Board Meeting Handout Financial Statement Presentation October 31, 2007

Transcription

1 PURPOSE The purpose of today s meeting is to discuss Board Meeting Handout Financial Statement Presentation October 31, 2007 a. Miscellaneous issues previously discussed b. Issues related to application of the cohesiveness principle. Note: the paragraph and issue numbers in this handout correspond to paragraph numbers in the Board memoranda used as the basis for discussion. MEMORANDUM #56A: MISCELLANEOUS ISSUES ISSUE 1: Classified Statement of Financial Position 2. In May 2007, the Boards expressed different views on how to describe which entities should be required to present a classified statement of financial position (that is, all assets and liabilities are classified into short- and long-term subcategories within each category, such as operating, investing, and the like). a. The FASB tentatively decided, as the staff recommended, that financial institutions (such as banks, investment banks, and insurance companies) would not be required to present a classified statement of financial position. The FASB also agreed that the initial discussion document would not define the term financial institution and would seek feedback on how to operationalize this view. b. The IASB tentatively decided that, as in IAS 1, Presentation of Financial Statements, an entity would not be required to present a classified statement of financial position when a presentation of assets and liabilities in order of liquidity provides information that is reliable and is more relevant. In those cases, an entity would present the statement of financial position in order of increasing or decreasing liquidity. 3. Both Boards agreed that an entity that does not present a classified statement of financial position should present a detailed maturity schedule for short-term contractual assets and liabilities. The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations.

2 4. The staff would like the initial discussion document to include a converged preliminary view on which entities should be required to present a classified statement of financial position. 8. Thus, the staff recommends that: a. The FASB change its view to be consistent with the IASB view b. Financial institutions, such as a bank, an investment bank, or an insurance company, be included as examples of entities that might not present a classified statement of financial position (incorporating the FASB view in the IASB view). Based on that recommendation, the Boards converged view would be as follows: An entity would be required to present a classified statement of financial position except when presenting assets and liabilities in order of increasing or decreasing liquidity provides information that is reliable and is more relevant. Financial institutions, such as a bank, an investment bank, or an insurance company are examples of entities for which a statement of financial position presented in order of liquidity may be more relevant. QUESTIONS FOR THE BOARD Q1. Does the FASB agree that, as in IAS 1, an entity should be required to present a classified statement of financial position except when presenting assets and liabilities in order of increasing or decreasing liquidity provides information that is reliable and is more relevant? (This would be a change to the FASB view expressed in May 2007.) Q2. Should financial institutions, such as a bank, an investment bank, or an insurance company, be included as examples of entities for which a statement of financial position in order of liquidity may be more relevant? ISSUE 2: Capital Management Disclosures 10. The Boards tentatively decided in May that, as required by IAS 1 (revised 2007), all entities should disclose the following capital management information: a. Qualitative information about an entity s objectives, policies, and processes for managing capital, including (but not limited to): 1. A description of what it manages as capital 2. When an entity is subject to externally imposed capital requirements, the nature of those requirements, and how those requirements are incorporated into the management of capital 3. How it is meeting its objectives for managing capital b. Summary quantitative data about what an entity manages as capital 2

3 c. Any changes in the above qualitative and quantitative data from the previous period d. Whether during the period an entity complied with any externally imposed capital requirements to which it is subject e. When the entity has not complied with such externally imposed capital requirements, the consequences of such non-compliance. 11. The FASB was of the view that the term capital could include items in the operating category as well as items in the financing and equity sections and agreed that the document should clarify what is meant by capital. Thus, the FASB would add (including as appropriate, operating, financing, and equity items) to the end of paragraph 10(a)(1) above. X At their October 2007 meeting, the IASB decided that capital management disclosures should not address assets and liabilities classified in the operating category. That is, the term capital should be limited to financing liabilities and equity. QUESTION FOR THE BOARD (REVISED): Q3. Given the recent IASB decision to limit the disclosure to items in the financing and equity sections, does the Board want to change its prior preference to include operating items in the capital management disclosures? ISSUE 3: Netting on the Statement of Cash Flows 16. At their respective March 2007 Board meetings, the Boards decided that cash, rather than cash and cash equivalents, should be used as the basis for presenting the statement of cash flows. At those meetings, the Boards directed the staff to consider whether net amounts of cash receipts and payments related to items currently classified as cash equivalents could be presented on the statement of cash flows. 17. In September 2006, the Boards agreed that, as a general working principle, entities should prepare financial statements using a gross presentation except when: a. Net presentation is required or permitted by the authoritative accounting literature; or b. There is no incremental value in the additional information provided in a gross presentation that is, there is no benefit in a user of the financial statements knowing the two amounts; the net amount provides all of the information that is necessary (referred to herein as the netting principle). 3

4 20. The existing guidance of both Boards (FASB Statement No. 95, Statement of Cash Flows, and IAS 7, Cash Flow Statements) permits net presentation of cash receipts and payments relating to: a. Short term investments not classified as cash equivalents in which 1. The turnover is quick 2. The amounts are large 3. The maturities are short b. Cash receipts and payments on behalf of customers when the cash flows reflect the activities of the customer rather than those of the entity. 21. The staff is of the view that the rationale for allowing net presentation of cash flows related to short-term investments that are not classified as cash equivalents can be extended to short-term investments that are currently classified as cash equivalents. Thus, the staff is of the view that net presentation of the cash receipts and payments related to former cash equivalents on the statement of cash flows should continue to be permitted. 23. Statement 95 and IAS 7 also permit net presentation of cash flows in the following specific circumstances [Statement 95: banks, savings institutions, and credit unions; IAS 7: financial institutions]: a. Cash receipts and payments for the acceptance and repayment of deposits with a fixed maturity date b. The placement of deposits with and withdrawal of deposits from other financial institutions c. Cash advances and loans made to customers and the repayment of those advances and loans. 24. The staff is of the view that the circumstances where net presentation is currently permitted in the statement of cash flows are consistent with the netting principle described in paragraph 17b. Because the existing guidance and the netting principle are consistent, the staff considered whether the netting guidance in Statement 95 and IAS 7 should be retained. The staff has identified three alternatives for dealing with the netting principle in relation to the existing netting guidance: a. Retain the existing netting guidance (paragraph 20a-b and paragraph 23a-c) as written in order to provide clarity to the netting principle in paragraph 17 b. Eliminate the existing netting guidance (paragraph 20a-b and paragraph 23ac) and include a question in the discussion document asking whether any 4

5 aspect of the existing guidance should be retained to supplement the netting principle in paragraph 17 c. Eliminate the general existing netting guidance (paragraph 20a-b) because the netting principle will capture those same criteria, but retain the more specific existing netting guidance (paragraph 23a-c) to provide clarity and additional application guidance. 25. The staff recommends Alternative C. Based on that recommendation, the guidance regarding offsetting in the statement of cash flows would be as follows: Cash receipts and payments should not be offset (presented net) in the statement of cash flows unless there is no incremental value in the additional information provided in a gross presentation that is, there is no benefit in a user of the financial statements knowing the two amounts; the net amount provides all of the information that is necessary. Net presentation of cash flows is permitted in the following circumstances for [FASB: banks, savings institutions, and credit unions; IASB: financial institutions]: a. Cash receipts and payments for the acceptance and repayment of deposits with a fixed maturity date b. The placement of deposits with and withdrawal of deposits from other financial institutions c. Cash advances and loans made to customers and the repayment of those advances and loans. 27. Implicit in the staff recommendation is the staff view that cash receipts and payments related to former cash equivalents should be presented net on the statement of cash flows based on the netting principle. QUESTIONS FOR THE BOARD Q4. Do Board members agree that net presentation of cash receipts and payments related to former cash equivalents should be permitted on the statement of cash flows? Q5. Should some or all of the netting guidance in Statement 95 and IAS 7 be retained, or does the netting principle provide adequate guidance? 5

6 MEMORANDUM #56B: ISSUES RELATED TO APPLICATION OF THE COHESIVENESS PRINCIPLE ISSUE 1: Classification and Presentation of Dividends Payable 2. Currently, a common dividend payable is classified as a liability. Under the working format, this liability is likely to be classified as a financing liability in the statement of financial position. The cohesiveness principle would suggest that the payment of dividends (the settlement of the liability) would be classified in the financing section in the statement of cash flows. However, because most dividend payments (or at least the declaration of the dividend) relate to a transaction with owners in their capacity as owners, one might expect the dividend payment to be classified in the equity section of the statement of cash flows. At the October 2007 Board meetings, the staff would like to discuss how the Boards want to address this potentially counterintuitive result (classification of dividends payable in the financing section, particularly in the change statements). 6. The staff recommends that the initial discussion document on the F/S/P project illustrate common dividends payable and the related cash flows based on how the liability is viewed under current GAAP as a (financing) liability and on the cohesiveness principle. The discussion document can mention that the classification of dividends payable related to certain types of equity instruments (including common shares) may change due to the outcome of the L&E project. But it should also state that the Boards are of the view that dividends payable and related cash flows should be classified consistently in the financial statements (because of the cohesiveness principle) regardless of whether the L&E project changes the classification of dividends payable (from a liability to equity). QUESTION FOR THE BOARD Q6. Do the Boards agree that for purposes of the F/S/P initial discussion document, the classification of common dividends payable and related changes in the financial statements should be based on the current classification of dividends payable as a liability and the cohesiveness principle? 6

7 ISSUE 2: Classification and Presentation of Foreign Currency Translation Adjustments 7. At their respective March 2007 Board meetings, the Boards discussed the presentation of other comprehensive income (OCI) in the statement of comprehensive income, including the presentation of foreign currency translation adjustments (FCTAs). a. The IASB decided that FCTAs related to consolidated subsidiaries and proportionately consolidated joint ventures 1 should be classified in the operating category within the business section in the statement of comprehensive income, and FCTAs related to equity method investments should be classified in the same category in which the equity method investment is classified in the statement of financial position. b. The FASB wanted to discuss how FCTAs would be presented in the possible statement of financial position reconciliation before discussing the presentation of FCTAs in the statement of comprehensive income. In June, the FASB agreed with the staff s analysis, which concluded that allocating FCTAs to individual assets and liabilities in the statement of financial position reconciliation might be too complex and costly to justify in terms of the related usefulness (the analysis was based on the reconciliation from the beginning to the ending statements of financial position). 8. At the October 31 meeting, the FASB will be asked to decide on its preliminary view regarding the classification of FCTAs in the statement of comprehensive income. ISSUE 2a: FCTAs related to consolidated subsidiaries and proportionately consolidated joint ventures 10. The staff considered the following alternatives for classifying FCTAs related to consolidated subsidiaries and proportionately consolidated joint ventures in the statement of comprehensive income: Alternative 1: Allocate FCTAs to the categories in which assets and liabilities of the subsidiaries and joint ventures are classified in the statement of financial position. Alternative 2: Do not allocate FCTAs but classify them in: (A): the operating category within the business section (B): a new FCTAs section 2. As noted previously, the IASB preferred Alternative 2-A in March Proportionate consolidation of joint ventures is not permitted under U.S. GAAP. On September 13, 2007, the IASB issued Exposure Draft 9, Joint Arrangements, which proposes eliminating the option to account for joint ventures using this method. 2 Under the alternative in which OCI items would be presented in a separate OCI section, this would be a new subcategory within the OCI section. 7

8 19. While Alternative 1 is attractive in the sense that perfect cohesiveness is achieved, the staff is of the view that it is unlikely that the benefits from providing the information would outweigh the costs. If allocating FCTAs (Alternative 1) is not cost-beneficial, the only other alternatives are those that do not achieve perfect cohesiveness. 20. Because not allocating FCTAs would be an exception (and possibly the only exception) to the cohesiveness principle, the staff recommends that that exception be highlighted and isolated in the statement of comprehensive income. Thus, the staff recommends that FCTAs be presented in a separate FCTA section in the statement of comprehensive income (Alternative 2-B) rather than in the operating category. QUESTION FOR THE BOARDS Q7. How should foreign currency translation adjustments related to consolidated subsidiaries and proportionately consolidated joint ventures be classified in the statement of comprehensive income? Issue 2b: FCTAs related to equity method investments 22. The staff considered the following alternatives for classifying FCTAs related to equity method investments in the statement of comprehensive income: Alternative 1: Classify FCTAs in the category in which the equity method investment is classified in the statement of financial position. Alternative 2: Classify FCTAs in a new FCTAs section. 25. The staff recommends that FCTAs be classified in the category in which the equity method investment is classified in the statement of financial position (Alternative 1). The staff is of the view that exceptions to the cohesiveness principle should be kept to a minimum. Accordingly, an exception to the cohesiveness principle should only be provided for FCTAs related to consolidated subsidiaries and proportionately consolidated joint ventures (as recommended in Issue 2a). QUESTION FOR THE BOARDS Q8. How should foreign currency translation adjustments related to equity method investments be classified in the statement of comprehensive income? 8

9 ISSUE 3: Basket Transactions 26. Basket transactions are single transactions that involve the purchase or disposal of multiple assets (or a combination of assets and liabilities) that would be classified in more than one category under the working format. A typical basket transaction would be a business combination in which the acquirer acquires 100% of the equity instruments of the acquiree in cash. 28. The fundamental decision the Boards need to make is whether the effects of basket transactions (revenues, expenses, and gains and losses in the statement of comprehensive income, and cash flows in the statement of cash flows) should be classified in more than one category. If so, the effects would need to be allocated to those categories. This one to many issue is not an issue under current U.S. GAAP or IFRSs because the effects of transactions that involve multiple assets and liabilities are often presented on one line in the change statements. The introduction of the working format (various categories) and the cohesiveness principle (consistent classification across all statements) gives rise to this issue. 34. The staff has been working on developing an allocation method for the effects of basket transactions; however, the staff will need more time to develop an allocation method that is ready for Board discussion. 42. If the Boards are of the view that the effects of basket transactions should not be allocated, the question that follows is how that unallocated amount should be presented in the financial statements. The staff considered the following alternatives: Alternative 1: Classify the effects in the operating category in the business section. Alternative 2: Classify the effects in the category that reflects the activity that is likely to be the predominant source of those effects. Alternative 3: Classify the effects in a new Basket Transactions section. 50. The staff recommends that the effects of basket transactions be allocated to the multiple categories in which the related assets and liabilities are classified. For the purposes of issuing the initial discussion document, the staff recommends that the document ask whether constituents agree that the effects of basket transactions should be allocated and if so, how that allocation should be done. In other words, the initial 9

10 discussion document would not include the Boards view as to how to allocate the effects of basket transactions, only its view on whether allocation is preferred over non-allocation. 51. If the Boards prefer not to allocate the effects of basket transactions, the staff recommends Alternative 2 (that is, the effects would be classified in the category that reflects the activity that is likely to be the predominant source of those effects). QUESTION FOR THE BOARD Q9. Should the effects of basket transactions be allocated to the multiple categories in which the related assets and liabilities are classified? a. If so, should the Boards develop an allocation method prior to the issuance of the initial discussion document? b. If not, how should the effects of basket transactions be presented in the financial statements? 10

11 Board Meeting Handout Accounting for Trading Inventory October 31, 2007 PURPOSE OF THIS MEETING At today s Board meeting, the Board will discuss four alternative accounting models for the purpose of determining which types of instruments and/or activities are required to be accounted for at fair value through earnings. ISSUES TO ADDRESS The staff has developed the following alternatives based on research and discussions with preparers, users, auditors, and regulators. Alternative 1 Mark-to-market accounting is required if the item is bought and sold with the objective of making a profit (that is, meets the definition of trading) and the item has a readily determinable fair value. Alternative 2 Mark-to-market accounting is required if the item is bought and sold with the objective of making a profit (that is, meets the definition of trading). Readily determinable fair value is not a criterion. Alternative 3 Mark-to-market accounting is required if the item has a readily determinable fair value. This alternative does not consider the entity s activity or intent to trade. Alternative 4 Mark-to-market accounting is required for a class of items if an election is made to mark to market any of the inventory that meets the definition of trading and has a readily determinable fair value. Staff Recommendation The staff recommends Alternative 1; that only activities that meet the trading definition/description and positions that have readily determinable fair values be accounted for at fair value. This FSP is not intended to require an entity to mark to market inventory that is used in an entity s normal business operations or in an entity s product life cycle (for example, WIP). The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations.

12 QUESTIONS FOR THE BOARD Question 1: Does the Board agree with the staff that the FSP incorporate Alternative 1 and move forward with drafting of an FSP? Question 2: If yes, does the Board want the staff to include definitions/descriptions of trading and readily determinable fair value within the FSP? 2

13 Board Meeting Handout Not-for-Profit Endowments and UPMIFA October 31, 2007 At today's meeting the staff will ask the Board to consider whether to add a project to its agenda to issue an FASB Staff Position (FSP) on the potential effect of the adoption of the model Uniform Prudent Management of Institutional Funds Act of 2006 (UPMIFA) on the classification of net assets related to donor-restricted endowment funds. BACKGROUND A donor s stipulation that a gift be invested by a not-for-profit organization in perpetuity creates a donor-restricted endowment fund. Investment of such endowed funds and use of investment return by a not-for-profit organization is governed by explicit donor stipulation and/or relevant state law. In 46 states and the District of Columbia, that law has been some variation of the model Uniform Management of Institutional Funds Act of 1972 (UMIFA), which is the predecessor of UPMIFA. In states that have followed UMIFA, a key factor in initial and subsequent net asset classification of donor-restricted endowment funds has been the concept of historic dollar value, the amount that UMIFA specifies as being not expendable. The historic dollar value of an endowment fund is defined in UMIFA as the aggregate fair value of: An endowment fund at the time it became an endowment fund Each subsequent donation to the fund at the time it is made, and Each accumulation made pursuant to the direction in the applicable gift instrument at the time the accumulation is added to the fund. Thus, in those states that have followed UMIFA, the original gift amount and any subsequent earnings that donors explicitly require to be retained permanently are considered not expendable and are classified under GAAP as additions to permanently restricted net assets. POTENTIONAL EFFECT OF UPMIFA ON NET ASSET CLASSIFICATION In July 2006, the National Conference of Commissioners on Uniform State Laws (NCCUSL) approved a model UPMIFA as a modernized version of UMIFA. (An annotated text, with the NCCUSL s comments, can be found at Thirteen states have enacted a variation of UPMIFA and several others have announced legislation (see Appendix I). It is expected that all of the remaining states that have followed UMIFA likely will enact a variation of UPMIFA. UPMIFA modernizes the guidance contained in UMIFA, taking into account developments in the management and investment of endowment funds that have occurred The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations.

14 over the past few decades. Among the revisions, UPMIFA prescribes new guidelines for endowment fund expenditure (in the absence of overriding, explicit donor stipulations). While UMIFA focused on the prudent spending of net appreciation on a donor-restricted endowment fund, UPMIFA focuses on the fund as a whole and eliminates the bright-line historic-dollar-value threshold in favor of a more robust set of guidelines about what constitutes prudent spending, with preservation of the fund being the first factor listed. With the potential for a wide range of views about how to classify net assets associated with donor-restricted endowment funds under UPMIFA, constituents have sought guidance from the FASB or its staff. Issue 1: Given the elimination of the historic-dollar-value threshold, how should the net assets associated with a donor-restricted endowment fund under UPMIFA be classified? The following four views have been identified: View A: None of the fund should be classified as permanently restricted net assets. View B: The entire fund should be classified as permanently restricted net assets. View C: The entire fund should be classified as a new net asset class/subclass. View D: Some, but generally not all, of the fund should be classified as permanently restricted net assets. The amount would be the portion of the fund that must be retained permanently as determined by interpretation of the state's version of UPMIFA (and any other relevant state law). Additional disclosures would be needed. Proponents of View A believe that UPMIFA effectively precludes classification of any portion of a donor-restricted endowment fund as permanently restricted net assets. They contend that in the absence of a historic-dollar-value threshold, an organization s ability to spend down an endowment balance below the amount of the original gift, even on a temporary basis, runs counter to the notion that, by definition, permanent restrictions result from donor-imposed stipulations that neither expire by passage of time nor can be fulfilled or otherwise removed by actions of the organization (glossary from FASB Statement No. 116, Accounting for Contributions Received and Contributions Made, emphasis added). Proponents of View B stress that, by eliminating the historic-dollar-value concept, UPMIFA shifts the focus to the endowment fund as a whole. They contend that, under UPMIFA, separately tracking the original gift amount apart from appreciation serves as little purpose as, say, focusing on original cost basis for investments accounted for at fair value. Reporting donor-restricted endowment funds in one net asset class would not only be simpler than the current net asset classification scheme, which differs from the fund as a whole reports that organizations typically send donors, but would better reflect the underlying nature of the fund under UPMIFA. They believe the notion of permanently restricted should be broadened to include unspent appreciation, and, thus, the entirety of these types of funds would be reported as permanently restricted net assets. 2

15 Similar to supporters of View B, proponents of View C believe that the net assets associated with a donor-restricted endowment fund should be reported in one place; however, they don t believe that the definition of permanently restricted net assets would or should allow for inclusion of donor-restricted endowment funds in their entirety. They suggest a more wholesale restructuring of the FASB s net asset classification model, such as the merging of the temporarily and permanently restricted net asset classes into one restricted net asset class with a breakdown into endowment and other-than-endowment, or more nuanced categories, either on the face of the balance sheet or in the notes. Proponents of View D believe that, at least in the long run, a portion, but not all of a donor-restricted endowment, is not expendable and should be classified as permanently restricted net assets. While the amount of that portion may not be as obvious as it has been under UMIFA, proponents believe that the key principle for determining the amount can be found by extrapolating to the overall fund the principle in paragraph 22 of FASB Statement No. 117, Financial Statements of Not-for-Profit Organizations, on investment gains; only the portion that a governing board has determined must be retained permanently in accordance with relevant law would be classified as permanently restricted net assets. While that determination would ultimately be a matter of state law, the amount that must be retained, as opposed to simply being good organizational policy to retain, would seem likely to approximate either historic dollar value or its purchasing power equivalent. Regardless of the FASB s interpretation of the effect of UPMIFA on net asset classification, additional qualitative and quantitative disclosures may be necessary. These could include, for example: (a) discussion of how the organization has interpreted the amount to be retained permanently in accordance with the state s version of UPMIFA; (b) the organization s spending policy and planned and actual spending rates; and (c) the amount of the organization s endowment fund assets that are contained in each of the net asset classes. However, additional disclosures such as these would be particularly important for the solution proposed in View D. Staff Recommendation On balance, the staff finds View D to be the most compelling. While View D may lack the simplicity of some of the other views, the staff believes that it best reflects the underlying nature of the fund under UPMIFA, at least within the current GAAP conceptual framework for not-for-profit organizations. View A overstates the flexibility allowed by UPMIFA, and has the potential to grossly mischaracterize a donor-restricted endowment as just another expendable fund. View B, conversely, understates the flexibility allowed by UPMIFA by implying the unavailability of funds that a governing board could indeed prudently spend. View C would require a wholesale reconsideration of the not-for-profit net asset framework, which would be a long-term project that is best done, if at all, after completion of the Not-for-Profit Phase of the Conceptual Framework Project. In contrast, through its principle and additional disclosures, View D provides both a workable and appropriate solution because it: Retains the current net asset classification scheme, which creditors and other users have found useful when looking at donor-restricted endowment funds 3

16 Neither overstates nor understates the flexibility afforded by UPMIFA Does not stray into the realm of either arbitrariness or definitive legal interpretation (as would, for example, an explicit requirement to continue to classify as permanently restricted the equivalent of historic dollar value ) Provides important information about how organizations are interpreting and managing donor-restricted endowment funds under UPMIFA. If this project is added to the Board's agenda, a final set of disclosures developed with the help of key preparer, practitioner, and user constituents, would be recommended by the staff for the Board's consideration in December. Issue 2: If the Board agrees with the staff recommendation on Issue 1 (View D), should investment losses continue to be charged to temporarily restricted net assets (if present) and unrestricted net assets, rather than permanently restricted net assets, when a donor-restricted endowment fund is under water? The historic-dollar-value concept has played an important role in the management and net asset classification of donor-restricted endowment funds in under water situations (that is, in situations in which the fair value of the fund is temporarily less than historic dollar value). Previously, UMIFA only allowed for the expenditure of net appreciation in excess of historic dollar value, and organizations had to cease any spending of funds until they regained above water status. In such circumstances, investment losses on donorrestricted funds were charged to temporarily restricted or unrestricted net assets, rather than permanently restricted net assets, in accordance with paragraphs of FASB Statement No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations. In light of the additional spending flexibility and the elimination of the historic-dollar-value threshold provided in UPMIFA, the Board will now need to consider whether the guidance surrounding investment losses is still appropriate. View A: The approach should be different; investment losses and spending (if any) in under water situations should be charged to permanently restricted net assets View B: The approach should be the same; investment losses and spending (if any) in under water situations should be charged to temporarily restricted or unrestricted net assets Staff Recommendation The staff finds View B, on balance, to be more compelling and thus recommends that the Board not fundamentally change the guidance in Statement 124. Some minor amendments, especially the references to UMIFA in the related footnote 4 to paragraph 13, may be needed. The staff would address these in the drafting of the FSP. The staff thinks that none of the changes in the spending guidelines provide a substantive reason for the Board to change its decision in Statement 124 concerning the reporting of endowment losses. Indeed, the possibility of continued organizational spending in under water situations, on top of investment losses, only increases the likelihood, under View A, of management intent, rather than donor intent, driving net asset classification and 4

17 causing the same consistency and comparability issues that the Board had tried to forestall in making its decision in Statement 124. Like other proponents of View B, the staff views spending in an under water circumstance as a type of intra-organizational borrowing that must ultimately be repaid in order to meet UPMIFA s long-term goal of preserving the endowment fund, rather than as a release from a donor-imposed permanent restriction. The latter would in fact diminish permanently restricted net assets and result in a reclassification of net assets to either temporarily restricted or unrestricted net assets. Issue 3: If the Board selects View A or View D on Issue 1, should a temporary restriction be implied from UPMIFA s provision in Section 4(a) that unless stated otherwise in the gift instrument, the assets in an endowment fund are donorrestricted assets until appropriated for expenditure by the institution? (This question applies to both perpetual and term endowments.) Shortly after the issuance of Statement 117, disagreements arose between accountants and attorneys in the state of New York concerning whether unappropriated endowment appreciation could be considered unrestricted. In response, the FASB staff provided guidance through a staff announcement made at the March 1996 EITF meeting, as reported in EITF Abstracts, Topic No. D-49, Classifying Net Appreciation on Investments of a Donor-Restricted Endowment Fund (see Appendix II). Topic D-49 clarifies that a legal requirement that a governing board act to appropriate net appreciation for expenditure under a statutorily prescribed standard of ordinary business care and prudence does not in and of itself extend a donor restriction to that appreciation. The donor restricted assets language in Section 4(a) of UPMIFA has been viewed by some as yet another incursion by legal professionals into the realm of accounting for endowment funds. The Board will be asked to consider the implications of this language in UPMIFA on the net asset classification of endowment funds. Staff Recommendation The staff recommends that the Board include guidance in the FSP concerning the donor restricted assets language in Section 4(a) of UPMIFA. Such guidance would be similar to Topic D-49, in that it would remind readers that not all legal restrictions constitute donor-imposed restrictions for accounting purposes, and would state that because the donor restricted assets language in Section 4(a) of the model UPMIFA revolves around an action that is solely within the purview of a governing board, the language by itself does not create or extend a donor-imposed restriction. However, the staff also recommends that the guidance include the caveat that an organization would need to make a definitive determination based on the specific language in their state s version of UPMIFA and any other relevant legal guidance. Issue 4: If the Board selects View A or View D on Issue 1, should a temporary restriction be implied from UPMIFA s optional rebuttable presumption of imprudence? (This question applies to both perpetual and term endowments.) For states that wish to include additional guidance regarding prudent spending of donorrestricted endowment funds, the model UPMIFA includes an option for adding a rebuttable presumption of imprudence for spending over 7 percent of the market value of 5

18 the fund (calculated over the period in which the organization bases its spending formula). Thus far, about half of the enacting states have chosen to include such a provision (Texas also varies the specific percentage based on the size of the organization; see Appendix I). The implications of a state s inclusion of this provision on the net asset classification of endowment funds will need to be considered. Staff Recommendation The staff believes that UPMIFA s optional rebuttable presumption represents additional rule of thumb guidance on prudence, rather than an absolute ceiling effectively imposing a temporary (time) restriction. It would thus seem to fall within the general principle articulated in Topic D-49. Accordingly, the staff recommends that the Board indicate such in the FSP, with the caveat that an organization would need to make a definitive determination based on the specific language in their state s version of UPMIFA and any other relevant legal guidance. Does the Board agree that a project should be added to its agenda to provide guidance on this matter in the form of an FSP? Does the Board agree with the staff s specific recommendations on Issues 1-4? 6

19 APPENDIX I: CURRENT STATUS OF STATE-BY-STATE ADOPTION OF UPMIFA (AS OF OCTOBER 1, 2007) State Status Effective Date 7% Imprudence Provision? Connecticut Enacted 10/1/2007 No Idaho Enacted 7/1/2007 No Indiana Enacted 7/1/2007 No Montana Enacted 10/1/2007 Yes Nebraska Enacted 9/1/2007 No Nevada Enacted 10/1/2007 Yes Oklahoma Enacted 7/1/2007 No Oregon Enacted 1/1/2008 Yes South Dakota Enacted 7/1/2007 No Tennessee Enacted 7/1/2007 Yes Texas Enacted 9/1/2007 Yes* Utah Enacted 4/30/2007 Yes Delaware Enacted 7/31/2007 No Alabama Pending District of Colombia Pending Kentucky Pending Michigan Pending Minnesota Pending Missouri Pending U.S. Virgin Islands Pending Vermont Pending Georgia 2008 Session Kansas 2008 Session New Hampshire 2008 Session North Carolina 2008 Session Pennsylvania 2008 Session Note: As of 10/1/2007, no other states had yet announced planned legislation. * While Texas has adopted UPMIFA, it has included two additional stipulations regarding appropriations of endowment funds. Consistent with the model act, appropriations of expenditures greater than seven percent of the market value of the endowment creates a rebuttable presumption of imprudence for endowments greater than $1 million. The State's two modifications are as follows: 1. For endowments of less the $1 million, the presumption of imprudence spending threshold is lowered to 5 percent of the market value of the endowment. 2. The adopted act also provides an exception for university endowment funds greater than $450 million. For these endowments, spending in excess of 9 percent of the endowment's market value creates a rebuttable presumption of imprudence. 7

20 APPENDIX II: EITF ABSTRACTS, TOPIC D-49 Topic No. D-49: "Classifying Net Appreciation on Investments of a Donor-Restricted Endowment Fund" Date Discussed: March 21, 1996 An FASB staff representative announced that the FASB staff has received the following technical inquiry about the application of the provisions in paragraph 22 of FASB Statement No. 117, Financial Statements of Not-for-Profit Organizations, and paragraph 11 of FASB Statement No. 124, Accounting for Certain Investments Held by Not-for- Profit Organizations, in classifying net appreciation on investments of a donor-restricted endowment fund. Paragraph 22 of Statement 117 states: A statement of activities shall report gains and losses recognized on investments and other assets (or liabilities) as increases or decreases in unrestricted net assets unless their use is temporarily or permanently restricted by explicit donor stipulations or by law. For example, net gains on investment assets, to the extent recognized in financial statements, are reported as increases in unrestricted net assets unless their use is restricted to a specified purpose or future period. If the governing board determines that the relevant law requires the organization to retain permanently some portion of gains on investment assets of endowment funds, that amount shall be reported as an increase in permanently restricted net assets. Paragraph 11 of Statement 124 states: A donor's stipulation that requires a gift to be invested in perpetuity or for a specified term creates a donor-restricted endowment fund. Unless gains and losses are temporarily or permanently restricted by a donor's explicit stipulation or by a law that extends a donor's restriction to them, gains and losses on investments of a donor-restricted endowment fund are changes in unrestricted net assets. Q Do legal limitations that require that the governing board act to appropriate net appreciation for expenditure under a statutorily prescribed standard of ordinary business care and prudence extend a donor restriction to the net appreciation on investments of a donor-restricted endowment fund? A No. The FASB staff believes that Section 2 of the Uniform Management of Institutional Funds Act and its reference to the standard of ordinary business care and prudence established by Section 6 does not extend a donor-imposed restriction as that term is defined in Statement 117. Paragraphs of Statement 117 explain the FASB's consideration of this matter. In jurisdictions in which the Uniform Act is in force, the governing board must exercise ordinary business care and prudence under the facts 8

21 and circumstances prevailing at the time of the action or decision in administering its powers to appropriate appreciation. In the absence of other relevant law, if the Uniform Act has been adopted without modifications that preclude the governing board from exercising its discretion to appropriate some or all of an organization's net appreciation on investments, realized or unrealized, the net appreciation is not donor-restricted unless the donor has explicitly restricted the use of either income or net appreciation. Paragraph 128 of Statement 117 notes that the state of Rhode Island has modified the Uniform Act to preclude a governing board from exercising its discretion over a portion of the net appreciation. Paragraph 128 also notes that in Rhode Island the amount of the net appreciation that must be maintained to cover required purchasing power adjustments would be classified as permanently restricted. Paragraph 168 of Statement 117 defines a donor-imposed restriction as "a donor stipulation that specifies a use for a contributed asset that is more specific than broad limits resulting from the nature of the organization, the environment in which it operates, and the purposes specified in its articles of incorporation or bylaws or comparable documents for an unincorporated association." The FASB staff believes that a requirement to exercise ordinary business care and prudence is not a limitation that is more specific than the broad limits of the environment in which charitable and other notfor-profit organizations operate. Furthermore, paragraph 127 of Statement 117 says, "Others, including Board members, believe that the responsibility to exercise ordinary business care and prudence in determining whether to spend net appreciation is similar to the fiduciary responsibilities that exist for all charitable resources under an organization's control." Thus, a legal limitation that requires that a governing board exercise ordinary business care and prudence when appropriating net appreciation is not the equivalent of a law that extends a donor-imposed restriction and, therefore, does not result in classification of net appreciation as donor-restricted, either permanently or temporarily. 9