Time to Take a Fresh Look at Old Board-Designated Funds

In my professional life I view many financial statements from a wide variety of nonprofit organizations, and I am always amazed, but not shocked, by how many of these nonprofits have Board-designated funds sitting on their balance sheets. Two questions immediately come to mind. Why where they originally established? Is the purpose still relevant today? Often the answers lie in understanding the circumstances occurring at the time the Board originally designated the funds.

Board-designated funds are often misunderstood because of inaccurate perceptions and the absence of clear and easy-to-understand information related to purpose and relevance.

To begin, Board-designated funds are generally defined as stated in this AICPA Journal of Accountancy article from December 2018:

“[N]et assets without donor restrictions that are subject to self-imposed limits by action of the governing board. They may be earmarked for a specific purpose, for example, and they can be undesignated at the board’s discretion. … [O]rganizations may need to adopt new policies and practices for tracking board-designated net assets. They should identify all board-designated net assets and understand the purpose of such funds for disclosure purposes. Funds unnecessarily designated may need to be undesignated” (emphasis added).

The definition is clear and straight-forward that, unlike donor restrictions, the Board’s action to designate funds is “self-imposed” and can be “undesignated at the Board’s discretion.” The article also points to two critical assessments that should be made each year by an organization with Board-designated funds. First, “understand the purpose of such funds for disclosure purposes” and second, assess whether “(f)unds unnecessarily designated may need to be undesignated.”

I agree with both points. However, I would add that it is equally important to understand the special circumstances occurring at the time of original designation. For almost every Board designation I have come across, there was a triggering event or circumstance, such as a large gain from sale of a building, sale of intellectual property, merger with another organization, or unusually large bottom-line net budget surplus. Negative events have also pushed Boards to designate funds, for example the collapse of a major program, rising risk of exposure to a legal action, or non-renewal of a major grant.

Pairing the understanding of the original circumstances surrounding the designation with the purpose assigned by the Board at the start of the designation will provide answers to the question whether the Board designation is still relevant or no longer necessary.

Planning Tip – Older Board-designated funds that are stagnant (i.e., have not changed in many years) are prime candidates for assessment and consideration to be undesignated. Annual assessment of all Board-designated funds is a best practice that will help nonprofits to better oversee these funds and ensure they are a net positive to the organization and not an impediment to advancing mission and enhancing sustainability.

One additional observation: I have seen many nonprofit organizations that do not have an operating reserve policy turn to establishing specific Board-designated funds to mitigate risk and enhance sustainability. A well-thought-out operating reserve policy could meet an organization’s needs better than maintaining Board-designated funds by allowing the organization greater flexibility to establish target goals and more easily and quickly modify these goals when needs arise to use these funds.