What Do Our Accreditors, Auditors, and Bond Raters Do for Us?

When I watch boards in action, I am surprised at how often I see them operating based on misconceptions about the three most important external entities that play a role in assessing colleges and universities: accreditors, auditors, and bond rating agencies. Here is a short primer on what those different entities do and how what they do serves your institution. It is not intended to cover every issue, only the ones that occur most frequently.

The Accreditor(s)

Accreditors serve a simple but essential function: They provide consumer protection for students. They tell a prospective student whether the institution they are considering has the resources and quality control to deliver the education it is promising, or in other words, that your institution is what it says it is. That is why both a large, elite university and a small, local college can be accredited.

Accreditation is required for institutions to receive federal financial aid and most other kinds of financial support. It validates that your institution is doing your work effectively given the kind of students you serve and the mission you have chosen.

All accreditors use accepted standards to evaluate institutions, and they publish those standards on their websites for all to see. The standards cover the academic, financial, administrative, and governance practices of the institution.

Accreditation usually has four steps:

1. A self-study by the institution (a close analytical look at your own college or university);
2. An external peer review (a site visit by a team of outside people who are experts in the kind of work your institution does);
3. The decision on accreditation (a determination by the accreditor’s board as to whether your institution meets its standards); and
4. Ongoing monitoring (if the accreditor’s board identifies any issues, a process to find out if the institution is successfully addressing those concerns).

Accreditors are professionals with deep experience in higher education. The boards, staffs, and visiting teams of accrediting agencies consist of seasoned administrators and faculty members who understand from experience the challenges your institution faces. They see themselves primarily as helping you rather than providing oversight.

In fact, you can view accreditation as a form of “free consulting” by the experts on the accrediting teams that come to campus as part of the process. Your institution is fortunate to have such a group of experienced professionals who can spot weaknesses and give valuable advice on improvements.

So, if your accreditor questions you about some aspect of your college’s or university’s operations, do not see them as an enemy. They have no vested interest other than your success and keeping your institution in good standing within the higher education community. They want your institution to improve and meet reasonable standards and are protecting the interests of students and others who rely on it to do its work effectively.

What the accreditor does:

• Validate that your institution can effectively serve its distinct mission, giving comfort to you as a board member, as well as to prospective and current students, faculty, and donors; and
• Give you independent and expert advice on the issues you face.

What the accreditor does not do:

• Find fault for the sake of finding fault.

The Auditor

The core purpose of an audit is to verify for you that the information in your financial statements is accurate enough for people to rely upon it for discussion and decision-making purposes. The top financial administrators at your institution will prepare the audited financial statements, not the auditor. They then pay the auditor for an “opinion,” contained in the auditor’s letter, as to whether or not the information is reliable “in all material respects”—or, in other words, sufficient for the purposes for which the financial statements will be used.

The board appoints the auditor and holds it accountable to the board, as safeguarding the financial condition of the institution is a key part of the board’s fiduciary duties. In addition to the board, many other individuals and organizations rely on the financial statements: administrators, donors, grant makers, accrediting bodies, bond holders, and bond rating agencies. Faculty members and students often have an interest in the statements, as well.

What an auditor does:

• Provide your board with reliable information about the types and amounts of revenue that comes into the institution in a given year, as well as the types and amounts of expenses incurred during the same period (“statement of activities”). That allows you to understand the size and kinds of assets and liabilities your institution has (“statement of financial position”). You can also see how the institution generates and uses cash (“statement of cash flows”). Those are the only three parts of the audit report that the auditor confirms can be relied upon.
• Verify that three schedules (activities, position, and cash) are prepared in accordance with Generally Accepted Accounting Practices (GAAP), in other words, the standard for good practice. GAAP defines the various categories of financial activity consistently. Following GAAP allows you to compare your college or university’s financial information to similar information at other institutions and benchmark against it.
• Offer views on the quality of the staff that prepares the audited financial statements and the effectiveness of the processes used to prepare those statements. In offering a “clean” opinion, the auditor is saying that the staff skills and reporting processes (“quality of internal controls”) are sufficient. In an executive session of the board, however, the auditor can offer a more nuanced perspective on the audit results that includes any potential risks and organizational inefficiencies.

What an auditor does not do:

• Confirm to you in its “opinion” that the footnotes or supplementary schedules are accurate—that is entirely the responsibility of management;
• Flag all fraudulent activity that might exist at your institution. An audit is not a comprehensive review of possible fraud; the auditors will just inform the board of any financial fraud they have discovered in the course of their work; and
• Indicate that the institution is well-managed in general or even financially—it indicates only the accuracy of the financial statements and the reliability of the process used to produce them.

The Bond Rating Agency

A bond rating agency provides its clients with an assessment of the creditworthiness of your institution’s debt. The core question is: If you are an investor in the bonds, what are your chances of being repaid?

Bond rating agencies do not work for colleges and universities—they are not their clients. Rather, rating agencies’ clients are the bond holders and potential bond holders to whom they issue an independent assessment of the risk and reward associated with an institution’s debt.

Your college or university will want as high a rating as possible. A high rating is a positive statement, from an independent source, about the financial condition of the institution, engendering confidence among various stakeholders, especially donors and potential donors. It also results in lower interest payments which means more dollars can go toward your institution’s core mission.

The rating indicates the level of risk associated with an institution’s bonds. Higher ratings indicate lower risk, and lower ones indicate higher risk. Of course, the higher the risk, the greater the return on the bond for its holder. For the institution, a higher rating means you pay a lower interest rate, but a lower rating means you will pay a higher one.

Like accreditors, bond rating agencies have established criteria that they publish on their websites. They look at both quantitative data (such as financial, enrollment, and repayment history) and qualitative information (for example, management, governance, strategy, and institutional reputation). They also examine macro trends in demographics, government funding, the regulatory climate, and other relevant areas.

What the bond rating agencies do:

• Provide potential and current investors with an expert and independent assessment of the current and prospective financial condition of the institution.

What the bond rating agencies do not do:

• Assess the academic quality or outcomes of the institution (raters focus only on the financial condition, though they look at other factors that might impact finances); and
• Evaluate the quality of the financial staff (raters do consider the quality of leadership and governance).

Conclusion

Higher education governing boards must understand each of the important roles that accreditors, auditors, and bond rating agencies play in sustaining the financial health of their institutions. Remember, accreditors are expert partners who are interested in helping your institution be successful—an accreditor is not your enemy. Auditors verify the accuracy of the financial statements that management prepares; it is not their responsibility to uncover all potential fraud at your institution. Finally, bond rating agencies give an independent assessment of the creditworthiness of your institution’s debt, but your college or university is not an agency’s client.

Larry Ladd is an AGB subject matter specialist and the author of “Financial Sustainability: Avoid Magical Thinking,” in A Guide to Strategic Board Retreats in Higher Education, edited by R. Barbara Gitenstein.