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Merced College
Young, David W.
Functional Area(s):
   Finance/Financial Management
   Financial Accounting
Difficulty Level: Intermediate
Pages: 4
Teaching Note: Available. 
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First Page and the Assignment Questions:
Last year the administration tells us they’re happy with our spending policy. Now they tell us it’s inadequate and they have to cut the Latin American Studies Program, which is a key element of our strategy. What’s right here? How do we set a policy that we all can live with without having to reexamine this issue every few years?

The speaker was Sam Scribner, Chair of the Budget Committee of the Board of Trustees of Merced College. He was commenting on the policy the college used to determine the amount of endowment earnings that should be used as revenue in the college’s operating budget. For the past several years Merced had been attempting to determine a policy that would be appropriate in light of the dual demands of preserving the purchasing power of the endowment fund, while simultaneously providing the central administration with some predictability of revenues for the operating budget.


Merced College was a 150-year old, 4-year undergraduate institution with an enrollment of approximately 2,000 full-time residential students. It offered a liberal arts education with a full complement of athletic programs and a variety of special programs, including Latin American studies, communications, and meteorology.

Over the years, its alumni, many of whom had assumed position of leadership in business, had donated generously to the college, with the result that Merced’s endowment fund had grown considerably. Data for the past 17 years are contained in Exhibit 1.

The Spending Policy

Prior to 1988, the board’s spending policy had been to provide the administration with all dividends and interest earned on the endowment. All other earnings were reinvested in the endowment fund. In 1988, in response to complaints from the college’s administration that dividends and interest fluctuated widely, depending on the kinds of investments being made with the endowment fund’s portfolio, the board shifted to a policy of providing the administration with 5% of the beginning balance of the fund, lagged one year. The lag was needed to allow budget preparation activities to proceed with complete certainty of the amount to be transferred from the endowment fund.

In 1993, noting the dividends and interest were much greater than the amount being transferred to operations under the 5-percent policy, the administration convinced the board to return to a dividends and interest policy. The result, beginning in 1994, was a sharp increase in the transfers from the endowment fund to operations.

The current crisis had arisen because the administration, noting that dividends and interest transfers had declined in 1996, and were below what they would have been under the 5 percent approach, once again was requesting a shift in the policy. It now was recommending a return to the 5 percent approach. Mr. Scribner commented: . . .


  1. What are the issues that face the committee? Be specific in separating the issues, and then showing how they relate to each other.
  2. What policy would you recommend the board adopt to deal with each of the issues you identified in your answer to Question 1? In doing this, you should compare your recommendation with the board’s policy over the past 19 years to show how the transfers from the endowment fund would have been affected.