I sat down today to read the audited financial statements of a
client. I had not performed the audit and was unconcerned with
it. The only users were the banks, and we could easily answer
their questions.

I keep tripping over the way my not-for-profit clients manage their
endowments and what gets reported on the financial statements. First
and foremost, we’re not allowed to use the term <i>endowments</i> in
the financial statements. One must use <i>permanently restricted net
assets</i>, <i>temporarily restricted net assets</i>, and
<i>unrestricted net assets</i>. Only a careful reading of the audit
reports will reveal that net assets&quot; are not assets but equity. Our
journey to Never-Never Land has just begun.

Most of the endowed not-for-profits that I have worked with
keep the corpus of their endowments with investment firms,
which transfer the income to the firm’s operating account on
some schedule.

The not-for-profits concentrate on their operating account;
the endowment is just a source of income. They meet with their
investment advisers once or twice a year to discuss strategy
and their needs. As they’ve segregated the endowment assets
from operations, the endowments are treated as a separate

In the audited financial statements everything is turned on
its head.

First, some endowments are not donor restricted but board
restricted. These investments show up as current assets. One
must dig to assemble the assets in the endowments.

Second is the required asset valuation disclosure. It is mired
in the technical language of the Financial Accounting
Standards Board (FASB). After you carefully parse the thing,
you conclude that the procedure is to transfer the totals from
the brokers’ and trustees’ statements to the balance sheet. If
you do a little more digging, you discover that there are
small adjustments whose description is technical and
not at all clear.

There are two concerns of the FASB which make the whole thing
difficult: First is the move to international accounting
standards and fair valuation of assets and liabilities. Gone
are the conservative principles of historic cost, recognizing
gains when realized and losses when they become known. This
change leads to valuation methodology, its disclosure and the
unrealized gains that now show up as income.

The second is Wall Street’s predilection for derivatives. The
whole world discovered in 2008 exactly how difficult it is to
value these contracts, much less predict thier actual
performance. One of the reasons the valuation disclosure is so
opaque is that some of these investments might be derivatives.

Frankly, I’d rather read Peter Pan than financial statements.

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