Keeping Up With the Downturn
It was beyond “business as usual” at this year’s Higher Education Accounting Forum. Along with the latest updates on tax and financial reporting requirements, presenters focused on the hard work of crafting solutions to today’s tough financial challenges.
By Mary Bachinger, Bryan Dickson, and Sue Menditto
For higher education institutions, the economic downturn, unlike any experienced for decades, has dramatically changed endowment investment holdings and credit arrangements. Severe declines in the stock market and turmoil in the credit markets require presidents, chief financial officers, controllers, planning and budgeting leaders, and governing boards to work together on near- and long-term financial solutions. This year's Higher Education Accounting Forum (HEAF) in Miami, April 26-28, provided new guidance to accounting and financial professionals looking to balance business as usual with recent epic events. Among the many meeting topics, the following were of special interest to attendees: international convergence, warning signs and responses to financial challenges, performance metrics, endowments, fair value guidance, and tax changes.
A World View
The forum opened with a presentation by Robert Bunting, president of the International Federation of Accountants (IFAC), on the impact of interconnections on the global economy. Bunting noted that currencies and transactions have no respect for international boundaries. The economic downturn that escalated in late 2008 revealed how interdependent the many countries and economies are on one another. Recognizing this complex relationship, the majority of the world's economies are committed to International Financial Reporting Standards (IFRS).
Meanwhile, in the United States, where the Securities and Exchange Commission (SEC) is the ultimate decision maker, many wonder what America will do with respect to practicing international standards. Clearly, the current crisis unfolded despite SEC regulation and oversight. Bunting believes we have to adopt international systems and standards to ultimately protect our citizens and institutions from the kind of economic fallout we've seen in recent months.
Bunting outlined the significant convergence of standards and activities that is already taking place. IFAC is the global organization for the accounting and auditing profession, and it sets ethics, global auditing, educational, and accounting and reporting standards. Bunting explained that there is a direct relationship between each U.S. standard setter and its international counterpart. In addition, U.S. standard-setting professionals are often observers or members of international bodies, and the resulting relationships have grown significantly over the years.
There is a direct link between the IFAC's international accounting standard-setting board and the Financial Accounting Standards Board (FASB). Similarly, the chair of the American Institute of Certified Public Accountants (AICPA) is the vice chair of the international auditing standards board. As the world moves beyond the current economic crisis—and as auditing standards move quickly into the international arena, said Bunting—at some point international standards will need to become the driver of the standard-setting process. It only stands to reason that one worldwide set of foundational standards will better facilitate measurement and assessment.
In the United States, some movement in this direction has already taken place. For example, the AICPA decided in 1998 that private company auditing standards would be based upon international standards. Consequently, international standards also come into the U.S. Government Accountability Office's Government Auditing Standards, commonly known as the “yellow book.”
For higher education institutions, the most immediate challenge, said Bunting, will be how future accountants are educated. At some point, recent graduates will need to deal with the international climate. And, future generations of accountants will eventually need to understand the new world of global standards. Although the public and nonprofit sectors are responding more slowly to international convergence than the business community, noted Bunting, many universities setting up operations abroad are already doing their financial reporting in accordance with IFRS foreign statutory requirements. In conclusion, Bunting suggested that the group consider whether NACUBO might focus advocacy efforts on pushing for one common set of accounting standards.
Predicting the Future
Will independent institutions be able to survive an enrollment shift toward public institutions? Will public institutions be able to accommodate a deluge of demand coupled with ever-decreasing state support? In the presentation “Is Anyone Solvent Anymore?” Richard Kneedler, president emeritus of Franklin & Marshall College, Lancaster, Pennsylvania, spoke about financial and market conditions. Kneedler explained that he uses publicly available information from IRS Forms 990 and the Department of Education's Integrated Postsecondary Education Data System (IPEDS) to create his own national database to help understand and predict higher education institutions' current and future risks and vulnerabilities. He applies three stress tests that can offer insight to business officers in helping their institutions find their way forward in these tough economic times. The tests consider the following criteria:
- The impact that taking on debt prior to the 2008 market downturn has had on individual institutions and the industry as a whole.
- The ways in which the downturn has changed an institution's capital replacement abilities.
- The incremental impact of a second poor market year on the 2008 effects on institutions.
For example, said Kneedler, more debt has translated into higher education institutions having less power to influence the future. Just as debt has crushed the consumer-housing market, so too has debt pressed the capital needs of many institutions. Kneedler cautioned that college and university leaders need to think ahead to the possibility of a domino or “echo” crash—the downstream ripple of manufacturing industry changes, nonhousing consumer debt, unemployment, a finite federal stimulus time line, and so forth.
In light of recent events, congressional accusations in 2007 of higher education endowment hoarding couldn't have been more inappropriate. Rather, said Kneedler, managing for a rainy day is a necessity and reserves are incredibly important. Even the wealthiest institutions, he noted, are currently cutting budgets. And, while Kneedler said that he hopes an echo crash is not imminent, he stressed that managing and planning with an eye toward that possibility makes sense at this time.
Kneedler also said that today, growing cash is the best investment and that the budget's bottom line should influence management's decisions about the top line—and not the other way around. Strong leadership must balance this approach against mission optimism. In the end, said Kneedler, business officers should immerse themselves intellectually, analytically, and affirmatively in global phenomena and tactically connect their discoveries to what is happening directly on campus.
In their presentation “Dealing With Economic Challenges,” Deborah Moon, vice president and chief financial officer at Carnegie Mellon University, Pittsburgh, and J. Michael Allred, associate vice chancellor, finance, and controller at University of California, Davis, outlined their institutions' approaches to the financial crisis.
Both business officers reported that the economic and financial downturn affected all primary sources of revenue. They discussed strategies and tactics for cutting spending, maintaining liquidity and reserves, looking for new revenues, and dealing with student and family financial challenges. The actions they described were familiar to many in attendance, occupied months of business officers' time, and reinforced Kneedler's opening remarks.
Moon and Allred reported that at their respective institutions they made the following changes:
- Eliminated nonessential costs.
- Cut incentives.
- Reassessed compensation.
- Evaluated staff positions.
- Examined programs for consolidation or elimination.
- Evaluated initiatives to lower the cost of administrative processes and services while maintaining or improving quality.
- Altered or postponed information technology infrastructure investments.
- Reviewed capital projects and delayed many.
Metrics to Measure Progress
Jack Mahoney, director of institutional research at Rensselaer Polytechnic Institute, Troy, New York, defined performance measurement as “a process of developing measurable indicators that can be systematically tracked to assess progress made in achieving predetermined goals.” Measurement is often driven by external and internal factors, he said. For example, federal and state governments, accreditation organizations, students and families, and higher education organizations are all externally concerned with performance measurement. On the other hand, board activity, the need for institutional self-improvement, and academic or administrative program review drive the process internally.
To succeed with performance assessment, said Mahoney, identify strategic metrics and then create comparison groups. Many of the metrics—such as enrollment and retention trends, graduation rates, salary data, and revenue and expense analysis—will naturally arise as part of normal institutional operations. Others, such as setting tuition and fees, measuring student satisfaction, and determining faculty workload, can arise from issues that come from organization stakeholders. Mahoney provided a simple acronym—SMART—to help attendees remember the key elements of effective metrics: specific, measurable, attainable, realistic, and timely.
Once the organization identifies the metrics it wishes to measure, said Mahoney, it's time to develop a comparison group against which to benchmark. The composition of the group generally changes for each metric analyzed. While there are many types of comparison groups, noted Mahoney, four are typically used:
- Peers—institutions similar in scope or mission.
- Competitors—organizations with which the home institution competes for resources.
- Aspirants—groups that may or may not be similar but possess characteristics and qualities that the home institution wishes to possess as well.
- Predetermined groups— those that are generally based on jurisdiction; Carnegie classification; or traditional, historical relationships. (Go to the Carnegie Foundation's Web site to generate a group of institutions similar to yours based on selected criteria.)
It is best to have a small number of institutions in the comparison list, recommended Mahoney; Rensselaer uses 10 to15 institutions. He also suggested numerous sites where higher education data is publicly available, including the National Center for Education Statistics, the Voluntary System of Accountability Program, and Economic Diversity of Colleges.
Mahoney stressed that comparison data be integrated with the institution's data warehouse so that they are always available for senior management. He concluded that careful integration of internal and external data sources produces useful tools and reports for decision support.
FASB and Fair Value
A roundtable update and related discussion on recent Financial Accounting Standards Board (FASB) pronouncements focused on endowment accounting and reporting requirements, fair value, and valuation questions related to alternative investments.
Statement of Financial Accounting Standards (FAS) No. 157, “Fair Value Measurements,” affects both nonfinancial and financial assets; the majority of its provisions are effective in FY09. This statement does not extend fair value measurement requirements but rather defines fair value and outlines approaches to measuring it. Consequently, FAS No. 157 is considered a “how to” standard. More importantly, new disclosures will shine a light on processes used to measure fair value. Although this standard is principles-based, the FASB has focused quite a bit on implementation details and guidance.
Debt has translated into higher education institutions having less power to influence the future. Just as debt has crushed the consumer-housing market, so too has debt pressed the capital needs of many institutions.
The fair value option described in FAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” can be used with split-interest agreements. Under this option, the asset and liability are assigned a fair value in order to determine the proper value of the contribution. Each subsequent year, the liability is updated for factors like mortality assumptions. However, in these additional years, the current discount rate should be used, allowing for less administrative tracking of the individual discount rates over the years. Although the typical discount rate is a non–tax-exempt borrowing rate of reasonable duration, and because there may be several such rates over time, as a practical matter an average long-term borrowing rate can be used. This option makes a lot of sense for the nonprofit sector, particularly independent institutions with portfolios of split-interest agreements.
Fall 2008 market turmoil brought to light the various fair value challenges caused when a readily determinable market does not exist. Limitations on redemptions for certain alternative investments have created a question of whether net asset value is really fair value for such investments. Consequently, according to Jeff Mechanick, FASB's assistant director of nonpublic entities, the FASB staff is working on a position paper that provides cost-beneficial practical guidance in this area. The paper was released in June with comments due July 8, 2009.
GASB Addresses Expected Implementations
A roundup of updates on the work of the Governmental Accounting Standards Board (GASB) included information on pollution remediation and derivative instruments.
GASB Statement 49, “Accounting and Financial Reporting for Pollution Remediation Obligations.” This statement is effective for FY09 financial reporting. This standard requires a restatement of the beginning balances of pollution-related liabilities. Public institutions are required to disclose the nature and source of pollution remediation obligations, the amount of the estimated liability, the methods and assumptions used to develop the estimate, the potential for changes in estimates, and estimated recoveries that reduce the measurement.
Of greatest practical significance to public institutions is that asbestos is within the purview of the standard. However, asbestos is only a concern when there is an obligating event. Generally five major areas can trigger obligating events: imminent danger, violation of a pollution permit, a lawsuit, an obligating action, and a known polluted site. The presence of asbestos becomes an issue only when the substance becomes exposed. Consequently, knowledge of asbestos contained within the walls of older buildings is not an obligating event. In fact, if asbestos is dealt with as part of a renovation project, there is no extended liability to the remaining sections of a complex or building that were not renovated.
GASB Statement No. 53, “Accounting and Financial Reporting for Derivative Instruments.” Statement 53 is effective in FY10. David Bean, GASB's director of research and technical activities, noted that, although the standard is effective in FY10, institutions must evaluate their derivative instruments at the end of FY09. This is because the standard would be retroactively applied for hedges deemed effective. Most in attendance noted that swaps were commonly used by public institutions—many to hedge interest rate risk. Statement 53 establishes disclosure requirements, such as a summary of all derivative instruments by type, information about hedge effectiveness, fair value, management's objectives, and significant terms and risks.
Compliance With Tax Rules and Reporting Requirements
In the tax update, Mary Rauschenberg, tax director, Deloitte, Chicago, reminded HEAF attendees that the Internal Revenue Service's spotlight is focused on colleges and universities, as evidenced by the Service's compliance project on colleges and universities, currently under way. The IRS launched the project last October, sending out a 33-page questionnaire to 400 colleges and universities. The document asked detailed questions relating to governance, related organizations, endowments, executive compensation, and activities that may or may not give rise to unrelated business income tax. IRS officials have stated that they hope to publish an interim report on the survey by the end of the year.
The Internal Revenue Service's spotlight is focused on colleges and universities, as evidenced by the compliance project currently under way.
Rauschenberg also reported on the Service's compliance project in the bond area, indicating that questionnaires had been sent to approximately 200 state and local governmental entities that are the focus of the effort. Issues of interest in the bonds compliance initiative include post-issuance recordkeeping and retention, investments and arbitrage compliance, and private business use. An overview of the redesigned Form 990 was included in the update (see details that follow). Rauschenberg also noted the continuing interest of Sen. Charles Grassley (R-IA) in a number of issues related to colleges and universities, including executive pay, endowment spending, and the relationship between medical school faculty and pharmaceutical manufacturers.
Begin Work Now on 2008 Form 990
For those interested in taking a closer look at the 2008 Form 990, Rauschenberg presented a session identifying the “Top 10 Challenges” the expansive new reporting regime presents for campus administrators. She began by urging those in the audience to move quickly to gain an early understanding of the breadth and depth of the new Form 990 that would help them tackle the immense task of readying their institution for completion of the 2008 form. Rauschenberg selected a number of critical areas of the form to discuss, including sections on governance and management issues, compensation, and fundraising activities. The session concluded with a strong emphasis on the continual need for campus tax professionals to educate campus colleagues and board members about the new requirements, and how the requirements fit into institutional data gathering and disclosure.
Crash Course on 403(b) Plan Rules
Tax Council Chair Joe Irvine, development and tax counsel, Ohio State University, Columbus, brought the audience up-to-date on the new final regulations for 403(b) pension plans. Generally, the rules became effective for plan years beginning Jan. 1, 2009. The final rules combine more than 30 years of prior guidance and align 403(b) plans more closely with 401(k) and 457(b) plans. While the effective date of compliance is generally January 1, the written plan requirement has been extended. Employers have until Dec. 31, 2009, to adopt a written plan. Such plans need not necessarily be in the form of a single document, but may incorporate related provider documents and contracts by reference.
The new rules spell out mandatory 403(b) plan contract requirements, including nonforfeitability of elective deferrals, nontransferability, limits on elective deferrals, minimum required distribution rules, direct rollover rules, and limitations on incidental benefits. In addition, 403(b) plans have the option of providing (but are not required to offer) loans; hardship withdrawals; plan-to-plan transfers; annuity contract-to-annuity contract transfers; acceptance of rollovers into the plan; and Roth contributions. The regulations also set forth requirements relating to the form and timeliness of contributions, nondiscrimination, transfers and exchanges, distributions, and plan termination.
Irvine noted that in Announcement 2009-34, the IRS established a program for the preapproval of prototype 403(b) plans and a process for receiving determination letters for individually designed plans. Under the program, employers will be allowed to retroactively correct defects in the form of their plans by the timely adoption of an approved prototype plan submitted to the IRS for review. The date for submitted prototype plans will be no earlier than March 15, 2010. This correction process will apply only for years after 2009.