SFAS 124: accounting for investments by not-for-profit entities.
In general, SFAS 124 applies to investments in equity securities (i.e., stock) with readily determinable market values and all investments in debt securities. The standard became effective for fiscal years beginning after December 15, 1995, with earlier application encouraged. This article addresses the main points of SFAS 124, including the special problems surrounding accounting for endowment funds.
Accounting for Investment Gains, Losses and Income
SFAS 124 bears a striking resemblance to SFAS 115, Accounting for Certain Investments in Debt and Equity Securities, which establishes reporting requirements for business enterprises' investments. That similarity is the use of fair value accounting. A primary difference between the two investment standards is that there is no requirement under SFAS 124 for investments to be categorized as either held-to-maturity, available-for-sale or trading. Under SFAS 115, investments must be classified in these groups, with different reporting requirements for each group. SFAS 124 simplifies investment accounting for NFPs by requiring all investment securities under its scope to be accounted for at fair value.
As previously mentioned, SFAS 124 applies to an NFP's investments in equity securities that have readily determinable fair values and to all investments in debt securities. Equity securities are considered to have readily determinable fair values if any one of the following conditions exist:
* For a security traded in the domestic market, a sales price or bid-and-asked quotation is available on a securities exchange registered with the SEC or in the over-the-counter market.
* For a security traded only in a foreign market, that foreign market is of a breadth and scope comparable to one of the U.S. markets referred to above.
* For an investment in a mutual fund, the fair value per share is determined and published and is the basis for current transactions.
The quoted market price for equity securities meeting one of the above criteria will be the measure of fair value used for accounting and reporting purposes.
SFAS 124 also notes that quoted market prices represent the best measure of fair value for debt securities. However, some debt securities do not trade regularly and therefore, quoted market prices are not available. In these instances, other means of measuring fair value must be used. These measures will be more subjective and should consider the market price of similar securities and the results of valuation techniques, such as the present value of expected cash flows discounted at a rate commensurate with the risk involved. Regardless of the particular method employed to determine fair value, the investments are reported on the NFP's statement of financial position at this amount.
SFAS 124 requires all gains and losses, both realized and unrealized, related to an NFP's investments be reported in the current period's statement of activities. These gains and losses are measured as the changes in the fair values of the investments. For example, on January 1, 1995, Acme College has an investment portfolio with a fair value of $1,200,000. On December 31, 1995, the makeup of the investment portfolio is unchanged, but it has a fair value of $1,300,000. For 1995, Acme College has a gain, albeit unrealized, of $100,000 from their investments; the gain would be recognized in full in the statement of activities.
In the absence of any donor-imposed or legal restrictions on how an investment may be used, this gain would be reported as an increase in unrestricted net assets. A loss, realized or unrealized, would decrease unrestricted net assets. If restrictions do exist on the use of an investment, the gain or loss is shown as an increase or decrease in either temporarily or permanently restricted net assets, depending on the type of restriction existing. Investment income (i.e., interest and dividends) earned during the year is reported as an increase in unrestricted net assets, unless the income's use is restricted; in that case, temporarily or permanently restricted net assets are increased depending upon the restriction. The steps used in reporting investments and their gains and losses are summarized in Table 1.
One issue concerning donor-imposed restrictions on the use of investment income and gains is how to report these items when the restriction is satisfied in the same period the income or gain is earned. In this situation, the investment income and gains may be reported as increases in unrestricted net assets as long as the organization has a similar policy for reporting contributions received, reports consistently from period to period and discloses its accounting policy.
For example, assume an individual donates $1,000,000 to a private college to establish an endowment to be used to bring nationally known speakers to the college's speakers forum. The $1,000,000 principal is permanently restricted by the donor and the investment income can only be used to pay speaker fees and related travel costs. During the first year of the program, the endowment earned $95,000 of investment income and the university spent $80,000 on speakers for the forum. Therefore, during the year, the restrictions on $80,000 of the $95,000 of investment income were met and $80,000 would be shown as an increase in unrestricted net assets in the statement of activities. The remaining $15,000 would be reported as an increase in temporarily restricted net assets. Of course, the $80,000 paid to the speakers would also be recognized as a program expense (i.e., reduction of unrestricted net assets).
This is a fairly straightforward example of a donor-restricted endowment. However, these types of funds often create the greatest complexities associated with applying SFAS 124. The next section addresses the problems associated with endowment funds.
Accounting for Endowment Funds
A donor-restricted endowment fund results from a contribution carrying a stipulation that the gift be invested in perpetuity or for a specified time period. This donor stipulation sometimes relates not only to the principal amount but also to a net appreciation value.
Reporting investment income and gains on endowment funds depends on the existence of any donor restrictions concerning the use of the income or investment appreciation. If no restrictions exist, investment income and gains are shown as increases in unrestricted net assets. If part of the net appreciation value is permanently restricted, any investment income or gains would be reported as increases in permanently restricted net assets until the required net appreciation value is reached. Once this value is reached, any further investment income and gains are increases in unrestricted net assets unless donor restrictions on their use exist, in which case either temporarily or permanently restricted net assets are increased, depending on the nature of the restrictions.
Classifying losses on endowment funds is slightly more complicated than classifying gains, since most donor agreements are silent regarding loss disposition. SFAS 124 requires, unless donor stipulations exist to the contrary, that losses not affect permanently restricted net assets, even if fair value falls below the principal amount. Instead, these losses reduce temporarily restricted net assets to the extent that donor-imposed restrictions on net appreciation have not been reached before the loss occurs. Any remaining losses reduce unrestricted net assets. Gains occurring in subsequent years that restore the endowment fund to the permanently restricted amount are reported as increases in unrestricted net assets. Table 2 summarizes the reporting requirements for gains and losses on endowment funds.
As an example of accounting for a donor-restricted endowment fund, assume on January 1, 1992, an individual donates $1,000,000 to a private college. The donor stipulates that the principal plus the first $100,000 of net appreciation are to be permanently maintained. All remaining income and gains earned by the fund are unrestricted. Further assume that the fair values of the endowment fund are as follows:
December 31, 1992 $1,070,000 December 31, 1993 1,150,000 December 31, 1994 980,000 December 31, 1995 1,040,000
For the year ending December 31, 1992, the endowment fund has a total gain of $70,000 ($1,070,000 fair value at the end of the year minus $1,000,000 fair value at the beginning of the year). Since the fund has not attained the required net appreciation value ($1,100,000) at this point, the $70,000 gain is shown as an increase in permanently restricted net assets.
The fund has an $80,000 gain in 1993 and met and surpassed the required net appreciation value during the year. As a result, the first $30,000 of the gain (the amount needed to reach the required net appreciation value of $1,100,000) is shown as an increase in permanently restricted net assets. The remaining $50,000 gain results in an increase in unrestricted net assets.
The endowment suffers a loss of $170,000 in 1994. Since there are no donor stipulations on loss disposition and the required level of net appreciation value had been reached prior to the loss, the full $170,000 loss is shown as a reduction in unrestricted net assets.
Finally, the fund recovers somewhat in 1995 and shows a gain of $60,000. The full amount of this gain is reported as an increase in unrestricted net assets.
SFAS 124's disclosure requirements are extensive and are designed to allow the financial statement reader to understand the investments owned, the changes in these investments and the risks associated with the investments of the NFP. The standard requires the following disclosures for each period for which a statement of activities is presented:
* the composition of investment return, including investment income, realized gains and losses on investments reported at other than fair value, and net gains and losses on investments reported at fair value; and
* a reconciliation of investment return to amounts reported in the statement of activities if the investment return is separated into operating and nonoperating amounts, together with a description of the policy used to determine the amount that is included in the measure of operations and a discussion of circumstances leading to a change, if any, in that policy.
Additionally, the following must be disclosed for each period a statement of financial position is presented:
* the aggregate carrying amount of investments by major types (e.g., equity securities, mutual funds, corporate debt securities, etc.);
* the basis for determining the carrying amount for investments not covered by this standard;
* the method(s) and significant assumptions used to estimate the fair values of investments other than financial instruments, if those other investments are reported at fair value; and
* the aggregate amount of deficiencies for all donor-restricted endowment funds for which the fair value of the investment at the reporting date is less than the level required by donor stipulation or law.
Finally, for the most recent period for which a statement of financial position is presented, the NFP shall disclose the nature of each individual investment or group of investments that represents a significant concentration of market risk.
SFAS 124 is the latest standard resulting from the FASB's ongoing NFP project. This standard eliminates inconsistencies in how various NFP sectors account for investments and also enhances the comparability of NFP financial statements with those of business enterprises. For all investments under its scope, SFAS 124 requires fair value measurement in the statement of financial position with the effects of changes in fair value reported in the statement of activities.
This standard is effective for fiscal years beginning after December 15, 1996, with earlier application encouraged. The adoption of SFAS 124 can be made either on a prospective basis with the related cumulative effect reported in the current year's financial statements or on a retroactive basis with prior years' financial statements restated.
Table 1: Accounting for Investments
1. Determine which investments fall under SFAS 124's scope.
A. investments in equity securities, not accounted for under the equity method or in consolidation, with readily determinable fair values.
B. all investments in debt securities
2. These investments are measured and reported at fair value in the statement of financial position.
A. quoted market prices, if available, are best measures of fair value
B. for debt security for which there is no quoted market price, use selling price of similar securities or valuation techniques such as discounted cash flows to determine fair value.
3. Report gains and losses, both realized and unrealized, related to the change in the investment's fair value on the statement of activities.
A. if no donor restriction exists, the gain (loss) is an increase (decrease) in unrestricted net assets
B. if donor restriction exists, the gain (loss) is an increase (decrease) in either temporarily or permanently restricted net assets, depending on the nature of the restriction.
Table 2: Accounting for Gains and Losses on Endowment Funds
1. Endowment funds are contributions required to be maintained in perpetuity or for a specified period of time.
2. Reporting gains on endowment fund investments:
A. In general, until any net appreciation requirement is met, gains are shown as increases in permanently restricted net assets.
B. Once the net appreciation requirement is met, gains are shown as increases in unrestricted net assets unless donor restrictions exist; in that case, either temporarily or permanently restricted net assets are increased, depending upon the restrictions.
3. Reporting losses on endowment fund investments:
A. Assuming the net appreciation requirement has been met, losses are shown as decreases in unrestricted net assets.
B. If the net appreciation requirement has not been met, losses are shown as decreases in temporarily restricted net assets. Any remaining losses are shown as decreases in unrestricted net assets.
C. All subsequent recoveries of previous losses result in increases of unrestricted net assets.
Stanley J. Clark, PhD, CPA, is an assistant professor of accounting at the University of Southern Mississippi. Charles E. Jordan, DBA, CPA, is an associate professor of accounting at the University of Southern Mississippi.