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Familiarity Breeds Accuracy

Interim financial reporting requires working with the same numbers quarterly or even monthly. The benefit: You’re more likely to catch problems long before year-end.

By Sandra R. Sabo

It was about six years ago when Schwartz, Duke’s assistant controller for accounting and reporting, began seeing a demand for increased interim reporting. Although the board had begun to see GAAP-based statements quarterly, senior management saw the need for monthly reports to use as internal measurement tools.

Schwartz saw a benefit from fulfilling the request for monthly updates via interim financial reports—official statements of GAAP financial results that are prepared on a routine basis for dissemination to boards and executive management. “The repetition—doing it every month—gives you a much better understanding of the reporting process and what’s behind the numbers in the statements,” he says. Not surprisingly, the notes accompanying the monthly report now run about nine pages, up from fewer than two pages in 2002, when Duke introduced interim reporting.

“We’re also much more efficient in the process,” adds Rachel Satterfield, director of financial reporting. “When you assemble financial statements annually, you spend a lot of time relearning and remembering how to do it. When you assemble these statements monthly, it becomes second nature.”

Quality First

At the Massachusetts Institute of Technology, the goal of accelerating the close process was one motivation for the Cambridge, Massachusetts-based institute to begin producing interim financial reports. Demonstrating the institution’s focus on prompt reporting, Gillian Emmons’s former boss at MIT used to carry around a small sign that simply said, “July 31.” It was his not-so-subtle way of reminding everyone to close within one month of June 30. 

MIT had another objective as well: It wanted to improve the quality of its financial information.

“If you close your books once a year and it takes you three months to do it, that’s three months you can’t spend working on the ongoing activities of the institution,” says Emmons, associate controller. “We figured that if we did some processes more often than once a year, we’d not only speed them up but also have more accurate information.”

Now, seven years later, the controller’s office produces quarterly GAAP  financials—including a statement of position, a statement of activities, and a cash flow statement—plus supporting schedules that provide details on key revenue and expense lines. “The format is similar to that of our published financial statements at the end of the year, although we don’t do the footnotes,” Emmons explains.

Awareness Aids Accountability

The controller’s division of the Oregon University System (OUS), Corvallis, also issues interim financial reports every quarter. But, says Paul Bartlett, director of accounting and reporting, “our management reports do not look like our annual financial statement. In fact, they’re quite a bit different, although both have revenues and expenses and beginning and ending fund balances.”

Within the report, each of the seven institutions in the state system has its own page showing year-to-date actual, prior-year actual, budget, and projections for current unrestricted funds. In addition to being presented to the board’s finance and administration committee, the quarterly reports serve as an official record. OUS also distributes the interim reports to executive management within the chancellor’s office and the individual institutions.

“Before quarterly management reports,” says Bartlett, “financial communications to the board were primarily limited to approval of an annual operating budget and a review of the annual financial statements—usually six months after the fiscal year had closed. We saw the need for greater and more timely financial awareness.”

At about the same time that OUS was coming to this realization, Oregon’s legislature began pressing the university to be more accountable. The governor appointed an entirely new governing board charged with improving higher education and increasing accountability. Interim financial reporting, introduced in 2003, helped OUS respond to those constituent expectations.

“It’s part of carrying out our responsibilities to the board and the legislature,” says Michael Green, associate vice chancellor for finance and administration and controller. “The board should expect to see interim reports to track the financial health of the university system and to identify trends to be concerned about.” 

Early and Often

While OUS and MIT began generating interim financial reports within the past decade, the University of Kentucky has been doing it for years—143, to be exact. The 1865 statute that authorized creation of the university in Lexington required the governing board to review finances regularly as part of its fiduciary responsibilities.

The reporting format favored by the University of Kentucky includes a fund-format balance sheet and budget-to-actual revenues and expenses, accompanied by a high-level summary. “Our board is interested in the budget-to-actual and the fund accounting perspective,” explains Christine Donahoe, assistant controller. 

“For the board members, it’s a management tool,” adds Marc Mathews, controller. “They’ve approved a budget, and they’re watching to see if we’ll be in line with the budgeted revenues and expenditures.”

Typically, the board receives a four-page financial statement and several summary pages. However, for management purposes and to gather the information contained in the summary document, the university prepares a much larger packet containing an analysis of each financial statement line and detailed listings of receivables and payables, investments, and endowments. In fact, the auditors use the March 31 packet as the starting point for the annual audit.

For its internal audiences—primarily the general accounting office—the university also produces a monthly financial report in the Governmental Accounting Standards Board format. “That helps us with the quality of information at year-end. When you get to June, you don’t have something that has been miscoded all year long,” says Mathews. “The general accounting staff balances the report every month to make sure revenues minus expenses equal the change in the net assets.”

Internal Challenges 

Every month, within three weeks from the ledger close, Duke now produces a full set of financial statements, including a balance sheet, a statement of activities, a statement of cash flows, and footnotes.

How do you compress into three weeks a reporting process that usually takes three months? In Duke’s case, it’s accomplished by becoming selective.

With the goal of getting as close to GAAP financial statements as possible, Schwartz and Satterfield reviewed the significance of every year-end journal entry. They asked: Which entries are significant and need to be made monthly? Which ones could we use estimates for? Which entries are immaterial and don’t need to be updated for interim reporting?

Schwartz explains, “We had to produce a report that we could hold up to management or to the board and say, ‘This is a fair approximation of our current-year performance and financial position, based on GAAP.’” Duke uses the same reporting software application that’s employed for year-end reporting to convert the interim general ledger and journal entries into the financial statement presentation. 

Similarly, technology has played a role in the University of Kentucky’s reporting efficiency. After a systems change and much tweaking to its data warehouse, the university can generate a consolidated financial statement within a few days of the close. Mathews estimates that accounting staff once spent 75 percent of their time assembling the financial statements and 25 percent doing the analysis; now, those percentages are reversed.

Gillian Emmons reports that MIT increased its use of spreadsheet tools and its data warehouse to streamline its process. From her perspective, however, the biggest efficiency came from finding common ground with other people who contribute to the reporting process. And that brought its own challenges.

For example, says Emmons, different offices throughout MIT maintained different numbers related to enrolled students and tuition revenue. Some used an October number, while others favored a January number. Such inconsistencies not only weakened each office’s credibility but also made it difficult to do reasonableness tests on tuition—something the auditors wanted to do as well.

Emmons started meeting with student financial services staff to discuss the varying numbers. Eventually, she says, “we got to where everyone, across the institute, uses the same number for tuition revenue and agrees to use ‘students billed’ in presenting tuition revenue trends.” The meetings with student financial services have continued quarterly, providing opportunities to discuss such issues as accounts receivable, bad debt, and student credit balances.

Even after five years of interim reporting, says Michael Green, OUS still faces challenges with the process because of the operating culture. He observes, “The challenge is in the precision of the numbers and projections—not from the capabilities of the people doing them but because of higher education’s decentralized operating environment. It gives to lower levels of the institution a lot of authority for making day-to-day budgetary decisions.”

 Absent the rewards, incentives, and systems to control financial outcomes, which you’d find in the corporate world, higher education may experience greater unpredictability in spending patterns. Say, for example, the budget proposed by the state legislature indicates an upcoming restriction on monies available for a public institution. Green notes, “The decision makers on campus at the department level may decide not to spend money—and make decisions that aren’t predictable based on normal patterns. Then the projections you’ve made, which are based on normal patterns, don’t come to bear.”

That could lead to some year-end surprises. And surprises are one thing that interim reporting aims to reduce.

Controls Offer Comfort

“Our operating funds are only a portion of what actually gets produced in a GAAP financial statement,” acknowledges Duke’s Rachel Satterfield. “With our interim reports, we’re giving a predictor of where GAAP results will end up.

“If the operating results look positive, and the GAAP results come out as a deficit, people may not understand how those two can be different,” she continues. “We’d rather predict what will happen by year-end than announce a big surprise.”

If alerted to a trend or area of concern in a timely fashion, a board can make appropriate adjustments to maintain the institution’s financial health. In addition to preparing the board and senior management for what’s to come financially, interim reporting offers the institution’s leadership—and the auditors—some degree of comfort.

“With Sarbanes-Oxley and the heightened attention on finances, the audit committee wants to know that we have control and that our numbers show reliability and consistency,” says Emmons. “Even when the numbers are not especially interesting—for example, December is not that different from March—the fact that we have the reporting process in place, are looking at the numbers throughout the year, and have explanations for those numbers is good accountability.”

While creating good discipline in the form of internal controls, interim reporting can simplify and speed up the annual audit. Duke’s auditors, for example, often get a head start by reviewing interim statements and footnotes to determine where to focus their testing.

The University of Kentucky, which has a year-end of June 30, typically wraps up its audit by the end of September. Marc Mathews credits much of that swiftness to the “routine scrubbing” of information done as part of the interim reporting process. He notes, “You already have clean data to work with because you’ve been looking at and analyzing the data all year.” 

From the Trenches

If you’re convinced that interim financial reporting could benefit your institution, too, here’s some advice from colleagues.

Start on solid ground. Ensure that the board understands and appreciates the benefits of interim reporting. You’ll need the board’s support to sustain a long-term commitment to the process.

“It’s critical to define the value of the reporting,” says Brian Meara, senior financial analyst for the Oregon University System. “Talk about how interim financial reporting supports the institution by identifying financial challenges or opportunities earlier—all so that the institution can respond more quickly and efficiently.”

Joe Schwartz, of Duke University, recommends evaluating your year-end reporting process to ensure that it’s not only structured and reliable but also supported by an effective financial reporting tool. When you already have an efficient annual process in place, you’re well-prepared to use it more frequently.

Don’t automatically assume you’ll need additional staff to handle the extra responsibilities of producing quarterly or even monthly reports. When Duke first began interim reporting, Schwartz produced quarterly statements and simple footnotes on his own. 

Tailor the format to the board’s needs. Christine Donahoe describes the fund format of the quarterly consolidated statements presented to the University of Kentucky’s board as “a little bit unusual, but you have to do what works for your institution. An interim report is not one-size-fits-all and, as a result, is not going to be the same for every institution,” emphasizes Donahoe.

MIT, for instance, doesn’t provide reports by schools and departments. Instead, its interim reports focus on several main areas: research revenue (which constitutes approximately half of MIT’s total income) and related research expenses; tuition revenue; fees and services revenue (including MIT’s university press, other auxiliaries, and technology licensing); a detailed expense-fluctuation analysis by “natural” classification; and financial aid. A separate table shows tuition revenue and number of students by term.

“Right now, people are especially interested in the research revenue by sponsor group,” says Emmons. “With federal government research funding under pressure, they want to develop a strategy to increase funding from other sources.”

Keep tweaking. When Schwartz compares Duke’s current interim reports to what he first produced, he sees a night-and-day difference. “We continually fine-tune and improve the process, always with the goal of making the statements more transparent,” Schwartz says.

OUS has refined its reports to include changes and projections in enrollment data and has changed the way at least one ratio was calculated. For now, OUS limits its interim reports to current unrestricted funds; the reports don’t address restricted funds, plant funds, or endowment funds (although the latter is covered in a quarterly investment report).

That may change. “We’re beginning to think about producing a quarterly facilities report,” says Green, “which would include the status of capital projects—their financing, their funding, and where they are relative to their budgets.” 

MIT has a process in place for improving interim reporting. Each quarter, a small group of people in a particular area, such as general receivables, will take an in-depth look at how to improve reporting. Last year, improvements focused on land, buildings, and equipment; this year, Emmons plans to target net asset accounting.

“We view interim reporting as a work in progress,” she says. “We’re always trying to have the reporting take less time, have the numbers be of higher quality, and have a high comfort level with the numbers we’re producing.”

Be patient. You’ll need time to communicate the need for interim reporting and get people accustomed to answering your questions.

Emmons says one of MIT’s ongoing challenges is convincing people to use the appropriate general ledger (GL) account rather than focusing simply on the cost object. To encourage people in MIT’s labs, centers, and departments to change their practices and use the correct general ledger account from the start, Emmons’s office conducts training and workshops—-especially as the financial close approaches.

Even after seven years of workshops, Emmons says, “We still have to tell people to use the correct GL accounts.” The one-on-one approach is often the most effective. Emmons regularly finds herself talking to people directly to resolve issues surrounding specific transactions, often giving a personal tutorial, for example, on the difference between internal and external revenue.

OUS relies on the budget offices in its seven institutions to make year-end projections and to review and explain in writing all significant variances from adjusted budget. As time goes by, the institutions are becoming more proficient at this step, says Meara, who consolidates the report and spends about three quarters of his time on financial analysis.

>>> Conversation Starter
Is your institution considering an interim financial reporting process? If so, what benefits and challenges are you discussing as a basis for deciding whether or not to move forward? E-mail carole.schweitzer@nacubo.org.

“The quality of their projections has gotten better over the past two years,” Meara explains. “Although each institution uses its own processes to create the projections, we’re getting to the point where we can better understand those processes and then identify the best practices that can be shared among institutions.”

The controller’s division of OUS used to work primarily with the accounting or business offices at the individual institutions, but interim reporting also calls for input from the budget offices. OUS staff welcomes the open and informed financial dialogue that naturally accompanies interim reporting. In fact, they can’t imagine turning back the clock to a time when OUS didn’t provide quarterly financial reports.

“You might hear about interim financial reporting and think, ‘Wouldn’t that be nice to do?’ Well, it’s more than nice—it’s a necessity,” Paul Bartlett says. “Producing quarterly management reports is what every board member—or anybody else inside or outside the university system—would expect us to do from a prudent management-principle perspective.”

SANDRA R. SABO, Mendota Heights, Minnesota, covers higher education business issues for Business Officer.