Nonprofits work hard to steward their endowment funds wisely, but in times of market volatility or economic uncertainty, even the best-managed investments can dip below their original value. When this happens, organizations may find themselves managing what’s known as an underwater endowment — a scenario with specific accounting and disclosure requirements.
Understanding when an endowment is considered underwater is essential for transparency, compliance, and sound financial management.
Here’s a practical guide to help nonprofit leaders navigate the definition, determination, display, and disclosure requirements for underwater endowments.
What is an Underwater Endowment?
An endowment is considered underwater when the fair value of the fund falls below either:
- The amount of the original donor gift, or
- The amount required to be maintained by the donor or by law.
Importantly, this determination must be made for each individual endowment fund, not on a combined or aggregate basis. If your organization has multiple endowments, each fund is evaluated separately at the financial statement reporting date.
Where & How to Report Underwater Endowments
Nonprofit accounting standards provide clear guidance for how underwater endowments must be displayed in the financial statements.
Statement of Financial Position
Underwater endowments are included in net assets with donor restrictions — reflecting the original intent of the donor even if the fair value has decreased.
Statement of Cash Flows
Contributions to endowments and investment returns that are restricted for long-term purposes are classified as financing activities.
Required Disclosures
Organizations must include specific disclosures in their financial statements when an endowment is underwater. These include:
1. The Board’s Interpretation of Applicable Law
Describe the board’s interpretation of the laws affecting the organization’s ability to spend from underwater endowment funds — including any decisions to appropriate funds for spending.
2. Spending Policies for Underwater Endowments
Disclose policies regarding how and when the organization will spend from underwater endowments, especially where donor requirements apply.
3. Quantitative Disclosures (Reported in Aggregate)
Organizations should report the following totals across all underwater endowment funds:
- Fair value of the underwater endowment funds
- Original gift amounts (or amounts required to be maintained by law)
- Total deficiency (the difference between the original gift and current fair value)
A Note on Spend Policies
Many nonprofits have formal endowment spending policies — often distributing a set percentage (e.g., 5%) of the endowment’s average fair value over a rolling period (such as 12 quarters).
In underwater situations, an organization’s policy may allow continued spending (if deemed prudent, or if dictated by the donor) or may limit spending based on the depth of the shortfall — unless donor restrictions or legal requirements prohibit it.
Proper documentation of these policies — and how they are applied in practice — is essential for transparency and compliance.
Final Thoughts
Endowment accounting can feel complex, especially when navigating underwater funds during uncertain economic times. But clear policies, accurate reporting, and thoughtful disclosures help maintain donor trust and position nonprofits for long-term sustainability.
At Han Group, we help nonprofit organizations stay ahead of accounting requirements, ensuring compliance while supporting mission-driven financial stewardship. Contact us to learn more.
