Accounting Considerations for Private Schools
In March 2020, the World Health Organization declared COVID-19 a pandemic. Since that time, COVID-19’s effect has been far reaching and devastating within the United States. Private schools are worrying about their employees’ and students’ health, innovating new ways to carry out their missions while practicing social distancing, ensuring they have adequate cash flow, and considering the effect this pandemic will have on their financial reporting.
Potential Accounting Effects on Private Schools
The potential accounting implications of COVID-19 below aren’t exhaustive and will be updated periodically as the outbreak’s effect unfolds:
In August 2016, FASB issued Accounting Standards Update (ASU) 2016-14, Presentation of Financial Statements of Not-for-Profit Entities. This ASU made changes to how a nonprofit presents its financial statements. Some of these changes are particularly important to consider given the current economic environment, including the accounting for underwater endowments presentation and disclosure, as well as disclosures for how a nonprofit manages its liquid resources to meet its cash needs and the availability of its financial assets. Some of these requirements stemmed from lessons learned from the 2008 recession.
In addition to these particular requirements from ASU 2016-14, there also are other accounting requirements that existed prior to the new ASU’s issuance, such as certain disclosures if there’s a failure to maintain an appropriate composition of assets to comply with donor restrictions, subsequent events (FASB Accounting Standards Codification (ASC) Topic 855), going concern (ASC Subtopic 205-40), valuation of accounts and contributions receivable, debt covenants and troubled debt restructuring, and expenses related to the COVID-19 response.
- Underwater Endowment Presentation & Disclosure – An underwater endowment fund is defined by FASB as “a donor-restricted endowment fund for which the fair value of the fund at the reporting date is less than either the original gift amount or the amount required to be maintained by the donor or by law that extends donor restrictions.” The measurement date of whether an endowment fund is underwater is as of the balance sheet date. The analysis to determine which donor-restricted endowment funds are underwater is done on a fund-by-fund basis. It only applies to donor-restricted endowment funds and not board-designated endowment funds.
The stock market has been very volatile during the pandemic. All funds should be looked at during each reporting period, and attention should be paid to the more recent funds received.
ASC 958-205-50-2 describes the requirements for underwater funds. It states, “For each period for which a statement of financial position is presented, an NFP shall disclose each of the following, in the aggregate, for all underwater endowment funds:
- The fair value of the underwater endowment funds
- The original endowment gift amount or level required to be maintained by donor stipulations or by law that extends donor restrictions
- The amount of the deficiencies of the underwater endowment funds ((a) less (b))”
There’s also a requirement to disclose the school’s policy over spending from an underwater fund, i.e., to continue spending, reduce spending, or stop spending from the underwater funds.
To illustrate underwater endowments, imagine you have three specific endowment funds with values as follows:
In this case, there are two funds that are underwater with an aggregate amount of $50. The financial statement would require a disclosure of the original amount/required amount to be maintained ($245)—the fair value ($195) and the underwater amount ($50). These aren’t required to be listed individually, but rather in the aggregate. In addition, the policy the nonprofit has as to whether it will stop spending, continue spending at the full amount, or reduce spending from the underwater funds is a required disclosure.
- Private School Liquidity Policy & Availability of Its Financial Assets – Private schools are required to disclose certain information in their financial statements about how they manage their liquid resources to meet their cash needs and the availability of their financial assets. ASC 958-210-50-1 states, “A not-for-profit (NFP) shall disclose in notes to financial statements relevant information about the liquidity or maturity of assets and liabilities, including restrictions and self-imposed limits on the use of particular items, in addition to information provided on the face of the statement of financial position, if shown, in accordance with paragraph 958-201-45-8. Specific disclosure requirements to meet that objective include the requirements in this Subtopic.” ASC 958-201-50-1A further states, “An NFP shall disclose the following:
- Qualitative information in the notes to financial statements that is useful in assessing an entity’s liquidity and that communicates how an NFP manages its liquid resources available to meet cash needs for general expenditures within one year of the date of the statement of financial position
- Quantitative information either on the face of the statement of financial position or in the notes, and additional qualitative information in the notes as necessary, that communicates the availability of an NFP’s financial assets at the date of the statement of financial position to meet cash needs for general expenditures within one year of the date of the statement of financial position (see paragraph 958-210-45-7(c)). Availability of a financial asset may be affected by:
- Its nature
- External limits imposed by donors, laws and contracts with others
- Internal limits imposed by governing board decisions”
The qualitative information becomes increasingly important to financial statement users as they look to understand how the school will have the liquidity to operate its business in these volatile times. What lines of credit exist, if any, and are they committed lines? Does the organization have cash or other reserve targets, and are they achieved? Does the entity have board-designated funds it could use for operations if necessary?
The preparation of quantitative information includes discretion in how a school defines the term “general expenditure.” Some nonprofits have chosen to include certain financial assets that resulted from donor-restricted contributions, while others have chosen to exclude certain financial assets that resulted from donor-restricted contributions. Paragraph b above includes language that states, “additional qualitative information in the notes as necessary.” This is important to remember, as a school either includes or excludes certain information in its note to comply with this disclosure requirement. It helps the financial statement user to understand how the school interpreted the term “general expenditure.” Further, FASB has stated in its Basis for Conclusion (BC) of ASU 2016-14 that this disclosure will “(a) make more transparent the effects of restrictions and other limitations on assets and (b) provides a potential starting point for an analysis of an NFP’s liquidity. However, as noted in paragraph BC37, a comprehensive analysis of liquidity resources requires forward-looking information about revenues, expenses, and cash flows as well as management commentary and analysis that go beyond the scope of the financial statements.”
Many private schools didn’t weather the 2008 recession well. These required disclosures will help financial statement users understand how a school manages its liquid resources to meet its cash needs. It also provides a quantitative measure for financial statement users so they can begin to assess a school’s liquidity position. All schools should have at least one year of this disclosure already made in prior-year financial statements, so the current-year disclosure will begin to provide trends to help with financial statement analysis. It should be stressed that FASB has said this information is a starting point to begin to assess a nonprofit’s liquidity. The calculated measure by itself isn’t conclusive without review of other available information.
- Failure to Maintain an Appropriate Composition of Assets to Comply with Donor Restrictions – One of the benefits of the availability of financial assets disclosure is it may highlight the failure to maintain an appropriate composition of assets to comply with donor restrictions. ASC paragraph 958-450-50-3 states, “If the noncompliance results from a not-for-profit entity’s (NFP’s) failure to maintain an appropriate composition of assets in amounts needed to comply with all donor restrictions, the amounts and circumstances shall be disclosed.” During the 2008 recession, many nonprofits struggled, and some didn’t have the appropriate composition of assets to comply with donor restrictions. As a result of COVID-19, the economic and stock market struggles could have a similar effect on schools and would require this disclosure.
- Going Concern – Given the economic shock resulting from COVID-19, management should perform a detailed review of its operations and liquidity and assess if there’s substantial doubt about its ability to continue as a going concern. Per ASC Subtopic 205-40, a school’s management is required to evaluate whether there are conditions and events that raise substantial doubt about its ability to continue as a going concern for one year after the financial statements are issued. Management should consider its current financial condition, the liquidity sources it has available, its obligations due, funding necessary to operate, and other conditions that affect it for a year from the date the financial statements are issued. The liquidity and availability of financial assets analysis that management does to prepare its disclosure for those requirements are a good starting place for management to do this assessment. When projecting cash flow, management should take into consideration that advanced tuition payments, which are available at year-end, will deplete by the end of the calendar year with new deposits not getting replenished until late spring.
- Subsequent Events – ASC 855-10-25-1 requires an entity to recognize in its financial statements the effects of subsequent events that existed about a condition at the balance sheet date. ASC 855-10-25-1A states that if the nonprofit has conduit debt that’s traded in a public market, it’s required to do the evaluation through the date the financial statements are issued. In addition, ASC 855-10-25-2 states that if the nonprofit doesn’t have conduit debt, it’s required to evaluate the events through the date the financial statements are available to be issued. Further, ASC 855-10-25-3 states that a nonprofit shouldn’t recognize subsequent events that didn’t exist at the balance sheet date and occurred after the balance sheet date but before the financial statements are issued or available to be issued. Even though some events aren’t permitted to be recognized at the balance sheet date, ASC 855-10-50-2 requires certain information to be disclosed, including the nature of the event and an estimate of its financial effect. Changes in the fair value of investments and entering into significant commitments or contingent liabilities are examples of items that should be considered for this type of disclosure if they were material.
- Accounts & Contributions Receivable – As a result of COVID-19’s economic effect, there may be some collectibility issues of receivables that are recorded. Schools should look at their allowance for uncollectible accounts and determine if it’s adequate based on the hardships being faced by their students’ families and donor base.
- Debt Covenants & Troubled Debt Restructuring – Entities with debt covenants may now find themselves in trouble as a result of their declining assets, e.g., their investments may be down significantly, and therefore may find themselves out of compliance with debt covenants. As a result, some schools may try to get waivers or try to restructure and take advantage of lower market rates. Schools should ensure they’re following the proper accounting and disclosures for these activities. If you’re considering a debt restructuring, you might want to discuss with the lender what it’s going to have in place of LIBOR, since LIBOR is going away as a benchmark rate.
- Expenses Related to COVID-19 Responses – Many schools have incurred expenses related to COVID-19 responses and may not be sure how to functionalize these expenses. Consideration should be given to how the expenses are incurred, e.g., if the expenses are part of carrying out the school’s programs or if they support the administrative and fundraising activities. The expenses should follow the area they’re supporting. In some cases, allocations between program and supporting may need to be performed.
- Liquidation of Investments for Endowment Draws – Using a spending rate over the long run avoids significant swings in the endowment draws. However, a school must still make decisions about which investments to liquidate to cover its draw. Depending on the endowment’s asset allocation, that may be a difficult decision. Selling investments during a down market to satisfy an endowment draw or a capital call makes it harder for the endowment to recover when the market rebounds. Things to consider include:
Does the school have ample short-term investments to use for the endowment draw to avoid the need to liquidate equity investments during poor performance times? Does it have significant alternative investments with future capital commitments that may need to be funded? If it has funding needs for the alternative investments, is there ample liquidity in the portfolio to cover those needs?
A school has a few options to create the needed liquidity:
- It could choose to liquidate certain short-term or fixed-income investments and avoid liquidating equity investments to cover its spending amounts needed to cover its spending rate and capital commitments.
- It could choose to borrow from a line of credit and not liquidate any of its investments to cover those commitments (the low interest rate environment has created an inexpensive way to obtain funds).
- It could choose to reduce the spending from its endowment and simultaneously reduce its budget.
It also could choose to do a combination of these actions. During the 2008 recession, nonprofits used all these options.
BKD has created a COVID-19 Resource Center to help disseminate important tax and accounting information for our clients and friends as we evaluate ways to mitigate the inevitable financial effects. We’ll keep you up to date with relevant news, tax and compliance changes, new regulations, and anything else we believe you need to know.
The views expressed above don’t constitute professional advice. You shouldn’t act on the information contained in this BKD Thoughtware® article without obtaining professional advice.
As with most topics related to COVID-19, changes are being made rapidly. Please note that this information is current as of the date of publication. To connect on this or other accounting matters affecting private schools, reach out to your BKD Trusted Advisor™ or use the Contact Us form below.