Accounting for donation restrictions

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In 2016, FASB issued Accounting Standards Update (ASU) 2016-14, Not-for-Profit Entities – Presentation of Financial Statements of Not-for-Profit Entities, which became effective for fiscal years beginning after December 15, 2017. Among other items, this update addressed the complexity and understandability of net asset classification, reducing the number of categories from three down to two. The purpose of this was to simplify the classification to show users which net assets had some type of donation restrictions (Net Assets with Donor Restriction) and those that did not (Net Assets Without Donor Restriction).

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Contributions make up a significant amount of revenue for most nonprofit organizations. Many donors simply make gifts to an organization because they believe in their mission and want to support their general operations. This type of gifts does not contain any restriction and would be reported as Net Assets Without Donor Restriction. Management and the governing board can make decisions on how to use these funds to best support the organization.

Often donors place a restriction on the use of their donation. This may be in the form of restricting funds for a certain program or for a future period. The restricted contributions would be reported as Net Assets With Donor Restriction until either the program restriction has been satisfied or the applicable time restriction has elapsed.

A donor may also place a permanent restriction on a contribution. These types of donation restrictions normally results in the establishment of an endowment fund whereby the organization creates an investment account to hold the gift in perpetuity and is considered a Net Asset With Donor Restriction. The purposes of an endowment fund is to support the mission of the organization or a particular program within the organization by providing a portion of the annual investment earnings. Endowment funds are subject to the Arizona Management of Charitable Funds Act (AZ MCFA) which is a version of the Uniform Prudent Management of Institutional Funds Act (UPMIFA) of 2006. AZ MCFA/UPMIFA provides guidance to organizations on investment decisions and prudent spending to ensure the endowment fund remains in perpetuity. Organizations are required to have an investment policy and a spending policy, which should be in writing.

Some donors may only require their contributions for held for a specified period of time. This type of gift would also be considered a Net Asset With Donor Restriction and is often referred to as a term endowment. The organization can use the investment earnings to support its mission or a specific program in the same manner as a permanent endowment on an annual basis. The corpus would be released from restriction when the applicable passage of time has elapsed.

It is very common for governing boards to designate funds for certain programs or long-term purposes. It is important to note that this type of designation can only be classified as Net Assets Without Donor Restriction and is the result of an internal designation only. The governing board has control to change the designation. Board designation can be used to create endowment funds, whereby the organization creates an investment account and utilizes a portion of the investment earnings to support a program or operations annually or by simply designating funds in a cash account.

Organizations have a legal obligation to utilize the donor restricted contributions in the manner that was intended by the donor. Management or governing boards cannot designate net assets with donor restriction for a different purpose without the consent of the donor. Therefore, it is very important to review donor contributions in detail to determine if there is a restriction to make sure it is recorded properly.

Please contact your Henry+Horne tax professional with any questions on donation restrictions.

Karen Doyon Lord, CPA