What is an endowment: A nonprofit accounting guide

An endowment is a nonprofit fund where the donor's original gift, the corpus, is invested and preserved permanently or for a set term, with only the investment earnings available to spend. It's a donor-restricted fund, distinct from a board-designated quasi-endowment, which the board can reverse at will.

Key Takeaways

• An endowment is a fund where the original gift, or corpus, is invested and held permanently or for a defined term, with only the investment earnings available for spending, not the principal itself.

• An endowment is a type of donor-restricted fund, since the restriction on preserving the principal comes from the donor's own gift instructions, not from the organization's own choice.

• When an endowment's fair value falls below its original gift amount, it's called "underwater," and the accounting rule for reporting this changed significantly in 2018.

• Since ASU 2016-14, the entire underwater balance, both the original principal and the deficit, is reported within net assets with donor restrictions, reversing the prior rule that treated the deficit as unrestricted.

• Nearly every state has adopted a version of UPMIFA, which generally permits a board to spend from an underwater endowment if it determines doing so is prudent, contrary to the common assumption that spending is automatically frozen.

A donor gives a nonprofit $500,000 with instructions that the principal be invested permanently and only the earnings spent. Three years later, a market downturn leaves that fund worth $460,000. The organization hasn't lost the gift, and it isn't necessarily barred from spending anything at all, but the accounting treatment for that $40,000 shortfall changed in a way that still trips up practitioners nearly a decade after the rule took effect.

Numetix takes an expert-led, AI-powered, and human-in-the-loop approach to endowment accounting, applying the current underwater reporting rule correctly from the first reconciliation, not after an auditor flags a misclassification. This guide covers what an endowment actually is and the specific rule most likely to be gotten wrong.

Quick Answer: What is an endowment fund?

• An endowment is a fund in which the original gift is invested and preserved, either permanently or for a term set by the donor, with only the investment income available to spend.

• It's a donor-restricted fund, since the requirement to preserve the principal comes from the donor's gift instrument, not the organization's own board.

• When a fund's fair value drops below its original gift amount, it's underwater, and since 2018 the entire balance, principal and deficit together, is reported within net assets with donor restrictions.

Is an endowment a restricted or unrestricted fund?

A true endowment is a donor-restricted fund. The donor's gift instrument specifies that the principal be maintained, either permanently (a true endowment) or until a stated event or time period passes (a term endowment), and that restriction is exactly the kind of donor-imposed condition that lands a fund in the "with donor restrictions" net asset category. This is distinct from a board-designated or "quasi-endowment," where the board itself, not a donor, chooses to set aside unrestricted funds and invest them endowment-style. A quasi-endowment carries no legal restriction and the board can reverse the designation and spend the principal at any time, which a true, donor-restricted endowment cannot do.

What "underwater" means, and why the reporting rule changed

An endowment fund is underwater when its current fair value falls below either the original gift amount or the amount the donor or law requires be maintained. Before FASB's ASU 2016-14, an underwater fund's deficit, the gap between the fund's fair value and its required floor, was reported in unrestricted net assets, while the original gift amount stayed in permanently restricted net assets, splitting one fund's balance across two different net asset categories. ASU 2016-14 changed this: for fiscal years beginning after December 15, 2017, the entire underwater fund, both the original gift amount and the deficit together, is reported within a single category, net assets with donor restrictions. This reversed the prior treatment entirely, and organizations that haven't updated their internal reporting logic since the standard took effect are still classifying underwater deficits the old, now-incorrect way.

Can a nonprofit still spend from an underwater endowment?

In most states, yes, contrary to a common assumption that an underwater fund automatically freezes all spending. Nearly every state has adopted a version of the Uniform Prudent Management of Institutional Funds Act, which generally permits a governing board to appropriate for expenditure whatever amount it determines is prudent for the purposes the fund was established to serve, considering specific listed factors, even if the fund's current value sits below the original gift amount. This is a meaningful departure from the older, pre-UPMIFA standard, which more rigidly tied spending to preserving the fund's original "historic dollar value." A board still needs to exercise genuine prudence and document its reasoning; UPMIFA doesn't create unlimited discretion, but it does remove the flat prohibition many organizations assume applies.

What must be disclosed for an underwater endowment

ASU 2016-14 requires specific disclosures whenever an organization holds an underwater endowment fund, following the sample footnote format the AICPA has published for underwater endowment reporting: the organization's interpretation of its ability to spend from underwater funds under the relevant state law, the aggregate fair value of underwater funds, the aggregate of their original gift amounts, and the aggregate amount by which they're underwater, along with the organization's spending policy for such funds and any actions taken during the period. These disclosures are calculated at the individual fund level but presented in the aggregate in the financial statement notes, which means an organization managing multiple endowment gifts needs unitized, fund-by-fund tracking internally even though the public-facing disclosure combines them.

Frequently asked questions

Does a quasi-endowment require the same underwater disclosures as a true endowment?

No. The underwater disclosure requirements under ASU 2016-14 apply specifically to donor-restricted endowment funds. A board-designated quasi-endowment carries no donor restriction, so even if its fair value drops below the amount originally set aside, it doesn't trigger the same disclosure obligation, since the board retains full discretion to reverse the designation and treat the funds as ordinary unrestricted net assets at any time.

How often should an organization test whether an endowment fund is underwater?

At least at every reporting date, since fair value can move meaningfully between periods, particularly for funds invested in equities. Testing only at year-end, rather than at each interim reporting point where financial statements are prepared, risks missing a fund that dipped underwater and recovered within the same year, information a board's spending policy decisions may depend on having in real time.

If a single investment pool holds both endowment and non-endowment funds, does that complicate underwater testing?

Yes, meaningfully. Organizations that pool endowment funds with other invested assets for investment efficiency should still track the corpus, accumulated earnings, and underwater status of each individual endowed gift on a unitized basis internally, since the underwater test and required disclosures apply at the individual donor-restricted fund level, not to the investment pool as a whole, the same fund-by-fund discipline that governs a capital campaign's endowment-designated pledges.

What's the difference between a true endowment and a term endowment?

A true endowment requires the principal be maintained permanently, with no end date the donor has specified. A term endowment requires the principal be maintained only until a stated event occurs or a defined time period passes, after which the fund converts to an expendable, unrestricted resource. Both are donor-restricted while the requirement to preserve principal is active; only the duration of that requirement differs between the two.

Can a donor's endowment restriction ever be legally modified or released?

Yes, but not by the organization acting alone. Most states permit a nonprofit to petition a court, or in some cases the state attorney general, to modify or release a donor restriction that has become obsolete, impracticable, or wasteful, a doctrine generally referred to as cy pres. UPMIFA also permits release or modification of a restriction with the donor's own written consent, without needing a court proceeding, when the donor is still living and available to consent directly.

Does UPMIFA apply identically in every state?

No. UPMIFA is a model act, and while nearly every state has adopted some version of it, individual states have modified specific provisions, spending thresholds, and disclosure requirements when enacting their own statute. Confirm the specific version adopted in the organization's own state before relying on a general description of UPMIFA's rules, particularly around the exact factors a board must document when deciding to spend from an underwater fund.

What specific factors must a board consider before spending from an underwater endowment?

UPMIFA generally lists factors including the fund's duration and preservation purpose, the organization's overall financial resources, general economic conditions, the possible effects of inflation or deflation, the expected total return from income and appreciation of investments, other resources of the organization, and the organization's own investment policy. A board decision to spend from an underwater fund without documenting consideration of these factors is harder to defend if the decision is later questioned.

How does an endowment appear on a Statement of Activities compared to a Statement of Financial Position?

The endowment's fair value, including any underwater deficit, sits on the Statement of Financial Position within net assets with donor restrictions. Investment gains, losses, and any board-appropriated spending from the fund flow through the Statement of Activities for the period, which is where a reader sees the year's actual investment performance rather than just the fund's ending balance.

For nonprofit organizations managing donor-restricted endowments, our bookkeeping services track each endowed fund on a unitized basis and apply the current underwater reporting rule correctly, expert-led, AI-powered, and human-in-the-loop.

See the restricted vs. unrestricted funds guide for the broader net asset classification framework this fits inside.