In August 1987 the FASB issued SFAS 93, "Recognition of Depreciation by Not-for-Profit Organizations." Statement 93 requires not-for-profit organizations to record in general purpose external financial statements the depreciation expense related to using long-term assets. In addition to depreciation expense, this includes recognition in the balance sheet of costs by category and accumulated depreciation and disclosure in the notes to the financial statements of the methods used to calculate depreciation. Exempted from depreciation recognition are works of art or historical treasures whose lives are long, if the asset is preservable and the owner has the capability of preserving the asset.

Many not-for-profit organizations, such as hospitals and charities, already record depreciation in their financial statements. The entities most affected by SFAS 93 are colleges, universities and religious organizations. This article focuses on the issue relating to colleges and universities, but many of the points are equally relevant to other not-for-profit organizations.

Who Will Comply?

There has been much controversy over SFAS 93. Enought debate was generated to postpone its effective date from fiscal years beginning after May 15, 1988, to fiscal years beginning after January 1, 1990. How many colleges complied with the pronouncement? What are the consequences if the colleges do not comply? What will be the impact on the comparison of financial statements for like not-for-profit organizations and governmental colleges and universities?

Arguments Concerning

Recording Depreciation

There are many arguments for and against recording depreciation expense by not-for-profit organizations. Malvern J. Gross, Jr., and William Warshauer, Jr., have summarized the arguments for and against depreciation in their text Financial and Accounting Guide for Nonprofit Organizations (John Wiley and Sons, New York, 1983).

Arguments against taking depreciation: 1. Nonprofit entities are not interested in matching revenues and expenses; 2. Nonprofit entities often raise specific funds to cover the cost of new purchases of capital assets, thus there is no need to cover these costs by current income having recorded depreciation; 3. Inflation causes the market value of assets to increase faster than the decline in value as a result of wear and tear and deterioration from time; and 4. Depreciation is difficult to show in the financial statements, especially when fund accounting is employed.

Arguments for taking depreciation: 1. Nonprofit entities provide services that are measured in costs and depreciation is a cost; 2. Even though major capital assets are funded through special drives, some capital assets are replaced by use of current funds. When this is done it causes income from year to year to fluctuate widely and misleads the public into thinking income is sufficient to cover expenses; 3. Nonprofit entities sell products or services that are available from commercial enterprises. This implies a matching of revenues and costs the same as commercial enterprises. If no depreciation is recorded there is a potential for misstatement of profit; and 4. Nonprofit entities are subject to federal income tax on unrelated business income. Depreciation should be recorded to reduce the tax liability.

For many years the AICPA industry guide Audit Guide for Colleges and Universities supported not recording depreciation in the operating fund; however, the Guide allows recording of depreciation in the plant fund section of the statement of changes in fund balances.

What happened to spark the FASB board members to issue SFAS 93? In the late 1970s and early 1980s the FASB began to put more emphasis on not- for-profit accounting. The FASB began to realize that the inconsistencies among different not-for-profit and for-profit enterprises needed to be eliminated as much as possible. This meant that rather than just concentrating on reporting how funds were received and how funds were spent, the emphasis was now on how efficiently these resources were utilized. The information most frequently sought from not-for-profit enterprises was whether the organization spent the money in the way intended and how close to the budget amount the expenditures were.

SFAS 93 explains the reasons the Board felt it was valid to record depreciation for not-for-profit organizations. For example, it states "... using up assets acquired involves a cost to the organization because the economic benefits (or service potential) used up are no longer available to the organization. That is as true for assets acquired without cost as it is for assets acquired at a cost." Therefore, the FASB recognizes that although colleges and universities and other not-for-profit entities receive donated assets, there is no difference between a donated asset and a purchased asset with regard to the depreciation issue.

An argument often used by those that oppose SFAS 93 is that not-for- profit entities are not concerned with matching revenues and expenses; therefore, depreciation should not be recorded. In FASB Concepts Statement 6, the FASB describes depreciation as a cost of using up assets, not as a technique for "matching" expenses with revenues. This definition of depreciation dispels the argument of matching, thus allowing depreciation to be recorded by not-for-profits.

Another common argument from opponents is that not-for-profit organizations are concerned with cash flows and how efficiently the organization manages cash flows. Because depreciation does not affect cash flows it should not be recorded. Concepts Statement 6 states that the not-for-profit is to be concerned with "...inflows and outflows of resources during a period." If one considers the word "resources" as opposed to "cash flows," then depreciation becomes a cost of using up the assets (resources). SFAS 93 explains that unless a not-for-profit organization maintains its net assets, its ability to continue to provide services dwindles; either future resource providers must make up the deficiency or services to future beneficiaries will decline. Normal wear and tear on the asset causes it to need to be replaced, so the not- for-profit organization has to prepare for this occurrence so as not to be surpised in the year of replacement with a huge unplanned cash outflow.

Opinions of College and

University Financial Officers

A survey was sent to 41 colleges and universities in order to determine the opinion of financial officers about SFAS 93. The usable response rate was 59%. A list of the college and university respondents is shown in Exhibit 1.

Table : EXHIBIT 1 LIST OF COLLEGE AND UNIVERSITY RESPONDENTS

MajorSource

SchoolNameofSupportLocation

1.ColumbiaCollegeChristianChurchMidwest

2.ConcordiaCollegeLutheranNorth

3.CornellUniversityPrivateNortheast

4.DukeUniversityPrivateEast

5.FriendsUniversityQuakerMidwest

6.HamlineUniversityMethodistNorth

7.HollinsCollegePrivateEast

8.HoughtonCollegeWesleyanChurchNortheast

9.JacksonvillePrivateSouth

University

10.JamestownCollegePresbyterianNorth

11.Lees-McRaeCollegePrivateEast

12.MeredithCollegeBaptistEast

13.MississippiCollegeBaptistSouth

14.NorwichUniversityPrivateNortheast

15.PepperdinePrivateWest

University

16.RochesterInstitutePrivateNortheast

17.TalladegaCollegePrivateSouth

18.UniversityofDenverMethodistWest

19.UniversityofMethodistWest

Puget Sound

20.UniversityRichmondBaptistEast

21.VanderbiltUniversityIndependentEast

22.WakeForestBaptistEast

University

23. Wayland Baptist Baptist Southeast

University

24. William Carey Baptist South

College

The sizes of the student bodies ranged from 394 to 18,600 with an average size of 3,601. The results of the survey indicated that the size of school is not relevant to the decision of implementing SFAS 93. Other factores that had no impact on survey results were the area of the country in which the school was located and the source of major support (affiliation).

In determining the impact of SFAS 93, a concern of the colleges and universities was the out-of-pocket costs that might be incurred to comply. One direct cost would be the purchase of a new system or an upgrade to an existing system to track assets or calculate depreciation. Of the respondents, 58% already had an asset system in place; of the remainder, 80% did not intend to purchase one. Of those that intended to get a system to be between $20,000 and $30,000 for software with no additional hardware needed.

Another cost of implementation is obtaining historical data. SFAS 93 requires retroactive restatement of all years presented in the financial statements and proper disclosure of the amounts. The beginning net asset balance should be presented as if recording of depreciation had been taking place all along. This involves capturing historical data related to cost, useful life, acquisition date, and salvage value. If this information has not already been captured it could be costly to obtain. FASB recognized that records for older assets might be difficult or impossible to obtain and indicated that reasonable estimates would be acceptable. The survey results indicated that 29% of colleges and universities have actual data and estimates. Potentially, if the data is not readily available and the organization does not feel comfortable with estimates, an appraiser may have to be engaged to value all the assets, probably starting with a physical inventory. The appraiser option would be costly. However, such steps have benefits other than recording depreciation and would be expected to improve accounting procedures and establish controls over capital asset acquisition and maintenance. If for no other reason that insurance purposes, most colleges and universities have some sort of mechanism for tracking capital assets. That same mechanism may not properly record depreciation, but the actual depreciation calculation is not as cumbersome and costly as collecting the data. Hence, for the average college or university there should not be a tremendous amount of historical data that is missing and cannot be estimated.

In summary, although there may be some additional out-of-pocket expenses incurred in implementing SFAS 93, these costs should not be prohibitive. Additionally, these costs would benefit the organization in other areas such as accounting procedures and controls.

Then Why Not Comply?

Richard Rosser, president of the National Association of Independent Colleges & Universities, reports that at least 80 schools are considering taking qualified opinions on their financial statements, rather that complying with the depreciation requirement. (Penelope Wang, "High Dungeon in the Ivory Tower," Forbes, New York, April 4, 1988, p. 78.) In contrast, the present survey indicated that all of respondents intended to comply with the Statement. None of the respondents indicated a willingness to accept a qualified opinion on its financial statements for not complying. However, several of the college associations and organizations". . . received assurances from Standard & Poor's Corp. and Moody's Investors Service Inc. that the bond rating agencies would not lower the colleges' bond ratings based on noncompliance with the FASB statement." (Lee Berton, "Several Private Colleges May Ignore New Accounting Rule on Depreciation", The Wall Street Journal, February 4, 1988, p. 28.)

Another concern was the impact of a qualified audit report on donations, which come from sources such as alumni, foundations, corporations matching gifts or community. Nevertheless, FASB representatives have argued that the perceived efficiency of an organization often makes a difference when deciding whether to contribute, and depreciation is one part of measuring the cost of services provided. In the present study, on average, total donations including those from alumni, corporate, and private sources were only 10.2% of total revenue. Thus, even going along with the opponents' view that donations would decrease, the effect might not be that severe.

Another concern for colleges and universities is the effect or depreciation on fund balances. The issue of where to record the depreciation expense has yet to be resolved. Comments showed that respondents intend to record depreciation in the plant fund. However, 46% responded that the majority of capital asset purchases are from current operating funds. Thus, it is reasonable, at least for these respondents, to record the depreciation in the current operating fund activity statement.

An Estimate of the Impact

Each college and university will be impacted differently by SFAS 93 depending on the total dollar amount of their capital assets and the age of these assets. However, some generalities can be made. Exhibit 2 presents information extracted from financial statements of three universities that assumptions have been applied. From this exercise some conclusions about the impact of SFAS 93 on the financial status of the "average" university can be drawn. Tabular Data Omitted

This profile of the average university indicates that the university would need a fund balance of $3,210,165 each year to cover annual depreciation. Of the three universities whose financial statements are being examined, each has an adequate plant fund balance to cover the annual depreciation, as well as an accumulated depreciation restatement for prior years, of $30,955,169, assuming average age of building and improvements is 18 years and equipment is five years.

However, none would have the proper balance to cover the restatement out of current operating funds, but all could cover the annual depreciation for the current year from current funds. Thus, the most advantageous approach to complying with FASB 93 would be to initially record depreciation in the plant funds. If the FASB decides to change this approach sometime in the future, the change will not adversely affect the current operating fund balance because the prior year's restatements will have already been recorded.

An advantage of recording depreciation in the current operating fund is that the expense can be included in the calculations to determine tuition and fees. This could be a potential way to fund the depreciation, thus having actual cash to replace the assets when necessary.

So Why the Resistance to

Change

The results of this study support the position of FASB that the costs of implementing SFAS 93 are far outweighed by the benefits of comparability of financial statements and provision for replacement of assets.

Most of the resistance to SFAS93 seems to stem from the lack of desire to make changes on the part of colleges and universities. The recording of depreciation is a worthwhile principle and will help make financial statements of not-for-profit organizations more comparable with each other and with business enterprises.

Ruth W. Epps, PhD, CPA, Assistant Professor of Accounting; and Annette Bailey, Research Assistant; both of Virginia Commonwealth University