Four Fund Accounting Essentials

Transcription

1 White Paper Four Fund Accounting Essentials LESSONS UNIQUE TO COMMUNITY FOUNDATIONS GEM Series AUTHOR: HENRY A. BROMELKAMP

2 Page1 TABLE OF CONTENTS INTRODUCTION... 2 FIVE FINANCIAL POLICY FACTORS... 3 Basis Factor... 3 Averaging Factor... 4 Formula Factor... 5 Timing Factor... 5 Effect Factor... 5 FOUR ACCOUNTING ESSENTIALS... 6 Joint Investment Allocation... 6 Fund Fees Assessment... 6 Spendable Allotment... 8 Rebalancing Among Funds... 9 TYPICAL POLICY FACTORS BY ACCOUNTING OPTION CONCLUSION... 10

3 Page2 INTRODUCTION Community foundations often work with local accountants who understand non-profit accounting principles however may not be well-versed in the uniqueness of fund accounting for community foundations. Executives and staff need to first understand non-profit fund accounting principles, next educate their accountant and then together determine the best fund management accounting practices for their community foundation. This white paper is intended for community foundation leaders who manage any number and size of funds. This document will deliver a non-technical overview of five community foundation financial policy factors, along with four accounting essentials that explore fund accounting concepts and options specific to community foundations.

4 Page3 FIVE FINANCIAL POLICY FACTORS Although community foundations vary a great deal in the type of individuals and groups they serve, the number of funds they manage, and the value of their assets, the five accounting policy factors outlined here are used by all kinds of community foundations. This section provides an overview of these financial policy factors and will be used in the following Four Accounting Essentials section to help each organization determine what policy factors and accounting methods work best for their community foundation. The five financial policy factors discussed here are: basis, averaging, formula, timing and effect. BASIS FACTOR Community foundations need to consider the following five basis factors and decide on which single or combination works best for their organization. 1) Ending Balance: the balance at fiscal or calendar year end. 2) Average Daily Balance: the average of all the daily balances for the month or year. 3) Number of Transactions: the number of fund transactions for the month or year. 4) Contribution Dollars: the amount of money contributed into a fund in a given period. 5) Grant Dollars: the amount of money distributed from a fund in a given period. Many community foundations use Ending Balance as their basis. Although this is the easiest to calculate it is often not the most equitable means to measure basis across multiple funds. The Average Daily Balance is similar to the Ending Balance basis, however it provides more accuracy due to the use of an average of the daily balances for the month or year versus a simple end of period average. Using the Number of Transactions for the basis can be a fair approach for funds with a high volume of transactions. For example if a foundation distributes $100 scholarships to each student and there are 1,200 scholarships, the community foundation incurs high administrative fees that can be tied directly back to this fund instead of shared equally with low transaction volume funds. Contribution Dollars can be the right basis choice when contributions are passed through a fund which may hold no long-term asset. For example a hospital fundraiser that has pass-through contributions may incur high administrative costs that are not recouped with other basis factors. With Contribution Dollars basis the community foundation can charge a fee or percent of the total amount raised to pay for administration costs. Grant Dollars basis is similar to Contribution Dollars however, instead of charging on contributions, a fee or percent of dollars is assessed based on the amount of money distributed. Regardless of the basis factor used, community foundations need to consider how to manage reductions and adjustments such as unrealized/realized gains, pass-through fees, and types of assets and activities that have different deductions or exemptions.

5 Page4 It is also worth noting that foundations can mix and match basis factors. For example they can measure assets for endowed funds and use transaction dollars for non-endowed funds. Another example is to use a combination of ending balance of non-spendable assets along with the average daily balance of other assets. AVERAGING FACTOR When community foundations choose to use averaging as their factor they select either a periodic or moving average. If using a periodic average, they can determine the averaging period such as each month or quarter. For example, if a foundation is using joint investment allocation and is allocating investments for the month, they would average over this month, instead of over years. Conversely rolling or moving averages are used over a longer period such as 36 months. This averaging method is often used by community foundations that want to mitigate investment volatility due to shortterm ups and downs in the market, to better manage their allocations. Review Exhibit 1 below to see how market volatility impacts funds based on either periodic or moving averages. One Month Average

6 Page5 Two-Year Average Ex. 1. Market Volatility Impact on Funds Using Periodic vs. Moving Averages. FORMULA FACTOR Using a formula factor is a simple and common policy in many community foundations. The simplest way to calculate this is to use a flat rate where each fund is charged the same dollar amount. A more effective and still easy method is to apply the same percentage rate to all of the bases. A more complex method to calculate formula factors is to use a step or graduated percentage scale where small and large basis are charged different rates. For example a $100,000 fund may have a 1.5% rate and a $200,000 fund has a 1.7% rate. Often there are minimums and maximums, filters, exceptions and negotiated rates that require adjustments, making stepped percentages more difficult to administer. TIMING FACTOR Timing factors can be either periodic or triggers. Most common are period factors, such as a monthly or annual calculation. Triggers on the other hand are used when something happens. For example when a contribution is received. This can be important for community foundations that need to utilize the fees to administrate the fund now, instead of waiting until the annual fee due date. EFFECT FACTOR The effect factor determines when the action takes place in the books. Foundations can either transfer fees to the general fund immediately or set them aside within the affected fund for future use. When the fund fee transfer is immediate, the fund loses that part of the asset. If it is set aside until later, the fund will own the asset until it is spent.

7 Page6 Decisions related to these five policy factors can have a large impact on community foundation administration and it is important to examine and discuss these methods with the board and key stakeholders to determine the best fund policy factors for their organization. FOUR ACCOUNTING ESSENTIALS When it comes to fund accounting, community foundations have unique needs that lead to uncharted territory for many accountants. Community foundation executives need to understand and discuss these accounting considerations with their accountants. This section explains the four essentials related to fund accounting for community foundations and will help executives, board members and accountants understand: joint investment allocation, fund administrative fees, spendable allotment, and rebalancing among funds. JOINT INVESTMENT ALLOCATION With Joint Investment Allocation each fund receives a part of the earnings based on its share of the total pool. This can be difficult to compute, however this is the most equitable approach. Here is how community foundations who opt for joint investment allocations typically apply policy factors. Basis Factor: takes the average balance for each fund and allocates pool earnings to that fund based on the realized gain, unrealized gain, dividend and interest and investment expense. Averaging Factor: typically uses the average daily balance of each participating fund over the period the fund is allocated. This way funds that are spent down before the end of the month still get credit and contributions that are given on the last day of the month do not get allocations for the entire month. Period averaging is standard in Joint Investment Allocation and rolling averages over many months is rarely used. Formula Factor: generally community foundations will use a percentage of what they receive from the income. Timing Factor: this is commonly done when the foundation receives the investment statements. Effect Factor: once the allocation calculations are made they are immediately transferred to the funds. FUND FEES ASSESSMENT The Fund Fees Assessment option is an opportunity for improvement with many community foundations. Almost every community foundation can charge a fee on assets, even when they cannot easily calculate other metrics. This works best for funds that have high fund balances and fairly low pass-through for grants and gifts.

8 Page7 However this method does not work well for funds with low balances and high pass-through such as a disaster fund that has very low asset balance until there is a crisis and there is a high volume of contributions. In situations like these an asset basis fund fee assessment will result in smaller fees, even though the foundation may be doing more work than they are with high funds that have low grants and gifts. In cases like this it is better to choose an option that works on more than just the fund balance. See Exhibit 2 Variety of Fund Types and Metrics Balance Grants Gifts Smith Family Wilson DAF Disaster Fund Ex. 2. Variety of Fund Types and Metrics. Policy factors are typically applied as follows when the Fund Fees Assessment option is used: Basis Factor: there are several basis factors you can use for fund fees and the most common is ending balance, which may be a holdover from the days of manual calculations. A more equitable method is to use average daily balance. Some community foundations charge a fee based on contributions coming in or grants going out. Foundations can alternately charge a fee on the asset and on the activity, based on size of the contribution or grant, not the number of transactions. Community foundations should evaluate whether fund fee policy can or should include both activity and average daily balance as basis factors. Averaging Factor: this approach averages the basis over a period of time, not just over the period of the fund fee. If for example there are quarterly charges for fees, averaging the fee over 36 months helps alleviate volatility due to ups and downs in the market. Formula Factor: fund fees as a calculated percentage and use of stepped or graduated rates are becoming increasingly common. For example the first $100K rate is 1.5%, $200k is 1.25%, etc. Minimum and maximum fees are often applied i.e. $150 for anything less than $1,000 or 1.0% for anything over $250K. Timing Factor: Most often a periodic schedule such as monthly is used for the fund fees assessment.

9 Page8 Effect Factor: Community foundations typically transfer administrative fees immediately, however different funds can be treated differently based on the type. Here are some examples. Non-Endowed Fund could charge fees in multiple ways: 1.5% of each contribution, charged on receipt $8 per grant $50 quarterly minimum Endowed Fund (Donor Advised) could charge fees based on: 1.2% of the first $50,000 average daily balance 1.0% on $50,001-$150, % on $151,000 and more Or use an annual percentage rate, charged quarterly, on a 36 month rolling average daily balance Endowed Fund (Scholarship) may charge fees on: 2.1% of the average daily balance Or an annual rate, charged quarterly using a 36 month rolling average daily balance Endowed Fund (Agency Endowment) might charge fees based on: 1.0% on average daily balance Or annual rate, charged quarterly, 36mo rolling average daily balance Community foundations can also charge fees for both average daily balance of assets and charge per grant and per contribution that are not into the endowment. It is also becoming increasingly common for community foundations to charge a fee for either pass-through contributions received or charge a fee per scholarship or grant distributed. SPENDABLE ALLOTMENT Endowed funds often allot an annual 4 to 5 percent for grant making, calculated by multiplying the average daily balance by a percent. Community foundations often use these policy factors when Spendable Allotment is calculated. Basis Factor: typically this is a percent of the average daily balance. Averaging Factor: usually this is done on a rolling month cycle to help lessen the impact of market volatility. Formula Factor: is frequently determined as a flat percentage rate that often has minimums and maximums, exemptions and adjustments. Timing Factor: most often these spendable funds are allocated annually. Effect Factor: in most cases the money is not removed from the fund, instead it is designated as spendable and remains in the account. Some community foundations however remove the money from the fund immediately to earn income on the balance in the general fund.

10 Page9 Consider treating non-spendable assets differently than other assets, using ending balance for the nonspendable assets and a rolling average for other assets. This is particularly beneficial when a fund has an unusually large infusion of assets, allowing the spendable amount to also increase immediately, yet not greatly impacting other funds having more conventional growth. Take for example the hypothetical XYZ Family Fund that had a typical $26,000 fund balance until the grandmother passed away and a large $900,000 contribution was made to the fund. The community foundation and fund advisors want to increase grant making now instead of waiting 36 months to be able to access the fully averaged basis. They can choose to treat this contribution differently by allocating something like this: 5% of non-spendable balance, based on ending balance instead of the average for the period. This way they can allocate spendable immediately after this large increase in assets. 4.5% of accumulated earnings, based on the average daily balance over a rolling 48-month period. This should not include unpaid pledges or current spendable balance. Treat the earnings by averaging and the principal without averaging. As you can see there are a lot of options when a community foundation uses spendable allotment and it can be a complex set of calculations and automated fund accounting software is often needed to accurately allocate spendable. REBALANCING AMONG FUNDS Rebalancing among funds is not a formula, rather it is a process that happens when transactions occur between funds. Funds are typically rebalanced on a monthly or quarterly basis and once adjusted the fund balances need to be recognized. This often requires multiple journal entries for the period dating back to the last time fund rebalancing occurred. A best practice approach is to have a system that balances funds automatically for the most up-to-date information. Without rebalancing fund average daily balances become less accurate over time. This overview of four fund management accounting essentials provides the information needed to help community foundations determine which choices are right for their policies. A quick summary of how policy factors are typically applied for the various accounting essentials is presented in the chart following this section.

11 Page10 TYPICAL POLICY FACTORS BY ACCOUNTING OPTION This chart illustrates how policy factors are often used in the accounting formulas described in this white paper. Joint Investment Allocation Fund Fees Assessment Spendable Allotment Basis Average Daily Balance Average Daily Balance, Average Daily Balance Contribution and Grant Dollars Averaging Over Period of Effect Rolling/Moving Average Rolling/Moving Average Formula Percent of Share Stepped/Graduated Percent of Share Timing Periodic Periodic Periodic Effect Transfer Now Transfer Now Set Aside for Future Use CONCLUSION This white paper provided an overview of fund management policy factors and accounting essentials that are unique to community foundations. It is important that board and staff understand and discuss these variables with their accountant and how they impact funds for the best fund management accounting practices for their community foundations.

12 Page11 About Henry A. Bromelkamp Henry A. Bromelkamp, president of Bromelkamp Company LLC is well known among grant making foundations. He was a visionary when he created a software database to track grants for a non-profit organization. He has taken this vision forward to develop the most integrated and flexible grants management software solutions on the market today. Henry continues to lead Bromelkamp Company growth with both installed and online software solutions. He shares his in-depth knowledge of foundation technology by consulting with clients, presenting webinars and training sessions, and speaking at conferences to help foundations effectively manage their grant making processes. A strong believer in philanthropy, Henry travels annually to Africa as an Ambassador for Books for Africa, Africa Classroom Connection and Action for Children Zambia. He volunteers at St. Stevens Human Services, participates on three boards of directors and is a Rotary member. He also established Bromelkamp Foundation to provide funding for non-profit organizations that support literacy and address homelessness. When Henry is not busy leading Bromelkamp Company LLC and supporting charitable causes, he can be found either renovating his historic stone and brick Victorian house or keeping active by running, biking, drawing, singing and traveling. You can reach him at henry@bromelkamp.com. About Bromelkamp Company Bromelkamp Company LLC is a leading provider of integrated and online grant management software solutions. Its inspired design meets dynamic technology to provide installed and online software that effectively manages the entire grant management process for foundations. Find out more at: or call 888/ Computer World, How to balance maintenance and IT innovation by Minda Zetlin October