Non-Profit Endowments and FAS Compliance Challenges Making Tough Decisions on Asset Classification and Disclosures

Transcription

1 presents Non-Profit Endowments and FAS Compliance Challenges Making Tough Decisions on Asset Classification and Disclosures A Live 110-Minute Teleconference/Webinar with Interactive Q&A Today's panel features: Barry Hawkins, Partner, Shipman & Goodwin, Stamford, Conn. Kim McCormick, Audit Partner, Not-For-Profit Industry Group, Grant Thornton, San Jose, Calif. Harold Parsons, Principal, LarsonAllen, Minneapolis Brian Zygmunt, Senior Manager, Crowe Horwath, Chicago Thursday, September 16, 2010 The conference begins at: 1 pm Eastern 12 pm Central 11 am Mountain 10 am Pacific You can access the audio portion of the conference on the telephone or by using your computer's speakers. Please refer to the dial in/ log in instructions ed to registrants.

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4 Non-Profit Endowments And FAS Compliance Challenges Sept. 16, 2010 Barry Hawkins, Shipman & Goodwin Harold Parsons, LarsonAllen Kim McCormick, Grant Thornton Brian Zygmunt, Crowe Horwath

5 Today s Program Key Aspects Of UPMIFA Slides 6 through 21 (Barry Hawkins) FAS 117-1Review1 Slides 22 through 28 (Kim McCormick) Post-FAS 117-1: Accounting, Disclosure Issues Slides 29 through 37 (Harold Parsons) Post-FAS 117-1: Accounting, Legal Cycles Slides 38 through 50 (Kim McCormick) Post-FAS 117-1: Foundation Policy Revisions Slides 51 through 55 (Brian Zygmunt) 5

6 Key Aspects Of UPMIFA Barry Hawkins, Shipman & Goodwin

7 Introduction 1. UPMIFA (2006) replaced UMIFA (1972) (which was the law in 48 states) as the primary source of law governing g the investment, management and expenditure of donor generated dollars. 2. Economic impact A. $1.4 trillion in 2004 B. 5.2% of GDP in the U.S. C. Employment significance D. Types of NPOs and endowment funds 7

8 Legal Obligations Of An NPO Board 1. Prudently manage and invest the funds to maximize the return of assets (at least for endowment funds) 2. Spend a portion of return on investment for current needs of the NPO and retain the balance in investments to provide for future needs, being mindful of inflation and the long term viability of an endowment fund 3. Abide by the restrictions imposed by the donors on a separate fund-by-fund basis 4. Follow state law (UMIFA/UPMIFA), which supplies standards if not specified by donor 8

9 Examples Of Endowment Restrictions 1. This money should be kept intact and the income from it is for Bowdoin College. True endowment No use restriction 2. This money should be kept intact and the income from it is for the purchase of books for the Bowdoin College Library. True endowment, combined with use restriction 3. This money should be kept intact for the period of 10 years, during which the income from it should be used only for the purchase of books for the Bowdoin College Library, and thereafter the money may be used for the general use of Bowdoin College. Endowment for a term of years, and thereafter the money has no time or use restriction. ti Almost any combination is possible in this highly flexible concept of restriction. 9

10 Common Misconceptions 1. Board-restricted or quasi-endowment This money is set aside for investment and is to be used for the construction of a new library after it reaches $10 million. 2. Pooled investments vs. separate use, restrictions 3. Creditor reliance, borrowing capacity and insolvency risk. The types of donor restrictions are highly significant to those who read and rely upon the financial reports of any NPO. 10

11 UMIFA Allowed pooled or total return analysis of the portfolio Allowed investment in equity and other alternative investments Allowed NPOs to delegate investment authority to professional managers Allowed NPOs to adopt spending plans that recognized and spent both realized and unrealized appreciation Required spending plan to be prudent but required maintenance of historic dollar value as a legal requirement 11

12 Creation Process For UPMIFA study committee Uniform Law Commission 2. The prior adoption of Uniform Prudent Investor Act in 46 states clearly indicated need to extend modern trust standards to NPOs organized as corporations. 3. Drafting committee A. Timing B. Process 4. Since July 2006, UPMIFA has been adopted in 49 jurisdictions, a near-record pace, with three more adoptions in process and expected in the next year, leaving only Pennsylvania without UPMIFA and following its own statute, which even predated UMIFA. 12

13 The New Law: What Does UPMIFA Do? 1. Prudence is adopted as the articulated standard for investment management and expenditure. UPIA standards for the trust world are extended to charitable corporations. 2. Elimination of HDV and substitution of multi-faceted prudence standards become the linchpin of legal authorization for endowment expenditures. A prudent spending policy must be adopted by each NPO. 3. Greatly improved standards for modifying or eliminating restrictions imposed by donors, which have become outmoded, wasteful or impracticable 13

14 Elimination Of HDV As A Bright Line Restriction Boards may now adopt spending policies that will go below (invade) HDV, if it is prudent to do so. The standards to be considered: 1. Duration and preservation of endowment fund 2. Purposes of the institution and the fund 3. General economic conditions 4. The possible effect of inflation/depletion 5. Expected total return from income and appreciation 6. Other resources of the institution 7. 7 The investment t policy of the institution The key is to maintain long-term viability and short-term flexibility. 14

15 Other Possibilities Within Endowed Spending Authorization 1. The bracketed 7% presumption of imprudence in Sect. 4d A. Available if bright line is still desired B. Limited acceptance C. Three-year rolling average determination D. No presumption of prudence below 7% E. See next slide for state enactments 2. The small fund exception in comments A. Under $2 million B. 60 days notification to regulator before spending below HDV level C. Will they know about the requirement? D. Only Maine and New Hampshire have this requirement. E. Does require some non-profits to track HDV even with UPMIFA 15

16 Enactment Of 7% Presumption Of Imprudence Option 1. The basic option has been enacted in the U.S. Virgin Islands and 13 states: California, Maine, Maryland, Montana, Nevada, New Hampshire, North Dakota, Oregon, Rhode Island, Tennessee, Texas, Utah and Wyoming. 2. New York (passed by General Assembly but not yet signed by the governor) would make the 15 th jurisdiction with the 7% option. 3. California version of option does not apply to endowment funds held by foundations supporting higher educational institutions. 4. Texas uses percentages ranging from 5% to 9%, depending upon total asset size. 5. Ohio has a reversed presumption of prudence for expenditures below 5% of rolling average value. 16

17 Release Or Modification Of Restrictions What is new? Clearer, more articulated language. Under UMIFA, it was unclear that would happen if a court released a restriction because it was impracticable or wasteful. Under UPMIFA, modern cy pres and deviation concepts from trust law are mandated to NPOs. Sect. 6(d) allows a new departure for small (less than $25,000), old (more than 20 years) 60 days prior notice to charitable regulator. 17

18 UPMIFA Accounting Rules And FSP FAS Sect. 4A of UPMIFA specifies that unless donor specifically provides to the contrary in the gift instrument, the assets in an endowment fund are donor-restricted assets until they are appropriated for expenditure by the institution. 2. Note: This does not require the institution to determine what portion of the endowment is permanently restricted, which is an accounting concept, not a legal requirement. 3. Note: Legally, endowment funds are always restricted, either for time, purpose or for both, and become unrestricted t only when appropriated for expenditure by the institution. 18

19 UPMIFA Accounting Rules And FSP FAS (Cont.) 4. Reconciliation of FSP FAS with Sect. 4a of UPMIFA? (a) They apply different concepts. (b) The law (enactment of UPMIFA by state statute) trumps a contrary interpretation by FASB. 5. To the extent that FSP FAS requires strict adherence to HDV or changing other asset classifications to restore HDV level, the two are essentially in conflict and cannot be reconciled. 19

20 UPMIFA Accounting Rules And FSP FAS (Cont.) 6. What are the options available to a NPO? (a) Contest the FSP FAS requirements, by court action, persuasion or regulatory interpretation (b) Live with FSP FAS by acting as though it governs instead of statutory law, and adopt a spending policy which identifies what portion of endowment the NPO believes it is obligated to retain permanently (c) Take concerted action to have FASB adopt a new classification scheme for non-profit accounting for endowment funds 20

21 Concluding Concerns And Issues 1. Remember overarching rule This is a default statute. t t Donor restrictions govern. 2. How to draft around UPMIFA v.1 21

22 FAS Review Kim McCormick, Grant Thornton

23 Endowment Accounting And Disclosures FSP FAS (ASC ) Recap Endowments of not-for-profit organizations: Net asset classification of funds subject to an enacted version of UPMIFA, and enhanced disclosures The classification of net assets subject to UPMIFA Expanded disclosure requirements whether subject to an enacted version of UPMIFA Effective for fiscal years ended after Dec. 15,

24 Endowment Accounting And Disclosures FSP FAS (ASC ) Recap Actions Already Taken Governing board concluded what portion of endowment is permanently restricted net assets (PRNA) fund of permanent duration Recorded cumulative effect of change in accounting to reclassify accumulated and unappropriated endowment earnings from URNA to TRNA and re-instated purpose restrictions, as applicable Added significant new disclosures regarding g endowment funds Dealt with accounting and disclosures for underwater endowments 24

25 Endowment Fund Disclosures Disclosure Requirements Description of governing board s interpretation of relevant law underlying net asset classification Description of endowment spending (distribution) policy(ies) Description of endowment investment policy(ies) Return objectives and risk parameters How the objectives relate to spending policy(ies) Strategies for achieving objectives Composition of endowment by net asset class Endowment roll-forward by net asset class 25

26 Sample Endowment Composition Disclosure (No Underwater Funds) Endowment Net Asset Composition by Type of Fund As of June 30, 200Y Temporarily Permanently Unrestricted Restricted Restricted Total Donor-restricted endowment funds $ - $ 49,774 $ 97,959 $ 147,733 Board-designated designated funds $ 8,247 $ - $ - $ 8,247 Total funds $ 8,247 $ 49,774 $ 97,959 $ 155,980 26

27 Sample Endowment Composition Disclosure (Underwater Funds) 27

28 Sample Endowment Roll-Forward Disclosure (Ongoing Year) 28

29 Post-FAS 117-1: 1 Accounting, Disclosure Issues Harold Parsons, LarsonAllen

30 UPMIFA Vs. FAS The disconnect between the law and accounting 117-1: Permanently restricted amounts: The organization s governing board determines what must be retained (preserved) permanently consistent with the relevant law. UPMIFA: There is no concept of a specific amount that must be permanently retained. Endowment fund means an institutional fund or part thereof that, under the terms of a gift instrument, is not wholly expendable by the institution on a current basis. One of the considerations with investing and appropriations is the duration and preservation of the endowment fund. 30

31 UPMIFA Vs. FAS (Cont.) Issues that arise You do not have to replace endowment funds that are underwater. You might want to reconsider your spending policy, but there is no obligation to stop spending. What you must do is follow the law regarding prudence. Underwater funds can create a perception of being an unhealthy organization. Is it possible to raise new money to make up for past losses? How do you communicate your board s interpretation i of the law? 31

32 UPMIFA Vs. FAS 117-1(Cont.) Alternative presentation in the Statement of Financial Position NET ASSETS Unrestricted: Undesignated 1,050,000, Accumulated Endowment Losses (1,800,000) Total Unrestricted Net Assets (750,000) Temporarily Restricted 1,200,000 Permanently Restricted 15,500,000 Total Net Assets $ 15,950,000 32

33 Reclassification Of Net Assets TIS Changing Net Asset Classifications Reported in a Prior Year (TPA issued in May 2010) Are individual net asset classes, rather than net assets in the aggregate (total net assets), relevant in determining whether an NFP s correction of net asset classifications previously reported in prior years financial statements is an error in previously issued financial statements? Yes: Individual net asset classes, rather than net assets in the aggregate (total net assets), are relevant in determining whether an NFP's correction of net asset classifications previously reported in prior years' financial statements is an error in previously issued financial statements. 33

34 Reclassification Of Net Assets (Cont.) Reclassifications of net assets - that is, simultaneous increases in one net asset class and decreases in another - shall be made if any of the following events occur: a. The NFP fulfills the purposes for which the net assets were restricted. b. Donor-imposed restrictions i expire with the passage of time or with the death of a split-interest agreement beneficiary (if the net assets are not otherwise restricted). c. A donor withdraws, or court action removes,,previously imposed restrictions. d. A donor imposes restrictions on otherwise unrestricted net assets. For example, a donor may make a restricted contribution that is conditioned on the NFP restricting a stated amount of its unrestricted net assets. Such restrictions that are not reversible without donors consent result in a reclassification of unrestricted net assets to restricted net assets. 34

35 Dfii Defining The Ed Endowment tfund Not all permanent funds are endowment funds. The commentary for A8(b) notes that endowment funds are not analogous to perpetual trusts in part because none of the ongoing decisions i about either the investment t of the trust t or distributions ib ti from the trust are within the purview of a beneficiary organization s governing board. 35

36 Dfii Defining The Ed Endowment tfund d(cont.) t) Do the disclosures fit the circumstances? What should be considered in and what can be considered out? Perpetual trusts where the NFP is not the trustee Perpetual funds held at a community foundation where the NFP named itself as the beneficiary Charitable remainder trusts prior to termination of the trust Pledges receivable to the endowment fund Judgment can be used. 36

37 Dfii Defining The Ed Endowment tfund d(cont.) t) The endowment fund roll-forward does not need to tie back to the statement of activity or financial position. 37

38 Post FAS 117-1: Accounting, Legal Cycles Kim McCormick, Grant Thornton

39 Reminders: Underwater Endowments Making The Determination Once an organization determines how much should be classified as permanently restricted in accordance with the appropriate state law and donor intent, that amount is compared to the current market value to determine whether or not there is an underwater endowment. If market value is below amount calculated as permanently restricted endowment, the fund is underwater. 39

40 Reminders: Underwater Endowments Recording Losses In the absence of donor stipulations or law to the contrary, losses on permanently restricted endowment funds are recorded as follows: 1. Reduce temporarily restricted net assets to the extent that there is appreciation from the SPECIFIC underwater fund accumulated there 2. Reduce unrestricted net assets 40

41 Sample Endowment Composition Disclosure (Underwater Funds) 41

42 Reminders: Underwater Endowments Required Disclosures Aggregate amount of the deficiencies for all donorrestricted endowment funds for which the fair value is less than the level required by donor stipulation or law at the reporting date Depending on the severity, a discussion of the organization s liquidity and operating needs as affected by these underwater endowments 42

43 Reminders: Underwater Endowments Other Best Practice Disclosures Any change in organization s spending rate, based on underwater situation Description of how deficiencies originated and how accounted for 43

44 Reminders: Underwater Endowments Endowments Emerging Back Above Water In the absence of donor stipulations or law to the contrary, subsequent gains on underwater endowment funds are recorded as follows: 1. Re-instate unrestricted net assets for SPECIFIC endowment funds that were underwater (back to sea level) 2. Increase temporarily restricted net assets 44

45 Net Asset Classification With UPMIFA: Putting It All Together Step I: New gift comes in for endowment, without explicit donor language affecting initial net asset classification Managed as one fund, likely part of an investment pool All classified as PRNA, for financial reporting purposes 45

46 Net Asset Classification With UPMIFA: Putting It All Together (Cont.) Step II: Investment activity Allocated to fund based on unitization or pro-rata share PRNA normally does not increase or decrease Increase or decrease is to TRNA Exception: In underwater situations, TRNA cannot be negative, so URNA would be decreased. Very important: That URNA deficit is within the endowment 46

47 Net Asset Classification With UPMIFA: Putting It All Together (Cont.) Step III: Moneys are spent elsewhere for the same purpose No effect on either the fund balance or on net asset classification A time restriction is still in place until appropriation, and thus the funds are unavailable for spending for that purpose. p In other words, unlike with net asset classification for UMIFA endowments, the deemed spent rule does not apply here, and there is no reclassification to URNA for financial reporting purposes. 47

48 Net Asset Classification With UPMIFA: Putting It All Together (Cont.) Step IV: Board approves funding from the endowment for next year s budget No effect on either the fund balance or net asset classification until next year is reached 48

49 Net Asset Classification With UPMIFA: Putting It All Together (Cont.) Step V: Next year is reached, and the amounts approved are now available for spending. Fund balance is reduced by that amount, even if the cash is not yet transferred. In effect, the cash is due to the corresponding non-endowment fund where it will be spent (operating fund, plant fund, etc.). Alternative treatment: In a corresponding boarddesignated endowment fund until the cash is moved The UPMIFA time restriction for accounting purpose expires, because appropriation for accounting purposes is now deemed to be complete. 49

50 Net Asset Classification With UPMIFA: Putting It All Together (Cont.) Step V (Cont.) If the fund has no purpose restriction (beyond being an endowment), there is a reclassification of those amounts from TRNA to URNA. Very important: Such net assets are no longer associated with the donor endowment. Remember, the only URNA amounts associated with donor endowments are negative URNA ( deficits ) when the fund is underwater. If the fund has a purpose restriction, the reclassification would not occur until the amounts are spent or deemed spent for that purpose. Without the time restriction, such amounts are now available for spending, and the deemed spent rule would apply. 50

51 Post FAS 117-1: 1 Foundation Policy Revisions Brian Zygmunt, Crowe Horwath

52 ASC Policy Considerations Investment policy Return Objectives Risk parameters Relationship between return objectives and risk parameters Endowment spending policy Valuation policy Generic donor gift instrument An example that allows for payouts to invade corpus Draft board resolution to clarify definitions upon implementation Crowe Horwath LLP is a member of Horwath International Association, a Swiss association (Horwath). Each member firm of Horwath is a separate and independent legal entity. Crowe Horwath LLP and its affiliates are not responsible or liable for any acts or omissions of Horwath or any other member of Horwath and specifically disclaim any and all responsibility or liability for acts or omissions of Horwath or any other Horwath member. Accountancy services in several states are rendered by Crowe Chizek and Company LLC, which is a member of Horwath Crowe Horwath LLP 52

53 ASC Policy Revisions Description of the organization s endowment investment and spending policies Prior to UPMIFA and , investment policies were often limited to the responsibility for oversight of managers, target asset allocation, and sometimes return objectives. With the advent of UPMIFA and , an organization s investment policies should have much more robust content to comply with updated requirements. So, what is required to be disclosed in financial statements of NFPs under ASC ? Policies for appropriation of endowment assets for expenditure Return objectives Risk parameters Strategies employed for achieving those objectives Relationship between return objectives and risk parameters These factors all need to be considered in concert with each other, as decisions made in each area directly affect each other. Crowe Horwath LLP is a member of Horwath International Association, a Swiss association (Horwath). Each member firm of Horwath is a separate and independent legal entity. Crowe Horwath LLP and its affiliates are not responsible or liable for any acts or omissions of Horwath or any other member of Horwath and specifically disclaim any and all responsibility or liability for acts or omissions of Horwath or any other Horwath member. Accountancy services in several states are rendered by Crowe Chizek and Company LLC, which is a member of Horwath Crowe Horwath LLP 53

54 ASC Policy Revisions (Cont.) Example of investment policy Sect. 3 investment objectives Balancing the support for current operations with the long-term goal of developing and maintaining a strategic advantage Sections 4 and 5 performance goals and asset allocation To what are we going to benchmark? Develop asset allocation Organizations need to work with investment committee and advisors to develop these components of the policy. Spending policy Execution Investment t management guidelines Selection of new managers Delegation of responsibilities Conflict of interest policy Evaluation and review process Crowe Horwath LLP is a member of Horwath International Association, a Swiss association (Horwath). Each member firm of Horwath is a separate and independent legal entity. Crowe Horwath LLP and its affiliates are not responsible or liable for any acts or omissions of Horwath or any other member of Horwath and specifically disclaim any and all responsibility or liability for acts or omissions of Horwath or any other Horwath member. Accountancy services in several states are rendered by Crowe Chizek and Company LLC, which is a member of Horwath Crowe Horwath LLP 54

55 ASC Policy Revisions (Cont.) Stakeholders in process Trustee Finance committee Audit committee Investment committee Senior management team Finance Development Investment managers/consultants Legal counsel Audit firm Crowe Horwath LLP is a member of Horwath International Association, a Swiss association (Horwath). Each member firm of Horwath is a separate and independent legal entity. Crowe Horwath LLP and its affiliates are not responsible or liable for any acts or omissions of Horwath or any other member of Horwath and specifically disclaim any and all responsibility or liability for acts or omissions of Horwath or any other Horwath member. Accountancy services in several states are rendered by Crowe Chizek and Company LLC, which is a member of Horwath Crowe Horwath LLP 55