1. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Module 6 Endowment Funds

2. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Endowment Funds There are several ways in which an agency can generate funds for its operations –Fundraising to generate pledges and donations –Charging fees for services –Obtaining government grants –Creating an endowment fund which generates interest income

3. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP What is an Endowment Fund? An Endowment Fund, at its basic level, is a large sum of money, pooled from a number of donors, which is invested to earn interest income. –The income can then be withdrawn from the endowment fund and used to support agency programs –You can think of it as a really big savings account at the bank, where the interest earned is enough to run an agency program

4. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Types of Endowment Funds There are many different types of endowment funds –Philanthropic Funds/Donor Advised Funds – a pool of gifts where the donors get to say how they want the funds invested and how they want the interest used –Field-of-interest fund – donors invest in a specific area they care about, such as education, the environment, neighborhoods, community services or the arts. –Charitable Remainder Trusts - involves giving property to a fund whereby the donor maintains ownership in the property but makes an irrevocable gift of the residual interest to a registered charity. –Charitable Gift Annuities – where a donor makes a large lump sum gift and expects a stream of payments (an annuity) to be paid back until the end of the donor’s life

5. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP How does the money work? Depending on the goals of the endowment, there can be two ways to build the endowment policy –Using interest only for programs – Using the interest only for programs allows the endowment to last forever because the main principal is protected. Since market interest rates fluctuate, some endowments may produce more or less interest income in any year and so the program’s funds may change –Using interest and principle for programs – Using the interest and principal means that the agency will get access to more money over the life of the endowment, but eventually the endowment will run out Both of these policies make use of the Time Value of Money to generate funds

6. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Time Value of Money Have you ever heard the saying: “A dollar today is worth more than a dollar tomorrow” This saying describes the time value of money A dollar in hand today is worth more than a dollar in hand tomorrow because you can spend it, or invest it, today –As opposed to having to wait to receive a dollar tomorrow A dollar in hand today is also worth more because of the risk of actually not getting the dollar tomorrow –If someone lends a dollar to someone else, the lender takes the risk that the lendee cannot/will not repay the dollar –The lender may then charge interest (a rental fee for the use of the money) to pay for the fact that they don’t have use of the dollar today and for the risk of not getting the dollar back

7. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP How does an Endowment Work? To keep things simple, we are only going to consider an endowment which uses the interest only to fund agency programs Lets consider an example –Lets say we convince a number of donors to donate $100,000 to the agency to be pooled as an endowment fund –Lets also say the agency invests that money with a professional investor, who can earn roughly 10% per year in interest, but may charge 1% of earnings as fees Lets determine how much money the agency can use to fund a program this year:

8. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Calculating Interest Income Principal = 100000 Interest = 10% Investor Charge Rate = 1% First Year’s Interest Income = (Interest rate) x (principal) =.10 x 100000 = 10000 Investor Charges = Investor Charge Rate x Interest Income =.01 x 10000 = 100 Therefore…

9. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Calculating Interest Income Opening Balance = 100000 Add: Interest Income = 10000 Less: Investor Charges = 100 Balance after Income and Charges = 109900 Funds pulled out for use by agency = = Closing Balance – Opening Balance = 109900 – 100000 = 9900 Closing Balance = 109900 – 9900 = 100000 The amount of 9900 represents the amount available in interest income for use after expenses (the investor’s fees) –This amount also protects the principal (does not draw on the principal so that the full 100000 is available again next year)

10. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Accounting Implications So now we understand the types of endowments and how to calculate the interest income for a simple endowment –So, how do we handle this from an accounting perspective Lets start with the journal entry. The simplified journal entry to open the endowment would look like this In this case, the Endowment Fund itself is an asset account on the agency’s books The Donations Equity account is an equity account which would be shown on the bottom right side of the Statement of Financial Position near the Accumulated Surplus DateAccount Titles and explanationPRDebitCredit Apr 1Endowment Fund (Asset)100000 Donations Equity100000

11. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Accounting Implications Okay, now lets assume it is a year later and we have calculated the interest income available to the agency for use –Note, to arrive at this journal entry, we calculated the interest earned ($10000), deducted the investor’s fees ($100), then pulled the remainder out of the Endowment Fund to be used by the agency. The Endowment Funds balance does not change –We will place the interest into the cash account so the agency can use it. DateAccount Titles and explanationPRDebitCredit Mar 31Cash9900 Interest Income9900

12. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Posting to T-accounts CashAccounts Payable OB 1000 Mar 1 10000 100 Mar 7 500 Mar16 Mar 31 9900 Grants ReceivableWages Payable Mar 3 120003500 Mar 25 Endowment Fund Apr 1 100000 Prepaid Insurance Mar 1 3600Mar 31 300 TruckDonation Equity Mar 1 20000Mar 31 1800Apr 1 100000 Fuel ExpenseAccumulated Surplus Mar 7 1001000 OB Groceries Expense20000 Mar 1 (Truck) Mar 16 5003600 Mar 1 (Ins) Wages ExpenseIncome Mar 25 350010000 Mar 1 Insurance Expense12000 Mar 3 Mar 31 300Interest Income Depreciation Expense9900 Mar 31 Mar 31 1800

13. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Trial Balance Adjusted Trial Balance (depreciation and insurance only) DebitCredit Cash20300 Grants Receivable12000 Endowment Fund100000 Prepaid Insurance3300 Truck18200 Accounts Payable Wages Payable3500 Donations Equity100000 Accumulated Surplus24600 Income22000 Interest Income9900 Fuel Expense100 Groceries Expense500 Wages Expense3500 Insurance Expense300 Depreciation Expense1800 Totals160000

14. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Surplus Calculation Surplus calculation Income22000 Interest Income9900 Total Income31900 Fuel Expense100 Groceries Expense500 Wages Expense3500 Insurance Expense300 Depreciation Expense1800 Total Expenses6200 Total Surplus to be added to Accumulated Surplus25700

15. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Closing Trial Balance DebitCredit Cash20300 Grants Receivable12000 Endowment Fund100000 Prepaid Insurance3300 Truck18200 Accounts Payable Wages Payable3500 Donation Equity100000 Accumulated Surplus50300 Totals153800

16. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Statement of Activities Income Interest Income Total Income Expenses Fuel Expense Groceries Expense Wages Expense Insurance Expense Depreciation Total Expenses Surplus/Deficit 22000 9000 31900 100 500 3500 300 1800 6200 25700

17. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Statement of Accumulated Surplus Opening Surplus Balance Add: Initial donation Truck donation Insurance donation March surplus Total additions Accumulated Surplus/Deficit 0 1000 20000 3600 25700 50300

18. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Statement of Financial Position Current Assets Cash20300 Current Liabilities AP0 Grants Receivable12000 Wages Payable3500 Endowment Fund100000 Prepaid Insurance3300Equity Fixed Assets Donations Equity100000 Truck18200 Accumulated Surplus50300 Total Assets153800Total Liabilities & Surplus153800

19. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP