As another calendar year passes, one thing has become predictable in the world of accounting—the standard setters are all about forward progress. The Governmental Accounting Standards Board (GASB) has been working at an electrifying pace to identify all that is needed to communicate accountability, foster transparency, and complete the balance sheet.
Meanwhile the Financial Accounting Standards Board (FASB) continues to culminate international convergence activities and address the needs of private companies and not-for-profit entities. Since accounting standards are not industry specific, higher education institutions must scrutinize projects and proposals for potential impact.
GASB Actions in Review
Major areas of GASB’s recent work involve deliberating fair value and other postemployment benefits, and seeking comments on fiduciary activities and leases. Meanwhile, public colleges and universities will be implementing the pension standard.
Pensions
Public institutions that follow GASB are facing a major implementation this year—pensions. The vast majority of public institutions’ defined benefit pension plans are structured as multiple-employer cost-sharing plans. According to Statement No. 68, “Accounting and Financial Reporting for Pensions—an Amendment of GASB Statement No. 27,” all participating employers in a multiple-employer cost-sharing plan collectively share a portion of the plan’s net position, which could mean a proportionate share of funding shortfalls. Public institutions in cost-sharing plans must rely on data provided by the state retirement plan; this means relevant percentages for the employer that can be applied to unfunded pension liabilities and deferrals. Institutions will also need to determine if any audit procedures will need to be applied to the numbers.
Several public colleges and universities have indicated that their portion of the unfunded pension liability for their state’s retirement plan will be substantial. Although the balance sheet can take a dire turn as a result of implementing Statement No. 68, the issues created will need to be clarified through effective communication. The economics of state public pension plans and promises haven’t changed; rather, GASB’s measurement, display, and disclosure requirements offer an interpretation of the meaning of pension promises at a point in time.
Public colleges and universities will need to help stakeholders understand the context of the pension numbers on the financial statements. Various analysts (e.g., ratings agencies, accreditors, debt and investment experts) indicate that the impact of GASB’s mandate is minimal, as these analysts have been estimating and applying known liabilities all along. GASB Statement No. 68 does not change reality, but rather provides a means of reporting it. Consequently, public institutions should embrace a holistic communication framework that covers current and future legislative actions; plan status quo and modifications that could have a positive influence; funding requirements and outlook; institutional control; rating agency assessment; and accreditor perspective.
Other Retirement Benefits
While public pension underfunding and cost increases have grabbed headlines, postemployment benefits other than pensions—the most common being health care—are also significant for many state and local governments. Consequently, GASB issued an exposure draft (ED) in June for these other postemployment benefits (OPEB) that would supersede the requirements of Statements No. 45, “Accounting and Financial Reporting by Employers for Postemployment Benefits Other Than Pensions,” as amended, and No. 57, “OPEB Measurements by Agent Employers and Agent Multiple-Employer Plans,” for post-employment benefits other than pensions. The proposal would establish standards for measuring and recognizing liabilities, deferred outflows of resources, deferred inflows of resources, and expenses. Because the ED uses terminology, analogy, and definitions that are similar to those in Statement No. 68, GASB did not see a need to issue its preliminary views (PV) for comment; the ED was the sole due process document for this noteworthy project.
As with state-sponsored pension plans, the vast majority of public colleges and universities participate in multiple-employer cost-sharing OPEB plans. Because OPEB plans are administered as “pay as you go,” they do not typically have assets that are set aside in a trust for benefit payments. Consequently, experts believe that underfunding will be quite substantial. As with pensions, public institutions in multiple-employer cost-sharing plans are considered to collectively share in liabilities and deferred costs for these state-sponsored benefits. Public institutions will need to determine the type of OPEB plan offered and whether or not a trust exists.
NACUBO comments and testimony to GASB’s OPEB proposal stressed the following:
- Cost-sharing employer’s allocated portion of a collective liability does not meet the definition of a liability in GASB’s Concepts Statement No. 4, “Elements of Financial Statements.”
- Public institution cost-sharing employers do not have a legal obligation beyond contributions that are contractually determined or mandated by the institution’s state.
- Public institution employers would have no reasonable way of relieving a portion of a collective liability, when the state controls the factors that comprise the total liability.
- When public institution employers participate in a multiple-employer cost-sharing plan, the promise that the public institution makes to its employees in exchange for service is access to the state’s postemployment benefits, not the benefits themselves.
- GASB’s employment exchange paradigm is weakened by its conclusions concerning “special funding situations.” If the employment exchange is at the heart of cost-sharing employers’ liability recognition (according to GASB, the employer—not the state or the plan— promises the benefits), it is unclear what the conceptual reasoning is behind the exemption for “special funding situations.” (In special funding situations, when nonemployers make funding contributions on behalf of employers, the employer’s OPEB liability recognition is proportionately reduced by the percentage of required funding amounts paid by the nonemployer). NACUBO pointed out that it is illogical to diminish the employment exchange reasoning based upon “who” is paying the required contribution.
GASB continues to deliberate issues in its OPEB ED.
Accountability: Fiduciary Duties
In November, GASB issued for public comment a preliminary views titled, “Financial Reporting for Fiduciary Responsibilities.” Fiduciary responsibilities are those for which a government acts as a trustee or custodian in controlling assets that belong to others. The PV identifies fiduciary activities that should be reported in a government’s fiduciary funds, amends existing disclosure requirements for fiduciary activities, and would require a stand-alone business-type activity engaged in fiduciary activities (such as a public institution) to present fiduciary fund financial statements.
This is an interesting project that public higher education will need to decipher and pay attention to. Currently, colleges and universities engaged in business-type activities (BTA) do not have fund-level reporting requirements. If proposed fiduciary fund–level reporting requirements became authoritative, would fund-level reporting begin and end with fiduciary activities, or would other activities that BTAs are engaged in eventually lead to fund-level reporting? The GASB’s position is that financial statement users want and need to know that the governmental reporting entity is properly carrying out its fiduciary responsibilities, and there needs to be consistency among governments in understanding and defining the nature of fiduciary activities. Although GASB’s research indicated that user understanding of fiduciary activities is important, its research did not specifically focus on college and university (or other BTA entity) user needs.
Currently, from an operational perspective, colleges and universities may treat various types of transactions as fiduciary. However, it appears that the PV would only require fund reporting for fiduciary activities when assets controlled (a) do not originate from a government’s own-source revenues or (b) do not directly benefit the government, its related entities, or its citizens. For example, colleges with taxing authority would consider the portion of taxes collected on behalf of another government as subject to fiduciary reporting. On the other hand, the portion of property taxes that the college retains for its benefit would not be subject to fiduciary reporting.
Other examples identified so far include material amounts of (1) funds belonging to others that may be invested in the university’s investment pool or (2) student organizations’ bank accounts. Transactions that will require further clarification include all types of “on behalf” or “pass-through” financial aid (loans or aid, other than Pell Grants) that belong to students. Comments are due by March 31.
GASB Follows FASB Blueprints
GASB’s fair value and lease accounting and reporting projects are notable examples of technical efforts that leveraged FASB’s research, deliberations, experience, and guidance. Both projects were added to GASB’s agenda in 2011.
- Fair value. GASB began discussing fair value because of certain holes or gaps in its literature. There is currently no authoritative guidance for measuring and reporting alternative investments at fair value—which represent a growing percentage of endowment assets held by public higher education institutions. In 2014, GASB released Concepts Statement No. 6, “Measurement of Elements of Financial Statements,” which will serve as the foundation of a fair value standard designed to measure assets and liabilities. The new concepts address initial transaction and subsequent measurement attributes used for financial statement reporting.
The board has defined investments subject to fair value accounting as assets that a government holds for the purpose of income and with a related service capacity that is based on the ability to generate profit (or be sold to generate cash) for the benefit of the citizenry. The fair value project has used both a PV (in 2013) and an ED (in 2014) to gather input from constituents. In both years, NACUBO’s written comments and testimony drew from the extensive experience that many independent institutions have with FASB’s measurement and reporting requirements.
In its ED, GASB recommends that valuation techniques maximize the use of relevant observable inputs and minimize the use of unobservable inputs. Suggested guidance entails a three-level hierarchy of inputs currently required by the FASB:
- Level 1 inputs are quoted prices from markets and need not be adjusted in any way.
- Level 2 inputs are either directly observable or available from observable market information. Level 2 inputs are only used when level 1 inputs are not available.
- Level 3 inputs are assumptions a government develops based upon the best information available to it. Level 3 inputs are only used when level 1 and 2 inputs are not available.
Similar to current FASB guidance, a government is permitted, in certain circumstances, to determine the fair value of an investment that does not have a readily determinable fair value by using the net asset value (NAV) per share (or its equivalent) of the investment. The ED also calls for disclosure about fair value measurements, valuation techniques, inputs, and additional information about investments in certain entities that calculate NAV.
NACUBO’s comments asked GASB to add or clarify the following:
- Explain the difference between unit of account measurement and what the reporting entity should recognize. Since alternative investments often have complex structures, it is important to differentiate whether an investor owns an underlying asset or a percentage of an investment structure (such as a limited partnership).
- Enhance and consistently apply the definition of fair value (to be referenced in the GASB glossary when the standard is issued) related to how fair value might be determined when there is no available market.
- Provide logical descriptions and conclusions of adjustments to level 1 and level 2 inputs; the ED did not clearly state that input level adjustments result in the asset no longer being classified in that level. For example, although circumstances are listed in which adjustments could be made to level 1 inputs, once an adjustment is made to a level 1 input, it becomes a level 2 or level 3 input.
- Establish comparability and consistency with FASB fair value disclosure requirements for investments that have no readily determinable market value—especially since FASB and preparers who follow FASB have years of experience with such investments. GASB’s proposal inconsistently added asset “type” terminology to disclosure requirements where FASB currently requires that disclosures be made only at the asset “class” level. The ED also does not adequately define “class” or “type.”
- Allow an extension of the effective date by one year, because proper leveling of alternative investments involves assessing each investment, reviewing the terms of each investment, documenting the methodology used by third parties to estimate fair value, and understanding any limitations on redemption.
GASB is examining public comments and continues to deliberate issues related to fair value.
Leases. Public institutions routinely enter into lease arrangements that are classified as either capital or operating. Although capital leases result in long-term liabilities and receivables for lessees and lessors, respectively, there is no asset or liability recognition for operating leases―even when such arrangements are long term. GASB’s lease project is tracking FASB’s work to allow GASB to assess comments, debate, and potential guidance in the context of a governmental environment. GASB will consider whether operating leases meet the definition of an asset or liability as defined in Concepts Statement No. 4.
The board will also contemplate whether current requirements promote accountability and decision-useful information for financial statement users.
GASB released a PV document last November that suggests a new accounting model for both lessees and lessors. Intended guidance would eliminate the current distinction between operating and capital leases. Under the draft, public colleges and universities that are lessees would report the following in their financial statements for all leases that exceed 12 months in duration:
- An intangible asset that represents the government’s right to use the leased asset.
- A corresponding liability for lease payments.
- Amortization expense related to the lease asset (recognizing the asset amount as an expense over the term of the lease).
- Interest expense related to the lease liability.
- Public institutions that are lessors would report the following in their financial statements for all leases that exceed 12 months in duration:
- A receivable for the right to receive payments.
- A corresponding deferred inflow of resources to reflect resources related to future periods.
- Lease revenue (and a corresponding reduction in the deferred inflow), systematically over the term of the lease.
- Interest revenue related to the receivable.
FASB and GASB concur that all leases other than short-term leases should now be on the balance sheet of a lessee, and that expenses should be recognized, as (1) an interest component based on the lease liability and (2) an amortization expense component based on the leased asset. In addition, both boards agree that lessor accounting should parallel the accounting proposed for lessees.
FASB Continues Its Momentum
FASB marched on with the issuance of the new standard on accounting for revenue from contracts with customers. It also continued deliberations on changes to the not-for-profit reporting model. In addition, the board has a number of other projects in various stages of completion that are likely to impact independent colleges and universities, including the two remaining convergence projects, leases and financial instruments, and a project aimed at improving financial statement disclosures.
Revenue From Contracts With Customers
In May 2014, the FASB and the International Accounting Standards Board (IASB) issued the long-awaited converged standard on the recognition of revenue from contracts with customers. The project spanned more than five years and the boards received more than 1,500 comment letters on the two exposure drafts issued.
The standard, which affects all entities (public, nonpublic, and not-for-profit) that report under FASB or IASB standards, applies to contracts entered into with customers that result in a transfer of goods or services, or a transfer of nonfinancial assets, not within the scope of other standards (e.g., insurance contracts or lease contracts). The core principle of the standard is for organizations to recognize revenue in a way that depicts the transfer of goods or services to customers in amounts that reflect the consideration (payment) to which the company expects to be entitled.
Enhanced disclosures intended to allow users to understand the nature, amount, timing, and uncertainty of revenue and cash flows from contracts with customers are also required. Certain practical expedients are provided with regard to the disclosure requirements, including the exclusion of certain disclosures for contracts with durations of one year or less.
The overall impact of the new standard on independent higher education institutions is not expected to be significant. Many of the contracts that institutions enter into are relatively short term, such as those involving student tuition and fees. One area, however, that requires further attention and guidance is that of sponsored arrangements. This is because many sponsored arrangements do not meet the definition of a contract with a customer, a contribution, or a collaborative arrangement as defined in the FASB Accounting Standards Codification.
These arrangements are unlike contracts with customers, where goods or services are transferred; contributions, where funds are provided with no expectation of ongoing interaction between the parties; or a collaborative arrangement, where both parties share in the risks and rewards associated with the commercial success of a venture. Grants from governmental entities (and other sponsors) are typically arrangements under which funds are provided to the institution to fulfill mutually agreeable goals that are in keeping with the institution’s mission. The objective of these arrangements is the performance of the research, not the creation of an output with commercial value.
Members of NACUBO’s Accounting Principles Council have had preliminary discussions with FASB staff as well as members of the FASB/IASB Joint Transition Resource Group for Revenue Recognition, highlighting the need for further guidance in this area. NACUBO’s position is that these arrangements should be addressed on a stand-alone basis rather than by trying to adapt existing guidance to determine the appropriate accounting and reporting for them.
The standard is effective for public companies (including not-for-profit organizations that are conduit bond obligors or that have other publicly traded debt) for FY18, and FY19 for nonpublic companies.
Not-for-Profit Reporting Model Changes
In October 2014, the FASB completed its preliminary deliberations on proposed changes to the Not-for-Profit (NFP) Financial Reporting Model and approved the drafting of a proposed Accounting Standards Update (ASU), which is expected to be released for comment in early April 2015. The following is a summary of the board’s tentative decisions. (For more detail on these decisions, see the news articles posted on the NACUBO website at www.nacubo.org and the June 2014 Business Officer article, “A Full Accounting Plate.”)
Statement of Financial Position
The three classes of net assets currently required would be replaced with two classes of net assets: those with donor-imposed restrictions and those without. In order to avoid the potential loss of important information, disclosures about the composition of net assets at the end of the reporting period would be required. It will be important for institutions to highlight net assets with donor-imposed restrictions that need not be retained in perpetuity. This distinction will provide clarity that all net assets not required to be retained permanently are expendable to support the institution’s mission-related activities over the next reporting period and into the future.
Statement of Activities
FASB has identified a number of potential changes in this area.
Intermediate measure of operations. All NFPs would be required to present an intermediate measure of current operations on the statement of activities. The measure would be defined using two key dimensions: (1) a mission dimension, based on whether resources are related to the NFP’s primary mission; and (2) an availability dimension, based on whether resources are available for current period activities, reflecting both external limitations and internal actions of an NFP’s governing board.
The following factors related to the mission and availability dimensions will need to be considered, in implementing the proposed guidance:
- All gifts are considered to be related to the NFP’s mission.
- Gifts with donor-imposed restrictions that limit their use until a future period would be recorded as nonoperating in the period received.
- All legally available mission-related revenues would be presented within the intermediate measure of operations.
- Amounts designated by the NFP’s governing board for use in future periods would be shown as transfers below the intermediate measure of operations.
- Investing and financing activities would not be considered mission-related unless they are directed at carrying out the NFP’s programs such as:
1. Interest earned on an institution’s student loans.
2. A foundation’s subsidized loans to support grantees.
3. Programmatic loans directed at achieving the NFP’s mission.
Reporting expenses. NFPs would be required to present expenses by both functional and natural classifications within their financial statements. Currently, all NFPs must present expenses by function, but not by natural classification. The proposed guidance would require an analysis of the relationship between natural and functional expenses within the financial statements; however, the format would not be prescriptive. While no specific format would be required, a matrix that contains natural expenses by function will likely prove the easiest and most straightforward approach. Institutions would also be required to provide a description of the methods used to allocate costs among programs and support services.
Reporting investment returns. A net presentation of investment returns would be required on the face of the statement of activities. The current requirement to disclose the amount of netted investment expenses would be eliminated and replaced with a requirement to present only internal salaries and benefits of personnel directly involved in the investment area.
Capital transactions. Capital-like transactions would be presented as follows in the statement of activities:
- For gifts of long-lived assets received without donor restrictions, an NFP would report the fair value of the gift as operating revenue in the period received. If the NFP then elects to use the asset in its operations, it would show a transfer of the entire amount of the gift out of operations. No amounts would be transferred back into operations in subsequent periods. The asset, however, would still be depreciated over its estimated useful life.
- For gifts of cash restricted for the purchase or construction of long-lived assets, an NFP would report an increase in net assets with donor restrictions outside of operations. When the donor’s restriction is met, the amount of the gift would be shown as a release of restrictions within operations. The entire amount would then be transferred out of operations, consistent with the reporting for an unrestricted gift of a long-lived asset.
Expiration of restrictions. The current option of implying a time restriction to gifts of long-lived assets, or cash to acquire them, over the useful life of the asset would be eliminated. All restrictions would be considered to be satisfied upon placing the asset in service.
Other presentation matters. NFPs could choose to use a one-statement or two-statement approach when preparing the statement of activities. A subtotal of operating revenues and expenses would be required to be presented before transfers. Transfers would be presented in a separate, discrete section and would include, at a minimum, the aggregate total of transfers into operations and the aggregate total of transfers out of operations.
In addition, qualitative disclosures about the purposes, amounts, and types of transfers would be required. For example, an institution that has a policy of designating all bequests as quasi-endowments would show the amount of the gift coming into operations and then being transferred to nonoperating. In its footnotes, the institution would describe its policy and indicate the amount transferred out of operations in accordance with that policy during the year.
Impact on higher education. Although many independent institutions already provide a measure of operations in their financial statements, some adjustments will likely be needed in order to conform to the proposed guidance. For example, most institutions include interest expense as an operating activity. Under the proposed guidance interest expense would be considered nonoperating.
Also, some institutions have adopted the policy of releasing donor-imposed restrictions on long-lived assets over the useful life of the asset. Under the proposed guidance, these institutions would be required to release the entire amount of the restricted net assets at the time the asset is placed in service and then transfer it back to nonoperating, consistent with the reporting for an unrestricted gift of a long-lived asset. The current matching of depreciation and the release of restricted net assets would no longer be possible.
Statement of Cash Flows
Not-for-profit entities would be required to present the statement of cash flows using the direct method. The current requirement to provide a reconciliation of the change in net assets to net cash flows from operating activities (the indirect method) would no longer be required.
In addition, the following elements would be reclassified in order to better align the statement of cash flows with the statement of activities:
- Interest and dividends received would be investing cash flows, rather than operating.
- Interest paid would be a financing cash flow, rather than operating.
- Gifts and purchases of fixed assets would be operating cash flows, rather than financing/investing.
- Proceeds from the sale of long-lived assets would be operating, rather than investing.
Concerns have been raised about these proposed changes as well as corresponding changes in the statement of activities, specifically, the receipt and disbursement of cash for fixed assets—including contributions for such purchases—being included within operating activities. Many feel that including these amounts within the intermediate measure of operations in the statement of activities and within operating activities in the statement of cash flows distorts the true nature of these transactions.
Also on the Horizon
In addition to the projects already discussed, FASB is working on other projects that independent institutions will want to watch.
Investments measured using net asset value per share as a practical expedient. In October 2014, FASB issued a proposed accounting standards update that would eliminate the requirement to include investments measured using net asset value (NAV) as a practical expedient within the fair value hierarchy. This would alleviate the need for institutions to determine whether such investments should be categorized as level 2 or level 3 based on nearness to potential redemption. Currently, these investments are required to be categorized within the fair value hierarchy based on when, if ever, they are redeemable with the investee at NAV on the measurement date.
Many preparers agree that this will save time both in the preparation and audit of the financial statements. There is, however, concern that by essentially creating an “other” category into which investments measured using NAV would fall, the fair value hierarchy table would no longer provide beneficial information to users of the statements.
Leases. The FASB and IASB continue to redeliberate the accounting for leases. Although this is one of the convergence projects undertaken by the FASB and IASB, the boards have not agreed on a consistent approach for lessee accounting. FASB has decided on a dual approach for lessees, with lease classification determined based on whether or not the lease is effectively an installment purchase. This is similar to current accounting but without the bright-line distinction of what constitutes a capital lease versus an operating lease. Lessors would also use a dual approach with accounting similar to that applied today. Given the breadth of the topic, redeliberations are expected to continue for some time. No date has been projected for issuance of a final standard.
Disclosure framework. In 2012, FASB issued an Invitation to Comment on a potential framework for financial statement note disclosures. In 2013, the board conducted field testing to better understand the use of discretion in preparing footnotes. Several higher education institutions participated in those field studies.
Most recently, in December 2014, the board held a public forum to elicit additional feedback on financial statement disclosures from preparers and users of financial statements as well as standard setters and regulators. Deliberations on this project are ongoing with no date identified for the issuance of a Proposed Accounting Standards Update for public comment.
It’s All About Keeping Up!
The technical agendas of both standards boards are always in motion. For the foreseeable future, business officers will need to pay close attention in order to avoid being swept away by the momentum of change. Stay tuned.
KAREN CRAIG is accounting project consultant for NACUBO; SUE MENDITTO is director, accounting policy, NACUBO.