DATELINE: June 4, 2008, Chicago
CAVEATS: All comments are based on a discussion at today's meeting of the FASB. The comments and decisions at the meeting should be viewed as preliminary because the staff must first incorporate them into a final proposal and the FASB must then approve that proposal. Even more importantly, we might have misheard or misinterpreted comments as we listened on the Internet.
That said, this is what we heard:
The Financial Accounting Standards Board (FASB) approved major changes in the accounting for endowments today as it considered proposed staff FSP 117-a. The substantive changes will only apply to endowments that are governed by the Uniform Prudent Management of Institutional Funds Act (UPMIFA), which is now in effect in 20 states and under consideration by a number of others.
Boards will continue to be charged with interpreting state law to arrive at the classification of endowment funds. However, the interaction between the rules in the finalized FSP and how the plain-vanilla version of UPMIFA will be interpreted is expected to achieve the following radically...
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changed result:
The book value for permanently restricted assets will converge toward historic dollar value--we note that UPMIFA eliminated historic dollar value, but the FASB just can't seem to shake the concept.
All other amounts that are not appropriated by the board, but which carry donor restrictions in the nature "spend income, preserve principal" will be classified as temporarily restricted.
Net appreciation on permanently restricted endowments funds that was classified as unrestricted before the effective date of FSP 117-a will be reclassified as temporarily restricted.
This is a major victory for the legal profession and institutions with endowments. One staff member inferred that the staff resisted this change, but simply couldn't argue around the language in the statue that explicitly says the funds cannot be expended until the board affirmatively appropriates the funds for spending by taking into account seven factors. This same staff member said that the seven factor test imposed enough of a burden on a nonprofit board that the balance shifted toward treating unappropriated amounts as restricted, albeit temporarily restricted.
The board also addressed the question of underwater endowments. Here the board adopted a position that continues to get it wrong, misleading creditors, donors, and regulators. Specifically, the final rule continues to charge unrestricted assets when the value of the permenant endowment drops below historic dollar value despite the fact that a permanent endowment fund has no legal claim on the interest of the unrestricted assets. This is a classic green-eye shade decision. It leaves historic dollar value at "par," but maintains equality of debits and credits by charging something. The problem is that it doesn't appropriately reflect the legal claims on the organization's different categories of assets. Moreover, it may mislead the board in making its internal deliberations, which would be counter to the expressed and explicit intent by UPMIFA's drafters to permit spending from underwater endowments if continued spending adhered to donor intent, as interpreted through application of the seven factors. The staff noted that financial statements don't bind internal decisionmakers like boards in their deliberations. The staff got that right, but it completely undercuts the rationale for board review of financial statements, something that everyone is trying to get boards to do.
The staff indicated to the FASB that it received a number of comments that proposed FSP 117-a placed too much emphasis on maintenance of purchasing power. It heard the comments loud and clear that purchasing power is not a super factor. As a consequence, the staff advised the FASB that it would de-emphize the focus on purchasing power in the final version.
The FASB refused to open up a project to overhaul endowment accounting, taking the position that UPMIFA did not change the landscape sufficiently to warrant a rewrite. The FASB indicated that it wanted several years of experience and would entertain a formal request for reconsideration of the rules once more is known about the law. We were pleased with the one member of FASB who said that applying existing accounting principles to UPMIFA-governed endowments was putting a square peg in around hole. He seemed to be inclined to rewrite the rules from scratch, but deferred to his fellow FASB members.
At the end of the day, the FASB must address the "temporarily restricted" category. It just isn't descriptive. It suggests to people like Senator Charles Grassley that the money eventually will be spent, which could lead people like Senator Grassley to mandate more current spending through mandatory payout requirments. In truth, this money is more akin to early LIFO layers. Even though some of the money is spent every year, the amount stays constant or increases every year because of ongoing income. As a practical matter, much of this money will never be spent, but invested to continue producing future income.
We need clarification on one point that came up. One staff member focused on purpose-based restrictions. He gave the example of a cancer hospital which received a gift that said the money could only be used for cancer treatment. He seemed to take the position that this gift would be treated as unrestricted. We would agree, assuming the gift was not in the nature of an endowment. However, if the donor said, "Spend only the income to treat cancer, but preserve principle," we would argue that the gift is restricted and should be treated like any other restricted gift. In short, we do not believe whether the institution is a single-purpose institution should affect the classification in these situations.
As for the disclosure piece of the equation, the FASB decided to retain the basic disclosures mandated by Paragraphs 12(a) and 12(b) of proposed FSP 117-a. The FASB also agreed to retain the proposed investment policy disclosures in Paragraph 12(c). The tabular disclosures in Paragraphs 12(d) and (e) will be retained in part, but we think the FASB decided to eliminate the disclosure of amounts added to permanent endowment. Quite frankly, we lost the train of thought on this issue so we will have to review a transcript if one becomes available. The FASB did decide to drop Paragraph 13, which required forward looking statements regarding next year's planned appropriation. How can a board apply factors a year in advance of a decision which depends on then current circumstances. Last year at this time, was the consensus view that the U.S. financial system would be crippled by sub-prime lending and a liquidity crisis?
Finally, the FASB deferred implementation by six months to fiscal years ending after December 15, 2008. That also was the right decision.
So there you have it. We got a lot of what we wanted, but not everything. One procedural point of order. Each speaker should identify him or herself when entering the converation. Those listening to the meeting over the Internet would benefit from this.
Attached is the meeting handout for today's meeting. The portion of the handout that addresses proposed FSP 117-a begins on page 5.
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