[1] Make its budgets and monthly financial reports better match the format of the audited financial statements, and include all aspects of college finances in an integrated form.
[2] Use a reserves measure more directly related to annual-minimum unallocated cash, lower the minimum permitted for that measure to a level modestly above the greatest historical shortfall, and require correction of future reserves shortfalls within a year.
[3] Use preservation of net-asset levels and ratios as the best measure of financial health, and require that ACC budgets be balanced under such standard accrual-based measures. This entails appropriate use of depreciation in budgeting and planning, which will eliminate the need for arbitrary capital-related budget set-aside percentages.
Policy-amendment
language that would accomplish these goals is appended to this report.
[1] Current Policy – ACC Board
policy G-6 mandates that the year-end fund-based reserves level, including the reserves
required by bond covenants, should be between 15% and 25% of annual operating
expenses; if the reserves go outside this range, the President is to present a
corrective plan to the Board. No
current policies refer to bonding strategy or to use of accrual-basis measures
in college budgeting or monthly reporting, although ACC is required by external
regulations (especially Statements 34 and 35 from the Governmental Accounting
Standards Board) to use accrual-basis accounting for its audited annual financial
statements.
Because the reserves level is
currently the only prominent ACC financial figure that reflects the cumulative
effects of all activities (capital as well as operational), it is sometimes
used as the main indicator of the financial health of the college, in spite of
being poorly suited for such use.
[2] Current definition of reserves
– Under pre-GASB34/35 “fund” accounting, ACC reserves have been defined as the
sum of the fund balances (i.e., net-worth equivalents) for all funds except for
“Investment In Plant”, which contains the value of fixed physical assets and
any associated bond debt. This
definition of reserves has weaknesses as an indicator of liquidity (the
availability of cash for emergencies), since some non-liquid assets (such as
the $3 million remaining on the prepaid lease for the Rio Grande campus) are
included, as are some liabilities that are very stable from year to year (such
as the total of accumulated sick leave).
As they should be, bond funds are
excluded from reserves, since prior to expenditure the funds and the debt
balance each other in Unexpended Plant, and after expenditure both the asset
value and the corresponding debt are in Investment In Plant. However, any accumulated non-bond funds are
currently counted toward reserves until they are actually spent, even if they
are already designated for particular capital purchases.
[3] Cash level is higher than the fund-based reserves indicator – Actual cash levels run well above the fund-based reserves indicator (from a late-October low of about $6 million above to a late-January high [reflecting tax receipts] of about $26 million above). This means that ACC has not encountered cash-flow difficulties even in years that had serious budget overruns. Actual FY03 and planned FY04 unrestricted-cash balances (in millions of dollars) are:
|
|
Start |
Sept |
Oct |
Nov |
Dec |
Jan |
Feb |
Mar |
Apr |
May |
June |
July |
End |
|
FY03 |
22.6 |
19.0 |
15.5 |
19.6 |
24.4 |
33.3 |
27.3 |
24.2 |
21.8 |
23.3 |
20.9 |
17.1 |
23.2 |
|
FY04 |
23.2 |
19.3 |
15.4 |
20.1 |
25.4 |
35.3 |
28.8 |
25.3 |
22.7 |
24.6 |
21.9 |
17.8 |
24.5 |
A minimum cash reserve of about $4.5 million is required by the terms of the college’s bonds.
[4] Current reserves levels and recent history – The $8.9 million 8/31/03 estimate of FY03 ending reserves (as currently defined) is 8.7% of annual expenses, about 3/5 of the mandated minimum level of 15% (reserves were 9.4% in FY02, 13% in FY01, and 16% in FY00). This drop is due to budget overruns for FY00, FY01, and FY02, followed by a revenue shortfall due to state “takebacks” for FY03. The college’s net assets (the governmental equivalent of book net worth) have fallen by 25% over those four years (from $78 million to $59 million).
[5] Current reserves-building plans – The current (FY04) budget calls for $1.4 million to be added to reserves, and the budget planning pro-formas call for $3 million more to be added each year in FY05 and FY06. Achievement of the existing policy minimum is currently planned for FY07. One point at issue is whether such a buildup of reserves is needed, or whether some or all of this money could instead properly be used for either capital or operating expenditures.
[6] Budget and monthly-report formats – ACC budget and monthly-report formats reflect the pre-GASB34/35 structure of separate funds (although only the current funds are shown), and thus display weaknesses that GASB34/35 were adopted to address: failure to show the full range of financial activities in integrated form and vulnerability to confusion of short-term and long-term expenses/revenues, making it difficult to ascertain if a budget is balanced and how annual performance compares to budget plans. Convergence between ACC budgeting and GASB34/35 principles has been urged to enhance transparency and realistic budgeting.
[7] Depreciation – Annual depreciation has been shown in the audited statements since FY02, but is not used in the budgeting process at all. Instead, current policy provides that a “set-aside” of from 4% to 6% of total revenues be reinvested in capital equipment each year, and that building fees sufficient to cover both bond obligations and current facilities maintenance be assessed. The set-aside was adopted at a time when the college did not have a functioning planning process, and prior to the inclusion of depreciation (whose effects it approximates) in standard college accounting; replacing the set-aside mandate by recognition of depreciation in the budget process has been suggested.
[1] Market robustness – The primary strategic financial reserve of ACC is the fact that its services are priced well below the revenue-maximizing level (when tuition is increased, demand does not drop off so fast that net revenue falls). Since this is evidently true at even the high out-of-district tuition levels, the college has great financial potential, if required, for additional revenue (most of its students pay half that price). A large tuition-discount experiment in spring 2002 also produced no significant shift of demand. Since the college can increase revenue by higher tuition with no more than a few months notice, there is little reason to take money from students prior to proven need in order to build large reserves.
[2] Potential short-term cash-flow disruptions – While ACC could in any case borrow money to cover unexpected short-term cash shortages (prior to rebuilding needed reserves from tuition), the college should have enough reserves that such external borrowing will rarely be necessary. The largest annual call on reserves due to budget shortfalls in ACC history was the $6 million shortfall in FY1996. The largest multiyear sequence of decrease was the reduction of about $5.6 million over the FY2001-2002 period. In neither case did operational cash run short, even though in the latter case reserves ended at their current well-below-policy level.
[3] Reserve levels at other institutions – Of particular interest are the minimum reserve levels at which comparable institutions operate. The largest other Austin-area governments with discretionary income sources have relatively low fund-balance reserve levels (city of Austin 8%, Travis County 11%). On the other hand, most big Texas community colleges have quite high reserve levels (Dallas 55%, Alamo 27%, Tarrant 65%, Collin 81%). Tyler, at 8%, is more like ACC’s current reserves level (and thus about half of ACC’s current policy mandate).
[4] Component-based depreciation – The FY02 and FY03 statements reflect depreciation computed by spreading total building costs over 50 years. Because many building subsystems will have to be replaced much sooner than that, this method substantially understates reinvestment requirements for institutions such as ACC with growing facilities that are mostly relatively young. The preferred method is to “componentize” the depreciation schedules, with each major subsystem (building shell, HVAC, electrical, etc.) being depreciated on a schedule that matches its actual expected life. The ACFB supports the efforts already under way by ACC staff to covert ACC depreciation schedules to this more realistic methodology. This change is essential if, as proposed, depreciation is to be used in budgeting as a substitute for the current 4% minimum reinvestment level. Note that this will result in a significant one-time restatement of accumulated depreciation (and thus of net assets), and will under current conditions increase annual depreciation expenses by roughly $1 million. Depreciation expenses will also grow as the new buildings and campuses are added, reflecting the gradual growth in reinvestment required to maintain them.
[1] Alternative definition of reserves – What is wanted is an indicator that dependably reflects the availability of resources for unexpected needs.
Working capital: This standard liquidity measure equals total current assets (those expected to become cash during the next year) minus total current liabilities. ACC’s working capital was $3.9 million negative at the end of FY03. For ACC, requiring positive working capital would be roughly equivalent to a 12% reserves minimum under the present definition of reserves.
Realistic working capital: The standard definition of working capital includes as current liabilities every debt that could possibly come due in the next year, including such things as accrued vacation and sick leave that in practice at ACC are very stable from year to year. One possibility is for ACC to use a modified indicator based on working capital but excluding such unchanging liabilities. ACC already has positive realistic working capital.
Unrestricted and unallocated cash: A more direct approach would be to mandate a budget floor for the annual minimum for total unrestricted cash equivalents net of any amounts allocated but not yet spent for capital projects. This addresses the main point at issue, which is ensuring that operations are not disrupted due to cash shortfalls if there are unexpected financial setbacks.
Cash, net of payables: Since the main opportunity for manipulation
of cash levels (either by circumstances or deliberately) is by slowing vendor
payments, an indicator that subtracts accounts payable from
unrestricted/unallocated cash is attractive as a safe way to keep the focus on
cash. This is the ACFB
recommendation, with a recommended cash minimum of 8% of annual expenses in
excess of payables.
[2] Recovery plans for low reserves
– Current policy permits shortfalls in reserve levels to be recovered over
multi-year periods. While this is
reasonable if the target minimum is (as now) well above the level needed to
ensure liquidity, an extended recovery plan will be undesirable if the target
is lowered to close to the current level, as recommended by the ACFB. Requiring that any shortfall be reported immediately
and corrected within a year will be more appropriate.
Discretionary multi-year
mechanisms also promote disputes at budget-adoption time, with pressure to
defer the allocations to later years in the plan. This is the pattern of recent ACC budgets — an implicit
recognition that the 15% reserve level is high compared to other needs. The place for multi-year plans is in the
master plan, not the annual budget, and such plans should focus more on net
worth and bond strategy than on cash-reserves levels.
[3] Appropriate indicators of financial
health – Part of the controversy about the ACC reserves level stems from
the fact that this level and changes in it are sometimes used as the most
salient indicators of the financial condition of the college, as well as
indicators of financial robustness and liquidity (for which it is better
suited). In trying to serve these two
functions, it shortchanges both of them, with the current definition being both
a poor indicator of cash availability and seriously misleading as an indicator
of annual changes in financial condition.
While refining the definition of
reserves as recommended above will improve its value as a liquidity measure, it
will become even less suitable as a “bottom line” financial-health indicator. The GASB34/35 changes in accounting
standards replace the old emphasis on fund balances with a new bottom line – change
in net assets, which serves the same function as profit or loss in
business accounting. ACC would be
better served by focusing its budgeting and planning attention mainly on its
net-asset level, with reserve levels as a subordinate indicator focused on
ensuring adequate cash throughout the year.
The ACFB recommends that ACC should
require that the projected “change in net assets” figure be used as the
bottom line of the budget, and that budgets and monthly financial reports be
coordinated with the GASB34/35 format used in the audited financial reports. While the exact balances in the various
asset and liability accounts may legitimately vary from expectation somewhat,
pro-forma GASB34/35 statements for the budget period will greatly help trustees
and others compare the budget’s promises with actual institutional performance.
|
Approximate
History/Estimates of ACC Net Assets since FY1996 (millions of dollars)*** |
|||||||||
|
|
FY96 |
FY97 |
FY98 |
FY99 |
FY00 |
FY01 |
FY02 |
FY03 |
FY04 |
|
Starting Net Assets |
77.2 |
71.2 |
68.8 |
73.6 |
77.9 |
74.3 |
68.8 |
62.9 |
58.7 |
|
Ending Net Assets |
71.2 |
68.8 |
73.6 |
77.9 |
74.3 |
68.8 |
62.9 |
58.7 |
58.3 |
|
Change in Net Assets* |
-6.0 |
-2.4 |
+4.8 |
+4.3 |
-3.6 |
-5.5 |
-5.9 |
-4.3 |
-0.4 |
|
|
|
|
|
|
|
|
|
|
|
|
Total E&G Budget** |
66.9 |
73.3 |
71.3 |
77.9 |
84.6 |
92.8 |
94.8 |
103.2 |
111.7 |
|
Net Asset % of budget |
106% |
94% |
103% |
100% |
88% |
74% |
66% |
57% |
53% |
|
Change % of budget |
-9.0% |
-3.3% |
+6.7% |
+5.5% |
-4.3% |
-5.9% |
-6.2% |
-4.3% |
-0.4% |
* FY02/03 values from audits; FY04 is implied from
budget projection (also see *** note below).
** For consistency in comparison, budget-size totals
shown are based on pre-GASB34/35 accounting methodology.
*** This table is based on the depreciation values
of slightly under $6M from the FY02 and FY03 audits. These will be adjusted to be roughly $1M more per year when
restated to reflect component-based depreciation. See B-4 above.
[4] Balanced budgets – The change
in net assets figure is the best single indicator of whether
improvement or degradation of the financial condition of the college was
experienced (or is planned, for budgets) during a year. If ACC is to maintain financial health, its
net-assets total must, on the average, grow along with its budget. The recommendation of the ACFB is that
ACC policy require that each budget proposal be at least balanced on a
net-assets basis (including applicable depreciation), except when net assets in
excess of the target set in the current master plan are used for nonrecurring
expenses.
Coordination with GASB34/35
entails the recognition of depreciation in the budget (its use is required in
the audited statements). Note that depreciation
expenses are real, not “accounting fictions” — they are the same
expenses previously shown as capital expenditures and the principal portion of
debt payments — the difference is that they are recognized in the financial
statements at the same time as the corresponding benefits, giving a much more
realistic picture of financial performance.
Budgets that fail to cover depreciation are not balanced, and cannot
be sustained. Requiring that
budgets be balanced by accrual standards will encourage the college to steadily
address long-term as well as immediate needs.
Note that the FY04 budget falls
slightly short of balance on accrual-basis terms, although it is an improvement
of about $4 million over the previous year.
While the improvement over FY03 will be the same, the FY04 loss in net
assets will be somewhat larger than shown (totaling about $2 million) when the
more realistic componentized depreciation schedules are used. This means that achievement of a balanced
budget for FY05 will still require financial improvement, at about half the
scale of the improvement shown between FY03 and FY04.
[5] Use of bonds — While GASB34/35’s accrual-basis accounting is a much better approach than cash or fund accounting for budgeting and for assessment of financial condition and performance, cash availability is an important consideration in long-term capital-asset planning. While it is possible to either prepay long-term expenses (by paying for buildings from past surpluses) or to support current operations for a while on borrowed funds (by borrowing in excess of the rate of reinvestment), the ACFB recommends that ACC make a continuing practice of issuing bonds so as to keep the rate of debt repayment reasonably well matched to the rate of depreciation of long-term assets. Combined with annual budgets in which net assets are in most cases conserved or modestly increased, this will ensure that costs and benefits are reasonably matched in each time period, and will promote proper allocations for facilities development and maintenance.
The following pages show ACFB-suggested amendments to ACC Board policy to implement the recommendations described above. These policy proposals are shown first in “mark-up” form, where old and new language are both shown (along with short explanations), then in “integrated” form, which is a clean copy of the proposed new policy.
Some of the materials that the ACFB used in considering this topic are reflected on its web site: www.austincc.edu/board/commlink/ACFB.htm. These give some insight into the committee’s discussion process.
==================================================================
DRAFT
ACFB-RECOMMENDED AMENDMENTS TO BUDGET-RELATED POLICIES
Proposed
additions are shown in bold italic, proposed deletions marked by strikethrough.
Comments shown in [bracketed Courier font] are not part of the
proposed amendments.
==================================================================
G-1. COLLEGE
BUDGET (current policy with
suggested amendments)
The President shall, prior to the
end of June each year, develop and submit to the Board and for public review a
proposed comprehensive annual budget that:
1. Demonstrates compliance with all existing budget-related
policy provisions and with debt obligations.
2. Describes all expected fiscal activity of the District
in an integrated form consistent with generally accepted accounting practices,
showing what values are predicted for the main financial statements for the
budget year based on the proposed budget targets and the most recent estimates
for current-year performance. [Note: This would require
that the budget follow the principles of GASB34/35, and make it possible to
compare the budget with the audited statements.]
3. Provides adequate support for the educational programs
of the College, based on efficient operation of both direct and
support services.
4. Distributes resources primarily on objective criteria
based on student enrollment and program needs, and provides a justification or plan for correction of
any substantial disparities in the resources supplied to serve students in
similar programs at different campuses.
[Note: Combines two related provisions.]
5. Budgets revenues and expenses for each category
listed in the budget summary based on actual expected performance,
with comparisons to both budget and current estimates for the previous year. When there is substantial uncertainty about
performance in an area, the associated budget projection should be moderately
conservative; in such cases, the administration should describe its targets for
the area and the budget effects of the range of plausible outcomes. [Note: The current
dependence on a separate lapsed-salary category, rather than the incorporation of
appropriate level-of-use estimates into each of the major salary categories
shown in the budget, makes it impossible to compare the performance of salary
categories to budget projections.]
6. Budgets expected overall current-funds expenses plus
transfers mandated by law or policy of less than expected current-funds
revenues, and budgets fund balances within the limits imposed by policy G-6,
Fund Balance. Budgets total revenue from recurring
sources at least equal to total recurring budgeted expense, including
appropriate capital-asset depreciation.
Nonrecurring expenses may be budgeted to be funded from prior-year
surpluses to the extent that the ratio of net assets to total expenses exceeds
the standard declared in the current master plan (or the prior five-year
average if no standard has been declared).
[Note: Compliance with this would ensure that each
year’s budget is balanced. Note that
borrowing and transfers from reserves do not count as revenue under GASB 34/35
(or business accounting) rules, and thus cannot be used to balance an
operational budget. The provision for
nonrecurring expenses would permit accumulated extra assets to be used for
special cases.]
7. Budgets appropriate capital-equipment purchases and
facilities development for the year, Is consistent with a
multi-year master plan developed in compliance with policy E-1 on Master
Planning, in amounts at least equal to projected
depreciation. [Note:
This directs that the expected financial impact of all aspects of college
operations be shown in the annual-budget proposal, as called for by the GASB
34/35 mandate of consolidated financial statements. While inflation and the growth of the college will mean that in
most years reinvestment will need to be more than depreciation, this sets a
bottom limit and removes the need to have a separate policy on facilities
funding (such as the current G-4).]
8. Provides a recent history and (to the extent feasible)
a three-year plan for tuition/fee levels, enrollment, overall revenues and
expenses, debt service principal and interest payments, plant-fund
capital-asset expenditures, and fund-balance net-asset
levels, and minimum unrestricted-cash levels, with a
description of planning assumptions and significant changes. [Note: These minor amendments
make the policy’s terminology consistent with the accrual-basis GASB 34/35
terms.]
When deemed appropriate by the administration, capital
items in an annual budget may be purchased during the period after budget
approval but prior to the start of the fiscal year. [Note: Under GASB 34/35, the effect of early capital
purchases on the year’s profit/loss figure is minor, since only that year’s
share of the associated depreciation is posted as an expense.]
The President shall inform the
Board whenever the actual performance of the College differs significantly from
the approved budget, and shall propose corrective budget amendments if
projected performance differs from the budget target for current-funds
surplus increase in net assets by more than ½% of annual
Education&General-fund total revenues. [Note: This replaces
fund-oriented terms with accrual-oriented ones.]
The President shall provide the Board a monthly
financial report detailing year-to-date expenditures and revenues against the
budget and a monthly revised fiscal-year projection of expenditures and
revenues, expenses, capital transactions, and cash levels. The external auditor shall annually review
the availability of timely data under the reporting system and make any
recommendations to the President and Board of any improvement in the monthly
reporting system that may be necessary.
The format of monthly statements shall include reports that match
that of the annual budget and the audited annual statement to the extent
feasible. [Note:
The suggested changes better match accrual-basis terminology, and facilitate
comparisons of budget and performance.]
CAPITALIZATION
AND DEPRECIATION [suggested
new policy]
Capitalization
and depreciation practices shall comply with generally accepted accounting
practices, and shall provide information about the useful lives of physical
assets for use in financial planning.
Appropriate bond financing shall be used to approximately match
depreciation to reinvestment.
All
assets with useful lives of more than one year and cost more than $500 shall be
capitalized. Assets shall be
depreciated over their estimated useful lives using the straight-line
method. Facilities shall be depreciated
based on industry-recognized major categories of building components, rather
than by the facility as a whole.
G-4. FACILITIES IMPROVEMENT &
MAINTENANCE
Each
annual budget shall make transfers to Plant Funds sufficient to
meet all bond debt payments, maintain the debt payment reserve levels required
by the bond agreements, and meet the year's installment of the current
multi-year master plan for facilities improvements and maintenance. The
building fee charged by the college per credit hour shall be budgeted at the
level which, together with any other funding sources dedicated to these uses,
is sufficient to generate the needed funds. [Note: The mandate
to budget for this area is expressed in the proposed language for G-1, to
better match the GASB 34/35 mandate of integrated one-fund accounting of
program expenses and non-capital facilities maintenance.]
G-5. CAPITAL EQUIPMENT PROJECTS
Each
annual budget shall transfer not less than 4% or more than 6% of projected
annual revenues to a fund from which Education and General Fund capital
expenditures are made. The full amount budgeted each year shall be based on the
projected multi-year average budget for capital expenditures. In those years in which the increase in
annual revenue for the Education and General fund is projected to be below 4%,
the annual transfer may be less than 4%. [Note: Because the GASB
34/35 use of depreciation in the primary financial statement automatically
addresses the main Board concern that prompted this policy (that annual budgets
not neglect long-term needs in pursuit of cash for immediate expenses), any
further mandates felt needed for this topic should be included in planning
policies such as E-1. The specific 4%
number is a relic of a time when the college did not have a functioning
planning process; now that a planning process exists, the level and nature of
capital-equipment purchases should flow from the master plan.]
G-6. MINIMUM RESERVES LEVEL
CASH RESERVES
Austin
Community College annual budgets shall seek to maintain,
throughout at the end of each fiscal year, unrestricted
and unallocated cash levels of at least 8% of budgeted total annual expenses in
excess of total accounts payable adequate reserves including
Retirement of Indebtedness, equal to 1.8 months of current operating expenses
and not greater than 3 months of current operating expenses. If unrestricted
cash falls the reserves fall below this level, the President
shall present a corrective plan to the Board of Trustees that will fully
correct the shortfall within one year.
[Note: This is a change from the current
indirect fund-based liquidity measure to a direct focus on the essential
liquidity question, unrestricted cash levels.
It would set a floor for cash reserves slightly below their current
level, removing the mandate for large increases over the next three years (and
the concomitant $6/hr tuition increase).
But any shortfalls from this limit would have to be corrected more
promptly than in the current policy, meaning that the paragraph below can be
omitted. If it is retained, however,
the changes shown below convert to appropriate accrual-based terms.]
If
for three (3) consecutive months, the monthly financial report provided the
Board indicates (a) a projected deficit decrease in net assets for
the current fiscal year, or (b) that the projected unrestricted cash
reserves will fall below the level specified by this policy or (c) that unrestricted
cash the reserves will fall below the level specified in a
corrective action plan, the President shall provide a supplemental plan for
corrective action to the Board of Trustees.
==================================================================
DRAFT BUDGET-RELATED POLICIES, INC