Adaptive Boards Appreciate Depreciation and Don’t Defer Maintenance
Photo by Grant Durr on Unsplash
“Oh, that’s just depreciation.”
You hear this annual refrain while staring at the big red parentheses at the bottom of the Statement of Activities. “We still balanced our budget.” The reassuring words evaporate just after leaving the lips: “That’s a non-cash item. Don’t worry about it.”
The problem is, accreditors worry about it, and so should you. Depreciation is a quantifiable measure of two of the most qualitatively destructive forces confronting higher education today—deferred maintenance and our refusal to address it.
Most finance chiefs have grown weary of trying to educate boards and presidents who routinely disregard what to them seems like an accounting trick. This oversight is quietly eroding the financial integrity of our institutions.
Presidents are giddy when they learn expenses can be capitalized, and it is like winning double jeopardy to learn that the assets won’t go into service (i.e., won’t hit the books) until the next fiscal year. What could be better than shiny new objects you don’t have to pay for out of this year’s budget, right?
But we do have to pay for them, a fraction at a time over years. And that fraction shows up—often in a calculation at the end of the fiscal year—as depreciation.
Top 3 Reasons Trustees Ignore Depreciation
Depreciation is hidden in the financial statements, spread across all the functional expense categories.
Many trustees focus on cash in and cash out in their businesses and have trouble worrying about a non-cash entry on the financial statements.
Some trustees assume it is irrelevant for a non-taxed entity.
As easy as it is to ignore depreciation, boards have a responsibility to take it seriously.
Top 3 Reasons Trustees Should Care about Depreciation
Depreciation is a measure of the pace of replacement needs for campus facilities and essential systems such as roofing and HVAC.
Accumulated unfunded depreciation serves as a proxy for the loan you are taking out against your institution’s future.
Funding depreciation serves as self-insurance against catastrophic failure of a system whose repair you may not be able to finance. Remember, boilers only give out on cold days.
As implied above, funding depreciation annually is better than kicking the can down the road. It’s not easy to start, but it is a good habit to phase in.
Top 3 Ways to Focus on Depreciation
Unhide depreciation by breaking it out as a separate expenditure line for board presentation and review purposes, remembering that it is spread across all function areas in the audited financial statements.
Make a plan to fund depreciation through operations. This can be hard for an institution that hasn’t funded depreciation before. Phase it in over three to five years, if necessary, but put depreciation on par with every other functional expense item.
Use the cash generated by funding depreciation for capital budget expenses, extending the life of facilities and equipment, particularly through addressing deferred maintenance.
Beware
Another way to say that an asset is “fully depreciated” is to say that the asset has been “wholly unappreciated” for years or decades. While the accounting non-entry of a fully depreciated asset effectively lessens the depreciation expense, it means that the fiscal life of that asset has run its course. In other words, the institution has done nothing to extend its life.
We all love “Old Main,” right? Then stop waiting until a hailstorm hits to replace the roof! Ultimately, unfunded deprecation may be the quantifiable measurement of the difference between sentiment and strategy. If an institution is unwilling to invest in the extended life of an asset, then maybe the strategic benefit of that asset has expired. If we are unwilling to give the roof of “Old Main” a seat at the budget table through its proxy, depreciation expense, at the same time that salaries, benefits, IT, and new program starts are debated, that should tell us something.
The business model for higher education is broken. One component of that broken business model is our dependence on fixed assets, with catastrophic failures due to aging facilities hanging like the Sword of Damocles over our cash flow. Our assets and our strategies are misaligned. Our passive or willful failure to fund depreciation is one indicator of this.
From Fixed to Flexible
We are, literally, carrying on our books investments in the resources needed to meet yesterday’s strategies, leaving us cash-strapped when strategic innovation is called for. Building in the discipline to fund depreciation forces a board to confront this reality and make one of three decision about facilities, equipment, or large systems:
Renovate them because they still meet strategic aims today.
Repurpose them to adapt to emerging strategic aims.
Relinquish them with gratitude for providing a strong foundation upon which to build.
Boards have no excuse for ignoring deferred maintenance or, more likely, asset obsolescence, because depreciation—and our willingness to fund it—provide annual metrics of the alignment of our fixed assets with emerging strategy.
Higher education is good at a lot of things, including turning what most industries see as variable costs into fixed costs. One way to transform higher education is by changing our mindset about resources from one that sees them as fixed to one that sees them as flexible.
When you are asked why you want to see depreciation broken out as a separate expense line in the budget, you can explain, “Oh, that’s just appreciation—appreciation for the magnitude of paying for the past and the urgency of investing in the future.”
If it is time for your board to stop managing the costs of the past and start investing in the future, schedule a private Adaptive Governance Workshop today. In the meantime, register for Staying Afloat with Sunk Costs: Leveraging Existing Resources for Institutional Transformation, a complimentary AGB webinar on Thursday, May 13, 11:00 AM–12:00 PM ET.
David Rowe, PhD, is the interim president of Lancaster Theological Seminary and the immediate past president of Centenary College of Louisiana and Lake Highleand Preparatory School. He is AGB’s practice area leader for Adaptive Governance and Financial Sustainability as well as the founder and CEO of The Development President.