To Measure Or Not To Measure - That's Still In Question
Key insights from a NACUBO forum feed the continued debate about the value—and the feasibility—of a standard operating measure for colleges and universities.
By LARRY GOLDSTEIN
Key insights from a NACUBO forum feed the continued debate about the value—and the feasibility—of a standard operating measure for colleges and universities.
The approaching phase-in deadline of Governmental Accounting Standards Board (GASB) Statement No. 35—requiring all colleges and universities to follow reporting standards for either nonprofit organizations or state and local governments—hints at the possibility of a new era: development of a single, fundamental standard operating measure for all postsecondary education.
As improbable, and perhaps as undesirable, as that may seem to some, the topic has never been more germane. A recent NACUBO member survey reveals wide variance among the reporting practices of private colleges and universities under established Financial Accounting Standards Board (FASB) guidelines. (See the following article, "Inching Toward an Operating Measure.")
Many issues remain unresolved regarding a defined standard operating measure for colleges and universities. Among them: whether it's a good idea to have one. Debates about the merits of establishing standard measures and the difficulties of imposing them are nothing new. (See sidebar, "The Facts Behind the Fuss About Financial Statements.") Any serious discussion about developing a standard must weigh the drawbacks against the benefits of doing so.
Such was the intent when NACUBO teamed with the National Postsecondary Education Cooperative to host the Institutional Operating Measures Forum in September 2000. (See sidebar, "What Is NPEC?") The shared hope for the forum was to attract the right people to examine the issue of a standard operating measure and, if successful, propose a single measure that would gain wide acceptance within higher education.
We got the first half right. The forum attracted a wide range of participants from many sectors of higher education, including faculty and representatives from campus finance and institutional research offices, accreditation associations, higher education associations, rating agencies, Big Five accounting firms, and the federal government. However, consensus among forum participants was that it would be inappropriate to suggest a standard measure at that time without further effort and dialog. This article discusses key insights and questions emerging from the forum that remain issues of debate and concern today.
What can a majority of higher education institutions and stakeholders agree on with regard to the financial reporting practices of colleges and universities? In discussing operating measures for higher education, forum participants concluded that
- higher education institutions should consider making financial statements more inclusive by going beyond information about financial resources to include information that would assess operating performance;
- current financial statements provide information about economic resources, changes in financial resources, and cash flows, but statements provide little information that enables users to rearrange information to develop an operating measure;
- the primary challenge in developing a financial statement operating measure is that there are two accounting models ( FASB and GASB) used within the industry; and
- in addition to different accounting models, developing an operating measure is confounded by the treatment of the change in net assets from long-term investing, the endowment spending rate recognition, when and how the release of restrictions is recognized, and the recognition of capital asset gifts or resources to acquire them.
Likewise, a common set of questions exists for examining the feasibility of establishing a single operating measure for use throughout higher education. What would a standard measure achieve for higher education? What problems might be encountered in reaching consensus on a measure? What alternatives to operating measures might be considered?
Forum participants agreed that failure to account for differences in measures and institutional missions could result in an externally imposed standard measure that does not make sense for the majority of institutions. And no one wants that.
Benefits of an Operating Measure
Most agree that increased comparability and fiscal transparency could certainly benefit higher education. The latter is a concern raised by the National Commission on the Cost of Higher Education in its 1998 report, "Straight Talk About College Costs and Prices." The commission was critical of colleges and universities for not providing financial information in a way that makes it easy to get a good picture of the financial health of an institution. In terms of comparability, most institutions currently participate in some form of peer analysis, but this is limited because of the lack of an accepted financial measure of operations. Having a universal operating measure as part of the financial reporting process would enable expanded comparisons.
Given the latitude allowed by FASB and GASB, higher education has an opportunity to self-manage performance reporting by the industry. Taking the lead to develop a measure based on an acceptable rationale is preferable to having a potentially biased measure imposed from outside the industry. Additionally, an accepted measure could make a powerful, positive statement about management and the overall prosperity of the industry. Perhaps even more important, in cases where problems exist, the operating measure could serve as an early warning signal that corrective action is needed.
Adoption of a standard measure would also show responsiveness to states interested in performance assessment, especially those moving toward performance-based funding models. Similarly, accrediting institutions at all levels place a great deal of emphasis on financial stability. If they don't have consistent, reliable information that's comparable, how can they identify when an institution is truly in trouble? Though not the sole determinant of institutional effectiveness, financial performance—as demonstrated through an operating measure—can help prove the long-term viability of institutions. Finally, presenting an accepted measure of financial performance can demonstrate accountability to various stakeholders, including students, parents, taxpayers, legislators, and others interested in higher education performance.
While the merits for establishing an operating measure for higher education are plentiful, major issues must still be addressed to gain consensus about what such a measure should look like.
Incompatible reporting models. One of the largest obstacles is the incompatible FASB and GASB reporting models. Although both now prescribe entity-wide financial reporting, the models require differing treatment for some significant items such as Pell grants, investment portfolio appreciation, and gifts. These differences are so significant that it is hard to imagine that a single measure could work for every institution.
Over-emphasis on the measure itself. Much concern also centers on the use of a single measure that might prove detrimental to institutions if that measure is allowed to take on undue significance and be used for inappropriate purposes. Ideally, an operating measure would be one of many factors considered in assessing an institution's performance. If a single measure is established, the consensus is that care must be taken so that the measure is not misapplied or used as the sole determinant of an institution's effectiveness. For instance, with regard to performance-based funding, consider two institutions with comparable missions. Institution A has an incredible retention rate but doesn't perform quite as well financially as institution B, which has a mediocre retention rate. If only the financial performance of the two institutions is compared, one might conclude that institution B is more effective than institution A, even though institution A arguably is doing a better job of using resources to contribute to the overall longterm viability of the institution.
Diverse institutional missions. Still another obstacle to obtaining broad support for a single measure is the diversity of mission among institutions. For instance, some colleges or universities may subsidize academic operations through student charges, such as housing, and use that revenue to keep tuition relatively lower. This may result in a quite different measure compared to an institution that provides no housing whatsoever.
Unexplained data. According to Jack McCarthy, partner at PricewaterhouseCoopers, it's not only important to consistently apply a measure when one is used—it's also essential to describe what it includes and excludes. Forum participants agreed that operating measures that don't provide context are ultimately of little value.
Specific Operating Measures
No prescribed operating measures exist, although certain models currently being used may provide valuable insight. John Nelson, senior vice president of Moody's Investors Service, represents a firm that elected to develop and apply its own operating measure. Using information extracted from campus financial statements, Moody's performs calculations to arrive at an operating measure. While calculations don't adjust for every potential variance among institutions, they provide a measure that can be benchmarked against other institutions, says Nelson. However, obtaining the operating measure is not the ultimate objective, according to Nelson. The value of the measure itself is as a proxy for good management.
At the forum, Philip Tahey, partner at KPMG, described the composite financial index (CFI) developed by his firm. The CFI combines four separate ratios to provide an overall score representing an institution's financial health. Although the CFI is designed for flexibility and can be used by any institution, KPMG places relatively low weight on the net income ratio (akin to an operating measure) when working with campuses. Part of the motivation for the CFI is to respond to trustees, who tend to favor simple measures, asserts Tahey. Management, on the other hand, is typically uncomfortable with simple measures because they rarely tell the entire story. In Tahey's experience, large research universities tend to present operating measures while only half of small-to medium sized institutions do so. As such, he generally finds much less consistency among the measures used by smaller institutions.
Of course, higher education is not the only industry struggling to define an operating measure, says Tahey. Real estate also finds consensus difficult. In addition to FASB and GASB, he says, other groups may ultimately influence the issue. For instance, the Securities and Exchange Commission is interested in for-profit education providers, and those efforts may have an impact on the rest of higher education.
Forum participants voiced several suggestions for pushing forward the debate about developing a standard operating measure for higher education. Among those suggestions: to articulate a list of issues that create differences as a result of varying accounting methods and to provide definitions for those issues. The purpose of doing so would be to urge institutions to describe their accounting treatment with regard to these issues within the notes to their financial statements. By adhering to this approach, informed parties could use the information in the notes to adjust calculations irrespective of the specific measure presented. The proposed list of issues includes
- large gifts and bequests;
- capital gifts for long-lived assets (i. e., non-operating, temporarily restricted, amortized to match depreciation expense);
- restricted gifts;
- annual giving and gifts in general;
- endowment income—yield versus pay-out;
- realized and unrealized gains;
- gains and losses on sales of plant assets;
- investment income and earnings on working capital;
- and federal and state grants and contracts.
A second suggestion centered on the need for a collaborative effort to identify appropriate financial measures for use within higher education. Rather than one organization unilaterally proposing a single operating measure, forum participants suggested that a coalition of interested parties be established with representation from campuses, associations, financial statement users groups, federal and state governments, and others to more fully explore the issue and recommend one or more measures to be used throughout higher education. For a variety of reasons that include issues of funding, such a coalition has not emerged, though the need for collaboration remains real.
A third suggestion entailed examining the practices of private colleges and universities since the issuance of FASB 117 when private institutions first had the opportunity to employ operating measures in their financial reporting. The hope: to identify the variances that still exist among institutions that are using operating measures and to shed some light on what might constitute an appropriate measure for all colleges and universities. That survey—undertaken by NACUBO with support from PricewaterhouseCoopers—is now complete, the results of which follow this article.
The survey results reveal some wide variances in reporting practices among private institutions. As such, additional analysis of the survey data, or perhaps a related survey, is currently being explored to determine how best to proceed with establishing a standard measure. NACUBO's Accounting Principles Council paid considerable attention to this topic at its meeting earlier this year.
With the GASB 35 phase-in deadline coming up, time will soon tell whether public institutions will come any closer than private institutions to establishing a uniform operating measure. And whether the twain—private and public—shall ever meet is beyond anyone's best estimate at this time. What is certain is that the issues and the questions surrounding the development of a standard operating measure will not go away. Whether a standard measure or measures are feasible—and whether institutions will muster the wherewithal to document and define their practices in ways that make their financial information more transparent—will certainly carry implications for how institutions of higher education are perceived and treated in the future.
Author Bio Larry Goldstein, NACUBO senior fellow and former NACUBO senior vice president and treasurer, is a Charlottesville, Virginia-based consultant. Brenda Albright, former consultant to and now executive director of the National Postsecondary Education Cooperative, documented the forum proceedings and was an invaluable resource in developing this article.
WHAT IS NPEC?
In 1994, Congress authorized the National Center for Education Statistics to establish the National Postsecondary Education Cooperative. NPEC is comprised of individuals representing all levels of postsecondary education, including public and independent institutions, statewide governing and coordinating agencies, federal government, and national associations. NPEC's mission: "To promote the quality, comparability, and utility of postsecondary education data and information that support policy development at the national, state, and institutional levels."
In large part, the idea for the joint NACUBO/ NPEC Institutional Operating Measures Forum first emerged from conversations among members of NPEC's Working Group on Costs, Finance, and Productivity. Shortly after the forum, NPEC embarked on an examination of its organizational structure and approach to completing projects. Under the leadership of a new executive director, NPEC is considering adding the issue of operating measures to its current agenda.
The Facts Behind the Fuss About Financial Statements
Throughout higher education's history there has never been agreement about a relevant operating measure for colleges and universities. In the "good old days" the financial statements of public and private institutions could be compared based on the single audit guide to which higher education accounting was subject—the American Institute of Certified Public Accountants' Audits of Colleges and Universities. But under the AICPA industry audit guide, financial statements focused on the flow of funds instead of revenues and expenses. Comparability was obtainable, but no mechanism existed for determining an operating measure. In addressing the issue, the AICPA guide indicated that the statement of current funds revenues, expenditures, and other changes (the de facto activity statement for higher education) "does not purport to present the results of operations or the net income or loss for the period as would a statement of income or a statement of revenues and expenses."
This era of higher education accounting ended when the Financial Accounting Standards Board—which sets standards applicable to commercial and nonprofit organizations—began issuing new accounting rules for nonprofit entities. Since 1987 when FASB issued Statement No. 93 on depreciation, the differences among public and private institutional reporting practices have widened. With the issuance of FASB's nonprofit reporting model (Statement No. 117, "Financial Statements of Not-for-Profit Organizations") in 1993, the door was opened to an operating measure for private colleges and universities. But while the standards contained in FASB 117 made the AICPA guide obsolete for private institutions, FASB chose not to define a measure of operations and decided to neither encourage nor discourage the display of such an operating measure in the statement of activities.
Instead, according to Statement No. 117, FASB "neither requires nor precludes a not-for-profit organization from classifying its revenues, expenses, gains and losses as operating or non-operating within its statement of activities." The only exceptions relate to the separate display of income from discontinued operations, extraordinary gains and losses, and the cumulative effect of a change in accounting principle—which are the same items separately displayed in the income statements of for-profit entities. One reason for the lack of guidance was FASB's belief that the change in unrestricted net assets, a required reporting element, could serve as a measure of operating performance. Despite the standards applicable to private institutions, the flexibility permitted by FASB has made comparability a significant challenge.
The growing diversity of accounting and reporting practices between private and public institutions may no more easily be resolved by the Governmental Accounting Standards Board's more recent Statement No. 35 ("Basic Financial Statements—and Management's Discussion and Analysis—for Public Colleges and Universities"), issued in 1999. GASB is responsible for setting standards applicable to state and local governments, including public colleges and universities. GASB 35 eliminates the separate reporting model for public higher education, thereby making the AICPA guide obsolete for public institutions as well. With this new reporting model, GASB 35 now requires the presentation of an operating measure expressed as the net difference between operating revenues and operating expenses. However, with a few notable exceptions (i. e. , state appropriations, gifts, investment income), GASB allows institutions to define operations as they see fit.
With the final phase-in of GASB 35 by fiscal year-end 2004, both public and private institutions will now have a statement of activities and a statement of cash flows. However, the classification of the various elements and even the underlying measurement basis will continue to differ in important ways. Even so, this latest development once again presents an opportunity to address the issue of operating measures for higher education in search of standard practices that would benefit all stakeholders involved.
—Larry Goldstein; Mary Fischer, professor of accounting at the University of Texas at Tyler; and Teresa P. Gordon, professor of accounting at the University of Idaho, Moscow
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