Summary of Emerging Issues*
for Colleges and Universities in 2007
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Summary of Emerging Issues for Colleges and Universities in 2007
Executive Summary
PricewaterhouseCoopers is pleased to bring you this year's edition of our Summary of Emerging Issues for Colleges
and Universities ("Summary"). The accounting, financial reporting, tax, and regulatory compliance issues described
in this Summary might affect institutions like yours in the near future.
First, we want to highlight the FASB's pronouncements that move towards fair value as the measurement standard
for financial reporting. The FASB issued its Statement No. 157, Fair Value Measurements, this year as well as FASB
Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—including an Amendment of
FASB No. 115. Although we don't expect either pronouncement to significantly affect colleges and universities, they
represent important milestones as the FASB moves towards fair value measurement for all types of organizations.
A FASB pronouncement that could have a significant impact on colleges and universities is FASB No. 158,
Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB
Statements No. 87, 88, 106, and 132(R). This pronouncement was "fast-tracked" because of the concern that some
employers—but not necessarily colleges and universities—might not be able to meet their pension obligations. It
becomes effective for the fiscal year ended June 30, 2007.
This year we have added a new section to this Summary for "Other Issues." These new issues include Uniform
Prudent Management of Institutional Funds Act or UPMIFA. The National Conference of Commissioners on Uniform
State Laws (NCCUSL) approved it in July 2006 for consideration by the states. Note that UPMIFA is not effective
unless a state specifically adopts it; it's a model law that states may choose to adopt. Among other changes,
UPMIFA eliminates "historic gift value" in favor of a "prudence" standard that says spending above seven percent
creates a rebuttable presumption of imprudence.
In May 2006, the AICPA issued SAS No. 112, Communicating Internal Control Matters Identified in an Audit, which
adopts definitions for a "control deficiency," a "significant deficiency," and a "material weakness." We encourage you
to read more about this pronouncement in the AICPA section of this Summary. For now, the important point is that
we expect that the new definitions will lower the threshold for reportable control deficiencies, and may cause more
deficiencies to rise to the level of significant deficiencies and material weaknesses, which must be reported in
external financial statement audits. Note also that we believe SAS No. 112 may cause more internal-control-related
findings to be reported to management and audit committees under OMB A-133 audits.
The GASB issued its Statement No. 49, Accounting and Reporting for Pollution Remediation Obligations, in
November 2006. We believe that it will have a significant effect on public colleges and universities that are dealing
with pollution remediation on their campuses. Per GASB 49, institutions would need to estimate pollutionremediation-related liabilities, expenses and expenditures using expected cash flow measurement techniques.
The GASB issued two important standards in 2004—-GASB 45 and GASB 43—to provide guidance on accounting
and financial reporting for postemployment benefits other than pensions. GASB 45 and 43 are effective in three
phases. GASB 43 is effective one year prior to GASB 45 for sole or large governmental employers. Large employers
are defined as employers with annual revenues of $100 million or more. Such employers must implement GASB 43
for periods beginning after December 15, 2005—that would be the fiscal year ending June 30, 2007 for many public
colleges and universities.
With respect to regulatory compliance issues, the Government Accountability Office (GAO) issued comprehensive
revisions to the "Yellow Book" in January 2007. The revisions were the fifth since the Yellow Book was first published
in the 1970s. The changes are designed to: 1) emphasize the critical role of government audits, 2) ensure that
auditors have the necessary competence, integrity, objectivity, and independence, and 3) "modernize" the Yellow
Book and make it consistent with developments in the wider audit environment. We encourage you to read more
about the changes to the Yellow Book in the regulatory compliance section of this Summary.
Many of the federal government's initiatives to make not-for-profit organizations more accountable are taking place in
the tax arena. In 2006, the Pension Protection Act of 2006 was signed into law. It is important because many
provisions designed to tighten oversight of tax-exempt organizations were attached. For example, the Form 990-T
must now be made available for public inspection (as is already the case with the Form 990).
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Summary of Emerging Issues for Colleges and Universities in 2007
Executive compensation continues to be a focus of Congress as well as the IRS, media and others. In December
2006, the Senate held hearings about the tax status of educational institutions, and Senator Grassley, who chaired
the Senate Finance Committee, indicated concern with executive compensation. Institutions should have robust
policies as well as robust processes in place to approve, document and report compensation.
In November 2006, the Democrats gained enough seats in the Senate and House to achieve a majority over the
Republicans. It remains to be seen how this shift will affect tax policy.
Among the new initiatives of the IRS in its 2007 work plan is a college and university unrelated business income tax
(UBIT) project. The IRS intends to review the current practices of calculating UBIT, including reviewing the allocation
of income and expenses to arrive at taxable income. The IRS anticipates rolling out this project in 2008.
This year's Summary of Emerging Issues for Colleges and Universities has been prepared under the leadership of
John Mattie, PricewaterhouseCoopers' National Education & Nonprofit Practice Leader. We had assistance from
PwC partners Rick Wentzel and Nancy Shelmon as well as from Jocelyn Bishop, Erin Couture, Ralph DeAcetis,
Lisette Eggermont, Kaye Ferriter, Don Fischer, Liz Lippuner, and Gwen Spencer. We also consulted with Ed Chait
on the GASB emerging issues.
Note that we have excerpted some text in this Summary from the FASB's and GASB's websites as well as from other
internal sources. Also, because the issues in this Summary are emerging, their status is subject to frequent changes.
The latest status of these issues can be found on the following web sites, among others.
•
AICPA (http://www.aicpa.org/)
•
FASB (http://www.fasb.org/)
•
GAO (http://www.gao.gov)
•
GASB (http://www.gasb.org/)
•
IRS (http://www.irs.gov). In particular, see the section for "Charities & Non-Profits."
OMB (http://www.whitehouse.gov/omb)
If you have questions about any of the issues in this Summary, contact your PricewaterhouseCoopers' engagement
team or contact our national office at education.nonprofit@us.pwc.com or call us at 888-272-3236.
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Summary of Emerging Issues for Colleges and Universities in 2007
Table of Contents
I.
FASB Pronouncements and Activities ..................................................................1
II. Other Issues .......................................................................................................12
III. AICPA Pronouncements and Activities...............................................................14
IV. GASB Pronouncements and Activities................................................................17
V. Regulatory Issues ...............................................................................................25
VI. Tax Issues ..........................................................................................................32
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Summary of Emerging Issues for Colleges and Universities in 2007
I. FASB Pronoucements and Activities
The following section highlights FASB pronouncements and activities that will affect educational institutions in the
near future. We summarize these pronouncements beginning with FASB Statement No. 159, which is the most
recent. We also include the latest EIFT issues and several exposure drafts. In addition, we provide our observations
for each pronouncement.
New Pronouncements
FASB Statement No. 159 (FASB 159), The Fair Value Option for Financial Assets and Financial
Liabilities—Including an Amendment of FASB No. 115
FASB 159 was issued in February 2007. It permits entities to choose to measure many financial instruments at fair
value. Eligible items for fair value accounting include:
1.
Recognized financial assets and financial liabilities, except:
a.
An investment in a subsidiary that the entity is required to consolidate
b.
An interest in a variable interest entity that the entity is required to consolidate
c.
Employers' and plans' obligations (or assets if overfunded) for pension benefits and certain other
postretirement benefits
d.
Certain items recognized under leases as defined by FASB 13
e.
Deposit liabilities withdrawable on demand
f.
Financial instruments that are classified by the issuer as a component of shareholder equity
2.
Firm commitments that would otherwise not be recognized at inception and that involve only financial
instruments.
3.
Nonfinancial insurance contracts and warranties that the issurer can settle by paying a third party to provide
those goods or services.
4.
Host financial instruments resulting from separation of an embedded nonfinancial derivative instrument from a
nonfinancial hybrid instrument.
FASB 159 is effective as of the beginning of an institution's first fiscal year that begins after November 15, 2007 - that
would be fiscal 2009 for most colleges and universities.
PwC Observation: Institutions should work with their audit engagement team to determine if these financial assets or
financial liabilities exist and, if so, what the proper treatment would be.
FASB Statement No. 158 (FASB 158), Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R)
In September 2006, the FASB issued its Statement requiring an employer to recognize the overfunded or
underfunded status of its defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability
in its statement of financial position and to recognize changes in that funded status in the year in which the changes
occur in unrestricted net assets. FASB 158 also requires an employer to measure the funded status of a plan as of
the date of its year-end statement of financial position, with limited exceptions.
Implementing FASB 158 is expected to reduce unrestricted net assets for most institutions. With regard to the
transition adjustment upon initial adoption, previously unrecognized actuarial gains/losses (AGL) and unrecognized
prior service costs/credits (PSC) would be recognized in unrestricted net assets. Subsequently, they would be
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Summary of Emerging Issues for Colleges and Universities in 2007
recycled out of unrestricted net assets into operating expenses based on amortization and recognition requirements
in FASB 87 and 106. The previously unrecognized net transition asset/obligation from adoption of FASB 87/106
would be recognized as permanent adjustment, and there would be no subsequent "recycling."
For example:
Unrestricted net assets, before adjustment
$ 1,050,000
Adjustment:
Previously unrecognized PSC, AGL
(600,000)
Previously unrecognized transition obligation
(400,000)
Unrestricted net assets, after adjustment
$
50,000
The next phase of the FASB's project will be a comprehensive reconsideration of all elements of accounting for
pensions and other postretirement benefits, which is expected to take several years to complete.
The Board decided that the effective date for a public entity (i.e., an entity with equity securities traded in a public
market as defined in FASB 123(R)), would be its fiscal year ending after December 15, 2006. The effective date for a
nonpublic entity—including colleges and universities—would be the fiscal year ending after June 15, 2007 (i.e., fiscal
2007 for most). However, there are additional disclosures required of nonpublic entities beginning with the fiscal year
ended after December 15, 2006 but before June 16, 2007.
PwC Observation: We believe that the impact of this pronouncement on colleges and universities could be
significant and it is effective shortly. We highly recommend that institutions take the following steps if they haven't
already done so:
•
Identify and assess the impact of the potential balance sheet changes on covenants contained in loan and other
financial agreements, and examine the need or ability to renegotiate those agreements with lenders
•
Develop a communication strategy to meet the needs of financial statement users, such as credit agencies, and
lending institutions
•
Consider managing the balance sheet liability through changes in benefit arrangements
•
Plan for implementation with auditors and actuaries
•
Monitor the progress of the FASB's activities with regard to its pension standard
FASB Statement No. 157 (FASB 157), Fair Value Measurements
The FASB issued this Statement in September 2006. It defines fair value, establishes a framework for measuring fair
value, and expands disclosures about fair value measurements. This Statement applies to accounting
pronouncements that require or permit fair value measurements.
FASB 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, although
earlier application is encouraged. The provisions of FASB 157 should be applied prospectively as of the beginning of
the fiscal year in which it is initially applied, except as described in the pronouncement.
PwC Observation: FASB 157 is an important milestone as the FASB continues to move towards fair value
measurements. This pronouncement enhances the guidance for measuring fair value under approximately 40
existing statements, but it does not expand the use of fair value in any new circumstances. (See FASB Invitation to
Comment on page 6 of this Summary.)
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Summary of Emerging Issues for Colleges and Universities in 2007
Pronouncements of Continuing Importance
FASB Statement No. 154 (FASB 154), Accounting Changes and Error Corrections—a replacement of APB
Opinion No. 20 and FASB Statement No. 3
FASB 154 provides guidance on accounting for changes and error corrections. It is effective for accounting changes
made in fiscal years beginning after December 15, 2005. This Statement is designed to improve the comparability of
financial information by requiring retrospective application of all comparative financial statements when reporting
most accounting changes. When full retrospective application is not practical, FASB 154 requires that a new
accounting principle be applied as of the earliest possible date. This Statement also requires that a change in
depreciation method be accounted for as a change in accounting estimate rather than as a change in accounting
principle.
Much of the guidance in APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3, Reporting
Accounting Changes in Interim Financial Statements, was carried forward. Specifically, the following reporting
guidance was carried forward:
• The correction of an error in previously issued financial statements
• A change in accounting estimate
• A change in the reporting entity
• Guidance in Opinion 20 on justification for a change in accounting principle
Observation: This Statement will apply to colleges and universities that discover an error or in instances of
accounting changes. All changes in accounting principles require retrospective treatment. This includes changes to
accounting principles as a result of the issuance of new pronouncements.
FASB Exposure Drafts
Proposed FSP No. 154-a (FSP 154-a), Considering the Effects of Prior-Year Misstatements When Quantifying
Misstatements in Current-Year Financial Statements
We provided a summary of FASB 154 above. FASB 154 requires that an entity report the correction of an error in
previously issued financial statements by restating those financial statements—if the misstatement is material.
We also provide a summary of a U.S. Securities and Exchange (SEC) Staff Accounting Bulletin No. 108 (SAB 108),
Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements, in the next section of this document. SAB 108 clarifies the methods that SEC registrants (i.e.,
companies that trade securities on a stock exchange in the U.S. and must register with the SEC to do so) should use
to quantify a misstatement as a basis for evaluating the materiality of the misstatement.
The proposed FSP 154-a extends the guidance for SEC registrants in SAB 108 to all other nongovernmental entities.
It establishes a single approach for quantifying misstatements that could be material to users of financial statements.
Determining materiality is a matter of professional judgment that considers both quantitative and qualitative factors.
For purposes of evaluating the materiality of a misstatement, an entity should quantify the effect of the misstatement
in its current-year statement of financial position and statement of income using both the rollover approach and the
iron curtain approach. The rollover approach quantifies a misstatement based on the amount of the error originating
in the current-year statement of income. The iron curtain approach quantifies a misstatement based on the effects of
correcting the misstatement existing in the statement of financial position at the end of the current year, irrespective
of the misstatement's year(s) of origination.
If a misstatement using either the rollover approach or the iron curtain approach is material to the current-year
financial statements, an entity should correct its current-year financial statements. If a misstatement relating to prioryear misstatements exists after the current-year financial statements are corrected and is material to the current-year
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Summary of Emerging Issues for Colleges and Universities in 2007
financial statements, an entity should correct the previously issued financial statements. In some cases, which are
detailed in the proposed FSP, institutions will need to make a one-time cumulative-effect adjustment upon initial
application of the proposed FSP.
PwC Observation: When finalized, this FSP will apply to colleges and universities that discover an error in previously
issued financial statements. The deadline for comments on this proposed FSP is April 30, 2007. The proposed FSP
would be effective for financial statements issued for fiscal years ending after June 15, 2007, although earlier
application is permitted.
Exposure Draft (ED), Disclosures about Derivative Instruments and Hedging—Activities an amendment of
FASB Statement No. 133
This proposed Statement would amend and expand the disclosure requirements in FASB Statement No. 133,
Accounting for Derivative Instruments and Hedging Activities, and other related literature. This proposed Statement
is intended to provide an enhanced understanding of: a) how and why an entity uses derivative instruments, b) how
derivative instruments and related hedged items are accounted for under Statement 133 and its related
interpretations, and c) how derivative instruments affect an entity's financial position, results of operations, and cash
flows.
According to the FASB, this proposed Statement would:
1.
Modify the requirements of paragraph 44 of Statement 133 to include a discussion of objectives and strategies
for using derivative instruments by, at a minimum, the instrument's primary underlying risk that the reporting
entity is intending to modify (e.g., interest rate, credit, foreign exchange rate, or overall price).
2.
Require disclosure in tabular format by primary underlying risk, accounting designation, and purpose of: 1) the
notional amounts and fair values of derivative instruments, 2) the location and fair values of derivative
instruments and related gains and losses reported in the balance sheet and income statement, and 3) the
location and amount of gains and losses reported in the income statement on hedged items designated and
qualifying in hedging relationships. Disclosure of instances in which derivative instruments contain leverage
factors also would be required.
3.
Require disclosure of: 1) the existence and nature of contingent features in derivative instruments (e.g., payment
acceleration clauses), 2) the aggregate fair value amount of derivative instruments that contain those features,
and 3) the aggregate fair value amount of assets that would be required to be posted as collateral or transferred
in accordance with the provisions associated with the triggering of the contingent features.
4.
Require disclosure of counterparty credit risk in derivative instruments. Disclosure of the aggregate fair value of
derivative instruments in asset positions on both a gross basis and net of collateral posted by the counterparty
also would be required.
5.
Require cross-referencing to other footnotes in which derivative-related information is disclosed.
This proposed Statement would be effective for fiscal years and interim periods ending after December 15, 2007 with
early application encouraged.
PwC Observation: The Board issued this proposed Statement because the existing disclosure requirements for
derivative instruments and related hedged items may not provide adequate information on the impact that derivative
activities have on an entity's overall financial position, results of operations, and cash flows. Also, some feel that the
disclosure requirements in Statement 133 do not provide adequate information about derivative activities, considering
the increased use and complexity of derivative instruments and hedging activities in recent years. In light of their
complexity, most institutions should seek assistance in order to determine the implications of these changes in
disclosure requirements for their financial statements.
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Summary of Emerging Issues for Colleges and Universities in 2007
FASB Exposure Draft, Not-for-Profit Organizations: Mergers and Acquisitions—a replacement of APB
Opinion No. 16 and related interpretive guidance provided in AICPA Audit and Accounting Guides, Not-forProfit Organizations, and Health Care Organizations
This exposure draft, which was issued in October 2006, is one of the drafts resulting from the FASB Project,
Combinations of Not-for-Profit Organizations.
This proposed Statement would provide guidance on the accounting and reporting for a not-for-profit organization
upon initial recognition of another entity or a business or nonprofit activity in its financial statements as a result of a
merger or acquisition. It would apply to a merger of a not-for-profit organization's net assets with those of one or
more other organizations, as well as an acquisition of a business or nonprofit activity by purchase, contribution, or
other means. The objectives of a not-for-profit organization in applying this proposed Statement are to:
1.
Recognize the identifiable assets acquired and liabilities assumed that compose the business or nonprofit activity
acquired in a merger or acquisition, with certain exceptions.
2.
Measure those assets and liabilities at their fair values as of the acquisition date, with certain exceptions.
3.
Recognize either goodwill of the acquired business or nonprofit activity or the contribution inherent in the merger
or acquisition as follows: 1) measure goodwill as the amount by which the value of the consideration transferred
(if any) exceeds the net of the amounts assigned to identifiable assets acquired and liabilities assumed, and 2)
measure the contribution inherent in the transaction as the amount by which the values assigned to the
identifiable assets acquired exceeds the consideration transferred (if any) and the liabilities assumed.
4.
Disclose information to enable users of the financial statements to evaluate the nature and financial effects of the
merger or acquisition.
A not-for-profit organization would be required to apply the provisions in this proposed Statement prospectively in the
fiscal year that begins approximately six months after the issuance of a final Statement. For example, if a final
Statement is issued on June 30, 2007, its application would be required in fiscal years beginning after December 15,
2007. Earlier application would be encouraged for organizations with annual periods that begin on or after the date a
final Statement is issued. The Board expects that this proposed Statement would be effective at the same time as
the provisions in the proposed FASB Statement, Not-for-Profit Organizations: Goodwill and Other Intangible Assets
Acquired in a Merger or Acquisition.
PwC Observation: Existing standards require the use of one of two different methods of accounting that produce
dramatically different financial statement results for economically similar transactions and events. This proposed
Statement would eliminate the use of the pooling-of-interests (pooling) method of accounting by not-for-profit
organizations and would require that not-for-profit organizations apply the acquisition method to any merger or
acquisition. The FASB believes that use of the acquisition method would improve financial reporting because it
produces financial information that more faithfully reflects the underlying economics of those events and increases
the comparability of the financial results of not-for-profit organizations.
FASB Exposure Draft, Not-for-Profit Organizations: Goodwill and Other Intangible Assets Acquired in a
Merger or Acquisition—amendment of FASB Statement No. 142
This exposure draft, which was issued in October 2006, is one of the exposure drafts resulting from the FASB
Project, Combinations of Not-for-Profit Organizations.
According to the FASB, this proposed Statement would:
•
Amend the effective date and transition provisions of Statement 142, which would make those provisions
effective for a not-for-profit organization that acquires identifiable intangible assets in a merger or acquisition.
•
Require that a not-for-profit organization determine and assign acquired assets and assumed liabilities to
reporting units.
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Summary of Emerging Issues for Colleges and Universities in 2007
•
Require that goodwill, assigned to reporting units, be evaluated for impairment using the qualitative evaluation or
the fair-value-based evaluation. Statement 142 requires an entity to make certain assessments about the nature
of intangible assets acquired in a merger or acquisition as of the acquisition date, such as whether an intangible
asset is indefinite lived. Identifiable intangible assets that are recognized in accordance with the proposed
Statement on mergers and acquisitions by not-for-profit organizations would be accounted for after the merger or
acquisition in accordance with Statement 142, as amended by this Statement, and FASB Statement No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets.
A not-for-profit organization would be required to apply the provisions in this proposed Statement prospectively in its
fiscal year that begins approximately six months after the issuance of a final Statement. For example, if a final
Statement is issued on June 30, 2007, its application would be required in fiscal years beginning on or after
December 15, 2007. A not-for-profit organization also would be required to apply this proposed Statement's transition
provisions to intangible assets that were acquired before the adoption of this proposed Statement and were
accounted for using the purchase method. Earlier application would be encouraged for organizations with annual
periods that begin on or after the date a final Statement is issued. The Board expects that this proposed Statement
would be effective at the same time as the provisions in FASB proposed Statement on mergers and acquisitions by
not-for-profit organizations.
PwC Observation: This Exposure Draft would significantly impacts colleges and universities that are involved in
business combinations. An institution would be required to recognize identifiable intangible assets, goodwill, or both
as a result of a merger or acquisition. This proposed Statement describes the accounting and reporting for those
intangible assets after the merger or acquisition. Under the proposed rules, the acquiree's financial statements may
need to be stated at fair value. Depending on the nature of the transaction, the transaction would be accounted for
as a contribution under FASB 116, a business combination under FASB 141 and FASB 142, or a combination of
FASB 116, FASB 141 and FASB 142.
Additionally, the amortization of intangible assets may not be considered "allowable" for federal cost recovery
purposes. Institutions that would be impacted by this exposure draft should consider meeting with their federal
oversight agency to discuss what impact, if any, this could have on their indirect cost rate.
FASB Invitation to Comment
FASB Invitation to Comment, Valuation Guidance for Financial Reporting
In January 2007, the FASB issued this Invitation to Comment to obtain feedback from interested parties about:
a.
The need, if any, for valuation guidance, including related implementation guidance for financial reporting, the
specificity of this valuation guidance, and the duration of standard-setting activities.
b.
Whether the FASB should be solely responsible for providing valuation guidance or whether another organization
should be involved.
c.
The process that should be used to issue guidance for financial reporting.
The FASB requests comments on whether valuation guidance is needed to determine a value that would satisfy a
measurement attribute for financial reporting purposes. Some of FASB's accounting standards require or permit the
use of different measurement attributes for financial reporting. The Board is evaluating guidance for selecting the
appropriate measurement attributes as part of its conceptual framework project, which is a joint project with the
International Accounting Standards Board (IASB). As part of its deliberations on measurement attributes, the FASB
is considering various attributes that reflect the current price or value of an asset or liability, such as exit price (fair
value), value in use, and entry price.
In September 2006, FASB issued FASB 157, Fair Value Measurements, which provides financial reporting guidance
for measuring assets and liabilities at fair value. FASB 157 defines fair value, establishes a framework for measuring
fair value, and provides for expanded disclosures above fair value measurements. However, FASB 157 does not
expand the use of fair value as the measurement attribute for financial reporting and does not address many specific
valuation issues that auditors, and valuation professionals currently encounter.
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Summary of Emerging Issues for Colleges and Universities in 2007
The questions for which FASB is looking for specific feedback include:
1.
Is there a need for valuation guidance specifically for financial reporting?
a.
Should valuation guidance include conceptual valuation guidance, detailed implementation guidance, or a
combination of both?
b.
What should be the duration of any valuation-guidance-setting activities?
2.
What level of participation should existing appraisal organizations have in establishing valuation of guidance for
financial reporting?
3.
What process should be used for issuing valuation guidance for financial reporting?
4.
Should the process of valuation guidance be on an international or national level?
In the Invitation to Comment, the FASB provides background on each of the above questions so the reader better
understands the context in which it is being raised. The FASB requests comments by April 15, 2007.
PwC Observation: As more of the amounts reported in the financial statements are at fair value, the FASB is
exploring the idea as to whether or not the valuation guidance should be under one authoritative body. This would
eliminate any potentially conflicting guidance and place all of the relevant guidance at same hierarchical level of
GAAP.
EITF Issues
The Emerging Issues Task Force (EITF), addresses a wide range of topics related to convertible debt, equity
instruments, and derivative financial instruments, among others. We have summarized and highlighted below those
pronouncements of interest to colleges and universities beginning with EITF No. 06-2.
EITF Issue No. 06-2, Accounting for Sabbatical Leave and Other Similar Benefits Pursuant to FASB
Statement No. 43, Accounting for Compensated Absences
Institutions may provide employees with a sabbatical leave benefit under which an employee receives compensated
time off. FASB 43 provides the guidance for accounting for compensated absences. With regard to sabbatical leave
programs, and other similar benefit programs, most agree that the requirements of subparagraphs 6(a), 6(c), and 6(d)
of FASB 43 are met. However, since these benefits typically do not vest, the issue is whether employee rights to
compensated absences accumulate (as defined in paragraph 6(b)) under sabbatical or similar benefit arrangements
that have a requisite service period but do not increase with additional years of service.
At its June 2006 meeting, the EITF Task Force affirmed and the FASB ratified that compensation associated with a
sabbatical leave or other similar benefit arrangement should be accrued over the requisite service period, assuming
all of the other conditions of paragraph 6 of Statement 43 are met.
EITF Issue No. 06-2 is effective for fiscal years beginning after December 15, 2006. Earlier application is permitted if
an institution has not yet issued interim or annual financial statements for that fiscal year.
PwC Observation: Institutions should evaluate the impact of EITF Issue No. 06-2 on their accounting practices. As a
reminder, paragraph 6 of FASB 43 states: "An employer shall accrue a liability for employees' compensation for
future absences if all of the following conditions are met: a) the employer's obligation relating to employees' rights to
receive compensation for future absences is attributable to employees' services already rendered, b) the obligation
relates to rights that vest or accumulate, c) payment of the compensation is probable, and d) the amount can be
reasonably estimated."
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Summary of Emerging Issues for Colleges and Universities in 2007
EITF 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement SplitDollar Life Insurance Arrangements
Institutions may purchase life insurance for their employees for a variety of reasons, including funding deferred
compensation, postretirement benefits or investment return. With respect to split-dollar life insurance, the
arrangement can be complex and varied. The employer or employee could own the policy, but in either instance the
benefits are split between the employer and the employee's beneficiary.
The scope of this EITF is whether the employer is required to recognize a liability and related compensation costs if
the policy provides a benefit to the employee in a postretirement period. The consensus is that a liability should be
recognized in accordance with FASB 106 (as a postretirement benefit exists) or APB 12 (if, in substance, this is a
deferred compensation contract).
This EITF is effective for fiscal years beginning after December 15, 2007, with earlier application permitted. Entities
should recognize the effects of applying the consensus in this Issue through either: a) a change in the accounting
principle through a cumulative-effect adjustment to retained earnings or to other components of equity or net assets
in the statement of financial position as of the beginning of the year of adoption, or b) a change in accounting
principle through retrospective application to all prior periods.
PwC Observation: Endorsement split-dollar life insurance policies could be purchased by an entity in an attempt to
provide additional "fringe" benefits to key employees and to assist in recruiting talented employees. As the EITF is
not effective for at least a year, entities with such arrangements should begin to assess the impact of this EITF and
inform users of the financial statements if the impact will be material.
Additionally, as there are several EITFs addressing life insurance policies, the institution's policy with regard to
purchasing life insurance on its employees should be reviewed (probably at least jointly by Human Resources and
the Business Office) to assess the financial reporting impact and, where necessary, to consider alternative options.
EITF 06-5, Accounting for Purchases of Life Insurance—Determining the Amount that Could be Realized in
Accordance with FASB Technical Bulletin No. 85-4
Life insurance policies are purchased by entities for a variety of purposes, including funding the cost of providing
employee benefits and protecting against the loss of "key persons." A feature of many policies is the accumulation of
a cash surrender value. This EITF addresses what amount should be recorded as an asset by the holder (owner) of
the policy, as amounts recoverable may vary depending on various factors contained within the agreements.
Technical Bulletin 85-4 requires that "the amount that could be realized under the insurance contract as of the date of
the statement of financial position should be reported as an asset." Subsequent to the issuance of Technical
Bulletin 85-4, there has been diversity in the calculation of the amount that could be realized under the insurance
contract. The amount that can be realized under the insurance contract (that is, converted into cash) is dependent on
how the contract is assumed to be hypothetically settled and, if surrendered, whether the insurance policies are
surrendered at the individual or group level.
The Task Force reached consensus on a number of issues:
1.
A policyholder should consider any additional amounts included in the contractual terms of the policy in
determining the amount that could be realized under the insurance contract.
2.
A policyholder should determine the amount that could be realized under the insurance contract assuming the
surrender of an individual-life by individual-life policy (or certificate-by-certificate in a group policy).
3.
A policyholder should not discount the cash surrender value component of the amount that could be realized
under the insurance contract when contractual restrictions to surrender a policy exist, as long as the holder of the
policy continues to participate in the changes in the cash surrender value as it had done prior to the surrender
request.
4.
If a group policy or several individual-life policies (taken together as a group) only allows for the surrender of all
the individual-life policies or certificates as a group, then the policyholder shall determine the amount that could
be realized under the insurance contract on a group basis.
8
Summary of Emerging Issues for Colleges and Universities in 2007
5.
A policyholder should disclose when contractual restrictions on the ability to surrender a policy exist.
This EITF is effective for fiscal years beginning after December 15, 2006. Earlier application is permitted as of the
beginning of a fiscal year for periods in which interim or annual financial statements have not yet been issued.
Institutions should recognize the effects of applying the consensus through either: a) a change in accounting principle
through a cumulative-effect adjustment to net assets or to other components of equity of net assets in the statement
of financial position as of the beginning of the year of adoption, or b) a change in accounting principle through
retrospective application to all prior periods.
PwC Observation: Institutions that purchase life insurance policies on their employees should review the terms and
conditions of such policies in order to determine what amounts, if any, need to be recorded on the institution's
financial statements.
EITF 06-9, Reporting a Change in (or the Elimination of) a Previously Existing Difference between the Fiscal
Year-End of a Parent Company and that of a Consolidated Entity or between the Reporting Period of an
Investor and that of Equity Method Investee
ARB 51 and APB 18 allow a parent company to have a difference between the parent's reporting year-end and the
reporting year-end of a consolidated entity or an investor to have a difference between the reporting year-end of the
investor and the reporting year-end of an equity method investee to consolidate the results of an entity's operations
(or to recognize changes in the net assets of an equity method investment). In practice, questions have arisen as to
how a parent or investor should recognize a change to the reporting year-end of either a consolidated entity or an
entity method investee.
In September 2006, a tentative conclusion was reached in that a parent or an investor should report a change to (or
the elimination of) a previously existing difference between the parent's reporting period and the reporting period of a
consolidated entity or between the reporting period of an investor and the reporting period of an equity method
investee in the parent's or investor's consolidated financial statements as a change in accounting principle in
accordance with the provisions of FASB 154.
The consensus in this Issue is effective for changes occurring in interim or annual reporting periods beginning after
November 29, 2006. Earlier application of this guidance is permitted in periods for which financial statements have
not yet been issued.
PwC Observation: While it is unusual for a college, university or not-for-profit organization to have a consolidated
subsidiary or an equity method investee with different fiscal year-ends, such situations exist. For these entities, this
difference in reporting periods will need to be eliminated, with the consolidated subsidiary or equity method investee
changing their fiscal year-end to agree to that of the parent company. The impact on the consolidated financial
statements should be reported as a change in accounting principle.
EITF 06-10, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Collateral
Assignment Split-Dollar Life Insurance Arrangements
The Task Force reached a consensus on EITF 06-4 that for an endorsement split-dollar life insurance arrangement
(under which the entity owns and controls the insurance policy), an employer should recognize a liability for future
benefits in accordance with FASB 106 (if, in substance, a postretirement benefit plan exists) or APB 12 (if the
arrangement is, in substance, an individual deferred compensation contract) based on the substantive agreement
with the employee. However, questions were raised about whether the consensus reached in EITF 06-4 should
apply to collateral assignment split-dollar life insurance arrangements (the employee's estate or trust controlled by the
employee, owns and controls the insurance policy).
At the November 16, 2006 EITF meeting, the Task Force reached a tentative conclusion that an employer should
recognize a liability for the postretirement benefit related to a collateral assignment split-dollar life insurance
arrangement in accordance with either FASB 106 (if, in substance, a postretirement benefit plan exists) or APB 12 (if
the arrangement is, in substance, an individual deferred compensation contract) based on the substantive agreement
with the employee.
9
Summary of Emerging Issues for Colleges and Universities in 2007
The Task Force also reached a tentative conclusion that an employer should recognize and measure an asset based
on the nature and substance of the collateral assignment split-dollar life insurance arrangement. The employer
should assess what future cash flows the employer is entitled to, if any, as well as the employee's obligation and
ability to repay the employer.
The consensus in this Issue should be effective for fiscal years beginning after December 15, 2007, with earlier
application permitted. Entities should recognize the effects of applying this EITF through either: a) a change in
accounting principle through a cumulative-effect adjustment to net assets in the statement of financial position as of
the beginning of the year of adoption, or b) a change in accounting principle through retrospective application to all
prior periods.
PwC Observation: In light of the various EITFs affecting the recording of assets and liabilities associated with life
insurance policies, institutions should review their relevant policies and consider the new guidance.
New FASB Interpretations and Staff Positions
FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes and Related Implementation Issues
FIN 48, which was released in June 2006, prescribes a comprehensive model for how an entity should recognize,
measure, present and disclose in its financial statements uncertain tax positions that it has taken (or expects to take)
on a tax return, including a decision whether to file or not to file a return in a particular jurisdiction. Under the
Interpretation, the financial statements should reflect expected future tax consequences of such positions presuming
the taxing authorities' full knowledge of the position and all relevant facts, but without considering time values. The
Interpretation substantially changes the applicable accounting model and is likely to cause greater volatility in income
statements as more items are recognized discretely within income tax expense. The Interpretation also revises
disclosure requirements and introduces a prescriptive, annual, tabular rollforward of the unrecognized tax benefits.
FIN 48 is applicable to all uncertain positions for taxes accounted for under FASB Statement No. 109 (FASB 109),
Accounting for Income Taxes, and is not intended to be applied by analogy to other taxes, such as sales taxes, valueadded taxes, or property taxes. Significant elements of the new guidance include recognition, measurement,
changes in judgment, interest and penalties, balance sheet classification, disclosures, transition and effective date.
The Interpretation is effective as of the beginning of fiscal years that start after December 15, 2006. After considering
other applicable guidance (such as the guidance in EITF 93-7, Uncertainties Related to Income Taxes in a Purchase
Business Combination), an institution should record the change in net assets that results from the application of the
Interpretation as an adjustment to retained earnings (net assets).
PwC Observation: FIN 48 applies to colleges and universities. However, institutions should look at it in the context
of their overall tax position and assessment of tax risk.
FASB Staff Position 126-1 (FSP 126-1), Revision to the Definition of a Public Entity to Include an Obligor for
Conduit Debt Securities
The FASB issued this FSP in October 2006 for circumstances in which a governmental entity issues municipal bonds
(conduit debt securities) on behalf of a private party (conduit bond obligor). Some conduit debt securities can be
traded on a public market. The conduit bond obligor is required to make or fund all interest and principal payments
as they become due, and any future financial reporting requirements also are the responsibility of that conduit bond
obligor.
Should the conduit bond obligor for conduit debt securities that are traded in a public market be considered a public
entity for the purposes of applying certain existing authoritative accounting literature? The FASB staff say yes: such
an obligor meets the definition of a public entity. The definition of a conduit bond obligor includes all individual
conduit bond obligors that participate in a pooled conduit debt security. However, FSP 126-1 amends only the
accounting literature cited in the appendix of the FSP—not any other literature.
10
Summary of Emerging Issues for Colleges and Universities in 2007
FSP 126-1 is effective for periods beginning after December 15, 2006.
PwC Observation: Note that this standard does not attempt to impose SEC-registrant responsibilities on colleges
and universities and it does not change the definition of "not-for-profit organization" for purposes of application of
FASB standards. FSP 126-1 is not expected to have a significant impact on colleges, universities and other not-forprofit organizations.
11
Summary of Emerging Issues for Colleges and Universities in 2007
II. Other Issues
In this section, we provide a summary of two issues: the Uniform Prudent Management of Institutional Funds Act
(UPMIFA) and an Accounting Bulletin from the U.S. Securities and Exchange Commission (SEC).
Uniform Prudent Management of Institutional Funds Act (UPMIFA)
The National Conference of Commissioners on Uniform State Laws (NCCUSL) approved UPMIFA at its July 2006
annual meeting. The new act updated the Uniform Management of Institutional Funds Act (UMIFA).
UPMIFA is not effective in a state unless the state specifically adopts it. As of this writing, the legislatures of South
Dakota and Utah have adopted UPMIFA and it has been introduced in the legislatures of Connecticut, Idaho, Indiana,
Kentucky, Minnesota, Montana, Nebraska, Nevada, Oklahoma, Oregon, Tennessee, and Texas. (For an updated list
of states that have introduced or adopted UPMIFA, visit www.nccusl.org. Note that NCCUSL provides states with a
variety of nonpartisan legislation that they may choose to modify and adopt.)
UPMIFA eliminates the concept of "historical gift value," and relies on a "prudence" standard, which specifies that
spending above seven percent creates a rebuttable presumption of imprudence:
"The appropriation for expenditure in any year of an amount greater than seven percent of the fair market value
an endowment fund, calculated on the basis of market values determined at least quarterly and averaged over
a period of not less than three years immediately preceding the year in which the appropriation for expenditure
was made, creates a rebuttable presumption of imprudence." [Section 4 (d)]
The Act also includes a process for releasing or modifying restrictions on a gift, and specifies appropriate
circumstances for doing so:
"If an institution determines that a restriction contained in a gift instrument on the management, investment, or
purpose of an institutional fund is unlawful, impracticable, impossible to achieve, or wasteful, the institution, [60
days] after notification to the [Attorney General], may release or modify the restriction, in whole or part, if: 1)
the institutional fund subject to the restriction has a total value of less than [$25,000]; 2) more than [20] years
have elapsed since the fund was established; and 3) the institution uses the property in a manner the institution
reasonably determines to be consistent with the charitable purposes expressed in the gift instrument." [Section
6 (d)]
PwC Observation: In a February 2006 memorandum, the NCCUSL drafting committee explained its thinking about
the removal of historic dollar value from UMIFA as follows:
"… big institutions obtain sophisticated investment advice and have experience and guidance with spending
rules. The big institutions are not likely to need to spend below historic dollar value, and if they do spend below
historic dollar value for a particular fund, the institutions will adopt appropriate strategies to grow the fund and
will limit spending until the fund recovers its value…. institutions with small endowment funds, may not have the
experience or expertise to know how to invest in a prudent manner and how to spend in a prudent manner…
The new provision…requires an institution to notify the attorney general before making an expenditure that
causes its endowment funds to drop below historic dollar value. The provision only applies to institutions with
aggregate endowment funds valued below $2,000,000 and thus targets the institutions that may need help in
making prudent decisions."
We advise institutions to monitor the activities of their state legislatures to see if they will consider the new model act.
For more information, visit the web site of http://www.nccusl.org."
12
Summary of Emerging Issues for Colleges and Universities in 2007
SEC Staff Accounting Bulletin
SEC Staff Accounting Bulletin (SAB) No. 108, Considering the Effects of Prior Year Misstatements when
Quantifying Misstatements in Current Year Financial Statements
The FASB is expected to formally extend the guidance in SAB 108 to private companies, including colleges and
universities. Early adoption is being encouraged.
The U.S. Securities and Exchange Commission (SEC) issued SAB 108 to address the diversity in practice with
respect to quantifying financial statement misstatements for SEC-registrants (i.e., companies that register with the
SEC to trade securities on a public exchange). SAB 108 establishes an approach for quantifying financial statement
errors based on the effects of the error on each of the registrant's financial statements and the related financial
statement disclosures. This model is commonly referred to as a "dual approach" because it requires quantification of
errors under both the "iron-curtain" and the "roll-over" methods.
The iron-curtain method focuses primarily on the effect of correcting the period-end balance sheet with less emphasis
on the reversing effects of prior year's errors on the income statement. The roll-over method focuses primarily on the
impact of a misstatement on the income statement, including the reversing effect of prior year misstatements, but its
use can lead to the accumulation of misstatements in the balance sheet.
From a transition perspective, registrants are permitted to record the cumulative effect of initially applying the "dual
approach" in the first fiscal year ending after November 15, 2006 by recording the necessary "correcting" adjustment
to the carrying values of assets and liabilities as of the beginning of that year with the offsetting adjustment recorded
to the opening balance of retained earnings (e.g., net assets). Additionally, the use of the "cumulative effect"
transition method requires detailed disclosure of the nature and amount of each individual error being corrected
through the cumulative adjustment and how and when it arose. These disclosures are intended to make prior years'
materiality judgments easier for investors and others to assess.
PwC Observation: The SEC staff has indicated that if only one of the methods was applied, unadjusted
misstatements may be viewed as remaining immaterial to each prior year's financial statements. Even though the
application of the dual approach may result in a cumulative adjustment that is considered material to the current
financial statements, the SEC staff does not appear to be creating a requirement for registrants to withdraw reliance
on those earlier financial statements.
SAB 108 is clearly an important piece of guidance for registrants and their auditors (and could be for private
organizations, including colleges and universities, and their auditors). It is important to remember, however, that the
quantification of a financial statement misstatement is just the starting point for a materiality analysis. A complete
materiality analysis starts with the quantification of the error(s), but also includes an evaluation of qualitative elements
surrounding the error(s).
As noted above, we expect the FASB to adopt the provisions of SAB 108 to private companies, including colleges
and universities. Management of such entities, as well as audit committees and auditors, should begin to review and
evaluate past adjustments that were waived and not recorded, and consider adopting the provisions of SAB 108. The
evaluation should include assessing the impact - both qualitative and quantitative - of previously waived adjustments.
Past adjustments also should be viewed in light of SAS 112, which takes into account the quality of the fiscal closing
process. Waived adjustments could be assessed as material weaknesses or significant deficiencies. Management
and their audit committees should discuss with their auditors the impact of past waived adjustments in light of the new
measurement criteria.
13
Summary of Emerging Issues for Colleges and Universities in 2007
III. AICPA Pronouncements and Activities
In this section we highlight the American Institute of Certified Public Accountant's (AICPA's) widely discussed
pronouncement on Statement on Auditing Standards (SAS) No. 112. In addition, we provide with information on the
AICPA's SAS 114 as well as its Practice Aid on alternative investments.
Pronouncements
AICPA SAS No. 112 (SAS 112), Communicating Internal Control Related Matters Identified in an Audit
The AICPA, the national professional organization for certified public accountants, issued its SAS 112 in May 2006.
SAS 112 substantially incorporates the definitions of significant deficiency and material weakness used by the Public
Company Accounting Oversight Board (PCAOB) in its standards, making the definitions used for audits of nonpublic
entities consistent with those in place for audits of public companies.
Important definitions in SAS 112 include the following three:
1.
A control deficiency exists when the design or operation of a control does not allow management or
employees, in the normal course of performing their assigned functions, to prevent or detect misstatements on a
timely basis.
2.
A significant deficiency is a control deficiency, or combination of control deficiencies, that adversely affects the
entity's ability to initiate, authorize, record, process, or report financial data reliably in accordance with generally
accepted accounting principles such that there is more than a remote likelihood that a misstatement of the
entity's financial statements that is more than inconsequential will not be prevented or detected.
3.
A material weakness is a significant deficiency, or a combination of significant deficiencies, that results in more
than a remote likelihood that a material misstatement of the financial statements will not be prevented or
detected.
In addition, SAS 112:
•
Uses the term "those charged with governance" to refer to the person(s) with responsibility for overseeing the
strategic direction of the entity as well as its financial reporting and disclosure process
•
Requires the auditor to communicate, in writing, to management and those charged with governance significant
deficiencies and material weaknesses in internal control
•
Identifies control deficiencies that ordinarily would be considered at least significant deficiencies (e.g., ineffective
controls over the period-end financial reporting process)
•
Identifies specified circumstances that should be considered strong indicators of a material weakness (e.g.,
ineffective oversight by governing board, restatement of prior-year financial statements to reflect correction of
material misstatement)
•
Requires recurring significant deficiencies and material weaknesses identified in previous years to be
communicated annually until remediated
•
Will change the language in the opinion over internal controls in audits subject to OMB Circular A-133
requirements
PwC Observation: We expect that the new definitions of significant deficiency and material weakness will lower the
threshold for reportable control deficiencies, and could cause more deficiencies to rise to the level of significant
deficiencies and material weaknesses, which must be reported in external financial statement audits. We believe that
colleges and universities should enhance their control environments before the SAS becomes effective for financial
periods ending on or after December 15, 2006—that would be fiscal 2007 for most not-for-profit organizations.
14
Summary of Emerging Issues for Colleges and Universities in 2007
More specifically, we advise institutions to educate their boards, inventory the significant accounts, disclosures and
components as well as the processes and cycles, and begin to review the related controls. During the review,
consider, among other factors, appropriate segregation of duties, spreadsheet controls, the adequacy of
documentation, and the institution's responsibilities for outside service organizations.
AICPA SAS No. 114 (SAS 114), The Auditor's Communication With Those Charged with Governance
This standard was issued in December 2006 and supercedes SAS No. 61, Communications with Audit Committees.
The new standard requires formal communications to all those charged with governance regardless of the size of the
entity. Particular attention should be paid to situations where those charged with governance also manage the entity.
PwC Observation: In the post-Sarbanes environment, one area of focus is the auditor's communications with the
audit committee. SAS 114 is generally consistent with SAS 61 but it includes additional matters to be communicated
and it focuses more attention on the communication process. Additional matters to be communicated include an
overview of the planned scope and timing of the audit and the representations that the auditor is requesting from
management. In addition, SAS 114 requires the auditor to evaluate the adequacy of the two-way communication
between the auditor and those charged with governance. Also, the auditor must document required communications
with those charged with governance.
Practice Aid
AICPA, Alternative Investments—Audit Considerations, A Practice Aid for Auditors
Colleges and universities have dramatically increased their investments in financial instruments that do not have a
readily determinable market value and are commonly referred to as alternative investments. Such investments may
be higher risk and difficult to value, especially when institutions invest in them through a third party and have only
limited access to the underlying detail.
While the accounting rules governing fair valuation have not changed, the AICPA amended the relevant auditing
standards in July 2005, issuing two Interpretations of Statements on Auditing Standards (SAS) pertaining to auditing
fair values. The first is AU Section 9332, Auditing Derivative Instruments, Hedging Activities, and Investments in
Securities, and the second is AU Section 9328, Auditing Fair Value Measurements and Disclosures. The
Interpretations raised specific questions about how to satisfy the existence and valuation assertions 1 as they relate to
auditing hedge funds and private equity partnerships.
To provide further guidance, the AICPA issued Alternative Investments—Audit Considerations, a Practice Aid for
Auditors (the "Practice Aid") in July 2006, which was intended to clarify procedures that institutions and auditors
should consider in substantiating the existence and valuation of securities. The Practice Aid is not definitive. It
suggests, but does not require, procedures that may help in auditing fairly valued investments.
PwC Observation: Management's responsibilities begin when considering whether to invest in alternative
investments. Among others, management's due pre-investment diligence procedures should include reviewing
internal controls, tax exposure, and risk.2
1
The auditor tests "existence" and "valuation" posing such questions as the following: Do the investments exist at
the given date? Are the investments reflected in the financial statements at appropriate amounts?
2
It might be helpful to read PwC's 2004 paper, Meeting the Challenges of Alternative Investments, and our 2007
Supplement, Institutional Oversight: Managing the Challenges of alternative Investments in the Higher Education
Environment. Both papers can be downloaded at no charge at www.pwc.com/education.
15
Summary of Emerging Issues for Colleges and Universities in 2007
After investing in alternative investments, management should consider the following ongoing monitoring procedures:
•
Conduct regular meetings in person or by telephone with the fund manager or general partner
•
Review fund communications, including financial statements
•
Review valuation of portfolio for reasonableness
•
Monitor portfolio performance
•
Monitor the firm and the fund manager (e.g., review press reports for significant management changes, monitor
staffing levels)
Management's responsibilities continue when making the fair value measurements and disclosures in the institution's
financial statements. At this stage, management should:
•
Document the institution's policies for alternative investments
•
Establish a process for determining the fair value measurements and disclosures that should include obtaining
the fund's audited financial statements and noting: a) whether the independent auditor's opinion is unqualified on
a GAAP basis or whether the opinion is modified; b) the audit firm (review the audit firm's credentials if you are
not familiar with it); c) disclosed valuation methodologies; d) other disclosures that may have an impact on the
institution's valuation or financial statement disclosures; e) date of independent auditor's report; and f)
subsequent events footnote, if any.
•
Compare the value at fund's year-end (most likely December 31) to value at institution's year-end and assess
reasonableness of the change considering appreciation/depreciation, additions, distributions, and other changes.
•
Consider reference to external hedge fund indices (e.g., S&P Hedge Fund Index) to support assessments of
returns during the period.
•
Request the detail of the portfolio (underlying securities) from the fund manager
•
Prepare the institution's valuation
•
Identify and adequately support any significant assumptions used
•
Ensure that the presentation and disclosure of the institution's fair value measurements are in accordance with
GAAP
16
Summary of Emerging Issues for Colleges and Universities in 2007
IV. GASB Pronouncements and Activities
We highlight several GASB Statements that are expected to affect public colleges and universities, including two of
particular significance dealing with other postemployment benefits (OPEB). We also highlight several GASB
Exposure Drafts.
New GASB Statements
GASB Statement No. 49 (GASB 49), Accounting and Financial Reporting for Pollution Remediation
Obligations
The GASB issued this Statement, which is intended to provide guidance on the accounting and reporting of
obligations and costs related to existing pollution remediation, such as an obligation to clean up spills of hazardous
wastes and to remove contamination (e.g., asbestos), in November 2006. Pollution prevention or control is not within
the scope of GASB 49.
GASB 49 identifies the following five circumstances (called "obligating events") under which a government is required
to estimate and report a liability related to pollution remediation. The government is:
•
Compelled to take remediation action because pollution creates an imminent endangerment to public health or
welfare or the environment, leaving the government little or no discretion to avoid remediation action.
•
In violation of a pollution prevention–related permit or license, such as a Resource Conservation and Recovery
Act (RCRA) permit or similar permits under state law.
•
Named, or evidence indicates that it will be named, by a regulator as a responsible party or potentially
responsible party (PRP) for remediation, or as a government responsible for sharing costs.
•
Named, or evidence indicates that it will be named, in a lawsuit to compel the government to participate in
remediation.
•
Legally obligating itself to commence or already commencing cleanup activities or monitoring or operation and
maintenance of the remediation effort. If these activities are voluntarily commenced and none of the other
obligating events have occurred relative to the entire site, the amount recognized should be based on the portion
of the remediation project that the government has initiated and is legally required to complete.
GASB 49 also requires liabilities, expenses, and expenditures to be estimated using an "expected cash flows"
measurement technique. In addition, it requires disclosures about pollution clean up efforts in the notes to the
financial statements. The requirements of this Statement are effective for financial statements for periods beginning
after December 15, 2007.
PwC Observation: This Statement is expected to have a significant impact on those governmental colleges and
universities that must deal with pollution remediation on their properties. Originally, the GASB's goal was to
comprehensively examine environmental liabilities that related to past, current and future activities, but later the
GASB narrowed its scope to focus on the issues it believed most needed guidance, namely pollution remediation
obligations, including contamination. In the future, the GASB may address other environmental issues such as
pollution prevention obligations and asset retirement obligations.
GASB Statement No. 48 (GASB 48), Sales and Pledges of Receivables and Future Revenues and Intra-Entity
Transfers of Assets and Future Revenues
Governments sometimes exchange an interest in future cash flows for immediate cash payments. Should these
transactions be reported as sales or as collateralized borrowings that result in liabilities? Issued in September 2006,
GASB 48 establishes that such transactions should be reported as a collateralized borrowing unless certain criteria is
met that indicates that a sale has taken place. In general, if the government retains control over the receivables or
17
Summary of Emerging Issues for Colleges and Universities in 2007
future revenues, then the transaction would be a collateralized borrowing, but if the government relinquishes control,
then: a) transactions involving receivables would be reported as "sales," and b) transactions involving future revenue
would be reported as "deferred revenue," which would be amortized based on several criterion.
GASB 48 also would apply when a government creates a separate component unit (e.g., a higher education facilities
authority) that would issue debt on its behalf. The government would pledge a future revenue stream (e.g., from the
supplemental sales tax revenues) to cover the principal and interest payments. Per GASB 48, the pledging
government would not recognize a liability when the agreement is made, and the debt-issuing component unit would
not recognize a receivable for the future revenue pledged. Rather, the pledging government would recognize a
liability to the debt-issuing component unit and an expenditure/expense simultaneously with the recognition of the
revenues that are pledged. The debt-issuing component unit should recognize revenue when the pledging
government is obligated to make the payments.
GASB 48 would require certain disclosures. The notes to the financial statements should identify the revenues that
are pledged, the purposes for which they are pledged, the duration of the commitment, and some measure of the
relationships of the pledged portion to the total revenue and of the actual revenues to the amount pledged.
The requirements for this Statement are effective for financial statements for periods beginning after December 15,
2006.
PwC Observation: This proposed Statement is not expected to affect many governmental colleges and universities.
However, when a state sets up a higher education financing authority to issue debt on behalf of an institution, GASB
48 would be applicable to the pledging government and the debt-issuing component unit.
Previously Reported Pronouncements with Continuing Importance
GASB Statement No. 47 (GASB 47), Accounting for Termination Benefits
Issued in June 2005, GASB 47 establishes accounting standards for termination benefits. The standard requires that
for an organization with financial statements prepared on the accrual basis of accounting, a liability and expense for
voluntary termination benefits (e.g., early retirement programs) should be recognized when the offer is accepted and
the amount can be estimated. If there are involuntary termination benefits (e.g., severance), a liability and expense
should be recognized when a plan of termination has been approved by those with the authority to commit the
organization to the plan, the plan has been communicated to the employees, and the amount can be estimated. If
financial statements are prepared on the modified accrual basis of accounting, termination benefits (liabilities and
expenditures) should be recognized to the extent the liabilities are normally expected to be liquidated with
expendable available resources.
For termination benefits provided through an existing defined benefit plan, the provisions of this Statement should be
implemented simultaneously with the requirements of GASB 45. For all other termination benefits, this Statement
was effective for financial statements for periods beginning after June 15, 2005—that is June 30, 2006 for many
organizations. The cumulative effect of applying this
Statement should be reported as a restatement to beginning net assets and the statements should disclose a
description of the termination benefit arrangement, the cost of the termination benefits, and significant methods and
assumptions used to determine termination benefit liabilities.
PwC Observation: GASB 47 establishes standards for the way that governmental colleges and universities account
for voluntary termination benefits, and it also establishes standards for involuntary terminations. This Statement is
very pertinent to governmental colleges and universities that offer early retirement packages.
18
Summary of Emerging Issues for Colleges and Universities in 2007
GASB Statement No. 46 (GASB 46), Net Assets Restricted by Enabling Legislation, an amendment of GASB
Statement No. 34
Issued in December 2004, GASB 46 was designed to help governments determine when net assets have been
restricted to a particular use by the passage of enabling legislation and to specify how those net assets should be
reported in financial statements. Specifically, GASB 46 addresses the definition of the term "legally enforceable" that
is the key requirement of the restriction.
A government's net assets should be reported as restricted when the purpose for or manner in which they can be
used is limited by an external party, a constitutional provision, or enabling legislation. Statement 46 clarifies that
"legally enforceable" means that an external party—such as citizens, public interest groups, or the judiciary—can
compel a government to use resources only for the purposes stipulated by the enabling legislation.
The provisions of GASB 46 are effective for financial statement periods beginning after June 15, 2005.
PwC Observation: GASB 46 confirms that the determination of legal enforceability is a matter of professional
judgment that may entail obtaining the advice of legal counsel. The determination of legal enforceability should be
based on the underlying facts and circumstances surrounding each individual restriction.
GASB Statement No. 45 (GASB 45), Accounting and Financial Reporting by Employers for Postemployment
Benefits Other Than Pensions
Issued in June 2004, GASB 45 establishes standards for the measurement, recognition, and display of OPEB
expense/expenditures and related liabilities (assets), note disclosures, and, if applicable, required supplementary
information (RSI) in the financial reports of state and local governmental employers, including governmental colleges
and universities.
GASB 45 improves the relevance and usefulness of financial reporting by: a) requiring systematic, accrual-basis
measurement and recognition of OPEB cost (expense) over a period that approximates employees' years of service,
and b) providing information about actuarial accrued liabilities associated with OPEB and whether and to what extent
progress is being made in funding the plan.
GASB 45 requires employers that participate in single-employer or agent multiple-employer defined benefit OPEB
plans (sole and agent employers) to measure and disclose an amount for annual OPEB cost on the accrual basis of
accounting. Annual OPEB cost is equal to the employer's annual required contribution (ARC) to the plan with certain
adjustments if the employer has a net OPEB obligation for past under- or overcontributions.
The ARC is defined as the employer's required contributions for the year, calculated in accordance with certain
parameters, and including: a) the normal cost for the year, and b) a component for amortization of the total unfunded
actuarial accrued liabilities (or funding excess) of the plan over a period not to exceed thirty years. The parameters
include requirements for the frequency and timing of actuarial valuations as well as for the actuarial methods and
assumptions that are acceptable for financial reporting. If the methods and assumptions used in determining a plan's
funding requirements meet the parameters, the same methods and assumptions are required for financial reporting
by both a plan and its participating employer(s). However, if a plan's method of financing does not meet the
parameters (e.g., the plan is financed on a pay-as-you-go basis), the parameters nevertheless apply for financial
reporting purposes.
For financial reporting purposes, an actuarial valuation is required at least biennially for OPEB plans with a total
membership (including employees in active service, terminated employees who have accumulated benefits but are
not yet receiving them, and retired employees and beneficiaries currently receiving benefits) of 200 or more, or at
least triennially for plans with a total membership of fewer than 200. The projection of benefits should include all
benefits covered by the current substantive plan (the plan as understood by the employer and plan members) at the
time of each valuation and should take into consideration the pattern of sharing of benefit costs between the
employer and plan members to that point, as well as certain legal or contractual caps on benefits to be provided. The
parameters require that the selection of actuarial assumptions, including the healthcare cost trend rate for
postemployment healthcare plans, be guided by applicable actuarial standards.
19
Summary of Emerging Issues for Colleges and Universities in 2007
A sole employer in a plan with fewer than one hundred total plan members (including employees in active service,
terminated employees who have accumulated benefits but are not yet receiving them, and retirees and beneficiaries
currently receiving benefits) has the option to apply a simplified alternative measurement method instead of obtaining
actuarial valuations. The option also is available to an agent employer with fewer than one hundred plan members, in
circumstances in which the employer's use of the alternative measurement method would not conflict with a
requirement that the agent multiple-employer plan obtain an actuarial valuation for plan reporting purposes. Those
circumstances are discussed further in the Statement.
Employers participating in cost-sharing multiple-employer plans that are administered as trusts or equivalent
arrangements are required to recognize OPEB expense/expenditures for their contractually required contributions to
the plan on the accrual or modified accrual basis, as applicable. Required disclosures include identification of the
way that the contractually required contribution rate is determined (e.g., by statute or contract or on an actuarially
determined basis). Employers participating in a cost-sharing plan are required to present as RSI schedules of
funding progress and employer contributions for the plan as a whole if a plan financial report, prepared in accordance
with Statement 43, is not issued and made publicly available and the plan is not included in the financial report of a
public employee retirement system or another entity.
Employers that participate in defined contribution OPEB plans are required to recognize OPEB expense/expenditures
for their required contributions to the plan and a liability for unpaid required contributions on the accrual or modified
accrual basis, as applicable. This Statement also includes guidance for employers that finance OPEB as insured
benefits (as defined by this Statement) and for special funding situations.
The requirements of GASB 45 are effective in three phases based on a government's total annual revenues in the
first fiscal year ending after June 15, 1999. Governments with annual revenues of $100 million or more (i.e., phase 1
governments) are required to implement this Statement for periods beginning after December 15, 2006.
Implementation dates for phase 2 and 3 governments are discussed further in the Statement.
Earlier application of GASB 45 is encouraged. All component units should implement the requirements of this
Statement no later than the same year as their primary government.
PwC Observation: GASB 45 is likely to impact almost all public colleges and universities, and the amounts of
liabilities and their impact on net assets are likely to be material. It is important for institutions to understand the
reporting guidance and engage technical experts early to prepare the necessary actuarial valuations. For institutions
that participate in pooled arrangements (e.g., with a state system), it is important to understand the accounting and
reporting requirements applicable to employers participating in cost-sharing multiple-employer plans. Also, see the
Summary below for information about GASB 43.
GASB Statement No. 43 (GASB 43), Financial Reporting for Postemployment Benefit Plans Other Than
Pension Plans
Issued in April 2004, GASB 43 establishes uniform financial reporting standards for other postemployment benefit
(OPEB) plans and supersedes the interim guidance included in GASB 26, Financial Reporting for Postemployment
Healthcare Plans Administered by Defined Benefit Pension Plans.
The standards in GASB 43 apply for OPEB trust funds included in the financial reports of plan sponsors or
employers, as well as for the stand-alone financial reports of OPEB plans or public employee retirement systems or
other third parties, that administer them. GASB 43 also provides requirements for reporting of OPEB funds by
administrators of multiple-employer OPEB plans, when the fund that is used to accumulate assets and pay benefits or
premiums is not a trust fund.
GASB 43 is related to GASB 45. The GASB has coordinated the measurement and disclosure requirements of the
two Statements to avoid duplication when an OPEB plan is included as a trust or agency fund in an employer's
financial report.
The financial reporting framework for defined benefit OPEB plans that are administered as trusts or equivalent
arrangements includes two financial statements and two multiyear schedules that must be presented as required
supplemental information (RSI) immediately following the notes to the financial statements. The financial statements
20
Summary of Emerging Issues for Colleges and Universities in 2007
focus on reporting current financial information about plan net assets held in trust for OPEB and financial activities
related to the administration of the trust. The statement of plan net assets provides information about the fair value
and composition of plan assets, plan liabilities, and plan net assets held in trust for OPEB. The statement of changes
in plan net assets provides information about the year-to-year changes in plan net assets, including additions from
employer, member, and other contributions and net investment income and deductions for benefits and refunds paid,
or due and payable, and plan administrative expenses.
Required notes to the financial statements include a brief plan description, a Summary of significant accounting
policies, and information about contributions and legally required reserves. In addition, OPEB plans are required to
disclose information about the current funded status of the plan as of the most recent actuarial valuation date, and
actuarial methods and assumptions used in the valuation.
The RSI schedules provide actuarially determined historical trend information from a long-term perspective, for a
minimum of three valuations, about: a) the funded status of the plan and the progress being made in accumulating
sufficient assets to pay benefits when due, and b) employer contributions to the plan. The schedule of funding
progress reports the actuarial value of assets, the actuarial accrued liability, and the relationship between the two
over time. The schedule of employer contributions reports the annual required contributions (ARC) of the
employer(s) and the percentage of ARC recognized by the plan as contributions. The required schedules are
accompanied by notes regarding factors that significantly affect the identification of trends in the amounts reported.
For financial reporting purposes, an actuarial valuation is required at least biennially for OPEB plans with a total
membership (including employees in active service, terminated employees who have accumulated benefits but are
not yet receiving them, and retired employees and beneficiaries currently receiving benefits) of 200 or more, and at
least triennially for plans with a total membership of fewer than 200. The projection of benefits should include all
benefits covered by the current substantive plan (the plan as understood by the employer and plan members) at the
time of each valuation and should take into consideration the pattern of sharing of benefit costs between the
employer and plan members to that point, as well as certain legal or contractual caps on benefits to be provided. The
parameters require that the selection of actuarial assumptions, including the healthcare cost trend rate for
postemployment healthcare plans, be guided by applicable actuarial standards. OPEB plans with a total membership
of fewer than one hundred have the option to apply a simplified alternative measurement method instead of obtaining
actuarial valuations.
Multiple-employer defined benefit OPEB plans that are not administered as trusts or equivalent arrangements should
be reported as agency funds. Any assets accumulated in excess of liabilities to pay premiums or benefits, or for
investment or administrative expenses, should be offset by liabilities to participating employers. Required notes to
the financial statements include a brief plan description, a Summary of significant accounting policies, and information
about contributions.
Defined contribution plans that provide OPEB are required to follow the requirements for financial reporting by
fiduciary funds generally, and by component units that are fiduciary in nature, set forth in Statement 34 and the
disclosure requirements set forth in paragraph 41 of Statement 25.
The requirements of GASB 43 for OPEB plan reporting are effective one year prior to the effective date of GASB 45
for the employer (single-employer plan) or for the largest participating employer in the plan (multiple-employer plan).
Plans in which the sole or largest employer is a phase 1 government—with annual revenues of $100 million or
more—are required to implement this Statement in financial statements for periods beginning after December 15,
2005, that is the fiscal year ending June 30, 2007 for many institutions. Implementation dates for the other two
groups are discussed in more detail in the Statement. Early implementation is encouraged.
PwC Observation: It is important for governmental colleges and universities to distinguish between the requirements
of GASB 43 and GASB 45. GASB 43 provides guidance on reporting for OPEB plans while GASB 45 provides
guidance on accounting and valuation for OPEB expense/expenditures and related liabilities (assets), note
disclosures, and, if applicable, required supplementary information (RSI).
21
Summary of Emerging Issues for Colleges and Universities in 2007
Technical Bulletins
GASB Technical Bulletin No. 2006-1 (GTB 06-1), Accounting and Financial Reporting by Employers for
Payments from the Federal Government Pursuant to the Retiree Drug Subsidy Provisions of Medicare Part D
In June 2006, the GASB issued GTB 06-1. Medicare Part D is a federal program that provides prescription drug
benefits to eligible Medicare recipients. The federal government makes payments to employers and plans that
provide prescription drug benefits to persons who otherwise would be eligible to participate in Medicare Part D. The
new GTB clarifies how state and local governments or plans should report these payments. Generally:
•
State and local governments should report these payments as revenue. They should not be netted with costs.
•
Plans should report the payment separately from the contributions they receive from the government.
Per GASB Statement No. 24, Accounting and Financial Reporting for Certain Grants and Other Financial Assistance,
the subsidy should be treated by an employer government as an "on-behalf payment for fringe benefits." The
government's costs should be reported on the accrual basis of accounting and not reduced by the federal subsidy.
The government also would disclose in the notes to its financial statements the amount of the subsidy payment made
to the OPEB plan on its behalf.
The Technical Bulletin is effective immediately. However, the provisions that relate to the measurement, recognition,
or required supplementary information requirements of GASB 43 should be applied simultaneously with the
implementation of GASB 43 or GASB 45.
PwC Observation: This GTB is especially pertinent to public colleges and universities that provide prescription drug
benefits to retirees and differs from the relevant FASB requirements. It may have a significant impact on the
accounting for and disclosures of these Part D payments on the institution's financial statements.
GASB Technical Bulletin No. 2004-2 (GTB 04-2), Recognition of Pension and Other Postemployment Benefit
(OPEB) Expenditures/Expense and Liabilities by Cost-Sharing Employers
Issued in December 2004, GTB 04-2 clarifies the requirements in GASB 27, Accounting for Pensions by State and
Local Governmental Employers, and GASB 45 (discussed above) regarding accounting for employers' contractually
required contributions to cost-sharing pension and OPEB plans. Per GTB 04-2, with respect to expenditure/expense
recognition, contractually required contributions are recognized in the period they are due "for" rather than the period
they are due "on." For example, pension or OPEB expenditures that are "for" (i.e., related to) December's payroll
should be recorded in December even if they are due "on" February 1. This point was not clear in GASB 27 and 45,
and was causing confusion.
The provisions of GTB 04-2 are effective for financial statement periods ending after December 15, 2004, with
respect to pension transactions, and should be applied simultaneously with the implementation of GASB 45 with
respect to OPEB transactions.
PwC Observation: Note that GTB 04-2 relates to GASB 45, which we discussed above. In addition, it relates to
GASB 27. In the next section, we discuss an amendment that the GASB has proposed to its Statement 27.
GASB Exposure Drafts
Proposed GASB Concepts Statement, Elements of Financial Statements
This proposed Concepts Statement, which was exposed for comment in August 2006, would establish the following
general definitions for seven financial statement elements:
1.
Assets are resources that an entity currently controls.
2.
Liabilities are current obligations to sacrifice resources; the entity has little or no discretion to avoid sacrificing
them.
22
Summary of Emerging Issues for Colleges and Universities in 2007
3.
A deferred outflow of resources is an entity's consumption of net resources that is applicable to a future reporting
period.
4.
A deferred inflow of resources is an entity's acquisition of net resources that is applicable to a future reporting
period.
5.
Net assets are the residual of all of the other financial statement elements as presented in a statement of
financial position.
6.
An outflow of resources is an entity's consumption of net resources that is applicable to the reporting period.
7.
An inflow of resources is an entity's acquisition of net resources that is applicable to the reporting period.
This proposed Concepts Statement would improve financial reporting by providing a framework from which the GASB
could enhance consistency in future standards setting. The comment period on this Exposure Draft has ended and
the GASB has begun to deliberate it. A final concepts statement is expected to be published in April 2007.
PwC Observation: This concept statement is part of the GASB's overall project to reexamine the financial reporting
model, which began in 1984. This project culminated with the issuance in 1999 of GASB Statement No. 34, Basic
Financial Statements—and Management's Discussion and Analysis—for State and Local Governments, and GASB
Statement No. 35, Basic Financial Statements—and Management's Discussion and Analysis—for Public Colleges
and Universities—an amendment of GASB Statement No. 34. When finalized, the GASB believes that this concept
statement will help to provide consistent reporting under its new financial reporting model.
Proposed GASB Statement, Pension Disclosures, an amendment of GASB Statements No. 25 and No. 27
This proposed Statement would amend the footnote disclosure and RSI requirements of GASB Statements No. 25 3
and No. 27 4 to conform with the requirements of GASB Statements 43 and 45. It is designed to improve the
transparency of pension information by state and local governmental plans and employers. For example:
•
For defined benefit pension plans, this proposed Statement would require the disclosure of information about the
funded status of the plan as of the most recent valuation date.
•
For defined contribution plans, this proposed Statement would require the disclosure of the methods and
significant assumptions used to estimate the fair value of investments, if that fair value is based on other than
quoted market prices.
•
Employers that provide or participate in defined benefit pension plans would be required to disclose, among
other matters, the legal or contractual maximum contribution rates, if applicable, for each plan in which they
participate.
The GASB currently anticipates that the final Statement would be effective for periods beginning after June 15, 2007,
although early implementation would be encouraged.
PwC Observation: As discussed above, the GASB issued its Statements 43 and 45 to provide guidance on
accounting and reporting for other postemployment benefits (OPEB) plans and employers. Generally, the guidance
in GASB 43 and 45 followed the approach the GASB had taken in its earlier Statements 25 and 27—they apply to
pension plans and employers. However, to improve accountability and transparency, the GASB decided that the
disclosures and RSI requirements of Statements 25 and 27 should be modified in several areas, which has
culminated in this Exposure Draft.
3
GASB Statements No. 25 is Financial Reporting for Defined Benefit Pension Plans and Note Disclosures for
Defined Contribution Plans
4
As noted earlier, GASB Statement No. 27 is Accounting for Pensions by State and Local Governmental Employers
23
Summary of Emerging Issues for Colleges and Universities in 2007
Proposed GASB Statement, Accounting and Financial Reporting for Intangible Assets
In December 2006, the GASB released this proposed Statement dealing with whether intangible assets should be
considered capital assets for financial reporting purposes. In general, the GASB proposes that an intangible asset
should be recognized in the statement of net assets only if it is "identifiable," meaning that either: "the asset is
capable of being separated or divided from the government and sold, transferred, licensed, rented, or exchanged,
either individually or together with a related contract, asset, or liability; or b. The asset arises from contractual or
other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights
and obligations."
Comments on this proposed Statement were due to the GASB by March 23, 2007. The requirements of this
proposed Statement would be effective for financial statements for periods beginning after June 15, 2009.
PwC Observation: This proposed Statement would apply to public colleges and universities in certain instances. In
its Appendix, the GASB provides an example of how a university might recognize an internally generated patent for
new fiber to close surgical incisions. In the example, the GASB concludes that the university should begin to
capitalize outlays associated with developing the new fiber.
Other GASB Guidance and Projects
GASB Question & Answer
At its July 2006 meeting, the GASB cleared the following question and answer intended to provide implementation
guidance for qualifying OPEB plan trusts. It is part of recent changes made to the GASB Comprehensive
Implementation Guide.
Q—For purposes of financial reporting in conformity with the requirements of GASB Statements 43 and 45, what are
the functions of an OPEB plan that is administered as a qualifying trust (or its equivalent)? Do Statements 43 and 45
specify the manner in which the plan's functions should be administered?
A—An OPEB plan is a trust or other fund through which assets are accumulated and benefits are paid. Additions
generally include contributions from the employer(s), plan members, and other entities. The trust's assets are usually
invested, and the resulting income is added to the trust. Deductions generally include benefits paid, or currently due
and payable.
Statements 43 and 45 do not specify how an OPEB plan should be structured administratively. However, if an OPEB
plan is to be considered a qualifying trust (or its equivalent), it must hold and manage its assets in trust for the
exclusive benefit of plan members and their beneficiaries, not as assets of the employer.
PwC Observation: Institutions with qualifying OPEB plan trusts should be aware of this question and answer.
Fund Balance Reporting
A GASB project will assess whether existing reporting requirements related to fund balance reporting adequately
meet the needs of financial statement users and will consider potential changes to improve the usefulness of fund
balance information. The project's scope includes a review of current governmental fund definitions in order to
determine if clarifications are needed to enhance users' understanding of the information presented in those funds.
The GASB issued an Invitation to Comment in October 2006—the comment period ended on January 31, 2007—and
then held a user roundtable in February 2007.
PwC Observation: This project would only be applicable to colleges and universities that use governmental fund
accounting. The GASB is currently anticipating an Exposure Draft in 2007 and a final Statement in 2008. For more
information on this project, visit the GASB's website at www.gasb.org.
24
Summary of Emerging Issues for Colleges and Universities in 2007
V. Regulatory Issues
In this section, we highlight issues affecting the regulatory environment as well as changes to the professional
literature and regulatory standards.
Changes to the Professional Literature and Regulatory Standards
Yellow Book 2007 Revision
In January 2007, the Government Accountability Office (GAO) posted to its web site (www.gao.gov) the 2007
revision to "Government Auditing Standards," also known as "GAGAS" or "the Yellow Book"). The 2007 revisions
were comprehensive and include:
•
Clarification of the use of terms "must," "should," and "may" when describing the auditor's responsibility
•
A new chapter on ethics
•
Adoption of AICPA Statement on Auditing Standards No. 112, Communication of Internal Control Related
Matters Noted in an Audit. The new definitions of significant deficiency and material weakness that have been
incorporated into the Yellow Book are likely to affect the auditor's risk assessment for major programs under
OMB A-133. They also are likely to affect the number and type of control deficiencies reported in Yellow Book
audits. The revised Yellow Book incorporates SAS 112 effective for financial statement audits conducted under
GAGAS for year-ends ending after December 15, 2006.
•
Additional disclosure requirements related to the restatement of previously issued financial statements (e.g.,
discussion of the specific internal control deficiencies that contributed to the restatement).
•
Expanded discussion of the use of "matter of emphasis "paragraphs in an auditor report (e.g., uncertainties
about an institution's financial future).
•
Many edits to "modernize" and incorporate since the last Yellow Book revision in 2003 current thinking
concerning best auditing practices.
•
Performance Audit Standards have been significantly expanded and updated.
The effective date of the 2007 revised Yellow Book is audits of periods beginning after January 1, 2008. However,
portions of Chapter 3, "the General Standards," remain in draft form. The GAO needed more time to consider
responses from the public accounting profession, regulators and other stakeholders related to audit quality and peer
review and issued another draft of these sections for public comment. Upon finalization of Chapter 3, printed
revisions of the Yellow Book will be available from the Government Printing Office.
PwC Observation: The changes to the Yellow Book are substantial. They reflect the changing audit environment in
which greater transparency and accountability are expected from auditors and institutions. Broadly, the proposed
Yellow Book revisions are part of the GAO's overall objective: "supporting the Congress and the nation in facing the
challenges of a rapidly changing world while addressing the nation's large and growing long-term fiscal imbalance." 5
New AICPA Auditing Standard
As noted above and reported in a previous section of this publication, the AICPA has replaced its Statement on
Auditing Standards (SAS) 60 with SAS 112, Communication of Internal Control Related Matters Noted in an Audit.
The new SAS incorporates the Public Company Accounting Oversight Board's (PCAOB's) definition of significant
5
GAO's Strategic Plan: 2004-2009, page 1.
25
Summary of Emerging Issues for Colleges and Universities in 2007
deficiency and material weakness from the PCAOB's Auditing Standard No. 2, An Audit of Internal Control over
Financial Reporting Performed in Conjunction with an Audit of Financial Statements.
This new SAS will impact the audits of colleges and universities as well as other types of organizations that require
an audit under the Yellow Book. It will also impact grant audits conducted under various state regulations, because
some states follow the federal reporting guidelines. OMB and federal agencies have been considering the impact of
SAS 112 on OMB Circular A-133 and specific federal agency program audit regulations and guides.
PwC Observation: The revised Yellow Book standards that incorporate SAS 112 definitions may result in more
internal control-related findings being reported to management and audit committees, including more significant
deficiencies or material weaknesses. Although there are no plans to open A-133 for amendment at this time, an
AICPA task force recommends that OMB also adopt the SAS 112 definitions of significant deficiency and material
weakness interpretation as an interpretation of OMB A-133.
Yellow Book CPE Update
In April 2005, the Government Accountability Office (GAO) issued Guidance on GAGAS Requirements for Continuing
Professional Education, a revision to its 1991 Interpretation of Continuing Education and Training Requirements.
This revision substantially updates the topics that are eligible for continuing education credit. The basic 80-hour and
24-hour rules remain. However, the new guidance creates a partial exemption for auditors who are involved only in
performing fieldwork but not involved in planning, directing, or reporting on the audit or attestation engagement, and
who charge less than 20 percent of their time annually to audits and attestations conducted in accordance with
Government Auditing Standards.
Guidance on GAGAS Requirements for Continuing Professional Education is available electronically at:
http://www.gao.gov. (Scroll down and click on "Yellow Book.")
PwC Observation: Many individuals who in previous years did not need to meet the 24-hour rule will now be
required to meet it. The GAO says about the CPE requirements: Audit and attestation engagements should be
"performed by a team that, taken as a whole, possesses the technical knowledge, skills, and experience necessary to
be competent for the type of work being performed. The success of an audit organization in carrying out its mission
depends on having a competent, well-trained staff."
OMB A-133 Compliance Supplement
OMB is currently drafting the 2007 Compliance Supplement, which is expected to be issued in the second quarter of
2007. Significant changes anticipated include:
•
Various program updates to approximately 60 individual Catalog of Federal Domestic Assistance (CFDA)
sections in part four
•
No significant changes to the fourteen compliance requirements in part three
•
No significant changes to the Research and Development cluster in part five
•
An addition to the Student Financial Aid cluster (SFA) of two new grants 84.375 ("Academic Competitiveness
Grant") and 84.376 ("National Science and Mathematics Access to Retain Talent Grant" or "National Smart
Grant"). These are campus-based programs with specific eligibility criteria
•
Several other technical updates made through out the SFA cluster, including changes in the timing of return of
funds
•
A new statement included in the SFA cluster concerning audit sampling; "Samples of transactions selected for
audit must be representative of the universe of transactions affecting all programs included in the cluster that are
administered by the auditee."
26
Summary of Emerging Issues for Colleges and Universities in 2007
•
A requirement that the "institution as a lender under the Federal Family Education Loan" (FFEL) program must
now be audited as a major program every year either as a part of the SFA cluster (if the SFA cluster is a major
program) or as a stand-alone program. The Compliance Supplement is expected to contain detailed compliance
requirements that auditors must consider in order to opine on this program.
PwC Observation: Institutions should review the 2007 Compliance Supplement when it becomes available with their
auditor to determine the impact of these changes on the scope of their 2007 A-133 audit. The Compliance
Supplement will be posted to OMB's website at www.whitehouse.gov/omb.
Current Regulatory Environment
Department of Health and Human Services (HHS)
1) Time and Effort Reporting
Time and effort reporting continues to be a challenging area, particularly for institutions that receive funding from
HHS. In most federal awards, personnel costs, including direct labor charges, fringe benefits and the related indirect
costs, represent by far the largest charges to the government. The HHS Office of Inspector General (OIG) and the
Department of Justice are aggressive in bringing charges for noncompliance with labor cost requirements and for
overcharging for labor costs on federal awards.
The OIG of HHS recently released its fiscal 2007 work plan, which sets the direction for the OIG's audits for the
coming year. Among the areas HHS OIG plans to focus on in FY'07 are the following:
•
Effort reporting: Are the institutions accurately reflecting the portion of researchers' efforts spent on grants
sponsored by the National Institutes of Health (NIH)?
•
Administrative and clerical salaries: Are institutions appropriately charging administrative and clerical salaries to
federally sponsored grants and cooperative agreements?
•
Cost transfers: Are cost transfers supported by documentation that fully explains the reasons for the transfer?
Have responsible grantee officials certified the correctness of the new charges?
•
Compensation of graduate students: Is compensation for graduate student researchers who receive tuition
remission as a component of compensation charged to NIH grants consistent with NIH guidelines? Note that
Congress has requested this review.
Regarding effort reporting, the OIG notes in its Work Plan Fiscal Year 2007 (at www.oig.hhs.gov): "…the growing
number of settlements under the False Claims Act regarding this issue indicates that some major research
universities continue to engage in practices that do not result in an equitable distribution of their employees' activities,
resulting in overcharges to NIH grants and a reduction in funds available for other research costs."
PwC Observation: Institutions that receive federal awards from HHS should pay particular attention to these areas of
audit focus. When HHS finds that institutions have not complied with effort reporting, multimillion-dollar repayments
and fines can be imposed.
Federal recipients should be reviewing their time and effort reporting systems—and strengthening them where
needed. Specific areas to address include, among others:
•
Timeliness of certification
•
Access of the person certifying the effort to a suitable means of verification
•
Accountability of time incurred at other related and unrelated entities
•
Reconciliation of actual effort to the effort committed via award documents
•
Review of central administration policies
•
Review of effort report formats for OMB A-21
In addition, symptoms of potential deficiencies in time and effort reporting systems might include:
27
Summary of Emerging Issues for Colleges and Universities in 2007
•
Missing or incomplete effort reports
•
A high volume of cost transfers
•
Multiple documents recording faculty effort
•
Incentive pay agreements
In particular, research institutions with characteristics such as the following should continue to be aware of the
potential risks associated with their time and effort reporting systems in the current environment:
•
"Collaborative" research agreements with other institutions
•
Rapid growth in clinical research
•
Recent system implementations
•
Closely affiliated Faculty Practice Plans
•
Pre- and postaward processes that are outdated and understaffed
•
Closely affiliated hospitals and research institutions.
2) HHS Grants Policy Statement
Recipients of awards from the various operating divisions of the HHS Public Health Service (PHS) look to the PHS
Grants Policy Statement, published in 1994, for guidance concerning the administration of those awards. Recipients
of awards from other HHS divisions must use numerous other sources to obtain information for those awards.
In October 2006, HHS issued a Grants Policy Statement (GPS), which supersedes the PHS Grants Policy
Statements. It is intended to make available in a single document the general terms and conditions of HHS
discretionary grant and cooperative agreement awards.
GPS is applicable to all HHS awards, except for NIH awards. The source of information concerning the
administration of NIH awards continues to be the NIH Grants Policy Statement, which is dated December 1, 2003. In
addition GPS does not apply to mandatory grant programs or awards to individuals, such as fellowships. Although
not completely finished, GPS has been posted (now dated January 2007) to the HHS Health Resources and Services
Administration web site at: http://www.hrsa.gov/grants/. It is effective for all new awards.
The GPS contains four parts:
I.
HHS Grants Process
II. Terms and Conditions of HHS Grant Awards
III. Points of Contact
IV. Specific information and Terms and Conditions for awards from HHS Operating Divisions with requirements that
supplement the information contained in parts I, II, III of GPS.
PwC Observations: This is a substantial document that, when completed, will allow for greater consistency in the
administration of federal awards from HHS.
National Institutes of Health (NIH)
1) NIH Tuition Reimbursement Policy
In August 2006, NIH issued a new policy concerning salary caps used in funding reimbursements for tuition and other
costs for graduate students and postdoctorial researchers. This policy change is necessary because reimbursement
requests from NIH award recipients continue to outpace the growth in the NIH budget over the last few years.
The policy will be piloted in fiscal 2007 and 2008 and then reevaluated based upon progress reports submitted in
fiscal 2008 and 2009. NIH stated the policy will be finalized and issued in fiscal 2010.
Details of the new NIH finding provisions can be found in the NIH Notice NOT-OD-06-090, which was released
August 4, 2006 at http://grants.nih.gov/grants/guide/.
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Summary of Emerging Issues for Colleges and Universities in 2007
PwC Observation: Although the changes to reimbursement caps will likely shift more costs to institutions, there are
also changes to the rebudgeting rules contained in the NIH Policy Statement that are favorable to institutions.
Office of Management and Budget (OMB)
1) Federal Award Reporting Requirements
OMB Circular A-110 Section 52 requires the submission of a "Financial Status Report (FSR)." Federal awarding
agencies establish the frequency of submission, generally not more than quarterly and at least annually. For
example, according to the NIH Grants Policy Statement, reports generally should be submitted within 90 days after
the close of the annual budget, except for awards under the NIH Streamlined Non-Competing Award Process (SNAP)
program, which requires an FSR to be submitted within 90 days of the end of the award or competitive segment.
Federal agencies are concerned with the higher delinquency rate associated with both financial and technical reports
because it has resulted in significant delays to award closeouts. This problem is pervasive throughout the research
industry and all federal agencies.
For instance, in 2004, HHS, NIH Office of Inspector General (OIG) and the National Science Foundation (NSF) OIG
issued reports detailing the magnitude of late reporting, which is in the double digits. The HHS and NSF OIG reports
include similar recommendations to NIH and NSF program management officials:
•
Develop automated reminder systems
•
Improve ability for electronic submission of documents
•
Focus more attention on late reporting
•
Consider withholding future funding until the researcher and/or organization is caught up on late reports
PwC Observation: Financial Status Reports may be late for many reasons. For example, reporting deadlines may
be too tight, especially for complex awards involving subrecipients. Also federal agencies sometimes cannot respond
in a timely manner to requests from institutions for additional information. However, federal agencies have been
known to withhold funding to principal investigators when the delinquency rate is particularly high. Institutions must
work with the federal agencies to strike a reasonable balance. The completeness and accuracy of reports should not
be sacrificed for better timeliness.
2) Late A-133 Reports
OMB A-133 audit reports are supposed to be submitted to the Federal Audit Clearinghouse (the "Clearinghouse") by
nine months after the auditee's year-end. An OMB advisory Task Force ("Task Force") has been studying the impact
of late A-133 reporting. The Task Force's preliminary conclusion is that late A-133 reports—even if they are late by
one day—should preclude an entity from being designated as a low-risk auditee. Also, obtaining an extension from
the cognizant or oversight agency should not preserve low-risk status. The Task Force has scheduled further
discussions before making its final recommendation to OMB. Several federal agencies believe nine months is a
sufficient amount of time. They are also concerned about the possibility that the reports are late because of
underlying management and internal control problems that may not be included in A-133 audit reports.
PwC Observation: Institutions should make every effort to submit their A-133 reports to the Clearinghouse on a
timely basis. If your institution has had difficulties in the past, we advise you to contact your auditor and work out a
plan to submit the FY'07 report on time.
National Science Foundation (NSF)
Policy on University Facility and Administrative Cost Rates
On July 7, 2006, NSF Associate Inspector General for Audits issued a memorandum ("the Memorandum ") to the
NSF Division of Institutions and Award Support in order to remediate an inconsistency between the NSF Grant Policy
Manual and OMB Circular A-21 concerning facility and administrative cost rates.
29
Summary of Emerging Issues for Colleges and Universities in 2007
•
In May 1996, OMB revised Circular A-21, Subpart G, to require that F&A cost rates in effect at the time of an
award be used for the entire life of the award.
•
In July 2005, NSF issued a revised version of its "Grant Policy Manual." This version of the Grant Policy Manual
did not include the OMB May 1996 revision to A-21 concerning use of F&A rates throughout the entire life of an
award.
The Memorandum states that NSF officials orally agreed to revise the NSF Grant Policy Manual to incorporate the
OMB May 1996 Circular A-21 revision to allow for the use of the F&A rate in effect at the time of the award for the life
of the award.
PwC Observation: Institutions following the current NSF Grant Policy Manual should consider how this change will
impact F&A recoveries on NSF awards, particularly if the institution's F&A rate has been increasing.
Export Regulations
The U.S. export laws continue to be a compliance concern for colleges and universities that are engaged in the
transfers of export-controlled technical data and research, as well as access of export-controlled technical data and
research from visiting foreign nationals. In December 2006, U.S. GAO issued a report to the House Committee on
the Judiciary regarding export controls in which it indicated that its risk assessment of selected universities suggested
a lack of clear understanding of export control laws and a failure to mitigate a university's risk accordingly. The
government will apply increased scrutiny to university-sponsored programs to assess and decrease potential risks
associated with the failure to report and apply for licenses where deemed exports are being transferred along with
fundamental research.
The report concluded that both the Commerce and State departments should strategically assess vulnerabilities in
the conduct and publication of fundamental research, in order to address findings that universities misunderstand
their obligations to self-regulate their potential to illegally transfer Deemed Exports. While the report indicated
governmental guidance and support has been minimal, universities still have an obligation to be self-compliant and
implement internal controls, such as strategic contracting, access controls and modifications in the ways in which
research is conducted in order to ensure their research programs do not compromise national security. The report
issued recommendations for the Commerce and State departments to increase vigilance and scrutiny of universities
conducting research—fundamental or otherwise—in accordance with existing export control regulations.
The deemed export rule states that a transfer of certain controlled source code or technology to a foreign national
located in the United States is deemed to be an export to the home country of that individual and is therefore subject
to U.S. export controls. To determine if the deemed export rule applies, universities must establish the reasons for
controls (i.e., national security, nuclear proliferation, etc.) associated with the technologies/source code and identify if
they apply to the home country of the foreign national. If the controls apply to the foreign national's home country,
colleges and universities in the U.S. may be required to secure export licenses from the Commerce or State
Department before they can transfer or give access of controlled technical data to the foreign national. Many
countries trigger licensing requirements, depending on the degree of control associated with the technical data and
the particular country involved. These countries can include so-called "business friendly" countries throughout the
world, as well as embargoed countries, such as Cuba and Iran, that are highly restricted.
Failure to obtain the required licenses can result in substantial civil and criminal penalties, including monetary fines,
loss of export privileges, reputation damage, and imprisonment.
PwC Observation: Certain types of research that qualify for the fundamental research and public domain exclusions
may be exempt from export controls, including the deemed export rule, if institutions meet the exclusions'
requirements. However, exemption from export controls requires careful analysis of the project activities and close
scrutiny of contract and project terms (e.g., publication restrictions) to avoid disqualifications, as well as diligent
compliance with several regulatory requirements.
30
Summary of Emerging Issues for Colleges and Universities in 2007
Other Issues
Federal Funding Accountability and Transparency Act
On September 26, 2006, President Bush signed into law the Federal Funding Accountability and Transparency Act of
2006. This bill requires the OMB to develop a searchable web site that taxpayers can access at no charge that will
enable them to determine certain information about the grants, contracts, loans and cooperative agreements their tax
dollars are funding. OMB can designate other federal agencies to assist in the development, operation and support
of the web site.
OMB must launch a pilot of the web site by no later than July 1, 2007. By January 1, 2008, OMB must launch a
searchable web site, which must include the grantee data for FY'07 but not subgrantees or subcontractors. By
January 1, 2009, the web site must include data for grantees as well as subgrantees and subcontractors.
Regarding the reporting of subawards, award recipients can allocate as indirect costs reasonable costs for the
collection and reporting of subaward data. OMB is supposed to minimize the burdens imposed on award and
subaward recipients the method for collecting information about subawards.
PwC Observation: Upon successful implementation of this Act, the general public will have easy access to detailed
information about the federal awards an institution is receiving and the tax dollars being spent on it.
National Single Audit Sampling Project
The Department of Education (ED) and several other federal agencies, including HHS, NSF, the Department of
Defense (DOD) and the Department of Housing and Urban Development (HUD), have designed a statistically valid
approach to performing quality control reviews of single audits. Congress has provided several million dollars to fund
this effort now called the National Single Audit Sampling Project. The quality control reviews conducted under this
project began in early 2005 and will likely be concluded in the first quarter of 2007. A report summarizing the results
of this initiative is expected to be provided to Congress as well as federal agency officials in 2007.
PwC Observation: The AICPA created the Governmental Audit Quality Center in order to promote and improve the
quality of audits conducted under Governmental Auditing Standards (the Yellow Book). Membership in this center is
voluntary and requires a CPA firm to adhere to several stringent audit quality practices. Presently the GAQC member
firms audit federal award recipients that account for approximately 80% of federal awards to not-for-profit
organizations that require a single audit. The GAQC web site: www.aicpa.org/gaqc includes more information
regarding Governmental Audits and Audit Quality.
31
Summary of Emerging Issues for Colleges and Universities in 2007
VI. Tax Issues
6
In this section, we address new tax matters for consideration by colleges and universities, including the IRS's exempt
organization guidelines for 2007. We also include information regarding compensation as well as partnerships and
international activities.
New Issues
The Pension Protection Act of 2006
The Pension Protection Act of 2006 (P.L. 109-280) was signed into law on August 17, 2006. While much of the new
law focuses on strengthening traditional pension plans and retirement benefits, it also creates significant new
charitable giving incentives and imposes tighter oversight of tax-exempt organizations. We discuss several of these
issues below.
1)
Public Disclosure of Form 990-T
Effective for returns filed on or after August 18, 2006, any Form 990-T filed by a section 501(c)(3) tax-exempt
charitable organization also must be available for public inspection under the same regime already applicable to the
Form 990. However, the Form 990-T will have to be obtained directly from the organization and cannot be obtained
directly from the IRS. Certain information may be withheld if public disclosure would adversely affect the institution,
such as trade secrets, patents, and so on.
2)
Payments to Controlling Exempt Organizations
Section 512(b)(13) generally provided that if an exempt organization received interest, annuity, royalty, or rental
income from a controlled organization, then the exempt organization had to treat such payment as unrelated business
income to the extent that the payment reduced the net unrelated income or increased the net unrelated loss of the
controlled entity, determined as if the entity were tax-exempt. Under the new law, section 512(b)(13) still will apply in
the majority of circumstances unless the payments were: 1) received or accrued after December 31, 2005 and before
January 1, 2008, and 2) were made pursuant to a binding contract (or renewal of one) that was in effect on
August 17, 2006. If payments satisfy these two requirements, only the portion of the payment that exceeds fair
market value will be includable in taxable income. Legislators intend to undertake further study of such arrangements
before making a determination of whether to extend or expand the provision to apply to a broader range of situations.
Additionally, all exempt organizations must report payments from controlled organizations, as well as loans to and
transfers with the controlled organization, on Form 990 for Forms due after August 17, 2006, excluding extensions.
Information that must be provided in the disclosure includes the name of the controlled entity, income description and
amount, and detail of loans and other amounts transferred. Because the Pension Protection Act was passed into law
after the 2005 Form 990 had been published, the Form did not include instructions regarding disclosure of such
payments. However, instruction is provided on the IRS's web site and is provided with the 2006 Form 990.
3) Contributions
The Pension Protection Act includes several provisions addressing charitable contributions, including:
•
Tax-free Distributions from IRAs for Charitable Purposes - Under the new law, a taxpayer who has attained age
70 ½ by the date the distribution is made may exclude from adjusted gross income up to $100,000 of otherwise
taxable IRA distributions or Roth IRA distributions that constitute qualified charitable distributions.
6
This document was not intended or written to be used, and it cannot be used, for the purpose of avoiding U.S.
federal, state or local tax penalties.
32
Summary of Emerging Issues for Colleges and Universities in 2007
•
Donations of Clothing and Household items - Taxpayers may generally take an itemized deduction equal to the
fair market value of clothing and household items donated to eligible organizations. The new law disallows a
deduction for charitable contributions of clothing and household items if such items are not in good condition or
better.
•
Recordkeeping Requirements - Under the new law, no deduction of any amount is allowed for a contribution by
cash, check, or other monetary gift unless the donor can show a bank record or a suitable written
acknowledgement from the donee organization.
•
Façade Easements - Qualified conservation contributions, including conservation and façade easements, are
partial interest contributions that are currently eligible for a fair market value charitable deduction. The new law
revises the rules for contributions of façade easements with respect to property in a registered historic district.
The provision disallows a deduction with respect to a structure or land merely because it is located within a
historic district, but continues to allow a deduction with respect to buildings.
4) Notification Requirement
Exempt organizations that normally have no more than $25,000 of gross receipts do not have an annual filing
requirement. Under the new law, such organizations must furnish annually, in electronic form, information regarding
basic contact and financial information, including evidence of the continuing basis for exemption from the filing
requirements. Failure to provide such notice for three consecutive years will result in the revocation of exempt status.
5) Donor Advised Funds and Supporting Organizations
The Pension Protection Act provides several new rules with respect to donor advised funds and supporting
organizations in response to perceived abuses of the exempt organizations by donors. The rules include further
defining both types of organizations and describing automatic excess benefit transactions that apply to them.
PwC Observation: Colleges and universities should educate themselves on the new rules and establish procedures
for their institution and related organizations that reflect the changes.
The Congressional Election and Its Potential Effect on the Tax-Exempt Community
In the November 2006 Congressional election, Democrats gained enough seats in both the Senate and House to
achieve a majority over Republicans. The specific effect that this change in power will have on tax policy as it
pertains to tax-exempt organizations remains unclear. However, given the recent scrutiny of the tax-exempt sector
by Congress, organizations should be ready to respond to any attention that Congress directs towards them.
1) In the Senate – A staff member for Finance Chairman Baucus (D-MT) indicated that "charity reform is very
important to Senator Baucus" and "he will continue to provide oversight with regard to nonprofit organizations."
During a recent oversight hearing on tax exemptions and incentives for higher education, Senator Baucus affirmed
that issues related to education were a priority for him and promised to focus on college affordability and student
access. He historically has worked in a bipartisan manner with previous Chairman Grassley (R-IA). In light of their
relationship, Senator Baucus may cooperate with Senator Grassley's pursuit of some of his issues as long as they do
not conflict with the Democrats' agenda for the Finance Committee. Senator Grassley has pushed for charity reform,
and his staff has indicated that it will continue to pursue exempt organization-related issues, including tax-exempt
hospitals, charitable governance, and executive compensation.
2) Loss of a Charity Advocate – Exempt organizations lost one of their strongest advocates on the Finance
Committee with the defeat of Senator Rick Santorum (R-PA). Senator Santorum had worked hard for increased
charitable giving incentives and generally served as a counterweight to Senator Grassley's scrutiny of charities.
Some of Senator Santorum's proposals for charitable giving incentives were enacted last August as part of the
Pension Protection Act of 2006.
3) In the House – On the other side of Capitol Hill, Chairman Rangel (D-NY) remains undecided about whether to
pursue charitable issues, according to staff of the Ways and Means Committee. Congressman Rangel has focused
on facilitating the Democrats' "Six for '06" legislative agenda, which prioritizes national security, jobs and wages,
energy independence, affordable healthcare, retirement security, and college access.
33
Summary of Emerging Issues for Colleges and Universities in 2007
PwC Observation: There are a number of previously proposed revenue-raising measures that would affect taxexempt entities. If Congress were to need revenue-raisers, some of these proposals could be revived, or Congress
could consider new revenue-raising measures that could affect exempt organizations. It is difficult to predict with
certainty the level of emphasis that Congress' members will place on issues affecting the tax-exempt community.
Nevertheless, the previous Congress increased its oversight of tax-exempt organizations in general, and it passed
several pieces of legislation that contained charity reform provisions and charitable giving incentives. The emphasis
of the previous Congress on oversight and reform should serve as a reminder for organizations to remain alert to
future oversight and the potential for legislative changes.
IRS Issues 2007 Exempt Organization Implementing Guidelines
On November 7, 2006, the Internal Revenue Service released its 2007 exempt organization ("EO") implementing
guidelines, that outline the IRS's work plan for fiscal year 2007. As noted in a letter from Lois G. Lerner, Director,
Exempt Organizations, that accompanied the release of the guidelines, the IRS EO Division began a transition toward
what it believes to be a more balanced approach between enforcement and customer service and education two
years ago. The letter further notes that the implementing guidelines support the IRS's strategic plan by focusing on
enhanced enforcement of the tax laws, improved customer service, education and outreach, and better business
processes through improved technology. For example, the IRS has begun to use "compliance checks" and
educational letters to reach more organizations than would be possible through resource-intensive examinations,
reserving its examination resources for high-risk noncompliance areas. In addition, with the passage of major pieces
of EO-related legislation this year, implementing and providing guidance on the new statutory provisions rank high on
the IRS's list of projects.
The following are highlights of the guidelines that apply to higher education institutions and their affiliates, which may
be found in their entirety at http://www.irs.gov/pub/irs-tege/fy07_implementing_guidelines.pdf.
1)
Unrelated business income: During fiscal year 2007, the IRS will develop a college and university unrelated
business income tax ("UBIT") project to review the current practices of calculating UBIT, including reviewing the
allocation of income and expenses to arrive at taxable income. The IRS plans to roll out the project in 2008.
2)
Employment taxes: In an effort to ensure that organizations report and pay employment taxes properly, the IRS
will initiate a project to identify potentially noncompliant organizations through its "Combined Annual Wage
Reporting Program." The IRS will use risk-modeling to help select productive employment tax cases for
examination.
3)
Tax-Exempt Bonds: The IRS is continuing to followup on its initiative to audit postissuance compliance of taxexempt bond issues. Initially, the IRS focused primarily on bonds issued by healthcare organizations. See Page
44 for more information on tax-exempt bonds.
4)
Forthcoming Guidance
The IRS EO Division, in conjunction with IRS Chief Counsel and the Department of Treasury, develops and regularly
issues guidance to taxpayers. In fiscal year 2007, the IRS's priority guidance plan includes:
•
Guidance on political activities by section 501(c)(3) organizations,
•
A revenue procedure on processing exemption applications that will replace Revenue Procedure 90-27 (setting
forth procedural rules for obtaining tax-exempt status),
•
Final regulations on the standards for revocation of tax- exempt status under sections 501(c)(3) and 4958
(commonly known as the intermediate sanctions excise tax),
•
Guidance on advance and definitive rulings for publicly supported organizations,
•
Guidance regarding supporting organizations (including Notice 2006-109 which was released on December 4),
•
Guidance with respect to the reasonable cause standard for penalties imposed on political organizations for
failure to comply with notice and reporting requirements,
•
Regulations under section 529 regarding qualified tuition programs,
34
Summary of Emerging Issues for Colleges and Universities in 2007
•
Guidance on the new section 4965 excise tax regarding the involvement of certain tax-exempt entities in
prohibited tax shelter transactions. (In February 2007, the IRS issued Notice 2007-18, stating that a tax-exempt
institution that merely invests in a partnership that engages in a listed transaction will not be subject to the new
section 4965 excise tax.)
In addition to the priority guidance, the IRS intends to work on other projects including:
•
Contacting organizations that met the electronic filing threshold, but failed to do so, and attempting to secure an
electronic return (or explanation as to why electronic filing is not applicable to the organization) prior to assessing
any penalties,
•
Continuing the Form 990 redesign project, with the goal of releasing a draft form and instructions for comment in
2007,
•
Emphasizing various education programs for the EO community, including the launch of an interactive webbased program that provides users with an understanding of how to maintain tax-exempt status and comply with
tax obligations.
Finally, the implementing guidelines state that in fiscal year 2007 the IRS will emphasize education and outreach in
the EO community. Consistent with this objective, the IRS will publicize the many expected guidance projects
through its electronic newsletter, the EO Update. Individuals can subscribe to this free service by visiting the IRS
website at http://www.irs.gov/charities.
PwC Observation: The implementing guidelines that include an extensive list of critical initiatives and priority
guidance projects suggest that the IRS will continue its focus on the tax-exempt sector in fiscal year 2007. Exempt
organizations should monitor future IRS guidance to determine its impact and continue to focus on compliance with
tax laws and regulations.
Form 990 Changes
Both the 2005 and 2006 Forms 990 include significant changes. Some of these changes were legislated as part of
the Pension Protection Act of 2006. Most of the changes are designed to provide greater transparency. The most
significant changes are in the areas of compensation and related-party transactions.
1)
Changes to the 2005 Form 990 (which is filed for calendar 2005 or fiscal year 2006) include:
•
For the first time compensation and benefits paid to former officers, directors and key employees must be
disclosed.
•
The threshold for reporting compensation paid to officers, directors and key employees and the five most highly
compensated other employees by related organizations has been reduced from $100,000 to $50,000. In
addition, the instructions have clarified who are related parties.
•
The Form now requires disclosure of both the five highest paid professional service providers and the five
highest paid other service providers.
•
There is a new question that requires organizations to disclose transactions among its officers, directors and key
employees, five most highly compensated employees, and the ten most highly compensated service providers.
•
Detailed descriptions of loans to officers, directors and key employees have always been required, but now, the
Form 990 also requires detailed information regarding loans to former key employees and to all other employees.
•
Form 990 requires organizations to detail the allocation of their expenses among program, management and
general, and fund-raising. Compensation paid to officers, directors and key employees in the aggregate was
allocated among these three categories. The Form now requires this allocation to be done for each current and
former officer, director and key employee individually.
•
If an organization's Form 990 had an original due date after August 17, 2006 it will be required to provide
information regarding interest, rent and royalties paid by a controlled organization to them.
35
Summary of Emerging Issues for Colleges and Universities in 2007
PwC Observation: Organizations need to carefully consider their responses to the new questions on Form 990.
Organizations should revisit their approach to disclosure of related party transactions. They should reconcile their
responses to the new related party transactions question with their responses to the existing related party question to
be certain that the organization has taken a consistent approach. Organizations should also consider how they will
gather the information required to respond to this new question. Since allocating key employee compensation by
individual to the three functional expense categories is new, it is important for organizations to be comfortable with
how these amounts have been determined for each of the current and former officers, directors, and key employees.
Organizations need to consider how they will disclose loans to non-key employees. As indicated above, the
instructions call for detailed disclosure, including the name of the individual and the specific terms of the loan. It is
not uncommon for universities to offer loan programs to non-key employees (home mortgage loans, shared
appreciation loans, relocation loans, etc.). Institutions should consider carefully how they will disclose this
information.
2)
Changes to the 2006 Form 990 (which is filed for calendar 2006 or fiscal year 2007) include:
•
If an organization files at least 250 returns and has total assets of $10 million or more it must file Form 990
electronically in fiscal year 2007 (For fiscal year 2006 the asset threshold was $100,000,000).
•
The definition of a related organization for purposes of completing Form 990, Part V-A, Line 75c has been
clarified by the listing of eight specific categories of related organizations.
•
New disclosure is required for compensation and other distributions to disqualified persons who are not
otherwise officers, directors, trustees, or key employees. In this regard, compensation and other distributions
provided to disqualified persons must be listed on Form 990, Part II, Line 25c. "Compensation" includes all
forms of income earned or received for services provided. Distributions include anything of value provided to a
disqualified person.
•
Compensation reporting for officers, directors, trustees, and key employees has been expanded. For the
organization's Statement of Functional Expenses, compensation must now be reported separately for current
officers, directors, trustees and key employees (Form 990, Part II, Line 25a) and former officers, directors,
trustees, and key employees (Form 990, Part II, Line 25b).
•
Consistent with the requirements imposed by the Pension Protection Act on organizations that have an initial due
date for their 2005 Form 990 after August 17, 2006, and all organizations filing the 2006 Form 990, there is new
disclosure around transfers made to and from controlled entities as defined in IRC § 512(b)(13). Organizations
must disclose whether they directly or indirectly owned a controlled entity within the meaning of IRC § 512(b)(13)
(i.e., the organization owned more than 50 percent of the stock of a corporation, interest in a partnership, or
beneficial interest in any other entity).
•
A supporting organization will be required to file Form 990 even if its gross receipts are normally $25,000 or less.
A supporting organization is also required to certify that it should not be regarded as a private foundation
because it meets the requirements of IRC § 509(a)(3) as a Type I, Type II, Type III functionally integrated, or
Type III other supporting organization.
•
Organizations must separately report travel and entertainment expenses paid for federal, state and local
government officials and their family members as an other expense (Form 990, Part II, Line 43).
•
The definitions of "disqualified person" and "excess benefit transaction" have been revised in the instructions to
incorporate the changes affecting supporting organizations and donor-advised funds made by the Pension
Protection Act.
•
Organizations maintaining donor-advised funds must separately report contributions to such funds and
distributions from such funds, as well as providing certain additional information.
•
Receivables from officers, directors, trustees, and key employees must now be separated on the balance sheet
between: 1) current and former officers, directors, trustees, and key employees, and 2) other disqualified
persons.
•
The balance of investments in securities must be separated between publicly traded securities and other
securities on the balance sheet.
36
Summary of Emerging Issues for Colleges and Universities in 2007
•
Disclosure regarding changes in activities has been broadened. An organization must now disclose whether it
changed its activities or methods of conducting such activities during the past three years that were not
previously reported to the IRS.
•
Organizations must report whether they were a party to a prohibited tax shelter transaction (as provided under
IRC § 4965).
•
Organizations must disclose whether they acquired a direct or indirect interest in certain insurance contracts after
August 17, 2006, but before August 17, 2008.
•
Organizations receiving or holding conservation easements must attach a detailed statement, including the
number, size, and type of such easements.
•
The instructions have been modified to include the modifications to the definition of gross investment income for
organizations certifying their public charity status under IRC § 509(a)(2).
•
IRC section 501(c)(3) organizations that file Form 990-T after August 17, 2006 must make that Form 990-T
subject to public inspection.
PwC Observation: Institutions should carefully consider their responses to the new questions on the Form 990 for
FY'07. In particular, institutions should focus on the compensation-related areas of the Form 990. Another critical
area is the disclosure about whether an institution was a party to a prohibited tax shelter transaction. Although we do
not expect many institutions to engage in such transactions, institutions that fail to disclose them will face the
possibility of significant fines and penalties.
Electronic Filing
The IRS continues to expand the number of tax-exempt organizations required to electronically file ("e-file") their
Forms 990. For tax years ending on or after December 31, 2006, the regulations require tax-exempt organizations
with total assets of $10 million or more ($100 million in 2005), who file at least 250 returns annually, to file Forms 990
electronically. In addition, private foundations and charitable trusts will be required to file Forms 990-PF electronically
regardless of their asset size, if they file at least 250 returns annually.
The "at least 250 returns" requirement, includes income tax, excise tax, employment tax, and information returns,
filed during the calendar year. All original returns filed by a tax-exempt organization during the calendar year are
counted. Corrected or amended returns are not counted. For example, if a tax-exempt organization has 245
employees, each Form W-2 and quarterly Form 941 is considered a separate return. Therefore, the organization files
at least 250 returns (245 W-2s; four 941s; and one 990).
If an organization that is subject to the regulations fails to file its Form 990 or Form 990-PF electronically, the
organization will be deemed to have failed to file the return. For institutions with gross receipts exceeding $1 million,
the penalty for nonfiling is $100 for each day the failure continues, up to a maximum of $50,000 per return. In
addition, the person responsible for nonfiling will be charged a penalty of $10 a day up to a maximum of $5,000,
unless he or she shows that not complying was due to reasonable cause.
Institutions will need to file their return using either the services of a professional tax preparer or an IRS-approved efile software provider. A list of approved e-file software providers can be found on the IRS web site at:
http://www.irs.gov. If an organization chooses to file its own return using an approved e-file software provider, it
may be required to file with the IRS for e-file services as a "large taxpayer." As part of the registration process, the
organization will have to designate at least two individuals at the organization as the "responsible officials" for e-file
purposes. The responsible officials will be required to supply the IRS with their adjusted gross income from their
current or prior year individual tax return for identification purposes. It is recommended that organizations complete
the registration at least 45 days before they plan to electronically file their return and register at least two "responsible
officials."
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Summary of Emerging Issues for Colleges and Universities in 2007
In addition to the Forms 990 and 990-PF, institutions may also file the extension, Form 8868, for these forms
electronically. Institutions that are not required to e-file can continue to file a paper return or file electronically. E-File
of amended and final returns will be available in 2007. Tax-exempt institutions should check with the appropriate
state agency to determine e-file requirements for state returns.
PwC Observation: Institutions that are subject to the e-filing requirement should consider well in advance of their
return's initial filing deadline whether they will use a tax professional to prepare the electronic return or if they will
prepare and file their own return. An organization that plans to prepare its own return should discuss electronic filing
options with its software vendor as soon as possible and take steps to register and apply for e-file services with the
IRS. Organizations should also identify at least two individuals within the organization who will serve as the
"responsible officials" for e-file purposes. Since the e-filing specifications do not allow attachments other than those
prepared with the e-filing software, it will be important for institutions that have not e-filed previously to determine how
they can transfer data onto the returns and prepare required schedules in the most effective manner.
Telephone Tax Refund
In May 2006, the Internal Revenue Service announced it would stop collection of the long-distance telephone excise
tax beginning August 1, 2006. The IRS further announced that it would allow individuals, businesses and tax-exempt
organizations to obtain a refund for long-distance excise taxes billed after February 28, 2003. This refund is available
as a one-time payment on the 2006 income tax return.
Tax-exempt organizations may calculate their refund request using either: 1) the actual amount of the refundable
long-distance telephone excise tax paid; or 2) a formula developed by the Internal Revenue Service. The formula
method was adopted after the IRS received public input about the burden associated with the actual amount method.
Under the formula method, organizations can figure their refund by comparing their April 2006 and September 2006
phone bills to determine the percentage of their telephone expenses attributable to the long-distance excise tax.
Once a method is selected it must be used for the entire refund period.
The refund is capped at two percent of phone expenses for small businesses (250 or fewer employees) and one
percent for large business (more than 250 employees). When determining business size, organizations should use
the number of employees for the pay period that included June 12, 2006 (Line 1, Form 941 for the 2nd calendar
quarter of 2006). Interest is added to the refund amount.
The telephone excise tax refund can be requested by filing the 2006 Form 990-T, Exempt Organization Business
Income Tax Return, and attaching Form 8913, Credit for Federal Telephone Excise Tax Paid. The 2006 Form 990-T
will include a new line (44f) on which the taxpayer can claim the refund. The Form 990-T can be utilized to claim the
credit regardless of whether the organization has unrelated business income to report.
Due to the recent passage of the Pension Protection Act, a Section 501(c)(3) organization must allow for public
inspection of its Form 990-T after August 17, 2006. If an organization files a 2006 Form 990-T to report unrelated
business income and claim the telephone excise tax refund, Form 8913 will be subject to public inspection. However,
if the Form 990-T is used only to request a refund of the telephone excise tax, the Form 990-T and Form 8913 are not
subject to the public inspection requirements.
PwC Observation: Organizations should review their files to determine if they have access to the information
necessary to complete the calculation. If an organization would like to calculate its refund using the actual amount
paid method, it will need to have copies of 41 months of phone bills. Organizations should also determine if they
would like to prepare their own refund request or use a paid tax preparer to prepare the calculation.
38
Summary of Emerging Issues for Colleges and Universities in 2007
Compensation-Related Issues
Executive Compensation and Excess Benefit Transactions
Executive compensation at educational institutions continues be a focus of Congress, the IRS, the media, donors and
others. In December 2006, the Senate held hearings with respect to the tax status of educational institutions. Then
Chair of the Senate Finance Committee, Senator Grassley, indicated concern with the amount of compensation paid
to the presidents and other senior officers at educational institutions. The media continued to report issues
surrounding executive compensation and benefits.
In August 2004, the IRS announced the tax exempt compensation enforcement project. The goal of this initiative is to
identify and halt abuses by tax-exempt institutions that pay excessive compensation and benefits to their officers and
other insiders. The IRS has reported its findings from that initiative and more information can be found on the IRS'
web site.
Failure to appropriately report compensation could result in intermediate sanctions even if the compensation is
otherwise reasonable. Institutions should implement procedures to establish a rebuttable assumption of
reasonableness for the compensation paid to their key employees. The establishment of a rebuttable presumption of
reasonableness puts the onus on the IRS to prove that compensation is unreasonable. If contact is initiated,
questions will be directed toward establishing whether the institution's procedures met these criteria.
A rebuttable presumption of reasonableness is established if the institution meets the following three requirements: 1)
the compensation and benefits (especially deferred compensation plans) must be approved by the organization's
governing board, which must be comprised of persons who do not have a conflict of interest, 2) the governing board
must rely upon appropriate data (i.e., comparables) in deciding whether to approve the compensation and benefits,
and 3) the governing body must document its actions (usually in the board's minutes).
PwC Observation: Institutions should make sure that their policies and procedures are sufficient to establish a
rebuttable presumption of reasonableness as described above. Because documentation is essential for establishing
a rebuttable presumption of reasonableness and because it has been a primary focus of the IRS, documentation
should be an area of focus for tax-exempt institutions. Institutions also should consider other leading practices for
executive compensation, including:
•
Establishing a compensation committee;
•
Developing a formal process to determine executive compensation; and
•
Reporting compensation completely and accurately.
Nonqualified Deferred Compensation Plans of Tax-Exempt Institutions Affected by IRC §409A
Nonqualified plans maintained by tax-exempt employers are typically governed by IRC §457(f) of the Code. In this
type of plan, amounts owed to an employee are taxed when there is no longer a substantial risk of forfeiture. Under
IRC §457(f), a substantial risk of forfeiture exists when an employee must perform substantial future services in order
to receive the compensation.
IRC §409A further addresses nonqualified deferred compensation and it applies to employees of both tax-exempt
and taxable institutions. It has added an additional level of complexity to nonqualified deferred compensation plans.
Generally for tax-exempt institutions, IRC §409A applies after the first possible vesting date for compensation subject
to IRC §457(f). The rules under IRC §409A are more restrictive than those of IRC §457(f). Under IRC §409A,
agreements not to compete and/or a rolling risk of forfeiture may not qualify as a substantial risk of forfeiture. IRC
§409A applies when the payment of compensation that is earned and vested in one tax year is delayed and paid in a
later year. This may occur if institutions and employees agree to extend the vesting date beyond the original date. At
this time, the concern is that because a "covenant not to compete" does not qualify as a substantial risk of forfeiture,
IRC §457(f) plans with such a covenant as the only substantial risk of forfeiture may be immediately subject to the
IRC §409A rules.
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Summary of Emerging Issues for Colleges and Universities in 2007
The consequences of an agreement not conforming to the rules under IRC §409A are severe. All compensation
deferred under the plan will become subject to federal income tax immediately and a 20 percent penalty on the
amount of includible compensation will be added if the failure is not corrected within the statutory and regulatory
guidelines. Because IRC §409A was implemented by The American Jobs Creation Act of 2004 and, therefore, is
relatively new, transition rules are in place to allow for amendments of agreements that do not meet the new
requirements. The IRS has extended the deadline for taxpayer compliance until December 31, 2007.
The only types of programs excluded from the new IRC §409A regime are qualified retirement plans (including IRC
§403(b)s, IRC §457(b)s, SEPs and IRAs), vacation, sick leave, compensatory time, bonus (if the bonus is payable
within 2 1/2 months of year-end) and disability and death benefit programs. Among others, severance programs are
not excluded from the definition and accordingly are potentially subject to IRC §409A.
Finally, there are additional operational and documentation requirements for nonqualified deferred compensation
plans. Failures in this regard will not accelerate taxation for IRC §457(f) plans, because taxation is delayed until the
substantial risk of forfeiture expires (when amounts would already be subject to tax). However, because a failure to
satisfy these additional rules may result in the imposition of penalty taxes in the amount of 20 percent of the
compensation includible, employers should review and amend their plans to assure compliance.
PwC Observation: Employers should take the following actions:
1. Inventory their plans.
Look at programs denominated as retirement plans as well as at employment agreements, severance policies, and
other cash-based benefit programs. The definition of nonqualified deferred compensation plans is very broad, and is
not limited to programs between employers and employees. Thus, programs for directors or trustees and
independent contractors would also be covered.
2. Review deferred compensation plans.
Once all deferred compensation plans are identified, they should be reviewed and amended, if appropriate.
Revisions to comply with the new IRC §409A can be made until the end of 2007. The consequence of failing to
"catch" and amend an affected plan may be current taxation of all amounts deferred for all years (as well as a 20
percent penalty tax when the amounts are included as compensation to the individual).
Expense Reporting
Similar to compensation, the IRS and the media are focused on situations where employees are being reimbursed for
personal expenditures and these amounts are not reported as compensation. Therefore, it is essential that
institutions make certain that their expense reporting procedures are adequate and are followed by both employees
and officers.
Expense reports should be submitted on a timely basis, and they should include adequate documentation in order to
satisfy the rules. Receipts must be provided together with the name of the individual(s) involved and the business
purpose for the expenditures.
Institutions also should establish appropriate policies regarding the approval and sign-off of expense reports
submitted by senior management. For example, the CFO might sign off as to the completeness of the President's
expense report and that it is in compliance with institutional policies. Trustees should periodically review the overall
level of expenses incurred by the senior management for reasonableness. Such actions protect both the
organization and senior management.
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Summary of Emerging Issues for Colleges and Universities in 2007
PwC Observation: Institutions must establish adequate policies and procedures for reimbursing and documenting
business expenses. They also should be aware that some "expenses" may constitute additional compensation.
Institutions must identify and appropriately report additional compensation received by key employees through the
reimbursement of nonbusiness-related expenses. Additional compensation that is not considered when establishing
a rebuttable presumption of reasonableness may result in an automatic excess benefit transaction under Intermediate
Sanctions. Therefore, we recommend that the board consider all forms of compensation, including the
reimbursement of personal expenses, when considering whether their key employees are receiving reasonable
compensation.
Cellular Telephones and Other Listed Property
Increasingly, organizations are providing their employees with cellular telephones and other electronic equipment
(e.g., personal digital assistants or PDAs) to improve employee accessibility during periods of time that they are not in
the office. In addition, over the past few years, cell phone plans have become much more affordable and
organizations are now issuing cell phones and other electronic equipment to a broader population of employees.
Similar to automobiles, such electronic equipment is considered "listed property." The Internal Revenue Code and
regulations explicitly set forth special documentation rules for listed property. The Code and regulations require
employers to follow burdensome documentation rules when reimbursing employees for expenses associated with
listed property. For example, an employee must identify the date of the call, the length of the call, and the business
purpose for the call. The employee must either submit the documentation to his/her employer or retain the
documentation and regularly attest to the employer the amount of business/personal use. IRS personnel have stated
at conferences and meetings that they will examine compliance with listed property rules when they audit
organizations and examine compensation reporting. They have indicated that they will not initiate an audit to review
only cell phone use but if they are auditing an organization on compensation issues they will look at compliance with
cell phone documentation.
Many organizations have chosen to reimburse and/or charge employees for the use of electronic equipment in ways
that attempt to approximate a reasonable amount for personal use but that do not strictly comply with the
documentation requirements for listed property.
PwC Observation: The IRS has posted its cell phone policy on its web site demonstrating that it takes these rules
seriously. Institutions should consider the impact of these rules on their accountable plan policies and the potential
exposure to Intermediate Sanctions.
Items of Continuing Interest
Investments in Partnerships
Colleges and universities continue to diversify their endowment holdings through the use of alternative investments,
particularly limited partnership investments. When an organization invests in a partnership, the organization must
"look through" the partnership to the underlying activities to determine whether those activities would be subject to tax
or reporting had they been engaged in directly by the tax-exempt organization. This "look through" concept applies to
all of the tax and reporting obligations described below including:
•
Unrelated business income (federal and state)
•
Reportable transactions (federal and state)
•
Reporting of certain holdings in, and transfers to, foreign entities
While this discussion focuses on partnership investments, it is important to note that all of the tax and reporting
obligations listed above and described in detail below can arise outside of the partnership structure as a result of
activities engaged in directly by the organization.
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Summary of Emerging Issues for Colleges and Universities in 2007
1) Unrelated Business Income
An investment in a limited partnership by a tax-exempt organization may give rise to federal and state unrelated
business income (UBI) tax, regardless of the tax status of the other partners. The test here, as in all other UBI
determinations, goes to the nature of the activity pursued by the partnership. If the partnership is involved in an
activity that would be an unrelated trade or business activity if it were directly carried on by the organization,
participation by the organization in such a partnership does nothing to change the character of the activity carried on
by the partnership. Therefore, an organization's allocable share of gross income from a partnership pursuing an
unrelated activity constitutes UBI.
Although a partnership's revenue may be from passive investments, a percentage of its income may be unrelated if
there is debt financing. In addition, the partnership's activities may create state tax nexus for its partners that may result
in a state UBI tax liability for the tax-exempt organization. Over 35 states impose a tax on UBI.
2) Reportable Transactions
The reportable transaction regulations promulgated by Treasury (Treas. Reg. §1.6011-4) require disclosure of
reportable transactions entered into on or after February 28, 2003. These regulations are applicable to tax-exempt
institutions. A number of states have also introduced requirements where institutions that are filing reportable
transactions at the federal level may also have to file with certain states. At least seven states (CT, CA, NY, IL, WV,
UT and MN) require a separate state filing for reportable transactions.
The American Jobs Creation Act of 2004 added substantial penalties (up to $200,000) that generally cannot be
waived for failure to comply with the regulations. The penalty for failure to properly report a listed transaction
(described below) is $200,000 and the penalty for failure to properly report any other reportable transaction is
$50,000. The $200,000 penalty may not be waived. The $50,000 may be waived only if "rescinding the penalty
would promote compliance with the requirements of this title and effective tax administration" (IRC §6707A (d)).
Unfortunately noncompliance cannot be cured by refiling a tax return with the necessary disclosure attached.
The first category is listed transactions, which are transactions that the IRS has specifically identified along with
substantially similar transactions.7 Because tax savings generally represent a significant part of the economic
benefit, it is not likely that tax-exempt institutions would intentionally or directly engage in these transactions since
they would not benefit from the tax savings. It is possible, however, that a tax-exempt organization might be involved
in a listed transaction as an intermediary or through an investment in a limited partnership. The IRS now permits
partnerships to report certain listed transactions on behalf of their partners.
Institutions should be alert to potential issues if they are approached to act as an intermediary in a tax-motivated
transaction. Also, exempt institutions may indirectly engage in listed transactions when they invest in a limited
partnership, and they must disclose these transactions.
The second category is confidential transactions. These are transactions in which the taxpayer signs an agreement
with a paid advisor not to disclose the income tax treatment or structure of the transaction. Since most tax-exempt
institutions would not benefit substantially from income tax savings, we have not seen tax-exempt institutions involved
in confidential transactions.
The third category is transactions with contractual protection where the taxpayer's fees are contingent upon realizing
the intended tax result. This category applies only to income taxes. Therefore, a contingent fee arrangement with
respect to a claim regarding employment taxes is not covered by this category.
The fourth category is excessive loss transactions. Two types of transactions are included in this category. The first
type is capital loss transactions where the deductible loss per transaction exceeds $10 million in a single year ($20
million in a combination of tax years) for a taxpayer that is a corporation. When the taxpayer is an individual or a
trust, a deductible loss per transaction in excess of $2 million in a single year ($4 million in a combination of tax
years) must be reported.
7
The IRS has created a web site on which current reportable transactions and other tax shelter information is
summarized: http://www.irs.gov/businesses/corporations/. Click on "Abusive Tax Shelters and Transactions."
42
Summary of Emerging Issues for Colleges and Universities in 2007
The second type is loss from currency transactions under IRC §988. When the taxpayer is a corporation, IRC §988
losses in excess of $10 million must be reported. When the taxpayer is an individual or a trust, IRC §988 losses in
excess of $50,000 must be reported. Some tax-exempt entities that have invested in limited partnerships that are
engaged in foreign currency hedging have received information from the partnerships regarding the potential need to
disclose such transactions.
The fifth and final category is transactions where the taxpayer holds an asset for a brief period (45 days or less) and
claims a tax credit of more than $250,000. Again, it is not likely that tax-exempt institutions will enter into such
transactions.
3) Enhanced Foreign Reporting Requirements
Over the last few years, more reporting requirements have been established for institutions that engage in certain
transactions with foreign partnerships and foreign corporations. Penalties are associated with the failure to satisfy the
filing requirements.
a) Certain Holdings in, and Cash Transfers to, Foreign Corporations - Form 926 and Form 5471
Tax-exempt institutions that make certain transfers to a foreign corporation and/or hold certain interests in a foreign
corporation are required to report these activities to the IRS on Form 926 and/or Form 5471. Transactions that
require disclosure on Form 926 include transfers of more than $100,000 to a foreign corporation during any twelvemonth period that ends within the organization's fiscal year. In addition, certain direct or indirect holdings in a foreign
corporation of ten percent or more may require reporting on Form 926 and/or Form 5471. These reporting
requirements most commonly occur when an organization invests in a partnership that invests in a foreign
corporation.
b) Investments in Foreign Partnerships - Form 8865
Tax-exempt institutions that make certain transfers to a foreign partnership and/or hold certain interests in a foreign
partnership are required to report these activities to the IRS on Form 8865. Transactions and holdings that require
disclosure include transfers of more than $100,000 to a foreign partnership during any twelve-month period that ends
within the organization's fiscal year, holdings of more than ten percent in a foreign partnership, and holdings in a
foreign partnership that drop below ten percent.
PwC Observation: It is important for colleges and universities to institute appropriate policies and procedures to assess
and manage the federal and state tax obligations and the reporting obligations that arise from partnership investments.
This includes having a process in place to inform those who are responsible for tax planning when the organization is
considering entering into a partnership investment so that it can be reviewed for potential tax and reporting implications.
The organization should maintain a master list of all partnership investments to ensure that it receives a Schedule K-1
for each investment on an annual basis. The Schedules K-1 should be reviewed when they are received to determine if
any of the following arise.
•
UBI, both Federal and State: Estimated tax payments should be made if UBI is generated. Federal UBI should
be annually reported on Form 990-T. Many states also impose a tax on UBI. Therefore, it is important for
institutions to determine in which states they have state tax filing obligations.
•
Foreign Reporting Requirements: These requirements are frequently overlooked by tax-exempt institutions.
These reporting requirements are occurring more frequently since many investment vehicles have moved
overseas to avoid generating UBI. Although tax-exempt institutions were not the primary target for the added
reporting, they are not exempt from the requirements. Therefore, compliance is important since penalties for
failure to comply are significant. Institutions should identify direct and indirect transfers to foreign partnerships
and foreign corporations to determine if reporting is required.
•
Reportable Transactions: It is important that institutions be aware of these rules as the penalties for failure to
report are extremely severe and, in many cases, are nonwaivable. In addition, the failure to file cannot be cured
by filing an amended return with the reporting attached. Therefore, it is critical that institutions are
knowledgeable about the rules and are diligent about reviewing transactions and investments when there is any
possibility that disclosure may be required.
43
Summary of Emerging Issues for Colleges and Universities in 2007
PwC Observation: To date we have observed that colleges and universities are most likely to encounter reportable
transactions in connection with partnership investments. Generally, the reportable transactions are in connection with
currency hedging but we have also seen references to listed transactions.
Because of the severe penalty regime, we recommend that institutions circulate a letter to the partnerships in which
they have invested, and ask them to confirm whether there are any reportable transactions resulting from the
investment. It is also important that determinations made on this issue are appropriately documented for future
reference.
Tax-Exempt Bonds
The Internal Revenue Service' continues its initiative to audit tax-exempt bonds. Prior initiatives in this area had been
hampered by the difficulty the IRS had in coordinating efforts between the exempt institutions and financial services
groups. The targets for review were questionable bond transactions and postissuance compliance. Most of the
audits were opened at healthcare organizations. There has been little publicity surrounding these audits and the IRS
has not issued any comments as to how the audits are proceeding.
Tax-exempt bonds will lose their tax-exempt status if both the private use and private payment limitations are
exceeded. Private use occurs when bond-financed property is used in the trade or business of an entity that is not
tax-exempt. Private payments are revenues generated from private use. For private institutions, the limitation on
private use and private payment is five percent. For not-for-profit governmental institutions, the applicable limitation
is ten percent. The private use/private payment limitations are reduced to the extent that proceeds are used for
issuance costs. Up to two percent of bond proceeds may be used to fund issuance costs.
At the time of issuance, bond counsel would have engaged in a detailed review of all of the anticipated uses of and
contracts associated with the financed facilities. Institutions need to review any postissuance changes in the use of
financed facilities. The agreements should be reviewed to determine whether there will be private use/private
payments as a result of the new agreements. "Qualified management contracts" will not result in private use (see
Rev. Proc. 97-13). The IRS will work with institutions to resolve violations of these rules where appropriate.
PwC Observation: Institutions should review any changes in the use of bond-financed facilities subsequent to the
issuance of tax-exempt debt to determine if there is private use in excess of the allowable limits. Any proposed
contracts that involve the use of bond-financed space should be reviewed for compliance.
International Activities
Increasingly, colleges and universities are engaging in collaborations with institutions in foreign countries. These
collaborations may include joint education and/or sponsored research programs as well as consulting arrangements.
Some involve the granting of dual degrees within the foreign jurisdiction. Although colleges and universities may be
considered tax-exempt institutions for United States income tax purposes, they may be subject to taxes and a variety
of reporting requirements in foreign jurisdictions.
Various issues may arise as a result of foreign activities. For example, intellectual property may be developed out of
these collaborations which could result in foreign tax implications when the funds are repatriated. If employees work
in the foreign jurisdiction for periods ranging from a couple of days to well over a year, they also could be subject to
taxation in the foreign jurisdiction.
Institutions should review the specific facts to determine whether their activities result in income tax nexus in the
foreign jurisdiction. In addition, tax treaties should be reviewed as they may be applicable. There may also be
withholding and other taxes and reporting requirements associated with the activities. If there are tax liabilities
associated with the foreign program, it may be possible to negotiate for the foreign collaborator to assume
responsibility for any tax liability and for the institution to receive its payment net of tax.
44
Summary of Emerging Issues for Colleges and Universities in 2007
PwC Observation: It is important for institutions to understand the tax and registration requirements related to
proposed activities in advance of entering into agreements. Upfront planning is important not only to assure tax
compliance in the foreign jurisdiction, but also for the institution to properly assess the economic results of the project.
To control costs and avoid lengthy negotiations, institutions need to develop policies and procedures for
compensating employees on international assignments.
Treatment of Royalty Payments to Faculty and Researchers
Institutions typically require that researchers transfer to them all rights to inventions and technology that they develop
during their employment. Institutions generally have an arrangement that provides for the sharing of proceeds
generated by the licensing or assignment of patent rights or intellectual property among the various parties, including
the institution, the individual, and the department in which the individual works.
The question has been whether the proceeds that a researcher receives from such an arrangement are considered
compensation for services or royalty income. The Internal Revenue Service determined that the payments were not
compensation for services but rather were payments related to the transfer of property. The development of
technology was not considered a "work for hire." Payments resulting from the development of such technology are
therefore not wages. As a result, the recipient of royalty payments associated with the licensing or assignment of a
patent may be entitled to report the payments as capital gain and the organization would report the income to the
individual on Form 1099-MISC and not on their Form W-2.
PwC Observation: Institutions should review their intellectual property-sharing agreements to assure compliance
with the facts set forth in the Technical Advice Memorandum (TAM) 117258-02.
Nonresident Alien Withholding
The withholding rules for wages paid to nonresident alien employees changed for payments made after January 1,
2006. Employers are no longer required to withhold an additional $7.60 from nonresident alien employees on a
weekly payroll. Instead, for purposes of calculating income tax withholding only, employers are required to add an
additional $51 to the weekly wages of such employees. This additional amount is not included in the employees'
Forms W-2 at year-end. This change requires that all nonresident alien employees complete a Form W-4 and
indicate "NRA" on line 6 of the Form. The IRS' intent in making this change was to minimize the amount of
overwithholding on amounts paid to nonresident aliens.
PwC Observation: Institutions should obtain Forms W-4 for nonresident alien employees. They also should review
their payment systems for compliance with the new regulations.
The information is provided as is, with no assurance or guarantee of completeness, accuracy, or timeliness, and without warranty of any kind,
expressed or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose. In no event will
PricewaterhouseCoopers LLP or its professionals be liable in any way to the reader or anyone else for any decision made or action taken in reliance on
the information or for any direct, indirect, consequential, special, or other damages related to the reader or the reader's use of the information, even if
advised of the possibilities of such damages.
© 2007 PricewaterhouseCoopers LLP. "PricewaterhouseCoopers" refers to PricewaterhouseCoopers LLP, a Delaware limited liability partnership or,
as the context requires, the network of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent
legal entity. *connectedthinking is a trademark of PricewaterhouseCoopers LLP.
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www.pwc.com/education
© 2007 PricewaterhouseCoopers LLP. “PricewaterhouseCoopers” refers to PricewaterhouseCoopers LLP, a Delaware
limited liability partnership or, as the context requires, the network of member firms of PricewaterhouseCoopers
International Limited, each of which is a separate and independent legal entity. *connectedthinking is a trademark of
PricewaterhouseCoopers LLP (US). BS-BS-07-0496-A.0207.SHC