SFAS 124: accounting for investments by not-for-profit entities.
A primary goal of the FASB’s continuing project on
not-for-profit (NFP) accounting is to reduce the inconsistencies in
accounting methods used in the various NFP sectors. To that end,
Statement of Financial Accounting Standards (SFAS) 116, Accounting for
Contributions Received and Contributions Made, standardized NFP
accounting procedures for contributions and SFAS 117, Financial
Statements of Not-for-Profit Organizations, established a minimum level
of financial reporting and disclosures for all NFPs. The latest chapter
of the FASB’s NFP project is SFAS 124, Accounting for Certain
Investments Held by Not-for-Profit Organizations. This standard provides
accounting and reporting requirements for all NFPs with certain types of
investments. Prior to SFAS 124, accounting guidance for investments of
NFPs was contained in four separate AICPA audit guides which resulted in
diverse practices among the different NFP sectors.
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
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
SFAS 124 also notes that quoted market prices represent the best
measure of fair value for debt securities. However, some debt securities
don't trade regularly and therefore, quoted market prices aren't
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
SFAS 124 requires all gains and losses, both realized and unrealised,
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
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with a fair value of $1,200,000. On December 31, 1995, the makeup of the
investment portfolio is unchanged. It's a fair value of
$1,300,000. For 1995, Acme College has a gain, albeit unrealised, 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 unrealised, 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 summarised 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
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
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
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donor-imposed restrictions on net appreciation haven't been reached
before the loss occurs. Any remaining losses reduce unrestricted net
assets. Gains occuring 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. Net gains and losses on investments reported at fair
* 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's 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,
* 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
Finally. 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
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
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
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 unrealised, related to
the change in the investment’s fair value on the statement of
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 hasn't 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