8/22/2012. Speaker. Presentation Contents. Avoiding the Headlines: Auditing Restricted Funds

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1 Baker Tilly Beers & Cutler, PLLC, is a wholly-owned subsidiary of Baker Tilly Virchow Krause, LLP Baker Tilly Beers & Cutler, PLLC 8/22/2012 Avoiding the Headlines: Auditing Restricted Funds Speaker John Kiss CPA, CFE Manager Baker Tilly 8219 Leesburg Pike, Suite 800 Vienna, VA Tel john.kiss@bakertilly.com Presentation Contents > Session Objectives > Fund Accounting > Case Studies > Internal Audit Approach 3 1

2 Session Objectives Understand the importance of and identify specific challenges in accounting for, controlling, and spending donorrestricted funds in a higher education environment Describe the elements of legislation governing the management of restricted assets such as the Uniform Prudent Management of Institutional Funds Act (UPMIFA) Develop targeted internal audit activities to provide value to their institutions 4 +Key Construction Activities - Fund Accounting 5 What are Restricted Funds > Types of restricted funds include unrestricted, temporarily restricted, and permanently restricted net assets Net Assets = Not For Profit Net Worth = Personal Stockholder s Equity (Assets Liabilities) = Corporate > Sources of funds include gift/donations, income from endowment, and money set aside by the university > Separate and distinct from sponsored funds and awards 6 2

3 Types of Restricted Funds Unrestricted Funds are free from external restrictions Are available for general use by the institution Many gifts or donations are unrestricted, for operations and general use Temporarily Restricted Funds have restrictions (generally donorimposed) Can be satisfied either through the passage of time or by achieving a specific purpose For particular programs Permanently Restricted Funds with either time or purpose restrictions that will never expire The principle will remain with the investment Investment returns and interest will be used to fund restriction 7 Sources of Restricted Funds > Students > Alumni > Faculty > Community > Not for Profits > Corporations > Board of Trustees 8 Why is the Management of Restricted Funds Important? Reputational Risk Financial Risk Regulatory Risk Meeting expectations of your donors, faculty, student, alumni, and staff Having the accurate financial picture for budgeting and strategic planning Proper accounting for restricted funds, donor legal action, and increasing government oversight 9 3

4 Challenges for Managing Restricted Funds > Delegation of Authority > Decentralization > Turnover > Complexity of Processes > Volume of Process Owners > Budgeting Structure use it or lose it > Legacy Gifts > Accounting and Reporting > Changing Regulatory Environment 10 Regulatory Environment Relevant Regulations: FAS 116/117 - Accounting for Contributions FAS Fair Value Measurements (Endowment Investments) UMIFA - Uniform Management of Institutional Funds Act UPMIFA - Uniform Prudent Management of Institutional Funds Act 1972 UMIFA 2006 UPMIFA 1993 FAS 116/ FAS FAS 116/117 > Financial Accounting Standard No. 116 deals with contributions made and received Contributions will be recorded not just when cash is received, but also when pledges are made Contributions will be recorded immediately as income even though the contribution may have had donor restrictions that have not been met Establishes first dollar rule > Financial Accounting Standard No. 117 deals with financial statement format Contributions and net assets must now be separated into three categories based solely on donor imposed restrictions All capital gains and losses on investments and other assets will be reported in the unrestricted category 12 4

5 FAS 116 First Dollar Rule The FASB mandates the first dollar release method. Under first dollar release, restrictions are released if unrestricted resources are used for a purpose for which restricted resources are available. Although internal accounting and reporting may not be affected, the application of first dollar release converts previously restricted resources into unrestricted resources simply because they could have been expended and therefore affects external accounting. If a balance is left in the project account at the end of the year, it will be shown as "unrestricted." This will not change the total amount of money available to the project, nor will it affect our commitment to use the money in keeping with the donor's intentions. But it will appear from the university's public financial statements that much more of the funds on hand are unrestricted than in the past. 13 FAS 157 > This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. The principle change relates to establishing valuation techniques for investments. Level 1 - the highest on the hierarchy, indicates assets/liabilities with the most transparent and tangible valuation techniques. Level 2 - instruments require more involvement in valuing than Level 1 instruments. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 - is the most unobservable of the levels and indicates use of valuation techniques and data that may not be verifiable. These types of instruments involve a great deal of assumptions and estimates. 14 Uniform Management of Institutional Funds Act (UMIFA) > Before UMIFA, trust law was used. In order to avoid the appearance of impudence, investment managers usually invested in low-risk/high-yield stocks and bonds. The yield, rather than the growth was the focus in this regulatory model > UMIFA allowed investment managers to spend the value of the fund to the extent that the value of the fund exceed historic dollar value. Growth presented an added bonus for investment managers > This new model generally worked well until recently 15 5

6 Uniform Prudent Management of Institutional Funds Act (UPMIFA) > The Uniform Prudent Management of Institutional Funds Act (UPMIFA) was enacted on July 13, 2006 > Provides guidance on investment decisions and endowment expenditures for not-for-profit and charitable organizations > With UPMIFA in place, there is no longer a restriction on spending below the original value of any gift or endowment > The replacement now requires that any spending or investing must preserve the purchasing power of the principal > UPMIFA allows more room for interpretation > The Uniform Management of Institutional Funds Act (UMIFA) was the predecessor to the UPMIFA 16 +Key Construction Activities - Case Studies 17 Cases Universities and other not for profits A) Control Design Assessment B) Litigation Support C) Control Effectiveness Review D) Policy Review and Benchmarking 18 6

7 Case #1: University A - nonymous Control Design Assessment Business Challenge A large university wanted to understand financial vulnerabilities in their current operating environment. Capabilities Provided After a number of discussions, restricted fund management was selected for review because of the rather decentralized nature of the financial controls and oversight, along with the size of restricted accounts. This review was focused on the how to improve the design of controls. Results The university increased the Budget Office s role in the review and maintenance of restricted accounts. Under the new structure, they would be responsible for ensuring that appropriate assignments were made when a restricted fund was established and they also implemented general monitoring controls to ensure that those assignments were current and unusual activity was addressed. 19 Case #2: University B - eing respectful of the institution s privacy Litigation Support Business Challenge A large university needed to analyze its use of endowed funds. Capabilities Provided Baker Tilly analyzed the accounting treatment of the various funding sources in the university s financial systems. We traced the flow and application of funds to expenditures in general, departmental, and restricted fund categories. Based on our analysis, we created a flexible model to verify that endowed funds were used for their intended purpose according to a set of scenarios. Results Outside counsel and the university s counsel deployed these models to support the university s case in a litigation matter. 20 Case #3: University C - an t tell Control Effectiveness Review Business Challenge Departments expressed concerns that they are not allowed to spend restricted funds. There were close relationships between a donor and department manager. The general perception was that the institution had already spent the money allocated for that purpose even though there was money left in the account. Capabilities Provided The focus of this review was to perform data analysis to understand what was going on in not only the specific accounts, but also to look at trends and unusual activity across all of the restricted accounts. Results We identified a number of restricted accounts with negative or inactive balances. We also identified a number of accounts that did not have a fund manager assigned to them. At a high level, it would appear that the lack of proper accounting was contributing to the perception issues, e.g., the first dollar rule was not being applied and funds were showing residual restricted balances after the purpose had been achieved. We are assisting the university in creating a process to clean-up these accounts. 21 7

8 Case #4: Not For Profit D - on t ask, don t tell Policy Review and Benchmarking Business Challenge There was some disagreement between development/donor relations and accounting as to what would constitute prudent spending for their institution. The institution was looking for information on how their peers had implemented UPMIFA and what amount was being used as the spending rate. Capabilities Provided Performed a benchmarking survey, collecting information on endowment and restricted funds management for 10 peer institutions. Summarized findings and provided additional guidance on regulations. Results We found that the majority of the group spending rates are approximately 5% of the three year rolling average of the value of the endowment and that only a quarter of them allowed for spending into their endowment after UPMIFA was enacted. Additionally, the majority of the participants have standard donor agreements and provide their donors with annual reports on spending. This guidance helped reconcile the different perspectives on endowment spending between the two groups. 22 +Key Construction Activities - Role of Internal Audit 23 Role of Internal Audit Avoiding the Headlines > Supporting External Audit Testing Process Flows/Mapping > Business Process Improvement Benchmarking/Research Process Changes Data Collection and Clean-up Segregation of Duties > Investigation/Review Inactive Accounts Negative Balances Donor Intent Trend Analysis Net Assets Analysis 24 8

9 Baker Tilly Beers & Cutler, PLLC, is a wholly-owned subsidiary of Baker Tilly Virchow Krause, LLP Baker Tilly Beers & Cutler, PLLC. 8/22/2012 Any Questions? 9