Last year’s accounting cliffhangers included the possibilities of a new reporting model, new assessment and recognition criteria for research grant revenue, lease accounting decisions, and ongoing fair value discussions—and these were only for the institutions that follow Financial Accounting Standard Board (FASB) guidance.
Public colleges and universities were preparing to implement the pension accounting and reporting standard—and not sure of its effort or impact—while also keeping an eye on activities of the Governmental Accounting Standards Board (GASB). Public institutions and NACUBO were closely following projects on fiduciary responsibilities, split-interest agreements, leases, and other post-employment benefits, as well as preliminary evaluations of the utility of the current reporting model, after being in effect for 15 years.
GASB Moves Forward, Looks Back
GASB deliberations of interest to higher education focused on pension implementation issues, fiduciary responsibilities, split-interest agreements, leases, and a review of its 15-year-old financial reporting model.
Pensions
Concerning the promise of pensions by employers, GASB Statement No. 68 "Accounting and Financial Reporting for Pensions—an Amendment of GASB Statement No. 27" provides guidance on measurement, display, and disclosures, so that financial statement users can better understand the impact of pension benefits. The vast majority of public institutions’ defined-benefit pension plans are structured as multiple-employer cost-sharing plans. These institutions must rely on data provided by the state retirement plan; this means providing relevant percentages for every employer in the plan that can be applied against actuarially determined plan totals to determine an employer’s pension expense, liability (or asset), and deferrals.
An interesting discovery about the intended scope of Statement 68 relates to the promise of pension benefits to state government employees that are funded by other than state or local government plans—such as private union or federal government pension plans. Upon implementing Statement 68, land-grant public institutions discovered that certain employees and retirees were participating in federal and related civil service retirement systems. Initial inquiries to GASB revealed that all pension plans for which there is a trust are within the scope of Statement 68, regardless of the plan’s source. Therefore, GASB initially advised employers to quantify the number of employees (past and present) that are covered by "other" defined-benefit plans—and evaluate the possible materiality of the benefit. As inquiries to GASB mounted on this topic, a project to address the issue was added to the board’s technical agenda last July. The result—GASB Statement No. 78, "Pensions Provided Through Certain Multiple-Employer Defined Benefit Pension Plans," was issued in December 2015.
In Statement 78, the board asserts that there are significant challenges associated with obtaining the information needed to comply with Statement 68, in circumstances in which pensions are provided to the employees of state or local governmental employers by other types of multiple-employer defined-benefit pension plans. Consequently, the board concluded that the scope of Statement 68 should generally exclude defined-benefit pensions provided to state or local governmental employees through the types of multiple-employer plans described above.
Statement 78 requires recognizing pension expense equal to employer’s required contributions and liabilities for any unpaid contributions during the reporting period. The new standard also requires disclosures that address information about the plan and 10-year contribution trends to be reported as Required Supplementary Information.
Other Postemployment Benefits (OPEB)
Last June, GASB issued Statement No. 75, "Accounting and Financial Reporting for Postemployment Benefits Other Than Pensions." The standard is effective in FY18 for the vast majority of public institutions and largely parallels the pension standard’s requirements. The new guidance will require public institutions to report a liability whether the benefits are provided through the state’s or the employer’s plan, and regardless of whether there is a separate plan trust or the plan is considered "pay as you go." Since "pay as you go" plans do not have dedicated assets to offset unfunded liabilities, the impact to the balance sheet will be greater.
Fiduciary Responsibilities
More than five years after adding a project on fiduciary responsibilities to its technical agenda, in December, GASB issued an exposure draft, "Fiduciary Activities," with comments due March 31. Based on comments received on its preliminary views document, the board decided to change the name of the project from "fiduciary responsibilities" to "fiduciary activities." The title of the exposure draft more accurately reflects the goal of highlighting, through authoritative guidance, the nature and significance of actions that fall within the proposed definition of fiduciary arrangements.
The fiduciary project is about demonstrating accountability. Thus, the focus of the criteria generally is whether a government is controlling assets of a fiduciary activity. A government has control when it holds assets to provide benefits to specified beneficiaries, or when the government has the ability to direct the use, exchange, or employment of the present service capacity of the assets.
Under the proposed guidance, a government would report fiduciary activities when it controls assets that are not derived from its own-source revenue, and one or more of the following criteria exists:
1. The assets are administered through a trust agreement or equivalent arrangement in which the government itself is not a beneficiary and the assets are both (a) dedicated to providing benefits to recipients in accordance with the benefit terms and (b) legally protected from the creditors of the government.
2. The assets are to be provided to individuals who are not required to be residents or recipients of the government’s goods and services as a condition of being a beneficiary.
3. The assets are to be provided to organizations or other governments that are neither part of the financial reporting entity nor recipients of the government’s goods or services.
4. The assets result from a pass-through grant, the program for which the government does not have administrative or direct financial involvement.
Higher education has been concerned about the fiduciary project because of the potential need to break out certain financial statement elements representing fiduciary activities into funds for financial reporting—where no fund group reporting exists today. For example, short-lived custodial responsibility for payroll taxes withheld, property taxes collected, or perhaps student financial aid provided, would require "mocking up" fund statements of net position and changes in net position to produce fund reporting that could involve substantial effort but add little value to our financial statement users.
NACUBO reminded GASB of its conclusions in Statement No. 35, "Basic Financial Statements—and Management’s Discussion and Analysis—for Public Colleges and Universities." Specifically, GASB stated that "fund group reporting, though useful for some public college and university financial statement users, did not serve the same purposes as fund-based reporting for other governments and was not essential for most users’ understanding of the financial position and results of operations of public colleges and universities. The historical development of the governmental fund structure and the use of the current financial resources and modified accrual basis of accounting have been influenced by the public budgetary process and the taxing power of general purpose governments."
During a liaison meeting with the GASB last July, NACUBO’s Accounting Principles Council thought that fund reporting would make sense only for trusts—such as those related to single-employer pension plans. The council also expressed frustration that the fiduciary project was not going far enough to shed light on the various types of financial aid that public colleges and universities must manage with fiduciary care for its students. The hope was that the fiduciary project might lead to improved accounting for Pell Grants, which would foster consistency between public and independent higher education institutions.
The good news concerning fiduciary activities is that the exposure draft proposes an exception for business-type activities (public institutions) that expect to hold assets in a custodial capacity for three months or less. This exception would allow public colleges and universities to maintain financial statement elements that are custodial in nature but expected to be cleared in three months or less (for example payroll tax liabilities) on the statements of net position and cash flows without additional and separate fiduciary fund reporting.
Split-Interest Agreements
Since the inception of the current reporting model, GASB has been receiving questions concerning the appropriate accounting and reporting for irrevocable split-interest agreements. Because deferred-giving arrangements are a significant source of revenue for many higher education institutions, accounting and financial reporting for split-interest agreements is important. An irrevocable split-interest agreement is a trust or other arrangement in which a college or university is a named beneficiary and shares benefits with other beneficiaries. At inception, the donor transfers assets to a trustee (either a third party or the institution itself). The donor then specifies how income from the transferred assets will be shared among beneficiaries during the life of the agreement and, upon termination, how the remaining assets will be distributed.
GASB Statement No. 33, "Accounting and Financial Reporting for Nonexchange Transactions," has been considered authoritative for irrevocable split-interest agreements, because such donations are voluntary nonexchange transactions due to their irrevocable nature. Under Statement 33, assets and related revenues received in voluntary nonexchange transactions are recognized when eligibility requirements have been met or when the cash (or other assets) are received, whichever is earlier. With an irrevocable split-interest gift, the terms of the agreement contain instructions to invest the transferred asset and to make payments to the institution and one or more beneficiaries. Higher education has always regarded the requirement to invest the proceeds of the gift—for a certain period of time—as satisfying the "time requirement" as soon as the donated assets are invested (see NACUBO Financial Accounting and Reporting Manual, Section 331).
According to research conducted by GASB staff, however, there are variations in accounting practice for split-interest agreements. Some believe that the recognition criteria in Statement No. 33 are not met and recognition is not appropriate until the end of the term, when remaining assets are available for the institution’s use. However, many do not see a substantive difference between (1) permanent or term endowments received by an institution (and subsequently transferred to independent investment managers) and (2) split-interest gift resources deposited directly into an irrevocable trust. Nevertheless, users of financial statements have expressed interest in information on irrevocable split-interest agreements to the extent that trusts held by the government (or beneficial interests in trusts held by a third party) can be used to fund operations or debt payments of the government.
Although the proposed guidance would allow funds held in trust by "others" (meaning funds not held directly by the institution) to be recognized as assets—which is not the case today and which would align with recognition required by the FASB—the proposed guidance will result in a complete change in the financial accounting and reporting for irrevocable split-interest agreements that are directly held by the institution. The most significant change concerns the timing of revenue recognition. The exposure draft, and a tentative decision by GASB last October, would require recognition of a deferred inflow of a resource at inception for a government’s beneficial interest in an irrevocable split-interest agreement. Further, retroactive application will be required. This means institutions will have to derecognize revenue when the standard becomes effective and recognize it, instead, in the future.
NACUBO does not agree with the GASB’s decision. Paragraph 22 of Statement 33 clearly states that revenue is recognized when resources such as term endowments are received and that the time requirement is met as soon as the recipient begins to honor the provider’s stipulation not to sell, disburse, or consume the resources, and continues to be met for as long as the recipient honors that stipulation. Term endowments are similar to irrevocable split-interest gifts because the institution has the funds but can’t immediately use the asset. The asset, however, generates returns and can be used as collateral against borrowing. Further, per paragraphs 64 and 65 of GASB Statement No. 72, "Fair Value Measurement and Application," an investment is an asset with present service capacity based on its ability to generate income; investments indirectly enable a government to provide services. An irrevocable split-interest arrangement is an asset and an investment of the college or university. NACUBO’s Accounting Principles Council will discuss this matter with GASB staff in more detail during a liaison meeting in March.
Leases
The GASB has been deliberating comments on its document "Preliminary Views of the Governmental Accounting Standards Board on Major Issues Related to Leases," since last April and expects to issue an exposure draft in the first quarter of 2016, with a 120-day comment period. Board decisions reflected in the exposure draft rest on the foundational principle that all leases are financings of a right to use an asset. Although the board has been closely monitoring FASB decisions, GASB’s exposure draft will include differences with FASB to accommodate situations that are unique to a governmental environment—most notably that leases, in which external laws, regulations, or legal rulings significantly limit the ability of the lessor to set rates in excess of costs, would continue to be accounted for based on the current guidance for operating leases.
Other decisions that will be reflected in the 2016 exposure draft include the following:
- The final standard is expected to be issued in FY18, with an effective date that will be two years later.
- Changes, if any, made to comply with the standard would be reported as a restatement of beginning net position, and notes to the financial statements should disclose the nature of the restatement and its effects.
- A requirement that lessee and lessor disclosures of future lease payments present principal and interest separately to mirror the schedule of principal and interest payments required for long-term debt under Statement No. 38, "Certain Financial Statement Note Disclosures."
- Short-term leases (12 months or less) and leases of intangible assets would be excluded from the scope of the proposal.
- Leases meeting the definition of an investment would not require recognition of a lease receivable and related deferred inflow of resources.
Financial Reporting Model
A project to assess the effectiveness of the current reporting model, after more than 15 years in use, was added to GASB’s technical agenda in September. Although pre-agenda research indicated that most of the model’s components are effective, a number of areas in need of improvement were identified. Most notable for public higher education is the presentation of an operating measure that is not considered valuable by users of financial statements.
An Invitation to Comment is expected to be issued by the end of 2016 on government-wide and government funds reporting. Anticipated to be on the 2017 agenda is a discussion of reporting issues related to the display of operating and non-operating activities by special purpose governments reporting as a business-type activity.
NACUBO has presented several alternative formats to the board that focus on separating support revenue from exchange revenue. Subtotals are used to indicate the meaningful impact that both exchange and nonexchange revenues play in an excess or deficit between total revenues and total expenses.
FASB Completes Convergence, Moves Forward With Reporting Model Revisions
In addition to its Not-for-Profit (NFP) Financial Reporting project, which is discussed in detail later in this article, the Financial Accounting Standards Board (FASB) closed in on completing two international convergence projects, Leases and Financial Instruments, and continued work on a number of projects during 2015 that will impact independent institutions.
Fair Value
In May, FASB issued Accounting Standards Update (ASU) 2015–07, "Fair Value Measurement (Topic 820)—Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)." The standard eliminated the requirement to categorize within the fair value hierarchy investments measured using net asset value as a practical expedient. As a result, institutions no longer need to determine whether such investments should be categorized as level 2 or level 3 based on nearness to potential redemption.
Revenue Recognition
Last August, FASB issued ASU 2015–14, which delayed, by one year the effective date of implementation for its standard on revenue recognition from contracts with customers (Topic 606). That standard will now be effective for public entities (including not-for-profit organizations that are conduit bond obligors or that have other publicly traded debt) for fiscal years beginning after Dec. 15, 2017 (FY19 for most colleges and universities).
Nonpublic entities are required to apply the standard for fiscal years beginning after Dec. 15, 2018 (FY20).
Leases
The final standard on leases is expected to be issued in the first quarter of 2016. The basic tenet of the new standard is that all leases convey a right-of-use, which results in both an asset and a liability that should be reflected on the balance sheet of lessees. Leases will be classified as either Type A leases (similar to current capital leases) or Type B leases (similar to current operating leases). Amortization of the right-of-use asset will be recognized separately from the lease liability for Type A leases. Type B leases will be recognized as a single lease expense. There will be no changes to today’s model for lessor accounting. The standard will be effective for public entities for fiscal years beginning after Dec. 15, 2018 (FY20 for most colleges and universities) and for all other entities for fiscal years beginning after Dec. 15, 2022 (FY21).
Financial Instruments
FASB addressed this topic in two separate projects: classification and measurement, and impairment. In January 2016, FASB issued ASU 2016–01, "Financial Instruments—Overall (Subtopic 825–10): Recognition and Measurement of Financial Assets and Financial Liabilities." While the majority of guidance in the ASU will have little impact on independent institutions, one positive outcome is that NFPs will no longer be required to provide fair value disclosures for financial instruments measured at cost or amortized cost. For example, an institution that carries its debt at amortized cost would no longer be required to disclose the fair value of that debt. The standard is effective for all NFPs for fiscal years beginning after Dec. 15, 2017. Certain provisions of the guidance, such as the one described here, may be adopted immediately.
A final standard on the accounting and reporting of impairment of financial instruments is expected to be issued in the first quarter of 2016. Like the classification and measurement standard, it is not expected to have a significant impact on NFPs.
NFP Financial Reporting
Of greatest interest to independent institutions is, of course, the Not-for-Profit (NFP) Financial Reporting project. After three and a half years of research, outreach, discussion, and deliberation, FASB issued a proposed ASU in April. Through comment letters, public roundtables, and workshops, FASB received significant, and sometimes diverse, feedback on its proposals. A total of 264 comment letters—including 36 from higher education—were received from preparers, auditors, users, academics, individuals, and others. Many of the letters expressed a desire to maintain as much consistency as possible between for-profit and not-for-profit financial reporting. They also expressed the need for a proposal that better takes into consideration the differences among NFPs.
Based on feedback received, the board decided to divide its redeliberations into two workstreams or phases. The first phase, which began in December, reconsiders those proposals that are not dependent on other FASB projects and for which feedback received was relatively consistent—either positive or negative. FASB is hopeful of issuing an accounting standards update for the first phase by June 30, 2016.
The second phase will involve reconsideration of proposed changes that are likely to require more time to resolve. In particular, these changes would involve alternatives suggested by stakeholders that the board did not previously consider or that are related to similar issues being addressed in other FASB projects. Following is a summary of each of the original proposals, feedback provided by NACUBO and others, and plans for redeliberation.
Statement of Financial Position
Work in this area is focused on changes in net asset classes and a revision in the way underwater endowments are reported.
Combine net asset classes. FASB proposed replacing the three classes of net assets used today with two classes: those with donor-imposed restrictions and those without. The board acknowledged that the Uniform Prudent Management of Institutional Funds Act (UPMIFA) has blurred the lines between permanently and temporarily restricted net assets and felt that the proposed change would help to eliminate some of the confusion that exists in this area.
Feedback on this proposed change was generally favorable. In its comment letter, however, NACUBO stressed that the change would result in a loss of important information on the face of the balance sheet; specifically, the balance sheet would no longer show the portion of net assets with donor restrictions that must be retained in perpetuity. Because this information is critical to a user’s understanding of the expendability of net assets, financial statement users such as the Department of Education (ED), lenders, accreditors, and rating agencies would not be able to calculate the primary reserve ratio unless additional information on the "with donor restrictions" net asset class is provided in the notes to the financial statements. Given the overall support for this change, FASB affirmed the proposal as part of Workstream 1. It also reaffirmed the current requirement to provide relevant disclosure about the nature and amounts of donor restrictions on net assets, either on the face of the statements or in the notes.
Underwater endowments. Rather than reducing unrestricted net assets for amounts by which endowment funds are underwater, FASB proposed reporting those amounts within net assets with donor restrictions. In addition, institutions would be required to disclose their policy for spending on underwater endowments and the aggregate original gift amounts of underwater funds, along with the fair value of those funds.
This was another of the proposals that received overall positive feedback, including that from NACUBO. As such, the board voted to move forward with this change as part of Workstream 1.
Statement of Activities
FASB has identified numerous areas of potential change in the statement of activities.
Operating measures. One of the more controversial proposals was the requirement for all NFPs to report operating measures based on mission and availability. On the face of the statement of activities (SOA), NFPs would present two subtotals of operating activities associated with changes in net assets without donor restrictions. The first subtotal would include all activities associated with mission, while the second would reflect adjustments for availability. The second operating subtotal would reflect governing board designations related to legally available resources by displaying them as "transfers to" or "transfers from" operations. For example, a governing board designation of an unrestricted gift to quasi-endowment would be shown on the SOA as a transfer from operating to non-operating. Similarly, amounts designated for annual spending from quasi-endowment would be shown as transfers from non-operating to operating on the SOA.
NACUBO and many other respondents agreed that requiring an intermediate measure of operations was important, but disagreed with the intermediate measures proposed by FASB. There was also overwhelming disagreement with the presentation of internal transfers on the face of the SOA. In its comments to FASB, NACUBO said, "The requirement for all NFPs to display intermediate measures of operations would create consistency across the sector, but would not necessarily result in comparability. Comparability is relative and, therefore, only has meaning when users look at another similarly situated entity (or entities). In order to achieve comparability, a metric should not require several adjustments to arrive at a meaningful result for the specific entity. As such, we do not believe the two intermediate measures of operations proposed by the board would provide relevant and comparable information to financial statement users."
A number of respondents, including NACUBO, provided possible alternatives to the operating measures proposed in the ASU. Based on those and the overall disagreement with this proposal, this topic will be redeliberated as part of Workstream 2. Specifically, the board will consider: (1) whether to require intermediate operating measure(s); (2) whether and how to define such measure(s) and what items should or should not be included in the measure(s); and (3) the alternative approaches suggested by stakeholders.
Presentation of capital-related activities. The ASU contained two proposals related to the presentation of capital transactions in the SOA. The first would eliminate the current option to imply a time restriction that expires over the useful life of an asset, sometimes referred to as the "bleeding-in" method. Instead, restrictions on capital assets would be released when the asset is placed in service. This proposal received nearly unanimous support and was affirmed by the board as part of Workstream 1.
The second proposal would redirect how capital-related activities flow through the SOA. Gifts restricted to property, plant, and equipment would be recognized as an increase in net assets with donor restrictions. When the asset is subsequently placed in service, the restricted amount would be released to the operating section of the SOA and reflected in the first operating subtotal. Assuming that the institution intended to retain the asset (rather than sell it), the amount would be immediately reclassified to the non-operating section. The reclassification would be reflected in the second operating subtotal, because the long-lived asset is a resource that is not wholly available for use in the current reporting period.
In general, respondents strongly disagreed with this proposal. In its comments to the board, NACUBO said, "Gifts of, or for, long-lived assets do not meet the availability dimension and, therefore, should never be considered operating support. These are more akin to endowment gifts, which are meant to benefit future periods and should be treated similarly (as non-operating)." Because of the overwhelming disagreement with this proposal and the anticipated time necessary to refine it, this topic will be redeliberated as part of the operating metric discussions in Workstream 2.
Reporting of expenses. NFPs would be required to present an analysis of operating expenses by both their function and nature in a single location—generally in the notes. Enhanced disclosures about how costs are allocated among functions would also be required. This proposal received strong support from respondents, including NACUBO, which stated, "Today, NFPs that present their expenses by function on the face of their statement of activities are not required to provide any information about expenses by nature. As a result, financial statement users have no idea how much of the NFP’s resources was spent on salaries and benefits vs. supplies and services. We believe that information about expenses by nature is just as important—and often better understood by users more familiar with for-profit financial reporting—as information about expenses by function." Given the overall support for this proposal, it will be redeliberated as part of Workstream 1.
Investment returns. The ASU proposed that investment returns be presented net of external and direct internal expenses. In addition, the current requirement to disclose the amount of netted investment expenses would be eliminated and replaced with a required disclosure of the amount of internal salaries and benefits for personnel directly involved in the investment area that are netted against returns. This represents a change from the current guidance, which allows (but does not require) an NFP to report investment returns net of related expenses.
Although the board received generally positive feedback on this proposal, in its comment letter, NACUBO raised concerns about changing the guidance on amounts that can be netted from "related expenses" to "direct internal expenses." It stated, "Each NFP is likely to have unique expenses that they net based on their investment management structure and what costs are actually funded by the investment returns. For example, an NFP that outsources its investment management activities and has minimal internal resources dedicated to investment strategy and oversight would have a different expense structure than an NFP that manages all or a significant portion of its investments internally. We believe that presenting investment returns net of related investment expenses (i.e., no change from current practice), without disclosures about amounts netted, will provide the greatest consistency and comparability." This proposal is slated for redeliberations as part of Workstream 1.
Liquidity. The ASU would require NFPs to provide quantitative and qualitative liquidity disclosures that address restrictions, risk, and liquidity management—including demands resulting from near-term financial liabilities. The board received mixed feedback on this proposal. Many respondents felt that additional information about liquidity would be valuable to financial statement users, but disagreed with the proposed disclosures—especially those of a quantitative nature.
NACUBO staff and members of its Accounting Principles Council are working with FASB to draft example liquidity disclosures that will provide valuable information and will be cost beneficial to prepare. The discussion about liquidity disclosures is included in Workstream 1.
Statement of Cash Flows
Methods of presentation, along with realignment elements for statements of cash flows are under review by FASB.
Presentation methods. The board proposed that NFPs be required to present cash flows from operating activities using the direct method. In addition, the requirement to reconcile the change in net assets to net cash flows from operating activities (the indirect method) would be eliminated. Feedback to these proposals was mixed. Many respondents, including NACUBO, felt that the direct method of presenting cash flows was more understandable to financial statement users. Other respondents felt that the indirect method promotes understandability and consistency for users who frequently operate in a for-profit environment.
The board redeliberated this proposal as part of Workstream 1 and decided to allow NFPs free choice in their presentation of operating cash flows. For those that choose the direct method, the requirement to provide the indirect reconciliation would be eliminated.
Realignment. In order for the statement of cash flows to more closely comport with the statement of activities, FASB proposed realigning certain elements as follows:
- Interest and dividends received would be considered investing cash flows rather than operating cash flows.
- Interest paid would be considered a financing cash flow, rather than an operating cash flow.
- Gifts for, and purchases of, fixed assets would be considered operating cash flows, rather than financing or investing cash flows.
Respondents generally disagreed with this proposal. Many cited the inconsistency that would be created between a for-profit’s statement of cash flows and that of an NFP, a change that would likely result in confusion on the part of users. Based on feedback received, this proposal will be redeliberated as part of Workstream 2.
More to Come
As always, with so much going on with both standard-setting bodies, NACUBO will be actively advocating on behalf of higher education with FASB and GASB to ensure that the unique needs of colleges and universities are being addressed.
KAREN CRAIG is accounting project consultant for NACUBO; SUE MENDITTO is director, accounting policy, NACUBO.