Continuing the Quest
FASB and GASB efforts in 2008 showed an ongoing focus on transparency, accountability, and performance measures. Here's the year in review.
By Sue Menditto
The Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB) moved forward vigorously in 2008 with agendas that affect colleges and universities. The objectives of many of the boards’ new standards, positions, and recommended guidance centered on enhancing qualitative information, understanding endowments, quantifying potential liabilities, explaining complex financial instruments, and determining the roles of markets and risk in measurement. The boards followed the ongoing trend to shower many organizations—including higher education institutions—with expectations of accountability and greater transparency.
Endowments Are the Talk of the Year
|FASB, GASB Updates and More at Annual Accounting Forum|
Continuing pressure on higher education institutions for greater disclosure and more detailed reporting will be reflected in the programming of this year’s Higher Education Accounting Forum, April 26-28, in Miami. Designed for advanced-level accounting and finance professionals, the event will offer the latest information on trends, issues, and best practices in financial and managerial accounting, reporting, and analysis for all types of institutions.
A number of formats, including presentations, breakouts, and roundtables, will allow for networking with colleagues and speakers. Developed around plenary sessions, the program will also include smaller groupings to address special topics. The roundtable exchanges will be segmented in a way that brings together participants from comparable institutions to share ideas.
Substantively, the forum serves as an annual update, particularly for FASB and GASB activities, while providing perspectives on the future outlook for accounting and finance. Topics will come from the following areas: surviving the economic crisis, reviewing accounting standards, and highlighting what accounting professionals need to know about the Higher Education Opportunity Act and international accounting convergence. Endowments, derivatives, fair market value, and tax updates are also on the agenda.
For additional information and to register, go to www.nacubo.org/x10605.xml.
Regardless of the criteria used to characterize the type of year 2008 was for higher education, endowments quickly rise to the top of any list. In fact, the year began with the Senate Finance Committee contacting the 136 institutions with the largest endowments and requesting detailed information about the endowments. In the meantime, the Internal Revenue Service (IRS) asked for more details about endowment portfolios on its redesigned Form 990, including beginning and ending balances, earnings, contributions and other additions, and spending and other subtractions from endowment funds. The heightened profile of endowments did not escape the Financial Accounting Standards Board. Many elements of a research project, which addressed the impact of the relatively new Uniform Prudent Management of Institutional Funds Act (UPMIFA) on not-for-profit accounting and reporting, incorporated communication about endowment policies, growth, spending management, and investment targets.
Endowment implications of moving from UMIFA to UPMIFA. UPMIFA was approved by the Uniform Law Commission (ULC) in July 2006 to modernize the Uniform Management of Institutional Funds Act of 1972 (UMIFA) for governing the investment and management of donor-restricted endowment funds by not-for-profit organizations. At least a dozen more states enacted UPMIFA or had pending legislation during 2008—meaning that more that half of all states are currently affected. UPMIFA emphasizes a holistic view of donor-restricted endowment funds in that, conceptually, the original gift, appreciation, and earnings comprise the restricted endowment fund in perpetuity. The act allows a governing board to be flexible when evaluating organizational needs and making spending decisions—as long as the board prudently considers the duration and preservation of the fund. UPMIFA, as drafted and approved by the ULC, also states that assets in an endowment fund are donor-restricted assets until appropriated for expenditure by the institution.
The holistic view of the donor-restricted endowment fund under UPMIFA eliminates the concept of historic dollar value—the amount below which an institution could not spend under UMIFA. UPMIFA’s elimination of historic dollar value and honoring of donor restrictions until appropriated for expenditure required reconsideration by the FASB of portions of Statements 116, “Accounting for Contributions Received and Contributions Made,” and 117, “Financial Statements of Not-for-Profit Organizations.” After months of a process that involved a proposed FASB staff position (FSP) and consideration of dozens of comment letters, the FASB issued, in August 2008, FSP 117-1, “Endowments of Not-for-Profit Organizations: Net Asset Classification of Funds Subject to an Enacted Version of the Uniform Prudent Management of Institutional Funds Act (UPMIFA), and Enhanced Disclosures for All Endowment Funds.”
According to FSP 117-1, and consistent with guidance in Statement No. 117, a portion of a donor-restricted endowment must be classified as permanently restricted net assets. The portion classified as such must be in accordance with either the donor stipulations or the amount the organization’s governing board determines must be retained permanently under relevant law. Because UPMIFA states that donor-restricted endowments are restricted until appropriated for expenditure, the FSP clarifies that there is a time restriction on the portion of a donor-restricted endowment fund that is not permanently restricted.
The FSP also modifies a requirement in paragraph 17 of Statement No. 116 commonly known as the “deemed spent” rule. That is, donor-imposed restrictions are no longer considered fulfilled when a similar expense is incurred. Consequently, independent institutions in UPMIFA states will likely have significant reclassifications from unrestricted net assets to temporarily restricted net assets for amounts that were previously considered to be “deemed spent.” The final result is that donor-restricted endowments are classified in two net asset classes under UPMIFA: temporarily restricted and permanently restricted. The FSP is effective for FY09 financial reporting.
Multiple Accountability Measures
The role of the FASB and the GASB in setting accounting and reporting standards has always been clear. However, the role the standard setters play with respect to accountability was put to the test last year. Both standard-setting boards use the notion of accountability when describing the essential purpose of external financial reporting. For not-for-profit organizations, FASB concepts state that financial reporting should provide information that current and future resource providers can use to make decisions about support. Alternatively, GASB concepts recognize that general-purpose external financial reporting (GPEFR) should provide information to assist users in assessing accountability as well as in making economic, social, and political decisions. Accountability is considered the paramount objective of GPEFR by governmental entities such as public institutions. Although the GASB explicitly uses the word “accountability,” the FASB describes what accountability might mean to stakeholders that support independent institutions.
The FASB requires new disclosures for endowments. Although inspired by UPMIFA, the FASB’s staff position 117-1 requires several new endowment disclosures that are not directly related to the purpose of the law. The disclosures apply to all funds designated as endowments, not just the true endowment assets under the purview of UPMIFA, regardless of the status of UPMIFA adoption in an organization’s state.
All independent institutions and the not-for-profit foundations affiliated with public institutions are required to provide net asset composition, changes in net asset composition, spending policies, and investment policies. They must also display endowment activity in tabular form by net asset class, essentially providing a beginning and ending balance roll-forward and reconciliation. The board considered the additional information necessary to satisfy many interested parties (donors, parents, students, governmental organizations, analysts, grantors, and so forth). These additional note requirements reinforce the role of the FASB as a standard setter interested in accountability of not-for-profit organizations entrusted with resources provided by the public.
The GASB amends performance reporting. What accountability means within the context of financial reporting and the decision utility of information provided to the external uses of GPEFR continued to be a challenge for the GASB in 2008. When the board began taking steps to finalize its long-term project on service efforts and accomplishments (SEA), several constituents thought the board might be overstepping its role. SEA is also known as “performance measurement” or “performance reporting.” Simply put, this type of reporting allows the public to assess accountability by demonstrating that resources are appropriately used to accomplish the government’s objectives.
In response to concerns, the GASB continued to reach out to constituents to help amend and enhance the substance of Concept Statement No. 2, “Service Efforts and Accomplishments Reporting.” The statement was originally issued in 1994, and years of research by the GASB and governmental organizations such as NACUBO needed to be adequately reflected in an updated concept statement. An amended concept statement was exposed for comment in April 2008 and was close to final release at press time.
The proposed concept statement clarifies that it is not the GASB’s intent to establish performance measures for governments, including public colleges and universities. Rather, public institutions can determine the most meaningful nonfinancial performance measures. To support organizations that choose to present performance information, the GASB issued a “Request for Response” document, “Suggested Guidelines for Voluntary Reporting of SEA Performance Information,” in July 2008.
The draft guidelines describe the essential components of an effective SEA report and the qualitative characteristics that are appropriate for reporting SEA performance information. The four essential components are purpose and scope, major goals and objectives, key measures of SEA performance, and discussion and analysis of results and challenges. Because the GASB’s goal is to assist organizations that voluntarily choose to report SEA, the “Request for Response” was a unique due process document. Given their nonprescriptive nature, the guidelines provide helpful information for institutions seeking to present performance information through SEA reporting.
Derivatives Are the Focus of Both Standards Boards
Derivative instruments are financial contracts, the values of which are based on the relative worth of their underlying assets. Some common examples of underlying assets are commodities, stocks, commercial real estate loans, residential mortgages, bonds, interest rates, or exchange rates. Derivatives are often used as hedges by which to reduce financial risks. For example, instruments such as futures, forwards, options, and swaps are used to reduce financial risks related to asset and liability values, cash flows (such as interest payments), commodity market fluctuations, or foreign currency vacillation.
The FASB addresses hedge accounting. In June 2008, in an effort to simplify accounting for hedging activities, the FASB issued an exposure draft, “Accounting for Hedging Activities,” an amendment of FASB Statement No. 133 (SFAS 133). The proposed statement would affect the hedge accounting requirements of SFAS 133 in ways such as, but not limited to, changing hedge effectiveness analysis and risk designations, and measuring and reporting of hedge effectiveness.
Because independent institutions are not-for-profit organizations, SFAS 133 does not permit the use of special or cash flow hedge accounting. For example, although independent institutions may use derivatives or foreign currency cash flow hedges as part of a strategy to manage investment portfolio market and price risks, the vast majority of transactions would not qualify for hedge accounting under SFAS 133 or the exposure draft. Consequently, this proposed statement may only affect independent institutions for a limited number of transactions, if at all. Although the FASB was expected to issue a final standard in the fourth quarter of 2008, board discussions have focused on moving this project forward with the broader International Accounting Standards Board project on financial instruments. It is expected that the joint focus will delay the issuance of this standard.
In March 2008, the FASB issued Statement No. 161, “Disclosures About Derivative Instruments and Hedging Activities” (SFAS 161)—an amendment of FASB Statement No. 133—because experience with FASB Statement No. 133 indicated that not enough information was being provided about an entity’s use of derivatives. Although independent institutions have hedge accounting limitations, the increased disclosure requirements of SFAS 161 are applicable. New disclosures that independent institutions will need to provide are:
- The purpose of the derivative.
- The risk the instrument seeks to modify and the reasons why.
- Information about counter-party credit risk and possible cash flow issues.
The proposed statement is effective for FY10 financial statements, or calendar year 2009 for independent institutions that may follow a calendar year. Early application is encouraged. In the initial year of adoption, the FASB encourages but does not require comparative disclosures. In periods after adoption, comparative information for all years presented is required.
Public institutions and hedge accounting. In June 2008, the GASB issued GASB Statement No. 53, “Accounting and Financial Reporting for Derivative Instruments” (SGAS 53). The standard requires derivatives to be measured at fair value. If derivatives qualify for hedge accounting, fair value changes are deferred until termination events specified in the standard are met. Public institutions can use hedge accounting when the derivative instrument effectively reduces the intended risk. There is a requirement to assess the hedge's effectiveness using methods prescribed in the standard. The standard establishes disclosure requirements such as a derivative summary, information about hedge effectiveness, fair value, management’s objectives, significant terms, and risks.
This standard could have a significant effect on public institutions’ financial reporting. Because derivatives and hedges have become common, public institutions must pay attention to the standard’s transition and effective dates. Although the standard is effective in FY10, institutions must evaluate their derivative instruments at the end of FY09; the standard would be retroactively applied for hedges deemed effective. Ineffective instruments in FY09 would be subject to a transition adjustment and reported as a restatement of beginning net assets. Additionally, because investment derivatives may be common to public institutions, it is noteworthy that the disclosure requirements for these instruments were expanded by amending paragraph 16 of GASB Statement No. 40, “Deposit and Investment Risk Disclosures.” Since this standard is quite complex, public institutions must become familiar with this standard now.
Codification Efforts by Both Boards
In the latter part of 2008, the FASB and the GASB issued exposure drafts that suggested codifying auditing literature guidance into the accounting literature. The intent is to have all generally accepted accounting principles derived from a single source. The following codification recommendations are expected to quickly result in accounting standards:
- Codify from the auditing literature into the FASB accounting standards the accounting and financial reporting guidance for going-concern considerations and subsequent events.
- Codify from the auditing literature into the GASB accounting standards the accounting and financial reporting guidance for related-party transactions, subsequent events, and going-concern considerations.
Another GASB exposure draft would incorporate the hierarchy of generally accepted accounting principles (GAAP) into GASB’s authoritative literature. This means that the hierarchy governing GAAP for public institutions would be established within existing literature. Having the hierarchy in one place should help when researching authoritative priority and, therefore, enhance GAAP compliance. As a result of the late-2008 credit crisis and deteriorating bond market conditions, many public institutions had to research proper disclosure and financial statement presentation requirements for variable rate demand bonds called by issuers. (See also “Accounting for Variable Rate Demand Obligations at GASB Higher Education Institutions” at www.nacubo.org/liquidityandfairvalueresources for explanations on pertinent accounting and auditing considerations; a codified hierarchy would have expedited the necessary research.)
Addressing Fair Market Value
FASB Staff Position FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (FSP FAS 157-3), was drafted, exposed, and issued within two weeks on Oct. 10, 2008. The statement was considered necessary to respond to issues of fair value measurement resulting from the developing credit crisis. The FSP clarifies the application of FASB Statement No. 157, “Fair Value Measurements,” in a market that is not active. Independent institutions and the not-for-profit foundations of public institutions must be prepared to implement SFAS 157 in their FY09 financial statements.
In a nutshell, SFAS 157 establishes a fair value hierarchy that ranges from observable market inputs to unobservable inputs. The standard also describes three approaches for measuring fair value: market, income, and cost. The inputs and valuation techniques are used in combination to determine fair market value. SFAS 157-3 clarifies that forced liquidation or distressed sales prices do not automatically determine fair value; rather, three methods must be considered when determining fair value during times like the recent market upheaval:
- The use of a reporting entity’s own assumptions about future cash flows and appropriately risk-adjusted discount rates (Level 3 input), which is acceptable when relevant observable inputs are not available.
- The use of observable inputs (Level 2) that require significant adjustment based on unobservable data, which converts it into a Level 3 (input) fair value measurement.
- The use of broker (or pricing service) quotes, which may be an appropriate input when measuring fair value, but which are not necessarily determinative of fair value if an active market does not exist for the financial asset. For example, broker quotes based on proprietary pricing models that utilize significant unobservable inputs rather than actual transactions are Level 3 inputs.
The input assumptions that the FASB requires preparers to use when determining the value of an asset need to be reviewed and understood. The assumptions will also need to be conveyed to readers in the financial statement footnotes. For the many with alternative investments (assets not traded in public and/or active markets), FSP 157-3 provides an illustration that details the process for determining fair value using Level 3 inputs.
Expect More, Not Less
Although accountability and transparency have been topics of discussion for the past six years, the emphasis is not waning. Current economic conditions, standard setters, auditors, trustees, and stakeholders are expected to keep the pressure on accounting professionals.
SUE MENDITTO is director of accounting policy at NACUBO.
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