CPA Exam — REG (Regulation)Federal Taxation of EntitiesMedium
A client, a tax-exempt organization, received a $500,000 donation from a donor. The donor stipulated that the funds must be used to establish an endowment, and only the income generated from the endowment can be used for the organization's general operating expenses. The original principal must be held in perpetuity. How should this donation be classified in the organization's net assets?
- AWith Donor Restrictions, temporarily restricted, because the income is available for operations.
- BWithout Donor Restrictions, because the income can be used for general operating expenses.
- CWithout Donor Restrictions, as the organization has full control over the investment decisions of the endowment.
- DWith Donor Restrictions, permanently restricted, because the principal must be maintained in perpetuity.
Show answer & explanationAnswer & explanation
Correct answer: D. With Donor Restrictions, permanently restricted, because the principal must be maintained in perpetuity.
When a donor stipulates that the original principal of a donation must be maintained in perpetuity, it creates a permanently restricted net asset. While the income generated from the endowment might be temporarily restricted or without donor restrictions (depending on further donor stipulations), the principal itself is permanently restricted.
Why the other options are wrong
- A. Incorrect. Temporarily restricted assets have restrictions that expire by time or purpose. Here, the principal restriction is permanent.
- B. Incorrect. The donor's stipulation that the principal must be held in perpetuity creates a restriction.
- C. Incorrect. Investment control does not override the donor's restriction on the principal itself.
NFP Net Asset Classification (Permanently Restricted)
Permanently restricted net assets result from donor stipulations that the assets (e.g., endowment principal) be held in perpetuity, with only the income or specified portion of the income available for use.
- Donor-imposed restriction.
- Principal must be maintained indefinitely.
- Typically involves endowments.
- Income generated may be temporarily or without donor restrictions.
Memory trick: No Strings, Temporary Strings, Forever Strings.