More so than other nonprofits, private schools are often operated like a for-profit entity given the competition, increased costs and scrutiny that schools face.
Private school financial reporting is also unique and can be plagued by misclassifications or misstatements due to the complex accounting required for the different funding sources private schools receive.
Here are the top issues in private school financial reporting:
1. Classification of Net Assets
Net assets should be included in one of two classes depending on the presence and type of donor-imposed restrictions:
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Net assets without donor restrictions
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Net assets with donor restrictions
The school and its board of directors cannot restrict net assets; only donors can restrict net assets. If the board determines that it wants to limit the use of certain net assets without donor restrictions, the net assets are considered board designated net assets. Net assets with donor restrictions are subject to donor-imposed restrictions that are temporary in nature, such as those that will be met by the passage of time or other events specified by the donor, or are perpetual in nature, where the donor stipulates that resources be maintained in perpetuity.
2. Revenue Recognition
Private school income is accounted for differently depending on the source of revenue. Tuition income is considered an exchange transaction and is recognized ratably over the term of the school year. Tuition payments received in advance are recorded as deferred revenue when received. On the other hand, contributions are recorded when received or pledged as support that is either with or without donor restrictions depending on the existence and nature of any donor restrictions.
This can get much more complicated if the school maintains its books on the cash basis during the year instead of the accrual basis, which is typically the basis used for year end audited financial statements. Conversion from cash to accrual is usually where some disconnect happens and something ends up wrong in the financials. While monitoring and budgeting cash is extremely important and easier to do on the cash basis, we recommend keeping the books on the accrual basis and then preparing Excel-based cash monitoring reports with accrual basis change in net assets as the starting point and projecting cash position based on cash to accrual differences.
3. Pledges
Proper accounting for pledges depends on whether there are donor-imposed conditions, donor-imposed restrictions, or both.
Private schools need to carefully review the terms of the pledge to determine whether the pledge is conditional or unconditional, and with or without donor restrictions, as the accounting for each is different. Unconditional pledges should be recognized in full as revenue in the year the pledge is made. If the unconditional pledge contains a donor-imposed restriction, it should be classified as with donor restrictions. Conditional pledges should be recognized as revenue when the conditions are substantially met. This means an unconditional pledge is not recorded at all until the condition is fulfilled. One exception is if the money is actually received for a pledge but not available for use until the condition is met, the school would record the cash deposit and a liability instead of revenue.
4. Capital Campaigns
Private schools embark on capital campaigns because of the significant dollars that can be raised in a relatively short period of time. This can result in a large increase in revenue but a lesser increase in cash, as capital campaign pledges are usually paid to the organization over a period of years. Capital campaigns raise funds to renovate or construct buildings, develop athletic fields and facilities, initiate a new program or build an endowment. Capital campaigns usually have explicit or implied restrictions in which the stated objective is to raise funds for a specific program or purpose. Although the donor may not have explicitly communicated the restriction, the stated objective of the capital campaign usually makes the donor’s restriction clear.
5. Parent Associations
Parent associations are organized to allow the parents to provide additional support to the private school with the aim of enhancing the level of education. In addition to collecting dues, parent associations often sponsor fundraisers and special activities for the students and faculty. If the parent association is formed under the federal employer identification number (EIN) of the private school, the activities of the parent association must be included with the activities of the private school. On the other hand, if the parent association is formed under a separate EIN, the activities of the parent association are not included with the private school. While it is parent associations that are often overlooked, these rules apply to any group activity that is being done under the auspices of the school if it is not separately incorporated.
6. Planned Giving
One of the many ways donors provide financial support to charitable organizations is through arrangements under which nonprofits receive benefits that are shared with other beneficiaries. These planned giving arrangements are commonly known as split interest agreements.
The most commonly used split interest agreements are:
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Charitable lead annuity and unitrusts
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Charitable remainder annuity and unitrusts
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Charitable gift annuities
Depending on the type of arrangement and who holds the assets, the school will either recognize the split interest agreement as contribution revenue along with the related assets and liabilities, or recognize its beneficial interest in the assets as an asset and contribution revenue when the school is notified of the split interest agreement’s existence.
Unfortunately, nonprofits may not always be recording split interest agreements correctly or may not realize that they are a party to a split interest agreement at all. As a result, nonprofits might be understating assets, liabilities, revenue and net assets.
7. Endowments
Endowments are a common method private schools use to secure a steady income stream for the long term. Endowments represent donor gifts which are required to be invested in perpetuity or for a designated period of time. Endowments can also be amounts designated for long term investment by the private school’s board of directors. Endowments set up at the direction of the board are referred to as “quasi” endowments while donations with donor restrictions for the funds to be maintained and only income to be spent are true endowments.
The Uniform Prudent Management of Institutional Funds (UPMIFA), in the absence of specific donor instructions, provides guidance regarding endowments and specifically sets standards for endowment spending and the preservation of the original gift in accordance with donor intent. UPMIFA mandates that earnings, unless otherwise instructed, be classified as donor restricted for legal purposes until they are appropriated for expenditure. It is critical for private schools to adopt investment and spending policies for endowment assets approved by the board of directors in order to maintain a predictable income stream.
Note: Most states have adopted their own version of UPMIFA that have minor variations in regulations.
8. Deferred Compensation Plans
Private schools, like most nonprofits, often face the challenge of competing against for-profit companies to attract key employees. One option available to schools is to establish deferred compensation plans for key employees.
A deferred compensation agreement should be accounted for on an accrual basis in accordance with the terms of the agreement. In other words, the school should accrue deferred compensation costs so that the costs are recognized in the period the related services are performed. The costs accrued at the end of the employee’s service period should equal the present value of the benefits expected to be paid to the employee or beneficiaries. Misstatements occur because accounting and finance people are not always aware of the agreements until cash payments begin. By then it’s too late so it’s very important for the board and other members of the management team to keep the accounting and finance staff informed about all contracts so they can determine if anything should be recorded on the books.
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