In June of 2009, Ohio enacted its version of the Uniform Prudent Management of Institutional Funds Act under O.R.C. § 1715 (UPMIFA), which made changes to Ohio’s laws regarding spending and investment policies for institutional funds, including nonprofit endowment funds.
One notable change made by UPMIFA was the elimination of historic dollar value (HDV) as a “bright line restriction” legal requirement, allowing boards to adopt spending policies to go below (invade) HDV if they see it as prudent to do so. HDV was replaced with seven standards of prudence as the legal authorization for endowment expenditures with the goal of maintaining long-term viability and short-term flexibility of funds. These standards require a board to consider the following factors:
1) Duration and preservation of the endowment fund;
2) Purposes of the institution and the fund;
3) General economic conditions;
4) Possible effect of inflation and deflation;
5) Expected total return from income and appreciation of investments;
6) Other resources of the institution; and
7) Investment policy of the institution.
In response to UPMIFA, the Financial Accounting Standards Board (FASB) adopted Staff Position (FSP) No. FAS 117-1 in August 2008, “Endowments of Not-for-Profit Organizations: Net Asset Classification of Funds Subject to an Enacted Version of UPMIFA and Enhanced Disclosures for All Endowed Funds.” The Position provides guidance on the net asset classification of donor-restricted endowment funds for all nonprofit organizations subject to UPMIFA, and it expands required disclosures about endowed funds (both donor-restricted and board-designated) whether or not such funds are subject to UPMIFA. FAS 117-1 applies for fiscal years ending after December 15, 2008. If FAS 117-1 is not applied until after 2009, prior year amounts will have to be restated in order to show the accounting changes.
Reclassification of Assets
FAS 117-1 forces organizations to reconsider the classification of net assets and may require a reclassification of funds. Organizations must classify a portion of a donor-restricted endowment fund of perpetual duration as “permanently restricted.” The permanently restricted amount is that amount which the donor directed, or, in the absence of such a restriction, the amount the board determines, to be permanently maintained under applicable law. Many auditors interpret 117-1 as requiring strict adherence to HDV, or requiring changing other asset classifications to “restore” HDV level.
One of FAS 117-1’s most notable requirements is that donor-restricted funds may no longer be moved to an “unrestricted” net asset classificaAdvocate Page 2 tion until the board has appropriated the funds (such funds, e.g., unappropriated appreciation, must be placed in “temporarily restricted” until appropriated). “Appropriation” for these purposes occurs when the board authorizes the funds for expenditure. Asset reclassifications are a cumulative change adjustment and are reported in separate line items in the statement of activities, outside of any operating measures. Note that the forced reclassification may create potential debt or bond covenant issues with creditors, and credit agreements may need to be amended.
FAS 117-1 is FASB’s attempt to require nonprofits to get opinions on what funds are restricted, given the need of accounting to be able to present a fair statement of the value of funds and the ensuing need for the proper classification of assets.
In addition, FAS 117-1 requires new disclosures for all nonprofits with endowment funds, whether such funds are donor- or board-restricted. The following disclosures are now required:
- Description of governing board’s interpretation of law which underlies the organization’s net asset classification of donor-restricted endowment funds – the board should consider the disclosure and may need legal advice;
- Description of organization’s endowment spending policy;
- Description of organization’s endowment investment policy, to include return objectives and strategies to achieve them, risk parameters and relationship to spending policy;
- Details of composition of endowment funds at year end, in total and by type of endowment, with donor-restricted and board-restricted funds separate, and by asset class (i.e., permanent, temporary or unrestricted);
- Reconciliation of beginning and ending balances of endowment, by total and by net asset class, to include: investment income, net appreciation/depreciation, contributions, appropriations, reclassifications and other changes;
- Nature and types of restrictions;
- Information on deficiencies for all donor-restricted funds for which the fair value of assets at reporting date is less than the level required by donor stipulations or law; and
- Any resulting net asset reclassifications should be reported on a separate line on the statement of activities for that period.
The following practical tips should be considered in helping nonprofits to meet the requirements of FAS 117-1:
- Consult counsel to determine the funds covered by UPMIFA. Look at each fund in an endowment and determine what amounts classified as unrestricted may need to be reclassified as restricted.
- Consult with auditor to adopt approach to allow for meaningful financial disclosures while recognizing that legal restrictions will remain governed by UPMIFA.
- Create board policies - on interpretation of the law as to restrictions; investment policy; and spending policy.
- Re-evaluate the classification of all funds: e.g., unrestricted may become restricted, permanently restricted may become temporarily restricted.