Ketel Thorsetenson

Friends for Life

Endowment Funds: Investment Responsibilities and Accounting, Part I

Written by  Rebekah Wolkenhauer, CPA, Audit Manager, Ketel Thorstenson, LLP Jun 15, 2012 4:35 am

Endowment is a term used to describe funds received by an organization that are not allowed to be spent. The lack of ability to spend such funds arises as a term of the gift as illustrated in the example above. Joe has requested that the organization maintain his gift of $10,000 and use any income generated from these funds to support the organization's programs. This example is not uncommon for non-profit organizations but are you aware of what laws exist regarding endowments?

Have you ever received a letter like this one?

Dear ABC Charity, Enclosed is my donation of $10,000. Please deposit these funds into your endowment fund for purposes of supporting your programs. Thanks for all that you do.
Sincerely,
Joe

Endowment is a term used to describe funds received by an organization that are not allowed to be spent. The lack of ability to spend such funds arises as a term of the gift as illustrated in the example above. Joe has requested that the organization maintain his gift of $10,000 and use any income generated from these funds to support the organization's programs. This example is not uncommon for non-profit organizations but are you aware of what laws exist regarding endowments?

The Uniform Prudent Management of Institutional Funds Act (UPMIFA) has been enacted as state law by the majority of the states and serves as overall guidance on endowments. UPMIFA specifically:

  1. Provides overall guidance to charitable organizations regarding how these funds are managed and invested.
  2. Imposes additional duties on the charitable organization that serve to protect the organization and the interests of donors by establishing rules for spending income earned from these funds.

The full version of UPMIFA can be accessed at www.upmifa.org. A summary is provided below:

As the name of the act indicates, the main point expressed in UPMIFA is prudence. Prudence is the ability to weigh one task against another to determine the best decision and to avoid taking unnecessary risks. UPMIFA requires a charity and those who manage and invest its funds to:

  1. Give primary consideration to donor intent as expressed in a gift instrument
  2. Act in good faith, with the care an ordinarily prudent person would exercise
  3. Incur only reasonable costs in investing and managing charitable funds
  4. Make decisions about each asset in the context of the portfolio of investments, as part of an overall investment strategy
  5. Diversify investments unless due to special circumstances, the purposes of the fund are better served without diversification
  6. Dispose of unsuitable assets, and
  7. In general, develop an investment strategy appropriate for the fund and the charity

Let's go back to our example above. Once an organization receives the donation of $10,000, it is the organization's responsibility to consider UPMIFA in determining what to do with these funds.

  • Should the money be deposited into a checking account? This would fail the guidelines above as the intent of these funds is to raise money to support programs. No interest would be earned in a checking account.
  • Should the money be deposited into a certificate of deposit? Depends. If the Organization's program includes raising money for purchasing Christmas presents, this event only takes place annually. It could be considered prudent to maintain the principal balance of $10,000 and use the income earned annually to purchase presents. If the Organization's current situation is that enough funds exist to support current programs, then it may be prudent to deposit the funds into a higher yield but potentially more risky investment for future support. All of the factors listed above would need to be considered by the Organization to determine what would be considered prudent.
  • Should the money be deposited into an investment portfolio? As illustrated above, there are a number of factors that need to be considered when determining the element of prudence. When investing funds into a portfolio, it is the responsibility of the Organization (not the investment advisor) to diversify the portfolio, dispose of assets that are not performing well, and ensure expenses charged by an investment advisor are reasonable. An investment strategy would allow an organization to provide guidance to an investment advisor regarding how the organization feels funds should be invested (e.g. 20-35% in bonds, 50% in international mutual funds, 25-35% in common stock, etc.)

The guidelines provided by UPMIFA are not complex but it can be hard to define what would be 'prudent' and 'reasonable'. Because of this, it is wise to document all decisions and factors considered by the organization in the board minutes. The organization may also want to seek out guidance from the donor on what they feel would be a prudent means with which to invest the endowed funds. We would also recommend the organization adopt an investment policy. This should be provided to both the investment advisor and the donor.

Stay tuned to next quarter's e-newsletter which will cover the second guideline of UPMIFA spending of funds and accounting of such. For any questions on items covered above, please feel free to contact Jean Smith (This email address is being protected from spambots. You need JavaScript enabled to view it.) or Rebekah Wolkenhauer (This email address is being protected from spambots. You need JavaScript enabled to view it.).

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