On January 1, 2015, the JKG Foundation received a $10 million bequest consisting of a commercial warehouse building and $5 million of cash.
The foundation immediately invested the $5 million cash in 20-year, 7 percent corporate bonds having a face value of $4,485,512. The bonds, which pay interest annually, were purchased to yield 6 percent. The total premium was $514,488, and hence the total purchase price was $5 million. The annual interest payments (7 percent of the face value) are $313,986. In 2015, the fair value of the bonds decreased by $13,986, an amount equivalent to the first year's amortization of the bond premium.
The JKG Foundation leased out the warehouse for $600,000 per year. The useful life of the building is 20 years.
Per the terms of the bequest, income only is available for spending. However, neither the terms nor the applicable law specifies how income is to be determined.
1. Determine the amount available in 2015 for expenditure, assuming that the foundation calculates income:
a. On a cash basis
b. On a full accrual basis, recognizing changes in the market value of the securities and depreciating (on a straight-line basis) the warehouse
2. Assume that the foundation spent all of its income.
Prepare both a cash-basis and an accrual-basis balance sheet.
3. Is there a difference in fund balance between the two balance sheets? If not, can it be said that one basis of accounting better preserves endowment principal? Explain.