Endowment Fund

An endowment fund is a pool of assets, usually cash and investments, that a nonprofit organization holds for the long term and invests so that it can produce income year after year. The defining feature is that the original amount given, often called the corpus or principal, is expected to be kept intact, while the organization spends only a portion of the investment return on its programs.

Endowments usually start with gifts from a donor who wants a lasting effect rather than a one-time donation. Because the donor's wishes are often written into a gift agreement, an endowment is one of the most common examples of a donor-imposed restriction in nonprofit accounting. Its reporting is governed in the United States by FASB rules for not-for-profit entities and, on the legal side, by state versions of the Uniform Prudent Management of Institutional Funds Act (UPMIFA).

Not every endowment is restricted in the same way. Accountants and fund managers generally recognize three kinds:

• A donor-restricted (true or permanent) endowment is one where the donor requires the gift to be held in perpetuity, so the organization may never spend the original amount.
• A term endowment is restricted only for a set period or until a stated event, after which the principal may be released and spent.
• A board-designated endowment, sometimes called a quasi-endowment or funds functioning as endowment, is money the governing board chooses to set aside and invest; because the board imposed the limit, the board can also remove it.

The distinction matters because only donor restrictions change how the money is classified. A quasi-endowment is still legally unrestricted, even if it is managed exactly like a permanent fund.

Most institutions spend a fixed percentage of the fund's value each year rather than spending whatever income happens to arrive. This spending rate is commonly set somewhere between 4 and 5 percent of a rolling average of market values, often over the previous 12 quarters, which smooths out swings in the market. The aim is intergenerational fairness: today's students or patients should get roughly the same support as those in the future, after allowing for inflation.

For example, suppose a university's endowment had an average market value of $200 million over the past three years and its spending policy is 4.5 percent. The amount released for the coming year would be:

Here $\text{Average market value}$ is the smoothed fund value and $\text{Spending rate}$ is the board-approved percentage. Working it through, $200 million times 0.045 gives $9 million available for scholarships, research or other purposes named by donors. If the fund earns 8 percent in a good year, the extra return stays in the fund and builds the base for later years. The money itself is typically invested through a diversified portfolio of stocks, bonds and alternative assets, sometimes alongside a board of trustees fund pooled for the same purpose.

Under the reporting model introduced by ASU 2016-14, a nonprofit's financial statements show net assets in two classes: with donor restrictions and without donor restrictions. A permanent endowment sits in net assets with donor restrictions. Investment earnings on that endowment are also restricted until the board appropriates them for spending under its policy, at which point they are released and reported as unrestricted.

Gifts to an endowment are recorded as contributions revenue when received or unconditionally promised. Investment gains and losses flow through the statement of activities and therefore affect the change in net assets for the year. Organizations must also disclose their endowment composition, return objectives, spending policy and a reconciliation of the beginning and ending balances in the notes.

An endowment is described as underwater when its current fair value falls below the original gift amount, which can happen after a market fall. UPMIFA generally allows prudent spending to continue even when a fund is underwater, but nonprofits must disclose the shortfall. Other recurring issues include tax: large private university endowments in the United States became subject to an excise tax on net investment income under the 2017 Tax Cuts and Jobs Act, a rare exception to the usual treatment of nonprofits as earning tax-exempt income. Endowment managers also face questions about fees, asset allocation and responsible investing.

• Financial Accounting Standards Board
• Internal Revenue Service: Charities and Nonprofits