GASB

Article Dean Dorton

Increased attention and scrutiny from the public, government agencies, and financial institutions have placed a greater emphasis on accountability, transparency, and risk management for colleges and universities and their foundations. One of the first steps to addressing this increased scrutiny is by developing a strong audit committee as part of your board of directors.

Audit committees can contribute through facilitating:

  • Accurate and timely financial reporting
  • Strong internal control environment
  • Compliance with laws and regulations
  • Management of operating risks

According to a 2011 Association of Governing Boards of Universities and Colleges (AGB) Survey of Higher Education Governance, 65% of the boards of independent institutions and 45% of public institutions had a separate audit committee. A 2010 AGB survey found 70% of college and university foundations had a separate audit committee. The industry has obviously recognized the need for the committee and in this newsletter we will discuss the committee’s purpose and responsibilities, who should be a member of a strong audit committee, and some best practices for effective audit committees.

Purpose and Responsibilities

The audit committee’s purpose is to provide oversight of the institution’s financial practices and standards of conduct. In the execution of this purpose, the committee has the following responsibilities:

  • Understand and provide oversight of accounting practices and the financial reporting process
    • The committees of private institutions must be aware of Financial Accounting Standards Board (FASB) regulations
    • Public institutions’ committees must be cognizant of Governmental Accounting Standards Board (GASB) standards
  • Oversee the internal audit function
    • Review the internal audit plan on an annual basis
    • Internal auditor should report their findings directly to the board
  • Selection and oversight of the external auditor
    • Review the performance of the external auditor
    • Ensure the independence of the external auditor
  • Review the financial statements
    • Review should include “management discussion and analysis”
    • Compare results with prior years
    • Analyze revenue and expense trends
  • Risk management
    • Understand the risks (operational, strategic, financial, compliance, and reputational) facing the institution
    • Assess whether those risks will prevent the institution from fulfilling its strategic objectives
  • Compliance
    • Analyze the institution’s recognition of and reporting required under federal, state and local laws as well as contractual compliance

The depth and breadth of this list is further evidence of the need for a separate audit committee as part of the board of directors. The board as a whole simply would not have the resources to adequately carry out these responsibilities, whereas the smaller audit committee is dedicated to these six main objectives.

Composition and Structure

According to the Association of Governing Boards of Universities and Colleges (AGB), an audit committee generally has three to six members, but the exact number is dictated by the size of the organization. These members should serve staggered, multi-year terms (often three years) to promote continuity. Each member should have a general understanding of business and finance and be knowledgeable about key compliance issues and risks facing the institution. All members should also be independent of the institution. The institutions financial management team may attend meetings, but their role should be limited to that of a staff or support role. Ideally, the committee should include at least one member that is considered a financial expert. A financial expert should possess the following attributes:

  • Understand financial statements and accounting principles
  • Ability to apply these principles in relation to the review of accounting estimates, reserves, and accruals
  • Experience in the preparation and review of the financial statements
  • Understand internal controls and audit committee functions

Best Practices

Below is a list of audit committee best practices as outlined by the AGB:

  • Meet two to four times annually
  • Meet with the president, CFO, and internal auditor annually
  • Remain current with emerging accounting principles and practices
  • Review president’s expenses
  • Ensure management takes responsibility for the financial statements
  • Report to the board the following:
    • Technical issues uncovered
    • Legal environment, including any pending lawsuits
    • Compliance with regulations and contracts
    • Tax law changes that would affect the institution

Top Questions for the External Auditor, According to the AGB

  • How does the institution’s financial health compare to last year?
  • Did the auditor issue an “unmodified” opinion?
  • Were any internal control issues identified?
  • Were there any significant changes in accounting policies for this audit?
  • How comfortable is the auditor with management’s estimates?
  • Is there any evidence of fraud at the institution?
  • Were there any findings issued under a management letter?
  • Has any other auditing work been performed for the institution during the current year?
  • Are there any issues with management which the committee should be made aware?

 

Article written by Tom Smither, Supervisor of Assurance Services

Citations

Staisloff, Richard. “The Audit Committee”. AGB Effective Committee Series. 2011

Article Dean Dorton

Part 2 of 2

Part 2 in our series on GASB Statement 72 provides two example footnote disclosures; Example 1 is for a General Purpose Government and Example 2 is for a Defined Benefit Pension Plan. These examples are designed to assist with application of Statement 72.  These examples were pulled directly from Statement 72 and are purely for illustrative purposes only.

For questions regarding the GASB Statement 72, its application, or other measurement issues please contact Crissy Fiscus at cfiscus@deandortonstg.wpenginepowered.com or Simon Keemer at skeemer@deandortonstg.wpenginepowered.com.

View Crissy Fiscus’ Bio View Simon Keemer’s Bio

Background

Investment of public funds in Kentucky is governed by KRS 66.480, which provides limitations for the type of investments in which public funds may be invested. Example 1 is indicative of a disclosure for an agency in Kentucky following KRS 66.480. Defined benefit pension plans are not confined to the same investment limitations described in KRS 66.480; therefore Example 2 is a more robust application of the required disclosures required by GASB Statement 72.

Example 1—General Purpose Government

Facts and Assumptions

A city holds investments that are measured at fair value on a recurring basis. Because investing is not a core part of the city’s mission, the city determines that the disclosures related to these investments only need to be disaggregated by major type. The city chooses a narrative format for the fair value disclosures.

Illustrative Disclosure

The City categorizes its fair value measurements within the fair value hierarchy established by generally accepted accounting principles. The hierarchy is based on the valuation inputs used to measure the fair value of the asset. Level 1 inputs are quoted prices in active markets for identical assets; Level 2 inputs are significant other observable inputs; Level 3 inputs are significant unobservable inputs.

The City has the following recurring fair value measurements as of June 30, 20X1:

  • U.S. Treasury securities of $45 million are valued using quoted market prices (Level 1 inputs)
    • Corporate bonds of $12 million are valued using a matrix pricing model (Level 2 inputs).

The City also has a nonrecurring fair value measurement as of June 30, 20X1, for a closed performing arts hall that will no longer be used by the government and therefore is considered to be impaired. The hall has been written down from $5.6 million to $3.4 million based on an appraisal of the property (Level 3 inputs).

Example 2—Defined Benefit Pension Plan

Facts and Assumptions

A retiree pension defined benefit plan holds significant amounts of investments that are measured at fair value on a recurring basis. Because investing is a key part of the plan’s activities, the plan shows greater disaggregation in its disclosures. The plan chooses a tabular format for disclosing the levels within the fair value hierarchy. All of the derivative instruments are investments, not hedging derivative instruments.

Illustrative Disclosure

The Plan categorizes its fair value measurements within the fair value hierarchy established by generally accepted accounting principles. The Plan has the following recurring fair value measurements as of December 31, 20X1:

Investments and Derivative Instruments Measured at Fair Value ($ in millions)

Debt and equity securities classified in Level 1 of the fair value hierarchy are valued using prices quoted in active markets for those securities. Debt securities classified in Level 2 of the fair value hierarchy are valued using a matrix pricing technique. Matrix pricing is used to value securities based on the securities’ relationship to benchmark quoted prices. Commercial and residential mortgage-backed securities classified in Level 3 are valued using discounted cash flow techniques. Collateralized debt obligations classified in Level 3 are valued using consensus pricing.

Venture capital investments classified in Level 3 are valued using either a discounted cash flow or market comparable companies technique.

Private equity funds—international are valued as described in the following schedule, Note 6.

The valuation method for investments measured at the net asset value (NAV) per share (or its equivalent) is presented on the following table.

Derivative instruments classified in Level 2 of the fair value hierarchy are valued using a market approach that considers benchmark interest rates and foreign exchange rates.

Investments Measured at the NAV ($ in millions)

1 Equity long/short hedge funds. This type includes investments in 12 hedge funds that invest both long and short primarily in U.S. common stocks. Management of each hedge fund has the ability to shift investments from value to growth strategies, from small to large capitalization stocks, and from a net long position to a net short position. The fair values of the investments in this type have been determined using the NAV per share of the investments. Investments representing approximately 22 percent of the value of the investments in this type cannot be redeemed because the investments include restrictions that do not allow for redemption in the first 12 to 18 months after acquisition. The remaining restriction period for these investments ranged from three to seven months at December 31, 20X1.

2 Event-driven hedge funds. This type includes 3 investments in hedge funds that invest in approximately 60 percent equities and 40 percent bonds to profit from economic, political, corporate, and government-driven events. A majority of the investments are targeted at economic policy decisions. The fair values of the investments in this type have been determined using the NAV per share (or its equivalent) of the investments.

3 Global opportunities hedge. This type includes investments in 5 hedge funds that hold approximately 80 percent of the funds’ investments in non-U.S. common stocks in the healthcare, energy, information technology, utilities, and telecommunications sectors and approximately 20 percent of the funds’ investments in diversified currencies. The fair values of the investments in this type have been determined using the NAV per share (or its equivalent) of the investments. For one investment, valued at $8.75 million, a gate has been imposed by the hedge fund manager, and no redemptions are currently permitted. This redemption restriction has been in place for six months, and the time at which the redemption restriction might lapse cannot be determined.

4 Multi-strategy hedge funds. This type invests in 15 hedge funds that pursue multiple strategies to diversify risks and reduce volatility. The hedge funds’ composite portfolio for this type includes investments in approximately 50 percent U.S. common stocks, 30 percent global real estate projects, and 20 percent arbitrage investments. The fair values of the investments in this type have been determined using the NAV per share (or its equivalent) of the investments. Investments representing approximately 15 percent of the value of the investments in this type cannot be redeemed because the investments include restrictions that do not allow for redemption in the first year after acquisition. The remaining restriction period for these investments ranged from four to six months at December 31, 20X1.

5 Real estate funds. This type includes nine real estate funds that invest primarily in U.S. commercial real estate. The fair values of the investments in this type have been determined using the NAV per share (or its equivalent) of the Plan’s ownership interest in partners’ capital. These investments can never be redeemed with the funds. Distributions from each fund will be received as the underlying investments of the funds are liquidated. It is expected that the underlying assets of the funds will be liquidated over the next 7 to 10 years. Twenty percent of the total investment in this type is expected to be sold. However, the individual investments that will be sold have not yet been determined. Because it is not probable that any individual investment will be sold, the fair value of each individual investment has been determined using the NAV per share (or its equivalent) of the Plan’s ownership interest in partners’ capital. Once it has been determined which investments will be sold and whether those investments will be sold individually or in a group, the investments will be sold in an auction process. The investee fund’s management is required to approve of the buyer before the sale of the investments can be completed.

6 Private equity funds—international. This type includes two private equity funds that invest primarily in foreign technology companies. These investments can never be redeemed with the funds. Instead, the nature of the investments in this type is that distributions are received through the liquidation of the underlying assets of the fund. If these investments were held, it is expected that the underlying assets of the fund would be liquidated over five to eight years. However, as of December 31, 20X1, it is probable that all of the investments in this type will be sold at an amount different from the NAV per share (or its equivalent) of the Plan’s ownership interest in partners’ capital. Therefore, the fair values of the investments in this type have been determined using recent observable transaction information for similar investments and nonbinding bids received from potential buyers of the investments. As of December 31, 20X1, a buyer (or buyers) for these investments has not yet been identified. Once a buyer has been identified, the investee fund’s management is required to approve of the buyer before the sale of the investments can be completed.