Like many statements issued by the FASB, SFAS No. 117, Financial Statements of Not-for-Profit Organizations, and SFAS No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations, continue to have their controversies. The latest is over the requirements of the Uniform Management of Institutional Funds Act and the classification of net appreciation on investments of donor-restricted endowments.

The issue is how and where should realized and unrealized appreciation in donor-restricted endowment funds be recognized in states that have adopted this law. Should the appreciation be treated as permanently restricted, temporarily restricted, or unrestricted assets? The FASB staff presented the issues at a March meeting of the Emerging Issues Task Force, which subsequently led to the issuing of a FASB Staff Announcement on the subject.

The material presented to the task force included a letter from the Office of the Attorney General of the Commonwealth of Massachusetts that restated a previously announced position that "as a matter of Massachusetts law, unless explicitly stated otherwise by the donor, realized and unrealized appreciation on investments of permanently restricted assets of Massachusetts charities should be classified as temporarily restricted assets unless and until appropriated by proper board action."

The announcement was the result of memorandums from two New York law firms that advocated that appreciation on donor-restricted funds is permanently restricted until appropriated by the governing board.

The specific issues were raised because of language in the two
statements. Paragraph 22 of SFAS
No. 117 says:

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 SFAS No. 124 says:

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.

The inquiry to the FASB staff related to legal requirements for governing boards that are subject to a standard of ordinary business care and prudence under the requirements of the Uniform Management of Institutions Funds Act to classify a portion of endowment fund appreciation as donor-restricted assets in order to maintain the fund at what, in effect, would be inflation-adjusted levels.

The FASB staff believes "Sec. 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." In the opinion of the FASB staff, "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 SFAS No. 117 specifically deals with the issue of endowment funds as they relate to Rhode Island state law. Rhode Island apparently modified the Uniform Act to legislate a fixed percentage of appreciation that must be permanently classified as permanently restricted assets to cover required purchasing power adjustments.

Paragraph 168 of SFAS No. 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 not-for-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, the conclusion of the FASB staff that a general provision for a governing board to exercise ordinary business care and prudence as it relates to investment gains is not the same as a law, such as exists in Rhode Island, that extends a donor-imposed restriction. Accordingly, such a general provision would not lead to the classification of net appreciation as donor-restricted, either permanent or temporary.

The staff informed the task force that they believe their announcement is not necessarily applicable to Massachusetts, nor any state that adopted the Uniform Act with modifications that preclude the governing board from exercising its discretion over the use of an organization's net appreciation on investments. *

[Editor's note: FASB staff announcements are published as appendices to the Emerging Issues Task Force Abstract. The staff announcement discussed will be included in Appendix D under topic D.49.]