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Overview of University Finances: Accounting and Budgeting Principles for Higher Education

By SRAI JRA posted 11-22-2021 09:36 AM


Volume LII, Number 2

Overview of University Finances: Accounting and Budgeting Principles for Higher Education

Dean O. Smith
Professor Emeritus
University of Hawaii

During the past ten years, I have attempted to retire three times and written four books on university administration. Right after my first attempt at retirement, I wrote the first book, Managing the Research University (Oxford, 2011). I had served in research administration in one capacity or another for more than half of my academic career. Surely, I thought, I learned something during all of those years, something that might benefit younger colleagues in the field. So, I wrote the book, which became “research administration 101.”

Shortly after my second attempt at retirement, I got the writing “bug” again. This time, I wanted to expand on a topic mentioned only briefly in the first book: the limits of authority. Who’s in charge of what, and who can and can’t do what in the university? After spending many long hours of research in the law library, the result was Understanding Authority in Higher Education (Rowman and Littlefield, 2015). I learned more about universities while writing this book than I did in 37 years as a professor and administrator.

Then, on my third attempt at retirement, I decided to write about the topic that caused me as an administrator the most consternation, the greatest frustration, the worst headaches: university finances. The result was University Finances: Accounting and Budgeting Principles for Higher Education ( Johns Hopkins, 2019). As I wrote in the book’s preface, when I was a university executive officer responsible for generating sufficient revenue and managing expenditures to support the university’s mission, I wrestled with finances on a daily basis. This entailed regular conversations with university fiscal officers, governing board members, state legislators, auditors, and accountants. Through this on-the-job experience, I developed a profound interest in university finances.

In my administrative role, I was usually the one who had to explain the university’s financial condition to faculty members, deans, and various other campus constituencies. These explanations were not always easy, especially during times of budgetary stress. Occasionally, I encountered rumors about troves of money hoarded by the administration. The rumors were partly true; the university did have sizable restricted fund balances. Understandably, frustrated colleagues questioned why these funds could not be used to alleviate financial hardship in the operating budget. As former Stanford University president Donald Kennedy noted, “If we’re so rich, why do we feel so poor?” The explanations sometimes involved financial reporting methods that were familiar to professional accountants but were unfamiliar to most college and university

faculty and staff members. Or to many others who worked directly or indirectly with colleges and universities. This unfamiliarity was unfortunate because it bred confusion and misunderstanding about the university’s financial condition. And that weakened university governance.

To ease this confusion, I decided to write University Finances, explaining basic accounting procedures, budgets, and financial statements for the extended academic community. My goal was to clarify topics that I encountered routinely and that often bewildered my colleagues. In addition, I sought to clarify less ordinary (but certainly important) financial topics, such as methods for computing fringe benefit rates, refunding bonds, allocating Federal formula funds, and calculating institutional indirect (F&A) cost rates. As it turned out, this book became “research administration 201,” for it covered financial aspects of research administration in considerable detail.

As I was finishing work on University Finances, my editor asked me to prepare a shorter companion book focused on budgets: How University Budgets Work ( Johns Hopkins University Press, 2019). I took this opportunity to expand on the one-chapter introduction to budgets in University Finances. The two books complement each other, with minimal overlap. Thus, for research administrators, this companion book constitutes “research administration 202,” because of its explanations about budget construction and management, alignment with the strategic plan, year-end closeouts, and so forth.

While preparing to write University Finances I discovered the theoretical rigor of the accounting profession. As a medical school professor and university administrator, my work had entailed extensive analysis of data, so I was comfortable working with numbers. But, I had no formal training in accounting. So, doing my homework, so to speak, at the outset I studied accounting assiduously: read textbooks, consulted experts, took courses, studied financial reports, and so forth. Ultimately, I developed an appreciation of the underlying principles, the theoretical underpinnings, of accounting and budgeting; they made sense.

Pedagogically, the hallmark feature of University Finances is its rigor. It brings together theoretical and practical approaches to nearly all of the major issues confronting administrators in higher education. Notably, it provides useful examples of calculations that sometimes can be quite daunting. In fact, to enable readers to “follow the numbers,” all numerical examples throughout the book derive from two sets of core expenditure data, one set for a private university and one set for a public university. In that way, the respective examples are linked together; every number can be traced back to these core expenditure data. This linkage proved to be a daunting task (that is, a real headache), because a change in one number in one calculation rippled through the entire set of calculations related to that number, extending into numerous examples in different chapters. Consequently, after changing a number for one reason or another, I had to spend many hours poring over text and tables, looking for inaccuracies or inconsistencies resulting from the change. In that way, the book’s examples demonstrate the interdependence of data in the real world of university finances.

Most sample calculations involved straightforward arithmetic. Plug in numbers, calculate percentages, et cetera, and come up with answers. However, sample calculations of Federal formula funding allocations, such as Hatch or Smith-Lever Act funds, proved ironically to be particularly challenging. By statute, the allocations to various universities were based on exact financial data and formulas. The raw data, formulas, and Federal allocations were easy to find on the internet. But, using the same raw data and formulas, I often had difficulty coming up with the same allocations. The Federal agencies used algorithms that I found counter-intuitive. Ultimately, an agency director provided me copies of their Excel spreadsheets, which enabled me to decipher their algorithm and reproduce their calculations. Looking back, I learned (and wrote about) valuable lessons in Federal accounting procedures from these calculations.

While analyzing university finances, I encountered a familiar “eye-opener”: universities lose money on every research grant due to under-recovery of indirect costs. As a seasoned chief research officer, I knew that universities did not always recover their full indirect-cost reimbursement for one reason or another: the administrative cap (26 percent), institutional waivers, agency limitations, and so forth. Nonetheless, I adhered axiomatically to the quest for more and more grant funding. Naively, I seldom pondered the true financial implications of this under-recovery. Just bring in more money, increase research expenditures. But now, in retrospect, a question arose: why do universities strive so ardently to increase the number of grant awards if it just costs them money? After analyzing numerous potential benefits of increased research expenditures, I discovered that there were few significant advantages—financial or otherwise. The only significant financial reward is increased annual donations to the university, but the increased giving isn’t enough to offset the under-recovery of indirect costs. Not by a long way. Otherwise, the major advantage to increased research expenditures is simply institutional prestige, a costly but highly prized commodity.

University Finances debunks the widely-held suspicion that universities have large stashes of money available for general use. This suspicion becomes particularly prevalent during periods of budgetary stress. True, universities have sizable reserves of money. But, as this book points out, nearly all of that money is restricted legally for specific uses, which may include select faculty members’ salaries and student financial aid but not discretionary general-fund expenses. Thus, universities may appear wealthy on their balance sheets, but the use of this wealth is highly restricted. That is, use of the money must adhere to guidelines imposed by donors, bondholders, government regulators, and others. These restrictions are not always recognized or understood by many observers, including faculty members and legislators.

From its inception, I have hoped that University Finances will become a trusted resource for members of the extended university community. It may sit on the shelf for a while, but when readers seek answers to specific financial questions, they can reach for this book, confident that it will provide the answers.