cannot spend donor-restricted contributions in the near term and the board considers investing them long term (FASB, Accounting Standards Update 2016-14, paragraph 958-205-45-13A).
Where a CPA Firm Meets an Endowment Fund
Form 990 Part IV line 10 asks whether the organization, directly or through a related organization, held assets in donor-restricted endowments or in quasi-endowments, and a yes answer requires Schedule D Part V (IRS, Form 990).
Part V is a rollforward across five columns, running from the current year back four years. It carries the endowment from its beginning-of-year balance to its year-end balance through contributions, investment results, grants or scholarships, other expenditures for facilities and programs, and administrative expenses (IRS, Schedule D (Form 990), Part V).
The definitions behind those lines are not the IRS’s own. For Part V, the definitions of endowment and the types of endowments are governed by FASB ASC 958, and, for an organization that follows FASB ASC 958, the percentages on line 2 should be reported consistent with the organization’s footnote disclosure under FASB ASC 958-205 (IRS, Instructions for Schedule D (Form 990), Part V). The return is downstream of the financial statements, so a firm that reconciles the two starts with the note.
That note is substantial. The standard asks for enough disclosure that a reader understands the endowment’s net asset classification, its composition, changes in that composition, spending policies and related investment policies (FASB, Accounting Standards Update 2016-14, paragraph 958-205-50-1A). The minimum content is then spelled out for each period presented, and the two pieces that carry the most judgment are the governing board’s interpretation of the laws underlying the classification of donor-restricted endowment funds and the policy for appropriating endowment assets for expenditure (FASB, Accounting Standards Update 2016-14, paragraph 958-205-50-1B).
Appropriation Is What Releases the Money
In the United States, most donor-restricted endowment funds are subject to an enacted version of the Uniform Prudent Management of Institutional Funds Act, which extends the donor’s restriction to use of the funds, including the investment return, until they are appropriated for expenditure by the governing board (FASB, Accounting Standards Update 2016-14, paragraph 958-205-45-13B). The act says the same thing directly: unless stated otherwise in the gift instrument, meaning the record under which property is granted to or held by the institution, the assets in an endowment fund are donor-restricted assets until appropriated for expenditure (Uniform Law Commission, Uniform Prudent Management of Institutional Funds Act, Sections 2 and 4).
Appropriation needs a date, because the journal entry needs one. Absent an interpretation of the phrase appropriated for expenditure by legal or regulatory authorities, such as a court decision or a state attorney general’s reading, appropriation is deemed to occur upon approval for expenditure, unless the approval is for a future period, in which case it occurs when that period is reached (FASB, Accounting Standards Update 2016-14, paragraph 958-205-45-13F). Running the release against coded expense month by month, and proving the remaining restricted balance still ties, is restricted fund work in its own right.
What an Endowment Fund Is Not
An endowment fund is not a class of net assets. Net assets with donor restrictions is a reporting class on the statement of financial position, while an endowment fund is a pool of assets that can land in either class, since a board-designated endowment fund generally sits in net assets without donor restrictions (FASB, Accounting Standards Update 2016-14, paragraph 958-205-45-13A).
The statutory definition is also narrower than the accounting one. The uniform act defines an endowment fund as an institutional fund, or any part of one, not wholly expendable by the institution on a current basis under the terms of a gift instrument. It then says the term does not include assets an institution designates as an endowment fund for its own use (Uniform Law Commission, Uniform Prudent Management of Institutional Funds Act, Section 2). So a quasi-endowment is an endowment fund for accounting purposes and not one under the statute, and “the endowment” means two different things depending on who is saying it.
When an Endowment Fund Goes Underwater
A donor-restricted endowment fund is underwater when 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 (FASB, Accounting Standards Update 2016-14, Master Glossary). The accumulated losses then stay inside net assets with donor restrictions rather than moving out of them (FASB, Accounting Standards Update 2016-14, paragraph 958-205-45-13H).
For each period a statement of financial position is presented, the organization then discloses, in the aggregate for all underwater endowment funds, their fair value, the original gift amount or level required to be maintained by donor stipulations or by law that extends donor restrictions, and the amount of the deficiencies (FASB, Accounting Standards Update 2016-14, paragraph 958-205-50-2).
Common Questions
It is money a not-for-profit invests instead of spending, so the return supports the organization over time. The statutory test is whether the fund is wholly expendable by the institution on a current basis under the terms of a gift instrument, and an endowment fund is one that is not (Uniform Law Commission, Uniform Prudent Management of Institutional Funds Act, Section 2).
Permanent, term, and board designated or quasi-endowment, which is the split Schedule D Part V line 2 asks an organization to report as estimated percentages (IRS, Schedule D (Form 990)). The first two exist because a donor said so. The third exists because a board said so, and a board can change its mind.
The money is not available on demand. Subject to the donor’s intent expressed in the gift instrument, an institution may appropriate for expenditure or accumulate so much of an endowment fund as it determines to be prudent for the uses, benefits, purposes and duration for which the fund is established, acting in good faith and with the care an ordinarily prudent person in a like position would exercise under similar circumstances (Uniform Law Commission, Uniform Prudent Management of Institutional Funds Act, Section 4). A gift instrument can narrow that authority further, but only if it specifically states the limitation, so the constraint a board lives under is read off the document rather than assumed (Uniform Law Commission, Uniform Prudent Management of Institutional Funds Act, Section 4).
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