As you know. Section 4-8.0lg of the Appropriation Act requires that the Department of Accounts in consultation with the Auditor at Public Accounts and the Director of the State Council of Higher Education, analyze and report on the use of local funds by state agencies and institutions of higher education.

Attached is my report on this study. Data were collected from all institutions of higher education and the few other agencies which maintain local funds. The findings were reviewed with both Walt Kucharski and Mike Mullen. I would be happy to brief the Committee on the report, or should you have any questions, please contact me at 225-2109.

Sincerely,

William E. Landsidle

Enclosure

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The 1997 Appropriation Act (Chapter 924) directed that the Department of Accounts, in consultation with the Auditor of Public Accounts and the State Council of Higher Education, study the use of local funds by state agencies and institutions of higher education. The term local funds does not have a specific definition in law or accounting principle. As used in this report, the term local funds refers to any monies received and held by a state agency or institution of higher education outside of the State Treasury, with the exception of endowment funds, gifts, private funds held for students or inmates of state institutions, student loan funds, and donations or payments made by local jurisdictions to community colleges. Monies held by foundations affiliated with an agency or institution are also excluded.

Local funds are generally held in commercial bank accounts and may be invested by the holding agency or institution. By definition, local funds do not appear in the cash accounting records of the Department of Accounts and are not available for investment by the State Treasurer. Their receipt and destination may or may not be recorded in the central accounting records depending on the practice of the particular agency, institution and fund. There also appears to be substantial variation among the funds as to whether they are appropriated by the General Assembly. However, local funds are included in the comprehensive financial reports of the agency or institution and are audited by the Auditor of Public Accounts. Local funds are also included in the audited financial statements of the Commonwealth.

Study Background. The Virginia Constitution states that "all taxes, licenses, and other revenues of the Commonwealth shall be collected by its proper officers and paid into the State treasury. No money shall be paid out of the State treasury except in pursuance of appropriations made by law" (Article X. Section 7). Section 2.1-180 of the Code of Virginia states that "every agency and institution.., collecting or receiving public funds or moneys from any source whatever, belonging to or for the use of the Commonwealth, shall hereafter pay the same promptly into the State treasury, without any deduction..." This same section also establishes exemptions to the requirement that funds be deposited into the State treasury for endowments, gifts, private funds belonging to students, or inmates, and student loan funds. Guidance provided by the Office of the Attorney General regarding Section 2.1-180 has held that the presence of specific exemptions in the section indicates legislative intent that the section be narrowly construed, i.e. all monies not meeting one of the specific exemptions must be deposited into the treasury. Finally, Item 4-2.01 (b)(1) of Chapter 924 reiterates that all nongeneral funds collected by public institutions of higher education must be deposited in the State treasury and expended in accordance with an appropriation.

Although both constitutional and statutory law appear to place strict limitations on what monies may be held outside the State treasury, State auditors and finance offices in agencies, institutions of higher education and the central agencies have been aware that a large number of local accounts exist particularly in the colleges and universities. However, there has not been a recent comprehensive listing of these accounts and the balances contained therein. To collect data for this study, the Department of Accounts surveyed each agency and institution and received information for FY 1997 related to revenues, expenditures, beginning and ending balances and purpose of local funds held outside the State treasury, other than those exempted by the study mandate language. All agencies and institutions cooperated with the data request.

Study Findings. The survey of local funds found approximately 1,200 local fund accounts among the public institutions of higher education, and approximately 15 local fund accounts in all ocher agencies of State government.. FY 1997 revenues for the higher education local fund accounts were $138 million (Attachment A), while the agency accounts had revenues for the year of $2.4 million (Attachment B).

Local accounts held by agencies other than higher education are predominantly related to restricted accounts used to compensate outside parties injured as the result of negligence or illegal action by someone holding a state professional license (State Bar, Real Estate and Contractor licenses under the Department of Professional and Occupational Regulation). Other local accounts hold the proceeds from food service and gift shop operations at the Science Museum and Museum of Fine Arts.

College and university local fund accounts consist primarily of the receipts and disbursements from auxiliary enterprise operations such as dining halls, dormitories, book stores and ocher institutional fee-for-service activities (Table 1). Auxiliary enterprise revenues deposited into local accounts totaled $107.9 million, or 78% of all local funds in FY 1997. This is about one-fifth of the $492.5 million in total statewide auxiliary enterprise revenues recorded in the central State accounting system for FY 1997. During the research for this study the project team was unable to find any statewide body of policies governing which activities are funded through the State treasury and which are not. Rather, the current structure appears to be primarily the result of independent historical events. Information provided by the institutions of higher education cited improved processing efficiency as the reason why local funds are used to support this large component of the overall auxiliary enterprise activity.

The practice of using local fund accounts for auxiliary enterprise operations was last reviewed in 1984 when a study coordinated by SCHEV established the principle that all auxiliary enterprise activity using local fund accounts should be recorded in the State central accounting system through a journal entry. Since 1984 colleges and universities have been posting revenue and expenditure entries to the central accounts, although the cash does not enter or leave the State treasury. This practice provides a basic level of appropriation control over locally-funded auxiliary enterprise operations. However, it must be noted that without a corresponding cash accounting entry through the treasury. the Department of Accounts has no means of verifying whether all such disbursements are being recorded.

The deposit of revenues from auxiliary enterprise operations to accounts other than the State treasury could appear to violate a strict interpretation of both the Article X. Section 7 of the Constitution and Section 2.1-180 of the Code of Virginia. However, the fact that the current practice has been in place and unchallenged for many years, coupled with the wide variation in the structure of local funded auxiliaries among the individual institutions, makes it difficult to reach a conclusion regarding the legal status of local funded accounts. Moreover, as noted in the following section of this report. the Commonwealth’s current policies on the decentralization of administrative and financial management functions to individual colleges and universities have significantly altered the relationship between institutions of higher education and the central agencies of State government.

The remaining 22% of the monies in higher education local accounts represent a broad spectrum of activities. Many of these appear to be the receipts and disbursements associated with conferences, seminars, international study programs and similar events. There also are a large number of very small accounts which are used to segregate specific campus events and the associated fees in the same way that special fund accounts are used in the central accounting system. Finally, some local accounts appear to be custodial in nature, i.e. the institution holds small amounts of cash on behalf of student clubs and organizations.

Decentralization Initiatives. Beginning in FY 1994 the Commonwealth began a structured process of transferring the responsibility for most financial management and selected administrative functions to the central agencies to institutions of higher education which elected to accept these responsibilities. Authority for this program is established in the Appropriation Act. Although this program is referred to as "decentralization", it is in fact a broad redefinition of the relationship between the institutions of higher education and central agencies. The redefined relationship is documented in memoranda of understanding between the individual institution of higher education and the Secretary of Finance, in consultation with the Secretaries of Administration and Education and SCHEV.

Today, eight colleges and universities are decentralized, and the disbursement of the majority of public funds appropriated to higher education in Virginia is processed through local accounts. Although the institutions are required to post expenditure journal entries to the central accounting system, these entries are highly summarized and are similar to the entries for local auxiliary enterprises required by the 1984 SCHEV study referenced earlier. These entries provide basic appropriation control but the transaction-level control over the legality, regularity and accounting classification of these disbursements, which once was the responsibility of the Department of Accounts, now rests entirely with the college or university finance office, subject only to a post audit by the APA or Department of Accounts, Therefore, for control purposes, the distinction between local funds and State funds, on the disbursement side of the ledger, has been eliminated for decentralized institutions.

Important distinctions remain for decentralized institutions on the revenue/receipt side of the ledger. Decentralized institutions must continue to deposit State revenue into the State treasury where it is invested until drawndown by the institution to cover a disbursement from a local account. The drawdown process is designed to maintain interest earning neutrality between the State general account and the institutional local account. By having the cash in the treasury, the Department of Accounts is able to reconcile the amounts of decentralized disbursements to the movement of cash from the treasury to the institution. This provides a stronger appropriation control than is possible with local fund accounts.

Conclusion. The current use of local funds by the public colleges and universities reflects a history of many individual decisions and circumstances. The use of local funds does not appear to be consistent with statute in many cases. Moreover, it has been 13 years since the last comprehensive policy review on local funds was completed. The Commonwealth’s existing program for decentralizing financial management activities in higher education provides a good opportunity to revisit both the statute and policy framework for local funds in the colleges and universities. It is therefore recommended that the Governor and General Assembly consider the use of local funds in future legislation which may be adopted governing the decentralization program.

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Posted: December 3, 1998
By The Educational Policy Institute of Virginia Tech
sjanosik@vt.edu