New standards could make university finances appear at risk

Headaches ahead. Tired businessman image

Winning large research and capital grants could soon bring unwanted headaches for UK universities along with all the acclaim. From the next academic year, their accountants will be expected to adopt new international reporting standards that could make university finances appear more fragile than they actually are.

The International Accounting Standards convention – coming into place in the UK from 1 January 2015 – follows the Financial Reporting Council’s strategy to bring accounting in the UK into line with international standards. It is an admirable move to harmonise and raise standards for all – but with some serious and unintended consequences for senior management and members of university councils.

The change will mean that some universities will appear to be at financial risk, even when their cashflow remains the same, because of the way in which large projects are funded and then reported on. All of a sudden, surpluses (in terms of income compared with expenditure) may look diminished and any deficits exaggerated.

And all this comes as universities are having to absorb a net £45m reduction in their teaching grant for 2014-15, after an overall drop in the government’s grant to universities. This will mean a reduction of 5.85% to most university teaching budgets.

Books looking bad

The problem with the new rules are partially to do with presentation and communication. What will government, industry, research councils, and all our overseas partners think when a university’s financial position looks strangely vulnerable and unsustainable?

And also, what happens when institutions need to raise finance, renegotiate “swap rates” (on interest rates) and are making a case to, say, the bond markets?

Banks have tended to see higher education as a solid investment compared with private sector ventures. But this kind of evidence of fragility – even though it’s essentially unfounded – is going to potentially undermine confidence. There is also the threat that banks will no longer consider favourable rates on loans for universities, seeing them as higher risk than previously. Or worse, they may even exploit this perception.

Issues for capital projects

This is a particular issue at a time when more institutions are thinking about investing in campus development, smartening up and building new facilities. More competition and higher expectations from students who see themselves as paying “customers” means more universities are preparing to enter into a beauty parade. That means serious expenditure on the campus environment to offer a “five star” experience.

It’s not just a technical challenge for research-intensive universities. All institutions will need to comply with the statutory demands on accounting, and this could have a significant impact on all those making considerable capital investments or those who have major research programmes.

A Universities UK survey in 2012 showed that institutions were planning around £8 billion in large capital projects.

Government-funded capital projects, for example, which previously have been reported as “income” throughout the lifetime of the building or other facility, will now only be shown as income when the funded project is complete, in a single go.

In the case of research grants, the problem will be how cash milestones drive the timing of when income is included in a university’s accounts. If milestones don’t align with expenditure, there will be major fluctuations in financial reports.

Other proposed reporting changes that will have an unsettling affect will be the inclusion of the pension deficit and privately-financed new student accommodation. Figures released late in 2013 show the Universities Superannuation Scheme, which covers academics and academic-related staff in pre-1992 universities, had a deficit in March 2013 of £11.5 billion – up from £9.8 billion in 2012, according to valuations in its annual report.

The new standard may swing institutions into financial extremes on paper, possibly forcing them to break or renegotiate their banking covenant – in terms of what finance can be provided, at what rate.

At the very least, it will force institutions to question the timing of applying for and starting large capital projects, because starting projects at the same time might be considered very risky. It will also be interesting to see how the rating agencies respond to this new practice.

Once we’re all clear on the detail, higher education institutions will have to start moving quickly to pre-empt a number of issues, and before what might look to be a technical detail becoming a threat to reputations and financial viability.