Monday, January 31, 2011

What is Pennsylvania Act 141?

Monday, January 31, 2011
Pennsylvania Act 141 is a state law that changed the rules for how not-for-profit organizations can invest and spend the income from permanently restricted endowment funds. This Act does not apply to endowment funds internally designated as such by the Organization's Board of Directors. The Act which became law in December 1998 repealed the state’s old “9 percent rule”. Organizations need to act wisely to take full advantage of the basic strategies of the law.

Organizations must make a choice between two basic strategies:

  • Principal and Income –Organization may only spend the restricted endowment funds’ income, primarily interest and dividends, not the capital gains or the principal.
  • Total Return Policy –Organizations may elect under this Act to follow a “total return policy” for the determination of income from a restricted endowment. Total return includes the interest, dividends, and the net capital appreciation, both realized and unrealized. Annual spending is on a percentage of the fair market value of the investments in the restricted endowment. The board of directors may elect to spend between 2 and 7 percent of the fair market value of the investment in the restricted endowment.
The Board of Directors must elect to be governed by this Act. If the Organization does not specifically select a policy, it will automatically fall under the Principal and Income Policy. The Board of Directors must approve a statement that says that it is the policy of the Organization to use a total return policy. This document must be a permanent part of the Organization's records and should include the following:

  • A statement that the Organization will use the total return policy adopted under Act 141 and that the Organization is making an election to be governed by Act 141.
  • The spending rate percentage (between 2 and 7 percent) to be applied to the fair market value of the endowment, and the calculation of the spending rate. Spending rates can be calculated on a three to five year average of the market value of the endowment funds' assets. If the asset has been held for less than three years, the average is calculated over the period the assets have been held.
The Board of Directors can always change the election or the spending rate in future years, which gives the Organization more flexibility in planning.

This next point is very critical - Donor restrictions on contributions always overrule this Act. If a donor specifies that the earnings (interest, dividends, realized and unrealized gains) on an endowment must be used for a specific purpose, than that restriction must be followed. The earnings must be used for the intended purpose and the Organization cannot apply a spending rate percentage for that donation.

Under the Principal and Income policy the interest and dividend are recorded as unrestricted. The realized and unrealized gains/losses are recorded as permanently restricted.

Under the Total Return Policy the income (spending rate amount) is unrestricted. If the actual income exceeds the spending rate amount, the excess is recorded to temporarily restricted income. If the spending rate is higher than the actual return, the difference reduces the amounts that were previously recorded as temporarily restricted.

As you can see, the total return policy is a more advantageous policy for not-for-profit organizations to follow. The Organization must make sure that this policy is formally adopted and it is a part of the permanent records. If not the organization automatically falls under the principal and income policy which limits the not-for-profit to spend only the interest and dividends.

In August 2008, new accounting standards for classification and disclosure of endowments were issued and require that all of the above information be disclosed in the financial statements of the not-for-profit organization.

Please contact us if you have any questions about this matter.


Post a Comment

Nonprofit After Hours ◄Design by Pocket, BlogBulk Blogger Templates