Endowments, Part 2: Endowment Types

In part 2 of our endowment series, we’ll discuss the types of endowment funds. But first, let’s review what we discussed in part 1. In part 1, we discussed what an endowment fund is: a fund established to provide a source of income. In addition, we said that an endowment is separate from the not-for-profit organization’s (NFP’s) operations. Endowment funds should be tracked separately from other types of funds and from other endowment funds.

Let’s also review some definitions we are using for purposes of this series of articles. We are differentiating an endowment from an endowment fund by defining an endowment as the collection of all of the endowment funds that the NFP has. In addition, we are defining operations or operating funds as anything or any fund that is not part of the endowment.

An endowment fund is classified according to restrictions placed on the principal used to start the endowment fund. There are three endowment fund classifications: permanent endowment fund, term endowment fund, and board-designated endowment fund.

Permanent Endowment Fund

A permanent endowment fund is a donor-restricted endowment fund and is what most people think of as a traditional endowment fund. Here is how a permanent endowment fund works: A donor contributes a sum of money (for example, $1 million) to establish an endowment fund. The principal of the fund (i.e., the $1 million) is restricted in perpetuity (or permanently) and cannot be spent by the NFP for accounting purposes. (We will discuss the implications of the Uniform Prudent Management of Institutional Funds Act [UPMIFA], the general law governing endowments in our next article.) Accordingly, the principal is recorded as permanently restricted net assets. The income generated from the principal can be restricted or for general use, depending on the donor’s wishes.

Term Endowment Fund

A term endowment fund is also a donor-restricted endowment fund where a donor contributes a sum of money (for example, $1 million) to establish an endowment fund. The principal of the fund (i.e., the $1 million) is restricted for a specified period of time and cannot be spent by the NFP during that period of time for accounting purposes. (We will discuss the implications of the Uniform Prudent Management of Institutional Funds Act [UPMIFA], the general law governing endowments in our next article.) Accordingly, the principal is recorded as temporarily restricted net assets due to a time restriction. The income generated from the principal can be restricted or for general use, depending on the donor’s wishes.

Board-Designated Endowment Fund

A board-designated endowment fund is also known as a quasi-endowment and is not a donor-restricted endowment fund. This type of endowment fund is established by the NFP’s board of directors or equivalent rather than being established by a donor. The board designates a portion of its unrestricted net assets (for example, $1 million) to establish an endowment fund. Since, this is a board-designated fund, the principal is recorded as unrestricted net assets. The income generated from the principal can used according to the board’s wishes, which can be reinvested, used for a specific purpose, or used for general operations.

At this point in our endowment series, we discussed an overview of endowments and types of endowments. In future articles, we will discuss the differences between the Uniform Prudent Management of Institutional Funds Act (UPMIFA) and GAAP, accounting for donor-restricted endowment, and accounting for board-designated endowments.

For additional information regarding endowments, please contact us.