Modernization of the Financial Accountability Framework September 2009 Ministry of Education Fall Information Sessions
Purpose To explain upcoming changes to the Financial Accountability Framework, including: Rationale for changing the Financial Accountability Framework Two key accounting standard changes PS 1200 Financial Statement Presentation PS 3150 Tangible Capital Assets Ministry s response on the Government Transfers Re-Exposure Draft Four key Education Act changes Description and timeline of Financial Reporting Model changes 1
Why are changes being made? The Financial Accountability Framework has two components. Reporting model Estimates, Revised Estimates, Financial Statements Compliance model legislation (Education Act) under which it is determined whether or not a board is in financial compliance (i.e. balanced budget). Boards prepare audited Financial Statements on the accrual-based PSAB (Public Sector Accounting Board) standard of accounting. Boards prepare budgets (Estimates and Revised Estimates) based on the Education Act, which operates on a modified cash basis. This means that boards are preparing two sets of financial information. This leads to a lack of transparency and comparability, and can create situations where financial decisions impact the two sets of financial information quite differently. The goal of the new Financial Accountability Framework is to align the reporting model and the compliance model so that boards will budget and report under the same accounting method, i.e., accrual based PSAB standards. 2
Accounting Standard Changes The goal to align the Financial Accountability Framework to PSAB is influenced by two new PSAB standards. 1) PS 3150 requires boards to report their tangible capital assets (TCA). TCA are to be reported as assets on the statement of financial position. The amortization of TCA should be accounted for as an expense in the statement of operations. 2) PS 1200 and PSG-4 replace the concept of reserves. Information on funds or reserves can only be in the notes and schedules - not on the statement of financial position. Key concept: The creation of, addition to or deduction from funds and reserves does not create a revenue or expense, and would therefore not be reported on the statement of operations. Both sections apply to school boards for fiscal years beginning on or after January 1, 2009. Thus, boards will be implementing these changes in their 2009-10 financial statements. Since PSAB is an external standard setter, boards must comply with these timelines. 3
Implication for Tangible Capital Assets (TCA) Since boards financial compliance will be based on PSAB financial reporting, it is important that the new accounting standards are implemented in a way that provides meaningful financial information. When TCA are put on the financial statements in 2009-10, their amortization will be recorded as an expense on the Statement of Operations. On the revenue side, it is important to consider the treatment of capital grants that are used for TCA. There has been some flux in the standard that deals with the recognition of revenue related to capital contributions (PS 3410 Government Transfers). 4
Implication for Tangible Capital Assets (TCA) con t In the current standard, boards are required to recognize the revenue they receive from the province for capital when the capital is purchased. However, the board must recognize an amortization expense for the capital asset over the life of the asset (ex. 40 years). For example, assume a board receives a capital grant of $4M to build a school that has a useful life of 40 years. Under the current standard, the following would be recorded: Year 1 Year 2 Year 40 Revenue: Capital Grants ($) 4,000,000 0 0 0 Expense: Amortization ($) -100,000-100,000-100,000-100,000 In-Year surplus/(deficit) ($) 3,900,000-100,000-100,000-100,000 This means that the board would have a large in-year surplus in the year the asset is purchased due to the capital contribution, but would have small deficits for the following 39 years as a result of the amortization. 5
The Solution: Deferred Capital Contributions (DCC) If boards report their capital as per the previous illustration, the financial statements would not provide a meaningful indication of the usage of revenues and expenses, i.e., this would not be a good way to measure if boards are balancing their budgets and operations. The proposed approach to address the above is to introduce a deferral concept through an account called deferred capital contributions (DCC). A DCC account is used to record capital contributions. The amount in this account is recognized in revenue in proportion to how the related TCAs are recognized in expenses through amortization. 6
The Solution: Deferred Capital Contributions (DCC) con t Consider the previous example where a board receives a capital grant of $4M to build a school that has a useful life of 40 years. Under the proposed new standard, the board would record the $4M in a DCC account when they have purchased the asset. DCC is an account on the Statement of Financial Position, therefore the initial recording of DCC would not impact the Statement of Operations. Going forward, as the board starts to recognize amortization expense for the asset, the board would also recognize the capital grant revenue by reducing the DCC account at the same rate as the amortization. This means that the capital purchase would not impact the in-year surplus/deficit figure as long as boards spend only the approved amount on capital. Year 1 Year 2 Year 40 Revenue: Capital Grants ($) 100,000 100,000 100,000 100,000 Expense: Amortization ($) -100,000-100,000-100,000-100,000 In-Year surplus/(deficit) ($) 0 0 0 0 7
Deferred Capital Contributions Status The PSAB standards do not yet include DCC; however, the PSAB has released the Government Transfers Re-exposure draft (ReD) that proposes to introduce DCC into the standards. The proposed standards in the ReD are expected to come into force in the Fall of 2009. It is assumed, but not certain, that the standards that come into force will include DCC. This depends on the comments PSAB receives from the accounting community. The Ministry has provided a detailed response to PSAB, in consultation with the Reporting Entity Workgroup. This response has also been shared with the OASBO Finance committee and with COSBO. 8
Government Transfers ReD Response The Ministry strongly agrees with the Government Transfers Reexposure draft (ReD) in that it includes the concept of DCC. There are, however, five key areas where the Ministry has focused its comments in its response. 1. Opening balances 2. Definition of capital transfer 3. Land 4. Third-party contributions 5. Deferred revenue on unspent capital contributions 9
1. Opening balances Currently, the ReD requires a prospective application, meaning that DCC would only be applied on future capital transfers. This means that previous TCA purchased with capital grants would not have a corresponding DCC amount, whereas future purchases would have a corresponding DCC amount. The Ministry has recommended that PSAB provided the option to record DCC retroactively. The Ministry has also recommended that a reasonable method of estimating the opening DCC balance be included in the ReD, similar to what the handbook allows for initial TCA implementation. 10
2. Definition of capital transfer In the ReD, a capital transfer is defined as resources that are to be used for the acquisition and development of a tangible capital asset. Often, boards use their own short-term financing to acquire or develop TCA. The Ministry subsequently flows grants to pay off the short-term loans. Essentially, the intent of the grant is for capital, even though it is used to pay off a loan (substance over form). The Ministry is looking to clarify the definition of a capital transfer as: resources that are to be used for the acquisition, development or payment of a tangible capital asset. 11
3. Land The ReD does not specifically address land, however, the ReD defines the treatment of capital assets. As land is a capital asset, it is the Ministry s understanding that land is eligible to be recorded in DCC. Since land is a non-depreciable capital asset, the portion of DCC related to the land would also not be amortized. 12
4. Third-party contributions Third-party contributions, such as donations or fund-raising for capital, are not addressed in the ReD. Only government transfers are specifically eligible to be recorded as DCC. The implication is that government capital transfers used to purchase TCA are eligible to be recorded in DCC, whereas thirdparty contributions used to purchase TCA cannot be recorded in DCC. The Ministry has commented that consistent treatment is required to have financial statements that are relevant and understandable. 13
5. Deferred revenue on unspent capital contributions As per the current PSAB handbook (PS 3100), grants received for which the eligibility criteria or stipulations have not been met are to be recorded in deferred revenue (i.e. a liability). There is a consequential technical amendment in the ReD whereby PS 3100 would no longer be applicable to government transfers. The ReD does not provide guidance on how capital transfers that have not met eligibility criteria or stipulations should be recorded. The Ministry has commented that these grants should be recorded as deferred revenue, since they meet the definition of a liability. Once the grants are spent on their intended purpose, the Ministry is of the opinion that they would then be recorded in DCC. 14
Financial Reporting Model Status The Ministry is proceeding with the development of the new financial reporting model based on the assumption that DCC will be included in PSAB standards, because this is the most meaningful way to represent capital contributions. It is not certain when CICA will issue its guideline on government transfers. Training will be provided in early 2010, to facilitate this transition. The Ministry will, at that time revisit, the reporting changes to reflect policy decisions and to incorporate the guideline requirements if issued. 15
Key Changes to the Education Act The Education Act will be changed effective September 1, 2010 (i.e. the 2010-11 reporting cycle). It would have been ideal to implement the Ed Act changes earlier to coincide with the 2009-10 budget; however, this was not possible due to the flux in the accounting standards around DCC. The changes will be: 1. Updating budgeting requirements to align with provincial accounting standards; 2. Improving ability to manage grants separately from cash-flow; 3. Establishing new financial accountability controls based on financial results; and 4. Establishing new provisions related to multi-year deficit management strategies and recovery plans. 16
Status: Changes to the Education Act Initial policy approval for the changes was received from the Health, Education and Social Policy (HESP) committee of cabinet in January 2009. Approval of the actual Education Act changes was received from the Legislative and Regulatory Committee (LRC) of cabinet in June 2009. The changes are expected to be part of the fall budget bill, which will be tabled in legislature in the fall of 2009. Resultant regulations will be tabled at LRC early in 2010. 17
1. Updating budgeting requirements to align with provincial accounting standards The Ministry is amending legislation to update the budget requirements, currently on a modified cash basis, to the provincial accounting standards, which are on an accrual basis. Certain terms are no longer relevant and must be replaced with a new term. Other terms require definition in the Act for the first time. Old Terminology New Terminology 1. Expenditures 1. Expenses 2. Money 2. Amounts 3. Reserve fund 3.1 Deferred revenue 3.2 Restricted accumulated surplus 4. n/a 4. Operating revenue 5. n/a 5. Accumulated surplus 6. n/a 6. Accumulated deficit 7. n/a 7. In-year surplus 8. n/a 8. In-year deficit 18
1. Updating budgeting requirements to align with provincial accounting standards (con t) Expenditures was changed to expenses This is because expenditures means the cash that was spent whereas expenses refers to the costs accrued, and this may not equal cash spent. Money was changed to amounts Similarly, to provide a distinction between cash spent and costs accrued. Reserve funds were changed to: Restricted accumulated surplus for internally restricted amounts. Deferred revenue for externally restricted amounts, consistent with PSAB definition. 19
1. Updating budgeting requirements to align with provincial accounting standards (con t) Operating revenue will be used in the definition of compliance. It will include operating grants (revenues). Accumulated surplus/deficit is defined as the total of a board s current and prior in-year surpluses/deficits. In-year surplus is the amount by which a board s revenues exceed its expenses in that fiscal year. In-year deficit is the amount by which a board s expenses exceed its revenues in that fiscal year. 20
2. Improving ability to manage grants separately from cash-flow The Ministry is amending legislation so that school board grant entitlements will be independent from the timing of cash payments. Currently, under the Education Act, if a board receives a grant entitlement, the amount payable in cash will flow in the immediate future. Grants going forward will mirror a board s expense requirements under the new accounting standards, which might be different than a board s cash requirement. One example of where differences may occur relate to non-cash expenses, such as employee future benefits, where costs might be recognized now, but the cash will not be required for many years. 21
3. Establishing new financial accountability controls based on financial results Since reserves will no longer be used in PSAB (standard PS 1200), a new financial control will be put in place for boards budgeting purposes. The Ministry is amending legislation to place a limit on the use of operating reserves or reserve funds (to be called accumulated surplus in the future). Boards currently have unrestricted use of reserves; however, using reserves obscures a board s actual financial health. Adding to reserves means a board had an in-year surplus. Using reserves means a board had an in-year deficit. 22
3. Establishing new financial accountability controls based on financial results (con t) A board will be deemed to have a balanced budget if: its expenses do not exceed its revenues for the fiscal year by an amount greater than the lesser of: 1) 1% of the board s operating revenue for the school board fiscal year 2) the board s accumulated surplus for the immediately preceding fiscal year This is often called the 1% provision. It is the new section 231 in the Education Act. 23
3. Establishing new financial accountability controls based on financial results (con t) The board s deficit may be greater than the criteria above if the board has approval from the Minister. The Minister will consider the following in deciding to grant approval: Whether the in-year deficit is structural or one-time in nature. Whether the board has enough accumulated surplus to cover two years worth of in-year deficits. The extent to which the in-year deficit is the result of circumstances beyond the board s control. 24
3. Establishing new financial accountability controls based on financial results (con t) The boards accumulated surplus will be segmented into three parts: 1. Available for compliance This represents the portion of the accumulated surplus that may be applied to the 1% provision. Includes prior in-year surpluses. 2. Available for compliance internally restricted Similar to above, this is the portion of the accumulated surplus that may be applied to the 1% provision, and it is made up of prior in-year surpluses. The distinction is that it has been internally restricted, similar to what would have been previously known as a reserve (ex. snow removal). 3. Unavailable for compliance by regulation This represents the portion of the accumulated surplus that is not available to be applied to the 1% provision. These amounts would be excluded by regulation, and would be dependent on policy decisions. 25
4. Establish new provisions related to multi-year deficit management strategies and recovery plans The Ministry is amending legislation to permit multi-year deficit management strategies and recovery plans, triggered if: spending is unsustainable; an unplanned deficit occurs; or a deficit is forecast in excess of defined tolerances or approvals. Currently, boards are required to approve a balanced budget each year under the Education Act. Legislation is silent on deficits that become apparent at other times (e.g. at Revised Estimates or at Financial Statements). A new section has been introduced that gives the Minister the power to trigger a recovery plan: If the board s financial statements show the board had an in-year deficit contrary to section 231, or an accumulated deficit, or; If at any point the Minister has reasonable grounds to believe that the board s financial statements will show that the board will have a deficit contrary to the new section 231, or an accumulated deficit. 26
4. Establish new provisions related to multi-year deficit management strategies and recovery plans (con t) The board would be required to submit a recovery plan within a specified time period. The Minister could approve or change the plan as necessary to address the deficit. The board would be required to comply with the recovery plan until the board eliminated its in-year and accumulated deficits. The Ministry will propose regulations that address timelines. Options under consideration include criteria to fully address the deficits in less than four fiscal years, e.g. Phase 1 reduce the in-year deficit to less than 1% of operating revenue Phase 2 the board should balance in-year Phase 3 the board shall have eliminated its accumulated deficit 27
Financial reporting model changes 2008-09 Financial Statements: Boards will be submitting their 2008-09 financial statements in November 2009. TCA (land, building, furniture and equipment) will be reported in the notes to the financial statements. These figures will be audited; whereas in the prior year, these figures were not audited. From this period forward, boards are responsible to calculate their own amortization. The Ministry will, however, still collect data on land and buildings in the form of a TCA upload file at year-end. 28
Financial reporting model changes 2010-11 Estimates: Boards will be submitting their 2010-11 budget in June 2010. This is the first time budgeting will be on the new compliance model. This means that budgeting will be on an accrual basis. Previously, non-cash items like amortization were excluded from the compliance calculation. To complement the compliance calculation, the boards will be using the new reporting model which includes DCC (deferred capital contributions). Calculation of opening DCC balances will be required. Restatement of 2009-10 for DCC will also be required. Since this is the first time boards will not be expensing their capital, boards will be required to prepare capital budgets. These changes will be covered in detail in the presentation called 2010-11 Forms & Capital Budgeting. 29
Financial reporting model changes 2009-10 Financial Statements: Boards will be submitting their 2009-10 financial statements in November 2010. These financial statements will be based on the new reporting model, but not the new compliance model. The new reporting model is being implemented at this time due to the PSAB standard implementation deadline to include capital and remove reserves from the statement of financial position. The new reporting model will include capital assets but will not include DCC (deferred capital contributions). Opening capital balances will be restated. As the 2009-10 Estimates were not prepared under the new model, the budget will also need to be restated. The new compliance model does not come into effect until September 1, 2010, thus the 2009-10 financial statements will be evaluated under the old compliance model. This will involve reconciling statements between the new and old compliance models, similar to what we currently have in EFIS. Related training will be presented in early spring of 2010. 30
Summary: Financial reporting model changes Timeline 2008-09 Financial Statements (boards submit November 2009) Key Changes TCA audited in the financial statement notes Boards calculating own amortization Boards submitting TCA data through a TCA upload file 2010-11 Estimates (boards submit June 2010) Budgeting using new compliance model New reporting model (including DCC, removing reserves, adding TCA on statement of financial position) Capital budgets 2009-10 Financial Statements (boards submit November 2010) New reporting model (see above, but excluding DCC) Old compliance model 31
Further Information Elizabeth Sulkovsky Senior Business and Policy Analyst Reporting Entity Team Transfer Payments and Financial Reporting (TPFR) Branch Ministry of Education 416-325-8527 Elizabeth.Sulkovsky@ontario.ca Further details of the timing on the changes to the Financial Accountability Framework can be found at: http://tpfr.edu.gov.on.ca/reporting_entity_home.htm Click on timelines 32