Outgoing Accounting Principles Council member Kathleen McNeely explains how recent legislation affects accounting standards at higher education institutions.
By Mike McNamee
The biggest news in accounting in the last decade has been the 2002 Sarbanes-Oxley act. But S-Ox is directed at stock-issuing corporations, not nonprofits. Why is NACUBO recommending that colleges and universities take note of that legislation and even follow some of its new rules?
Many of our board members in higher education are CEOs, CFOs, or directors of corporations. They're hearing about all their new responsibilities under Sarbanes-Oxley in those jobs, and so it's natural for them to ask, "What are you doing along these lines?" The more important reason is that there are lessons to be learned and best practices that we can put in place. Sarbanes-Oxley puts a lot of emphasis on internal controls, which are very important at all our institutions. At Indiana University, we're spending about $2 billion a year. We're responsible for making sure those funds and their related assets and liabilities are properly recorded and properly audited. We don't have shareholders, but we do have students, parents, donors, legislators, rating agencies, bondholders, and taxpayers. We have the same obligation to do the right thing by them.
Many of the Sarbanes-Oxley requirements, even as best practices, don't apply to colleges and universities. Some provisions of the act are excessive even for corporations. So there is always a cost-benefit consideration that should be applied.
Which provisions of Sarbanes-Oxley has the Accounting Principles Council identified as most important for higher education?
It's important to look at your independent auditor and all your relationships with it. At IU, we are audited by the Indiana State Board of Accounts. Lots of publics are audited by state agencies; for others, the state chooses a public accounting firm or the school is able to make its own selection. The firm that does your financial audit should not be the firm that provides many other services for you. There's a conflict of interest: If the firm is making a lot of money off your relationship, it will have a hard time being hard nosed.
How often are you turning over your lead auditor? In Indiana, our lead changes every five years. NACUBO recommends changing the lead partner every seven years. That's not as often as Sarbanes-Oxley says, but auditing higher education institutions is a special challenge. Often, changing the lead partner means changing audit firms. Even in a large market like Chicago, it can be hard to find multiple firms with all the skills needed to audit higher education. In smaller cities, this recommendation will create a real challenge.
NACUBO's Accounting Principles Council is recommending that institutions consider having their CEOs and CFOs sign more extensive certifications of the financial statements. That's a hard one for the leadership, to assert that a certain level of internal controls is in place and working at every level. At large, diversified institutions, that may mean requiring subcertification—having officers of each campus, school or department sign off on their controls and financial statements. Some colleges and universities have gone to this; some are talking about it. What's clear is that we can't put that responsibility on our fiscal officers unless they're very well trained and really understand internal controls and the institution's internal controls.
NACUBO recommends that institutions have audit commit-tees, or finance and audit committees, with a charter that includes overseeing the external auditors. For publics, that poses problems. Our boards are smaller, and the way in which they are selected—by alumni vote, or appointed by the governor—doesn't allow us the ability to pick trustees for their special expertise. IU currently does not have a financial expert, as defined by Sarbanes-Oxley, on its board. The best we can do is to make sure our most fiscally knowledgeable trustees are on the finance and audit committee.
Sounds like Sarbanes-Oxley isn't a perfect fit on campus. Any areas where it doesn't apply at all?
For higher education, Sarbanes-Oxley Section 404, on internal controls, is excessive. I'm a true believer that institutions should look at their controls and have a plan to strengthen them. IU has just completed an internal controls assessment with an outside firm; we were talking about that before Sarbanes-Oxley. But the law calls for annual attestation by an auditor on your controls. For a not-for-profit, that's expensive. I'm not sure the value-added of doing it every year is worth the cost.
Another issue you've worked long and hard on is Government Account Standards Board Standard 39, Determining Whether Certain Organizations Are Component Units, an Amendment of GASB Statement No. 14, which is soon going to change the way public institutions report the financial statements of their affiliates.
GASB 39 is supposed to ensure that component units appear in the proper place in your financial statement. If the organization meets the rules under 39, its figures have to appear separately on the face of your financial report. That was the case under the old standard, GASB 14, but 14 depended a lot more on professional judgment to decide when an organization qualified. I think GASB 14 needed a change—there was too much disparity. For some institutions, you could read the entire annual financial report and never know they had a fundraising foundation with $1 billion in net assets.
GASB 39 takes effect…
With fiscal years that started after June 15, 2003. Basically, it's going to be on next June's financials.
Which means institutions are implementing it now. What should they be doing?
They should be running all of their affiliates—the fundraising foundation, the research foundations, the hospitals, the alumni association—through the question-and-answer format of the standard. GASB 39 is very clear and easy to read. At IU, we'll write up a white paper on every affiliate on what types of organization they are and how they should be reported based on guidance from GASB 14 and GASB 39. Then we'll sit down with the external auditors to see if they agree with us.
I'm told that you and your NACUBO colleagues worked very hard to improve 39. Are there still pitfalls?
Some state institutions are concerned that legislators will misread these statements. They'll think that if a foundation's figures are on the face of the report, then the school can reach into the foundation to pay salaries or utility bills. They might even think that the legislature can access those funds—which of course are largely restricted and not even readily accessible to the institution. So GASB 39 will require a higher level of communication.
It's also going to put a strain on the affiliates. They'll have to get their financials finished and audited in time for the parent institution to incorporate them.
What's the latest project APC is working on?
OPEB—other post-employment benefits—benefits you pay to retirees in addition to pensions. GASB is catching up with the nongovernmental world, where the Financial Accounting Standards Board issued a standard several years ago on how to accrue retirees' medical insurance, life insurance, and other benefits. Right now, public institutions expense those costs in the year that they pay them. That means a college could promise huge retirement benefits to its faculty and staff, incur a big obligation—but never record that obligation on the balance sheet. In that case, taxpayers and creditors are not getting a true picture. Appropriately, GASB has recognized that it's remiss in not having a standard.
When FASB implemented its standard, companies took a huge hit for retiree health care. Will public universities face the same situation?
GASB's approach is more reasonable than FASB's. Schools can have an actuarial analysis of their obligations and amortize them over time. That has a smoothing effect.
Is this a done deal, or can institutions still influence the rules?
The time for response has passed. NACUBO commented on the latest version—it's a very technical standard, and we recommended language changes in order to make it easier to understand. GASB is now considering all the comments. If they make significant changes, they may issue another exposure draft. But I expect they'll issue the final standard by mid-2004.
And will public institutions be able to live with this?
My response to the OPEB rule has been that I believe it is reasonable. This is information that institutions need, and something we should be recognizing in the financials. Colleges and universities need to be thinking about what their exposure to these obligations is, what benefits we are offering, and do we have the data we need to do the actuarial analysis.
You've spent six years on NACUBO's APC—twice the normal term. Are you going to miss it?
I will miss being a part of the APC. I was chair the year when GASB 34 and 35 were implemented. These two standards changed the basic financial statements of public colleges and universities from a fund accounting format to a consolidated, full accrual format. So in order to provide consistency NACUBO kept me around longer than normal. GASB 34 was huge—it consumed us for three years. Sarbanes-Oxley may be just as big. But, it is time for another professional to be provided the opportunity to develop expertise and help higher education.
Author Bio Mike McNamee is a Washington, D.C., writer.
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