By James L. Craig, Jr., CPA

The NYSSCPA Not-for-Profit Organizations Committee, chaired by Michael L. McNee, recently formed a subcommittee to address the classification of appreciation on endowment funds. The committee acted in response to an article in the Association of the Bar of the City of New York's The Record that presented the bar's Nonprofit Organizations Committee's opinion that, based upon its interpretation of the Uniform Management of Institutional Funds Act (UMIFA) and New York state law, appreciation on endowment funds should always be reported as temporarily restricted.

Accounting for unrealized appreciation on endowment funds is an important concern for many not-for-profits. Questions arise concerning whether the appreciation on endowment investments should be classified in the financial statements as net assets that are permanently restricted, temporarily restricted, or unrestricted. Because unrealized appreciation is not "spendable" unless the underlying investments are actually sold, many not-for-profits would prefer to show it as restricted in some way. Otherwise, they believe it gives a false impression that the organization has less need for contributions to meet its day-to-day expenses.

In practice, donors of assets to be held as endowments by organizations may or may not indicate how the not-for-profits can use the capital appreciation. If a donor explicitly states that the appreciation can only be used for specific purposes, classification as restricted is appropriate. The classification to use when the donor is silent on appreciation is another matter. In that case, according to the Financial Accounting Standards Board, organizations should refer first to the not-for-profit corporation law in the entity's jurisdiction.

The Society's subcommittee, chaired by Julie Floch, reviewed FASB's position that legal provisions, such as those in UMIFA that require not-for-profit organizations to exercise ordinary business care and prudence in making endowment appreciation available for general purposes, did not create a restriction on the use of the assets. It also considered the attorneys' arguments that New York state law requires an affirmative action on the part of the governing board that the appreciation's use is prudent under the circumstances, thereby creating a restriction. As part of its review, the subcommittee found that only Massachusetts and Pennsylvania currently mandate that appreciation be permanently restricted in the manner noted by FASB; New York does not. Ultimately, the subcommittee concluded that in the absence of precise donor stipulations, the not-for-profit board's ultimate authority to use the assets for purposes it felt prudent left no doubt that the appreciation was unrestricted, as contemplated in FASB pronouncements.

McNee said he believes that the conflict between the attorneys' interpretation of the law and the accountants' classification of assets for financial statement presentation may place CPAs in a difficult position. In the event that the classification of appreciation on endowment funds is material to the financial statements, with questions raised as to the appropriate treatment relative to New York state law, a CPA will have to consider the effect, if any, of such a conflict on the auditor's report.