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Private School Accounting & Finances: Best Practices Guide

A free guide for private school leaders, board members and finance staff.

The challenges of running a private school have never been greater. Having witnessed the successes and challenges of many private schools over the years, this guide contains best practices for managing your school's accounting and finances.

In reading, you'll learn what private school leadership teams, board members and finance staff need to know about their school's financial statements, budgeting, accounting and financial reporting, and more. 

 

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Private School Guide

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Budgeting

The budgeting process is arguably one of the most important tools for creating a road map to your private school’s success. Planning and monitoring your budget can help you identify wasteful expenditures, adapt to financial changes and achieve your school’s financial goals.

Before You Start Your Budget

The budgeting process shouldn’t be limited to your school’s financial personnel; it should also include the board and senior leadership. A timeline for the process should be established, leaving adequate time for budget research, review and feedback. Finally, be prepared to document everything along the way, as good documentation will ensure that each participant understands his or her responsibilities and deadlines.

Following is a list of three of the most basic, but important, budgeting best practices you can implement for your private school.

Practice Income-based Budgeting

It’s important to budget primarily for income, basing income goals on conservative, reliable and realistic expectations. However, in order to accurately budget for income, you’ll need input and cooperation from all departments.

Budgeting tuition income can be difficult, especially if enrollment numbers fluctuate widely from year to year. It is best to rely on past history, adjusted for current economic impact, and always be a bit conservative on enrollment expectations.

If you budget tuition income conservatively, it should create a natural cushion in the overall budget if enrollment exceeds expectations. By budgeting tuition income this way, you’ll have a realistic target of the amount needed from the fundraising side of the income equation in your budget. This might be revenue raised through events or through contributions.

Be sure to understand the impact and timing of restricted contributions and their releases, as the timing might not impact the current year’s budget. We do not recommend including income projection “cushions” simply to balance the budget, as this can set up your school for a budget deficit if the projected income fails to hit its target. Establishing your income first will lay the groundwork for setting organizational and programmatic expenses for your school.

Tie Your Budget to Your School’s Mission and Goals

Revenue and expenses should be tied to your school’s mission and goals. Salaries for instructors, one of the largest expenditures, are variable based on the student/teacher ratio of your school’s teaching model. If you tie this expense to the enrollment targets you should have your largest variable expense under control.

When you review the other expenses based on your mission and goals, you will likely be able to identify expenses that can be reduced or eliminated, potentially saving your school money. These savings can then be applied to other purposes that are more closely tied to your school’s mission. The same approach should be taken when it comes to revenue. Are you, for example, putting a lot of time and energy into applying for a grant just because it might be available, even though it might not support your school’s mission?

Be Detailed, Detailed and More Detailed

The more detailed your budget is, the better your school’s leaders – some of whom might not have a financial background – will be able to see sources of revenue and expenditures. A detailed budget helps position your school’s leaders to make informed decisions.

Many budgets are approved by board and finance committee members who might not have knowledge about all of the school’s departments and programs. This can make it challenging for them to fully understand the budget that’s presented to them for approval.

When assumptions (expected income or expected expenses) are included in the budget, it can be even more difficult for non-financial people to understand. A detailed explanation of each assumption will allow your board members to fully understand and determine if that assumption is necessary and accurate.

A Final Word on Budgets

Remember, a budget is not just a tool to be used at the beginning of your school’s new year. Budgets should be compared to actual numbers on a regular basis to determine in real time how your school is performing.

As much as you should try to stick to your budget, be prepared for potential changes. Unexpected circumstances that occur during the year might require deviations from the original budget. When variations occur or changes are made, be sure to clearly communicate to everyone who will be impacted, and document the change, including what brought it about and when, how and why the variance occurred or the change was made.


 

 

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Financial Statements

Anyone on a private school’s leadership team and board of directors should have knowledge regarding the financial oversight of their school. In addition to addressing funding and expenditure challenges, there is a legal and professional responsibility for a school’s leadership team and board to protect their school’s assets. This includes overseeing the school’s financial activities and implementing policies and procedures to protect the organization.

Financial statements can be a valuable resource in helping understand and evaluate a school’s performance. Here’s what every private school leader and board member should know about financial statements.

Who is Responsible for the School’s Financial Statements?

Although it’s the CPA firm that performs the audit, review or compilation of the school’s financial statements, a school’s financial statements remain the responsibility of the leadership team and board of directors. Although it is common for an independent CPA firm to assist with the preparation of financial statements, including footnotes, the only section of the statements the CPA assumes direct responsibility for is the Independent Auditor’s Report, known as the opinion letter.

In nonpublic company entities, like private schools, the school’s management is responsible for the presentation of the statements and the accompanying footnotes in accordance with generally accepted accounting principles (GAAP). If the school does not assume responsibility for these principles, the CPA would encounter a scope limitation and is required to disclose that limitation in his or her report.

Although your school’s management might not include experts in GAAP, they should at least be able to review the financial statements and confirm that the information is presented correctly and that there are no misleading statements or material omissions. The leadership team and board of directors is responsible for ensuring that management fulfills its responsibilities for financial reporting and is ultimately responsible for reviewing and approving the financial statements.

How Financial Statements Are Presented

Even though there are certain financial statement disclosures required by GAAP, there is often flexibility in how these disclosures are presented. Usually, your school’s management and board can present information in the style and format they prefer. From a practical standpoint, the audit firm typically has a standard way of presenting certain information. However, management has the final say as long as the minimum disclosure requirements are met.

It is also important to note that management may always disclose more than the required minimum information if they feel that the information presents a clearer picture of their school and its operations.

Nuances of Nonprofit Financial Reporting  

Most private schools are nonprofits, meaning their financial statements differ significantly from commercial entity financial statements, since nonprofits do not present or operate on the concept of net income or profitability. Some of the key differences between nonprofit and for-profit financial reporting include:

Contributions  

One of the biggest differences between for-profit and nonprofit organizations lies in how income and contributions are reported. With a nonprofit, contributions or gifts often come with certain stipulations, which may relate to a purpose or time frame. Contributions and net assets should be clearly identified on your school’s financial statements as with or without donor restrictions, or permanently restricted, depending on their exact specifications.

Pledges Receivable  

Pledges receivable also vary based on an organization’s entity type. Pledges are generally considered revenue in the year they are made, even though the funds may not have received and cannot be spent that year. This has the tendency to cause large fluctuations in the bottom line compared to a commercial entity that has a more stringent matching principle. This is because a nonprofit organization isn’t really tracking “net revenue” like a commercial entity. Rather, it reports changes in net assets.

If a pledge receivable is made with a condition that condition must be met before the organization can recognize the gift as revenue. If pledges with conditions exist, they will not appear on the financial statements.

Measuring Your School’s Performance

You can gain a better understanding of your school’s operating efficiencies and performance by analyzing the data presented in the financial statements. There are three basic comparisons used to assess both revenue and expenditures: year-to-year, actual-to-budget and peer results.

Year-to-Year Comparisons  

Year-to-year comparisons reveal changes that occurred from the previous fiscal year to the current year. Management should be able to explain to the significant increases or decreases.

Actual-to-Budget Comparisons  

Actual-to-budget comparisons look at the actual results from operations next to what was projected by management and the board at the beginning of the fiscal year. These variances determine whether the budget process was accurate or whether unforeseen circumstances occurred during the year.

Board members should be informed of all budget amendments. It is reasonable to question results that significantly exceed or fall short of the budget.

Peer Analysis  

Peer analysis compares your school’s results with those of other similar private schools. However, when making comparisons among schools, it is important to keep differentiating factors in mind, including student population, teaching style, fundraising and the cost of tuition.

Key Ratio Analysis

Along with comparison analytics, you can also use ratios to better understand your school’s current position. It’s easy to get overwhelmed by the large number of ratios you can consider, but there are a few simple ones that can provide useful information: student-teacher, cost-per-student and current ratio. (Interested in learning more about financial ratios? Check out this article on the top three financial ratios and benchmarks that nonprofits should know.)

Student-Teacher Ratio  

The student-teacher ratio, calculated by dividing the total student population by the total number of teachers, determines the number of students per teacher. By comparing this calculation with those of prior years or expectations, you can determine whether the school is appropriately staffed for its current enrollment.

Cost-per-Student Ratio  

Cost-per-student ratio is calculated by taking the total expenses or a specific group of expenses, such as salaries, divided by the number of students, to determine the average cost per student. This is helpful in evaluating whether your cost of tuition is on target.

Current Ratio

The current ratio (current assets divided by current liabilities) is a liquidity ratio that estimates the school’s ability to meet its short-term obligations. A higher current ratio indicates a more likely ability to repay debts.

Moving Forward

Financial statements are an important tool for understanding your private school’s financial position, performance and direction. Moving ahead, use financial statements to make informed decisions for your school. One way to simplify this process is to distribute your school’s financial statements to the board a few days before a scheduled meeting. That way, board members can review the documents and prepare a list of questions for either management or the outside accountants.

Compare the financial statements to board meeting minutes, conversations with staff and your own knowledge of the organization to see if the information is consistent. If applicable, follow up on any findings or recommendations reported by the external auditors.


 

 

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Accounting & Financial Reporting

How to Avoid Misstatements

More so than other nonprofits, private schools are often operated like a for-profit entity given the competition, increased costs and scrutiny that schools face. Private school financial reporting is also unique and can be plagued by misclassifications or misstatements due to the complex accounting required for the different funding sources private schools receive. Here are the top issues in private school financial reporting:

Classification of Net Assets

Net assets should be included in one of two classes depending on the presence and type of donor-imposed restrictions:

  • Net assets without donor restrictions
  • Net assets with donor restrictions

The school and its board of directors cannot restrict net assets; only donors can restrict net assets. If the board determines that it wants to limit the use of certain net assets without donor restrictions, the net assets are considered board designated net assets. Net assets with donor restrictions are subject to donor-imposed restrictions that are temporary in nature, such as those that will be met by the passage of time or other events specified by the donor, or are perpetual in nature, where the donor stipulates that resources be maintained in perpetuity.

Revenue Recognition

Private school income is accounted for differently depending on the source of revenue. Tuition income is considered an exchange transaction and is recognized ratably over the term of the school year. Tuition payments received in advance are recorded as deferred revenue when received. On the other hand, contributions are recorded when received or pledged as support that is either with or without donor restrictions depending on the existence and nature of any donor restrictions.  

This can get much more complicated if the school maintains its books on a cash basis during the year instead of an accrual basis, which is typically the basis used for year-end audited financial statements. Conversion from cash to accrual is usually where some disconnect happens and something ends up wrong in the financials. While monitoring and budgeting cash is extremely important and easier to do on the cash basis, we recommend keeping the books on the accrual basis and then preparing Excel-based cash monitoring reports with an accrual basis change in net assets as the starting point and projecting cash position based on cash to accrual differences.   

Pledges

Proper accounting for pledges depends on whether there are donor-imposed conditions, donor-imposed restrictions or both. Private schools need to carefully review the terms of the pledge to determine whether the pledge is conditional or unconditional, and with or without donor restrictions, as the accounting for each is different.

Unconditional pledges should be recognized, in full, as revenue in the year the pledge is made. If the unconditional pledge contains a donor-imposed restriction, it should be classified as with donor restrictions.

Conditional pledges should be recognized as revenue when the conditions are substantially met. This means an unconditional pledge is not recorded at all until the condition is fulfilled. One exception is if the money is actually received for a pledge but not available for use until the condition is met, the school would record the cash deposit and a liability instead of revenue.

Capital Campaigns

Private schools embark on capital campaigns because of the significant dollars that can be raised in a relatively short period of time. This can result in a large increase in revenue but a lesser increase in cash, as capital campaign pledges are usually paid to the organization over a period of years. Capital campaigns raise funds to renovate or construct buildings, develop athletic fields and facilities, initiate a new program or build an endowment.

Capital campaigns usually have explicit or implied restrictions in which the stated objective is to raise funds for a specific program or purpose. Although the donor may not have explicitly communicated the restriction, the stated objective of the capital campaign usually makes the donor’s restriction clear.

Parent Associations

Parent associations are organized to allow the parents to provide additional support to a school with the aim of enhancing the level of education. In addition to collecting dues, parent associations often sponsor fundraisers and special activities for students and faculty. If the parent association is formed under the federal employer identification number (EIN) of the private school, the activities of the parent association must be included with the activities of the private school. On the other hand, if the parent association is formed under a separate EIN, the activities of the parent association are not included with the private school. While it is parent associations that are often overlooked, these rules apply to any group activity that occurs under the auspices of the school if it is not separately incorporated.

Planned Giving

One of the many ways donors provide financial support to charitable organizations is through arrangements in which nonprofits receive benefits that are shared with other beneficiaries. These planned giving arrangements are commonly known as split interest agreements.  

The most commonly used split interest agreements are:

  • Charitable lead annuity and unitrusts
  • Charitable remainder annuity and unitusts
  • Charitable gift annuities

Depending on the type of arrangement and who holds the assets, the school will either recognize the split interest agreement as contribution revenue along with the related assets and liabilities, or recognize its beneficial interest in the assets as an asset and contribution revenue when the school is notified of the split interest agreement’s existence.  

Unfortunately, nonprofits may not always be recording split interest agreements correctly or may not realize that they are a party to a split interest agreement at all. As a result, nonprofits might be understating assets, liabilities, revenue and net assets.

Endowments

Endowments are a common method private schools use to secure a steady income stream for the long term. Endowments represent donor gifts which are required to be invested in perpetuity or for a designated period of time. Endowments can also be amounts designated for long term investment by the private school’s board of directors. Endowments set up at the direction of the board are referred to as “quasi” endowments while donations with donor restrictions for the funds to be maintained and only income to be spent are true endowments.

The Uniform Prudent Management of Institutional Funds (UPMIFA), in the absence of specific donor instructions, provides guidance regarding endowments and specifically sets standards for endowment spending and the preservation of the original gift in accordance with donor intent. UPMIFA mandates that earnings, unless otherwise instructed, be classified as donor restricted for legal purposes until they are appropriated for expenditure. It is critical for private schools to adopt investment and spending policies for endowment assets approved by the board of directors in order to maintain a predictable income stream.  

Note: Most states have adopted their own version of UPMIFA that have minor variations in regulations.

Deferred Compensation Plans

Private schools, like most nonprofits, often face the challenge of competing against for-profit companies to attract key employees. One option available to schools is to establish deferred compensation plans for key employees.

A deferred compensation agreement should be accounted for on an accrual basis in accordance with the terms of the agreement. In other words, the school should accrue deferred compensation costs so that the costs are recognized in the period the related services are performed. The costs accrued at the end of the employee’s service period should equal the present value of the benefits expected to be paid to the employee or beneficiaries. Misstatements occur because accounting and finance staff are not always aware of the agreements until cash payments begin. By then it’s too late so it’s very important for the board and other members of the management team to keep the accounting and finance staff informed about all contracts so they can determine if anything should be recorded on the books.  


 

 

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Planned Giving Arrangements

Split Interest Agreements Require Special Accounting Treatment

One of the many ways donors provide financial support to charitable organizations, including private schools, is by establishing trusts or other arrangements under which the nonprofit receives benefits that are shared with other beneficiaries. These planned giving arrangements are commonly known as split interest agreements.

The most commonly used split interest agreements are: charitable lead annuity and unitrusts, charitable remainder annuity, and unitrusts and charitable gift annuities.

Charitable Lead Trusts (CLT)

Under a CLT, the nonprofit receives periodic payments (the “lead” interest) during the term of the agreement. The payments may be for a fixed dollar amount, an arrangement called a charitable lead annuity trust or for a fixed percentage of the trust’s fair value as determined annually, known as a charitable lead unitrust. At the termination of the agreement, the remaining assets revert to the donor or the donor’s designated beneficiary (the “remainder” interest).

Charitable Remainder Trusts (CRT)

Under a CRT, the trust makes periodic payments to the donor (the “lead” interest) or the donor’s beneficiary during the term of the agreement. At the termination of the agreement, the remaining assets revert to the nonprofit (the “remainder” interest). The payments to the donor or beneficiary may be for a specified dollar amount, an arrangement called a charitable remainder annuity trust, or for a specified percentage of the trust’s fair value as determined annually, known as a charitable remainder unitrust.

Charitable Gift Annuities (CGA)

Under a CGA, the donor and nonprofit enter into an agreement whereby the donor contributes assets (typically cash or shares of stock) to the nonprofit in exchange for a promise by the nonprofit to pay a fixed amount for a specified period of time or for the life of the donor or beneficiaries designated by the donor. CGAs are similar to CRTs except that no trust exists. The assets received are held as general assets of the nonprofit and the annuity liability is a general obligation of the nonprofit.

Initial Recognition of CLTs, CRTs and CGAs 

The initial recognition of CLTs and CRTs depends on who controls assets (whether or not the nonprofit is trustee).  

When the nonprofit is not the trustee, a beneficial interest in trust and contribution revenue are recorded at fair value upon the creation of the trust. In cases where the nonprofit is the trustee, the nonprofit will recognize contribution revenue, assets held in trust and a liability for amounts held for others in the period in which the trust is established.  

Typically, present value techniques are used to determine the fair value of the contribution. Under a CLT, the fair value of the contribution can be estimated based on the present value of the future distributions to be received by the nonprofit as a beneficiary. Under a CRT, the fair value of the contribution can be estimated based on the fair value of the assets contributed by the donor less the fair value of the payments to be made to other beneficiaries.  

In the case of CGAs, the nonprofit should record a liability for the fair value (present value of the future payments if present value techniques are used) of the future payments to be made to the donor and contribution revenue for the difference between the assets received and the liability.  

Net Asset Classification  

Determining the classification of contribution revenues as with or without restrictions is another nuance of split interest agreements that must be considered.  

Contribution revenues recognized under split interest agreements are classified as with donor restrictions unless the donor has explicitly given the nonprofit immediate right to the assets without restrictions, in which case they would be classified as without donor restrictions.  

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Internal Controls

Concentrate Internal Controls on Your Biggest Risks

Nonprofit organizations that don’t exercise constant vigilance in adhering to internal controls open the door to fraud. For private schools, acts of fraud can cast an unwanted shadow on your school’s reputation, possibly warding off donors and future students.

While many nonprofit leaders want to believe that employees work at an organization as much for the mission as they do for the paycheck, sometimes that just isn’t the case. Unfortunately, weak economic conditions have only increased the likelihood of internal theft, making internal controls more important than ever. However, preventive theft and fraud measures can be upheld by regularly reviewing and updating your school’s internal controls and concentrating your energies on the biggest risks.

Narrow Your Focus On Most Risky Activities

A detailed internal controls list potentially contains hundreds of items related to everything from governance to financial statements to payroll to information technology. If your school has never drafted such a list, talk to your auditors or other financial advisors about doing so. However, most schools engage in far fewer risky activities compared to other entities and organizations and should, therefore, focus on a smaller group of controls. For example, a startup that’s putting donations to work as quickly as they come through the door probably doesn’t need to worry about investment and property management policies — at least not yet.

But such a nonprofit would benefit from implementing rules regarding cash receipts and disbursements. These include segregating duties (for example, the same staffer who accepts donations shouldn’t also record or deposit them), requiring dual signatures on checks and performing monthly bank reconciliations. Sometimes even segregation of duties isn’t practical, so you then have to rely on monitoring by someone outside of the process.

Cash and bank accounts have the greatest exposure to theft. Therefore, they require the greatest scrutiny and controls. Making sure receipts are recorded is important, meaning you need to have good controls to ensure that all of the efforts to raise funds pay off, with the money making it to the bank. Once in the bank you need to make sure disbursements are for legitimate organizational purposes.

Electronic banking can make it harder to enforce controls, but reviewing the transactions after they have posted is just as important as approving the disbursement. Whether the controls are done by segregation of duties or by compensating monitoring controls with additional review after the fact, one or the other is essential to avoid a terribly negative surprise that can prove to be a public embarrassment for any nonprofit.  

Don’t Let Foxes Watch the Henhouse  

Even the best internal controls can’t protect your nonprofit from fraud if managers override them. Although auditors review internal controls, audits aren’t designed to detect every fraudulent act that could occur, especially management overrides. It’s a good idea to ask your auditor or someone experienced in fraud prevention to observe how well your organization is adhering to controls and to identify any potential risks. One of your best lines of defense is your school’s board of directors. Your board can help prevent management-perpetrated fraud by:  

  • Overseeing annual audits
  • Ensuring that material weaknesses identified by auditors are addressed
  • Reviewing monthly bank reconcilements, investments reconciliations and analysis of other material accounts
  • Regularly reviewing financial statements
  • Signing off on completed IRS forms  

Your board might also stipulate additional policies, such as requiring the approval of at least one board member on the rare occasion a manager needs to override controls. Your board also should look for signs that managers aren’t following internal control policies to the letter — for example, failing to report risks and actual management overrides in a timely manner. Sloppy accounting and reporting errors and disputes with auditors and outside advisors are possible signs that a manager might be committing fraud.

Regularly Review Internal Controls

You and your staffers probably have a lot on your plates — so it’s understandable if internal controls occasionally get lax. Remedy such lapses as quickly as possible by reviewing with employees and managers alike the policies designed to control fraud.

Interested in learning more about fraud prevention? These are the lessons learned from a nonprofit who lost $160,000 in employee fraud. 

 

 


 

 

Gross Mendelsohn


Gross, Mendelsohn & Associates provides accounting, audit, tax and consulting services to private schools and nonprofits throughout the Mid-Atlantic area. Our private school specialists are here to help your school grow with services that go beyond just audit and tax.

 

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