Purpose of review At the request of the University, I have reviewed certain issues raised by the Students’ Union in its presentation to the Board of Governors in March 1999.
Issues reviewed The Students’ Union argued that a tuition fee increase was not necessary. They alleged that certain budget components were inflated by management to mislead the Board in order to gain approval for a maximum tuition fee increase. The allegations included statements that reserves were excessive and that revenues were in excess of the University’s
requirements. Their argument was based on: their analysis of the University’s consolidated financial statements for the year ended March 31, 1998, the University’s previous years’
consolidated financial statements, the budget documents including financial information supporting the budget, and the University’s annual reports. The argument focussed on the University’s financial operating results and financial position as presented in the budget and in the audited financial statements. Specific issues raised were:
• The accuracy of the budget surplus presented,
• Financial matters related to tuition fees,
• Salaries and benefits including the unfunded pension liability,
• Investment in capital assets including library acquisitions,
• Amortization of capital assets,
• Ancillary services revenue and expense,
• Restricted funding,
• Transfers to endowments, and
• Carryover reserves
Also, concerns over variances between budgeted and actual results were raised as were the differences between the methods used for budget accounting and the year-end
generally accepted accounting principles (GAAP) accounting.
My review included an examination of:
• Consolidated financial statements,
• Budget process,
• Tuition Cap, and
• Student Support
Summary and Conclusions My overall conclusions are that:
• The consolidated financial statements as at and for the year-ended March 31, 1998 as presented are appropriate and are prepared in accordance with generally accepted accounting principles.
• I did not find evidence of any matters in the budget designed to mislead the Board or that the reserves are excessive to the University’s needs. The budget
presented was consistent with the budget preparation and reporting practices of previous years. In fact, my
analysis shows that the University’s financial position is not strong enough to fully support the faculty carryover reserves as reported. Carryover reserves reflect the University’s commitments to its faculties that annual budget savings can be used for faculty purposes in subsequent periods.
• There are significant differences in reporting practices between the approved budget and the annual year-end consolidated financial statements. As a result of the differences in practices between the approved budget and the annual year-end consolidated financial statements, it is difficult to compare or discuss planned to actual results. These differences result in significant reported variances in revenues, expenses and operating results and consequently resulted in argument and confusion over the amount of budgeted revenues, expenses and annual results.
The Students’ Union focussed on certain of these differences in accounting practices between the budget and the annual year-end consolidated financial statements. They presented arguments for adjustments to capital and other costs included in the budget, which are not accounted for as expenses in the annual year-end consolidated financial statements. This led to their conclusion that the budget surplus was understated in the amount of $44.9 million. I disagree with this conclusion because it fails to account for amortization and other accrued costs, which are used to determine the annual surplus as reported in the consolidated financial statements. Had amortization and accrued costs been included, the
$44.9 million adjustment would have been significantly reduced. The differences between the budget and the year-end consolidated financial statements led to the accusation that the University is “cooking the books”. I
found no evidence that the University was generating excess surpluses. For example, the total available and unrestricted net assets at March 31, 1998 of $28.1 million are not sufficient to support commitments of $47.9 million to its faculties.
Budget process Recommendation No. 16
It is recommended that the University of Calgary’s approved budget be prepared on an accrual basis reflecting all transactions that will be reported in its consolidated financial statements.
Refinements to budget methodology required
I believe that the University should employ GAAP based budget methodology in order to communicate its financial requirements, especially in the areas of capital acquisitions, and also to determine a balanced budget. The annual consolidated financial statement reporting practices have changed in recent years in response to changes in generally accepted accounting principles. However, the budget reporting has not kept pace with such changes. As a result, there are significant variances that arise between the two methods. The main differences arise in the following areas:
• The budget reflects as expenditure certain non-expense items such as capital acquisitions, carryover reserve adjustments, and internal transfers.
• The budget reflects certain expenditures on a net basis including ancillary operations and cost recovery projects.
• The budget does not account for amortization, donations, pension liability changes and certain restricted revenues and related expenses including sponsored research. It is acknowledged that certain of these items are presented as information in schedules to the budget.
Why amortization needs to be budgeted
Investment in capital assets is disclosed as expenditure in the budget whereas the consolidated financial statements report amortization expense. Disclosing capital asset transactions as investing activities in the budget presentation would serve to eliminate the confusion generated by including operating and capital items together as expenditure. Amortization represents the consumption of the value of the asset over the useful life of the asset. It also serves as a gauge to determine whether revenues are sufficient to cover the amortization cost. If amortization is not included in the budget, revenues
that should represent recovery of amortization costs are reported as available and the risk is that they will be spent and not be set aside for capital asset replacement (reserves).
Why amortization represents cash spent
Unless capital assets are donated, the acquisition of capital assets requires cash. Capital asset cash requirements are funded in basically two ways – capital contributions and through operating revenues including operating grants and tuition fees. Amortization represents a portion of the cash expenditure of other periods used to acquire the capital asset and where such cash, already expended, is not recovered either through capital contributions or operating revenue, the effect is that the institution is depleting its aggregate
financial position. In short, it is downsizing. When amortization is viewed in its technical terms as a non-cash transaction, this view most often avoids the necessity to deal with the fact that unless sufficient revenues are available to meet the amortization expense, the cash costs of the asset are not being recovered.
Cash planning In order for the University to continue to operate and provide educational services, it should determine how the
replacement capital assets will be funded either through operating funds or through capital contributions. This is why I believe that the University should establish a position as to the appropriate level of reserves required for future capital investment.
Responsibility for the funding of capital assets
Typically, amortization on internally funded capital assets would result in an amount of cash at the end of the year that could be reinvested in capital assets. However, as indicated earlier, at March 31, 1998, the University had accumulated amortization of $172 million relating to furnishings and equipment and only $28.1 million in unrestricted net assets.
In its May 1995 Accounting/F inancial Policies memo, the Department of Advanced Education and Career
Development indicated that the institutions were responsible for capital asset maintenance, replacement and betterment through the revenues provided in the operating grant. It is imperative that the University develop a capital budgeting plan which identifies the strategies the University plans to use to fund its long-term capital requirements. This includes determining how the capital assets will be funded, whether through contributions, financing or operations. If the University intends to replace assets through equity, then it must ensure that an amount equivalent to amortization is set
aside in reserves so that sufficient cash is generated to replace the capital assets at the end of their useful life. The University will need to make some assumptions about future government funding policies, and consider whether it should be restricting funds for future capital needs from its present annual operating surpluses. Not restricting funds from surpluses, when there is an expectation that the University will use operating grant funds to fund equipment, could result in the University being unable to fulfill its mandate.
Accrual methodology in budgets is required
I recognize that the budget process is more complicated than financial reporting and as a result, more difficult to adapt to match accounting changes. It is acknowledged that a reserve in the amount of $18.9 million was established in the
1998-99 annual consolidated financial statements for equipment, construction, renovations and deferred
maintenance. I also wish to acknowledge that a number of changes have been made since the 1997-98 budget year.
Specifically, a restricted capital reserve has been established in the 1998-99 consolidated financial statements, a request for approval of the 1999-00 sponsored research budget was made and an estimate of amortization has been provided in the 1999-00 budget presentation. I further acknowledge that the current budget process was designed around cash-based fund accounting and would require significant modification to address the University’s future needs. The issue of re-examining the cash-based budgeting process is important to the University because of changes in recent years to funding provided by government. The Department of Advanced Education and Career Development’s policy guideline on capital asset maintenance and replacement sets out expectations that institutions must provide for capital asset maintenance, replacement and betterment through their operating revenues. In effect, this policy means that
institutions must not only consider cash needs on an annual basis but also consider future cash required for capital needs in the future. This is why accrual concepts in budgeting have become more important. In my view, the budget should include all the components as reported in the annual audited consolidated financial statements, which include all operating, investing and financing transactions.
Balanced budgeting Recommendation No. 17
It is recommended that the University of Calgary review its budgeting process to determine whether its current definition of a balanced budget is adequate to ensure programs and facilities are supported and will continue to be supported.
Balanced budgets must provide for appropriate reserves
The University defines a balanced budget as expected operating revenue equal to cash expenditure. Expenditures include the amount spent for capital replacement and
renovations. Capital acquisitions are budgeted in the amount of revenues available after operating needs are met.
Therefore, capital replacement can be delayed. The University should assess its needs and budget for the replacement of capital on a long-term basis. Using a cash-based budgeting model without generating a sufficient level of reserves presents the risk of downsizing of the University, as it becomes more difficult to replace capital assets and to perform deferred maintenance when the requisite resources are not available.
In Note 8 to its 1997-98 consolidated financial statements, the University reported carryover reserves at $47.9 million.
As previously indicated, the University does not have available net assets to support these carryover reserves.
It is my understanding that some faculties are building reserves for specific projects. As such, the reserves are commitments that cannot be met with existing available net assets. It appears that most of such reserves are targeted for much needed equipment replacement.
Reserve levels need to be reviewed
When viewed against the demands to replace furnishings and equipment already amortized to the extent of $172 million, it is evident that the current accumulated operating equity and contributions received for capital assets are inadequate to fund the replacement of these assets. A planned policy of replacing diminished assets is required to maintain the operations. New information technologies are also placing pressure on the University to replace and upgrade facilities more frequently. Certain faculty members have indicated that the University, due to scarcity of funds, can not accommodate all of their information technology requests.
The level of capital base needed should be established
It would be useful to have the University define a balanced budget based on GAAP which is sufficient to maintain a capital base (equity) commensurate with the overall fiscal needs of the University. I believe that failure to deal with the balanced budget issue could result in the consumption of the existing capital base. I also believe that the current
non-GAAP basis of budgeting focuses on cash payments and not on the overall resources including cash needs of the University.
Two key areas that the University deals with in the budget are:
• The amount of revenue, including tuition fee revenue, that is available to the University, and
• The allocation and matching of these revenues to the current operations (expenses) and to the capital infrastructure including future capital needs.
Matching is a key factor The failure to match, on a GAAP basis, revenues generated with resources consumed could result in the consumption of the capital base and the eventual downsizing of the
University infrastructure. My review indicates that the University is currently unable to adequately meet its
infrastructure needs. Accordingly, I am recommending that the University consider defining a balanced budget with sufficient revenues necessary to generate the capital base that the University requires to sustain its future needs.
Information to support the determination of an appropriate capital base for the University is needed. In making this recommendation, it is acknowledged that building a capital base could reduce funding for operational purposes or could require an increase in revenues.