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FAS 124: Guidance on How to Report Gains/Losses on Endowments

The ongoing credit and liquidity crisis in the United States and throughout the global financial system has resulted in substantial volatility in financial markets and the banking system. These and other economic events have had a significant adverse impact on investment portfolios. Despite conservative spending policies or a history of high investment returns, some organizations are finding, for the first time, that the fair values of investments that comprise many of their donor-restricted endowments have dropped below required levels of corpus, which is sometimes referred to as being "underwater."

The Financial Accounting Standards Board Statement No. 124, "Accounting for Certain Investments Held by Not-for-Profit Organizations," (FAS 124) provides guidance on how to properly report realized and unrealized losses on donor-restricted endowment fund investments. Organizations are required to apply gains or losses to each donor-restricted endowment on an individual basis. Offsetting one donor-restricted endowment that is "underwater" with another that is "above water" is prohibited.

The following example, based on an example from FAS 124, illustrates how FAS 124 applies to endowment gains and losses.

Example—Permanent Endowment: Temporarily Restricted Use of Investment Income

Year One

At the beginning of year one, the not-for-profit organization (the organization) received a gift of $1 million. The donor specified that the gift be used to create an endowment fund that will be invested in perpetuity with income to be used for the support of Program A. The investments purchased with the gift earned $30,000 of interest and dividends. The organization spent $50,000 on Program A during the year. At the end of the year, the fair value of the investments was $1,047,000.

Net Assets
Transactions	Unrestricted	Temporarily Restricted	Permanently Restricted	Total
Initial gift	$          -	$          -	$1,000,000	$1,000,000
Board-designated gift	20,000	-	-	20,000
Interest and dividends	-	30,000	-	30,000
Unrealized gain	-	47,000	-	47,000
Program expenses	(50,000)	-	-	(50,000)
Net assets released from restrictions	50,000	(50,000)	-	-
Total—End of Year	$ 20,000	$ 27,000	$1,000,000	$1,047,000

Year Two

On January 1, in accordance with its spending policy, the governing board of the organization sold some investments for $25,000 (no realized gain or loss) and spent the proceeds on Program A. The remaining investments earned $30,000 of interest and dividends, which the organization also spent on Program A. At the end of the year, the fair value of the investments was $1,097,000.

Net Assets
Transactions	Unrestricted	Temporarily Restricted	Permanently Restricted	Total
Interest and dividends	$          -	$  30,000	$                 -	$     30,000
Unrealized gain	-	75,000	-	75,000
Expenses	(55,000)	-	-	(55,000)
Net assets released from restrictions	55,000	(55,000)	-	-
Subtotal	-	50,000	-	50,000
Net Assets—Beginning of year	20,000	27,000	1,000,000	1,047,000
Total—End of Year	$ 20,000	$ 77,000	$1,000,000	$1,097,000

Year Three

On January 1, in accordance with its spending policy, the governing board of the organization sold some investments for $28,000 (no realized gain or loss) and spent the proceeds on Program A. The remaining investments earned $30,000 of investment income, which the organization also spent on Program A. At the end of the year, the fair value of the investments was $975,000.

Net Assets
Transactions	Unrestricted	Temporarily Restricted	Permanently Restricted	Total
Interest and dividends	$            -	$  30,000	$                 -	$     30,000
Unrealized loss	(45,000)	(49,000)	-	(94,000)
Expenses	(58,000)	-	-	(58,000)
Net assets released from restrictions	58,000	(58,000)	-	-
Subtotal	(45,000)	(77,000)	-	(122,000)
Net Assets—Beginning of year	20,000	77,000	1,000,000	1,097,000
Total—End of Year	$ (25,000)	$            -	$1,000,000	$  975,000

Year Four

On January 1, the governing board of the organization could not apply its spending policy because the fair value of the investments was less than the historic dollar value of the fund; thus, no appreciation was available for expenditures. The investments earned income of $27,000, which the organization spent on Program A. At the end of the year, the fair value of the investments was $1,005,000.

Net Assets
Transactions	Unrestricted	Temporarily Restricted	Permanently Restricted	Total
Interest and dividends	$            -	$   27,000	$                 -	$ 27,000
Unrealized gain	25,000	5,000	-	30,000
Expenses	(27,000)	-	-	(27,000)
Net assets released from restrictions	27,000	(27,000)	-	-
Subtotal	25,000	5,000	-	30,000
Net Assets—Beginning of year	(25,000)	-	1,000,000	975,000
Total—End of Year	$             -	$     5,000	$1,000,000	$1,005,000

FAS 124—Disclosure of "Underwater" Endowments

Organizations are required to disclose the aggregate amount by which donor-restricted endowment funds are valued below their corpus. Even if an organization's total permanently restricted net assets are net "above water", the amount by which specific endowments are "underwater" must be disclosed.

Summary

Organizations should understand how the provisions of FAS 124 apply to each of their donor-restricted endowment funds. They should keep adequate records to allow the organization to monitor the amount of required corpus to be sustained and the gain/loss activity for each donor-restricted endowment fund on an individual basis.

If you would like more information on how FAS 124 applies to your organization's endowment investments, please call Jim Hagestad, Audit Senior Manager - Not-for-Profit Practice, at 312-980-3245. To read the original pronouncement, click here.

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.