How to account for losses on endowment investments

In today’s market, you’re likely to be recording losses on your investments instead of gains. For your unrestricted investments, your organization records those losses — both unrealized and realized — in an unrestricted fund. But, for your permanently and temporarily restricted endowment fund investments, it’s more complex.

Generally Speaking …

Investment activity — that which generates unrealized and realized gains and losses, dividends, and interest — increases or decreases an organization’s unrestricted net assets, unless the donor or an applicable law restricts the use of that income. Nonprofits generally can use the investment income however they see fit. For example, they could use it for administrative costs, such as payroll or office supplies, for programming or for fundraising.

How you record the investment activity on your financial statements depends on donor stipulations or applicable law. If a donor contributes specific investments (for example, 30 shares of Microsoft stock) and states that it’s permanently restricted, then the related earnings and losses also would be permanently restricted, unless the donor specifically states otherwise.

If a donor contributes cash and lets the organization choose its own investment vehicle — for instance, $600 to invest in 30 shares of stock — the earnings and losses are unrestricted (unless the donor explicitly says otherwise).

Assume you have donor-restricted endowment funds, with no donor stipulations on the investment earnings. Statement of Financial Accounting Standards (SFAS) No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations, requires that net losses first reduce any investment income on a fund that has been recorded as temporarily restricted. When those earnings are exhausted, you must then decrease unrestricted net assets for any loss in excess of those amounts.

Why must unrestricted funds suffer? With the historical-dollar-value accounting method, the value of the donor-restricted endowment fund is “set” at the time it becomes an endowment. The investment must never go below this amount unless there’s a true dip into the funds, and that requires donor consent.

A Possible Scenario

Suppose your organization receives a $15,000 permanently restricted donation (an investment) whose donor explicitly states that the investment’s earnings are to be used for scholarship purposes. This means that the earnings are recorded as temporarily restricted until the purpose is met.

If, in Year 1, the investment earned $750 and your organization didn’t spend it for its purpose, at year end that amount would still be in temporarily restricted net assets. If, in Year 2, the investment lost $1,000, you would decrease that temporarily restricted fund by the $750 earned and unspent in Year 1. You then would decrease the unrestricted fund by $250 for the difference.

When the market recovers and your donor-restricted endowment fund shows gains, SFAS No. 124 will require the unrestricted net assets to “recover” any losses that were recorded from this fund. In the example above, imagine that in Year 3, the investment earned $1,500. Now you’d “give back” the $250 to the unrestricted fund. The rest would be recorded to the temporarily restricted fund, which was the donor’s intent.

How Upmifa Fits In

Your state may have adopted the provisions of the Uniform Prudent Management of Institutional Funds Act (UPMIFA). If so, and if you have a donor-restricted endowment fund that stipulates its earnings are unrestricted, you would classify those earnings as temporarily restricted.

You could release this restriction when those earnings are appropriated for expenditure, such as in a formal budgeting process. You also can set an organizational policy that specifically states this, and this should be documented in your board minutes.

UPMIFA also eliminates the historical-dollar-value accounting method. Instead, it focuses on what constitutes prudent spending while taking care to preserve the funds.

Future Expectations

Although your unrestricted fund seems to be suffering in this trying economy, the market will eventually recover, and the fund will likely be made whole again. In the meantime, keep in mind that these investment losses are unrealized until you actually sell the securities. •