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####  November 5, 2003

#### FINANCES OF RESEARCH UNIVERSITIES

#### Executive Summary

It is the purpose of this paper to present a current snapshot of the
primary revenue streams and expenditures at research universities. In
this context, a research university is described as an institution that
is committed equally to instruction, research, and public service. These
universities consider such activities to be inextricably intertwined,
and they have in place the necessary infrastructure to encourage and
support their faculty in the pursuit and conduct of research.

The paper explains the restricted and unrestricted sources of university
funds, and the typical distribution of university revenues. Tables and
charts illustrate the structural differences and financial options for
both private and public research universities. The financing of
sponsored research is explained. Data on the extent to which
universities cover their costs for conducting federally funded research
are given, as well as the reasons for under recovery of legitimate
expenditures and the extent of university subsidies. The paper closes
with comments on the reasons for cost increases, reasons for decreasing
external funding resources and the resulting difficulties for sustaining
the academic research enterprise.

# **Mission of Research Universities**

Research universities have in common the three-fold mission of
instruction, research and public service. For those research
universities that own a hospital and/or clinical practice, the
obligation of providing medical services constitutes a fourth mission.
Finally, yet another mission shared by some research universities is
represented by their Land-Grant designation, although this is often
subsumed under the mission of public service.

The mission of a university influences its financial structure. For
example, a university that owns a hospital is dominated financially and
physically by the hospital, with the value of plant assets and operating
revenues demonstrating the heavy weighting of the hospital. On the other
hand, universities without hospitals have balance sheets that reflect
significant investments in capital assets for instruction and research,
in addition to their endowments.

A second major factor that causes significant financial differences is
the respective private or public nature of the research university.
Historically, public universities were funded through state
appropriations as a primary revenue source. In recent times, some public
universities have seen a severe decline in state funding and are
exhibiting greater financial similarities to private universities than
to other public universities: similarities in the size of the endowment
and in the small proportion of the operating budget that is funded by
the state.

## The Operating Statement

# Sources of Funds

Sources of funds for both public and private universities can be divided
into unrestricted and restricted. The following charts show the
composition of revenue sources for private and public universities,
respectively, excluding hospital revenues. The data represent
research-intensive universities that are members of the Association of
American Universities. The source of the data is the FY2001 Integrated
Postsecondary Education Data System (IPEDS), a Finance Survey provided
annually to the Department of Education.

![](media/image1.wmf)

![](media/image2.wmf)

As the term implies, unrestricted resources can be used for the primary
missions of teaching, research and public service without any
restriction. Restricted resources are those that are restricted in use
by third parties such as donors or supporting agencies. The restrictions
are typically either related to the use of the resources for a
particular organizational unit, such as the College of Business, or
dedicated to a function, e.g. scholarships, or for an activity such as
special research or a lecture series.

The distribution of revenues shows many similarities between public and
private research universities. The four largest sources of revenues for
public higher education research institutions are tuition and fees, net
of scholarships and fellowships (13%); auxiliary enterprises revenues
(14%); government (primarily state) appropriations (31%); and government
(primarily Federal) grants and contracts (22%). Three of these four
sources also rank high for private higher education institutions: net
tuition and fees (20%) and government grants and contracts (25%) and
auxiliary enterprises revenues (18%). Gifts, grants and contracts from
private sources (22%) take the place of government appropriations as one
of the four largest sources. This same item accounts for only 9% of
public institution's revenues. The table below presents the public
universities' sources of revenues in descending order of magnitude, and
illustrates the comparison with private universities described above.

  ------------------------------------ --- ---------------- --- ----------------
  **Distribution of Revenues**                                  

                                                                 

                                                                 

                                           Public               Private
                                           Universities         Universities

  Federal, State & Local                   31%                  0%
  Appropriations                                                

  Federal, State & Local Grants &          22%                  25%
  Contracts                                                     

  Auxiliary Enterprises                    14%                  18%

  Net Tuition and Fees                     13%                  20%

  Private Gifts, Grants & Contracts        9%                   22%

  Sales & Services                         6%                   8%

  Other Revenues                           5%                   7%
  ------------------------------------ --- ---------------- --- ----------------

### 

Historically, private higher education research institutions relied more
heavily on net tuition and fees than public research institutions
because of public institutions' state support. Private institutions have
had the flexibility to set tuition and to increase it according to the
extent to which expenditures increase or other sources fall short. On
the other hand, most public institutions are constrained by state
statutes, which mandate that the state legislature will set or control
tuition.

Auxiliary enterprises are generally self-supporting activities, whose
services are provided primarily to individuals in the university
community such as students, faculty and staff, but which may also offer
incidental services to the public. Examples include university housing,
intercollegiate athletics, bookstores, and dining services. These
activities generally receive no subsidies from other sources unless they
are deemed to be a critical aspect of the academic mission that should
be funded even if a subsidy is necessary.

Of the remaining two categories of revenues, sales and services of
educational activities include all revenues derived from the sales that
are incidental to the conduct of instruction, research, or public
service. It also includes the revenues from activities that provide
instructional and laboratory experience for students and that
incidentally create goods and services that may be sold. Examples
include film rentals, scientific and literary publications, testing
services, university presses, dairies, and patient care clinics that are
not part of a hospital. The last category, other revenues, includes any
other revenues not reported elsewhere.

Both public and private universities finance their physical plant assets
and capitalized equipment with operating reserves, private gifts,
federal appropriations, debt financing usually in the form of revenue
bonds. In addition, public institutions may have access to capital
through state appropriations. The "facilities" portion of the F & A cost
recovery is intended to reimburse research universities for the cost of
research space.

# Uses of Funds

The following charts show the expenditure patterns of public and private
research universities by program category. While there are several
significant differences in sources of revenue, expenditure patterns are
very similar.

![](media/image3.wmf)

![](media/image4.wmf)

In the case of both public and private institutions, the majority of
expenditures cover the primary missions of teaching, research, and
public service (58% to 63%). The publics have a larger proportion of
public service expenditures, primarily due to the land grant missions of
a number of these institutions. Expenditures for auxiliary enterprises
amount to 18% and are directly tied to the revenues generated, since
these operations are expected to be self-supporting. Academic support,
including libraries and information technology, and student services,
including career planning and placement, counseling, registrar,
admissions, and financial aid offices, constitute approximately 12% to
13% of expenditures. Institutional support, ranging between 6% to 9%,
includes administrative cost, fiscal operations, fund raising, and
public relations. One can best understand this difference by remembering
that public universities have a number of administrative services
including payroll and purchasing disbursements, cash management, and
debt management provided by the state and that these are not reflected
in the university's expenses.

# Expenditures can also be classified by object, and this categorization underscores an important point. Universities are people-intensive organizations. Salaries, wages, and benefits constitute 65% to 80% of most university budgets. While private institutions are able to set levels of compensation and benefit programs, the state establishes and controls these for most public institutions. The fixed costs of physical plant maintenance and repair and utilities comprise another 10% to 15% of expenditure budgets. The remaining uses are attributed to general operating expenses including supplies, communication, service contracts, travel, non-capital equipment and interest on debt.

## The Balance Sheet

A review of the balance sheets of research universities clearly shows
that plant, property and equipment (PPE) constitutes the largest asset
group.  This category includes buildings, infrastructure, equipment,
furniture and computer systems (hardware and software).  In accordance
with Generally Accepted Accounting Principles, the value shown on the
balance sheet is the historical acquisition cost after depreciation.  
Thus, a newer plant is reflected on the balance sheet at a higher
un-depreciated value.  For private universities, a newer plant is
typically accompanied by larger liabilities, because the new capital is
being financed using debt instruments.  For public universities, capital
construction and acquisition are often state-funded, but the asset may
be shown on the balance sheet of the university itself or of the state
only, and the liability will not be disclosed on the university\'s
balance sheet if debt service payments are made by the state from
general tax revenues.  Changes in technology and the continual need to
upgrade equipment, facilities and infrastructure have a significant
impact on a university\'s balance sheet.   In recent years, many
universities invested heavily in administrative information systems such
as Enterprise Resource Planning systems and web-based technologies.

The second of the two largest assets for research universities are often
endowments. Most private research universities have significantly larger
endowments than the publics and the balance sheets reflect those
differences. The 2002 Endowment Study prepared by the National
Association of College and University Business Officers (NACUBO)
reported that public institutions account for \$61 billion or 27 % of
total endowment holdings, while private institutions account for \$161
billion or 73 %. [^1] Balance sheet ratios reported by Moody's Investor
Services for FY 2002, indicate that the wealthier private research
universities have significantly greater total financial
resources-per-student, expendable financial resources-to-operations, and
expendable financial resources-to-total net assets. This results in
higher credit ratings and a lower cost of capital for private research
universities, compared to public research universities.

## Financing of Sponsored Research

Sponsors, including the federal government, foundations, and
corporations, provide funds for research, usually through a competitive
process. Included in the awards are funds for direct costs of research
as well as indirect costs related to facilities and administrative (F&A)
expenses.

While direct costs of research can be identifiable readily with a
particular sponsored project (examples include chemicals for a specific
experiment, or salary of a laboratory technician who works 100% on a
specific sponsored project), infrastructure costs are incurred to
support all the missions of the university. Accordingly, these indirect
or F&A costs are subsequently allocated to each mission (including
"organized research") using the Office of Management and Budget (OMB)
methodology. COGR has developed a detailed document that discusses F&A
costs and F&A rates.[^2]

The F&A rate is the mechanism by which sponsors reimburse universities
for expenses that they have already paid for facilities and
administration, in support of sponsored research. The federal government
negotiates rates with individual universities. COGR's data for FY 2001
show F&A rates ranging from 41.5% to 72%. The variance is in the "F" or
Facilities component (building and equipment acquisition, operations and
maintenance), which ranges from 15.5% to 46%. The "A" (administrative)
cost component of the F&A rate generally was at or close to 26, because
of the federal government's mandated 26% cap.[^3]

## University Subsidy of Federal Research

Universities subsidize either one or both, the direct costs and the
indirect (F&A) costs of federal research. In terms of F&A costs,
universities are not reimbursed for the full amount of the costs that
they have spent on federal research. The most significant reasons for
this under recovery are described below:

1.  Some federal agencies request a full or partial waiver of F&A
    reimbursements. Additionally, a number of federal agencies do not
    pay the negotiated F&A rate, but establish a reduced rate, either
    for certain programs or for the entire agency portfolio. Details of
    this practice by individual agencies are contained in a study that
    COGR conducted at the request of the Association of American
    Universities, released in April 2002. It is entitled "Further
    Analysis of Under Recovery of F&A Costs at Colleges and
    Universities".[^4] Across all agencies and research universities,
    the study estimates that this additional discount represents about
    15% or \$1 billion in F&A recoveries.

2.  The 26% cap on the administrative component of the F&A rate was
    imposed in 1991, based on data representing average administrative
    costs at universities prior to that point in time. Since then, there
    have been many changes in research administration, which have
    resulted in significant increases in the administrative costs of
    conducting federal research. New compliance programs are the most
    significant factor driving up these costs. Since the late 1980's,
    research universities have developed and maintained extensive
    programs to comply with a plethora of new federal regulations on
    electronic research administration, cost accounting standards,
    protection of the environment, human subjects and animal subjects,
    intellectual property. The most recent additions include compliance
    with the Health Insurance Portability and Accountability Act (HIPAA)
    as well as new requirements to assure biomedical research security.
    These compliance programs have been expensive, and have forced
    universities to absorb all administrative expenses above the 26%
    cap. A 2000 COGR study showed that the actual median administrative
    cost rate for its 150 members was not 26% but 28.34%. Universities
    were absorbing 2.34% of this median rate. More recently, in 2003
    COGR released a study on the "Cost of Doing Business" that concludes
    that this subsidy amounts to about \$200 million in 2001 for
    research universities.[^5]

3.  There are other limitations on reimbursements that have been built
    into the OMB A-21 methodology, including those on utility expenses,
    library expenses and unallowable costs. OMB A-21 does not recognize
    as allowable costs certain categories that are intrinsic to a
    university's financial structure. For example, every university has
    alumni and fund-raising activities, which generate resources for all
    missions including research. However, these expenses cannot be
    allocated even partially to sponsored research*.*

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4.  Utility expenses. Scientific research consumes energy at a higher
    rate than instruction. Prior to 1996, universities were able to
    document this differential consumption through technical "utilities
    studies". In 1996 the federal government generated "cost-savings" by
    eliminating all utilities studies and replacing them with a factor
    of 1.3 for those universities that had been relying on the studies.
    This factor was below the one calculated in the studies for most
    universities, and resulted in the universities having to absorb the
    costs above the 1.3. At the same time, other universities were
    prohibited from joining those who had been grand fathered to use
    this weighting factor.[^6] In general, federal "cost saving"
    measures that reduce allowable F&A reimbursements are experienced by
    universities as a "cost transfer" of the cost burden from the
    federal government to the university.

5.  In terms of direct costs, the most common university subsidy is
    through cost-sharing of equipment or salaries. Additionally, a
    number of agencies require or request universities to pay some
    portion of direct costs.

> The cumulative impact of all these mandatory and voluntary
> cost-sharing requirements is remarkable. The National Science
> Foundation reports in its most recent report of support for academic
> research and development, that the university share of total
> expenditures for research is now 20% of total expenditures, or about
> \$6.5 billion in FY 2001.[^7]

# 

# **University Perspectives on Federally Funded Research** 

At research universities, faculty perform scholarly research in their
field. In the OMB Circular A-21 vernacular such research, if not funded
by a sponsor, is considered integral to the "Instruction and
Departmental Research" function. This is distinct from the "Organized
Research" function, which is "separately budgeted and accounted for" and
funded primarily by the federal government, but also by other sponsors
as well as the university itself.

On most university campuses, federal research is conducted largely in
the science departments. Even though the amount of federally-funded
research is large, it does not involve a majority of faculty, students
and academic programs. Thus, university administrators are faced with
managing the tension between the departments that receive federal
funding and those that do not, the faculty who participate in federal
research and those who perform unfunded research and/or teach.

It is particularly challenging to explain the subsidies that
universities provides for federal research to those not engaged in
federal research. The subsidy is perceived by many as a manifestation of
the choice to allocate university resources to federal research rather
than to teaching and areas of scholarly research typically not funded by
the federal government.

In particular, our sophisticated constituencies believe that
universities receive less in F&A reimbursements than private contractors
(who are on "cost-plus" arrangements) or even federal colleagues who
perform intra-mural research. This particular viewpoint was reinforced
by the report of the RAND study commissioned by the Office of Science
and Technology Policy (OSTP), released in 2000.[^8] One finding in
particular was that F&A rates vary considerably by performer, as
illustrated by the rates of 31% of total costs for universities, 33% of
total costs for federal laboratories and 36% of total costs for
industrial laboratories. Such a finding fuels the perception that
universities are not treated equitably by the federal government in the
sharing of costs of research, although there is general agreement that
federal research is vitally important to the research university's
reputation and standing and intellectual health.

**[Current Financial Situation]{.underline}**: 

The economic downturn of the last few years and the bursting of the
high-tech bubble have created significant financial imbalances in higher
education.   For the public universities, the single largest impact is
that states have tried to adjust to the drop in tax revenues by cutting
appropriations, including those to state universities, often in
preference to reducing budgets for other state services such as security
and K-12 education.

Further complicating the problem for public universities are structural
problems in state budgets.  Growth in mandatory expenditures for
Medicaid, elementary and secondary education, and corrections is far
outstripping growth in revenues and is expected to continue to do so
even when the economy turns around. Higher education funding is one of
the few places where states have discretion and this area is expected to
continue to be targeted for reductions.

As explained earlier, state appropriations are the largest source of
funds for public universities, representing 31% of funding sources.
Therefore, the effect of recent cuts has been conspicuous and painful. 
Employees have been laid off, and tuition increases have been
instituted.  

Other impacts of the economic downturn include the reduction in private
gifts and the erosion in the value of endowments.[^9]   This loss in
revenues from private gifts and endowment returns is felt especially
keenly by the private universities that have built dependence on these
sources to pay for operating expenses. It is fair to say that both
private and public universities are in a budget-cutting mode, attempting
to mitigate revenue losses by increasing tuition where feasible and
appropriate.  

These funding problems of research universities, combined with the
increase in the costs of doing research cited earlier, threaten the
nation's basic research capability. In this financial environment every
academic program is subject to scrutiny and justification. Even if the
federal budget were to not to improve significantly in the near future,
the growing imbalance between available resources and mandatory outlays
of the nation's research universities needs to be addressed.

The principal authors of this paper are Natalie Krawitz, Vice President,
Finance and Administration, University of Missouri and Yoke San
Reynolds, Vice President, Finance, University of Virginia. Both are
members of COGR's Costing Policies Committee. Their support and counsel
is greatly appreciated.

[^1]: "2002 NACUBO Endowment Study", National Association of College and
    University Business Officers at http://www.nacubo.org/publications/

[^2]: "University Facilities and Administrative Costs: What They Are and
    Why They Are so Important", Council on Governmental Relations, 2002,
    www.cogr.edu/docs/FATechnical.html

[^3]: "Factors that Influence F&A Cost Rates at Research Intensive
    Universities", Council on Governmental Relations, June 1, 1998,
    www.cogr.edu/docs/variancesreport.html

[^4]: "Further Analysis of Under Recovery of F&A Costs at Colleges and
    Universities", Council on Governmental Relations, April 2002,
    reported in the June 2002 COGR Meeting Agenda,
    www.cogr.edu/docs/june02age.doc

[^5]: "Report of the Working Group on the Cost of Doing Business",
    Council on Governmental Relations, June 2003, www.cogr.edu/docs/codb
    final 6-02-03.doc

[^6]: COGR August 2, 2002 letter to the OMB Deputy Controller on the
    Utility Cost Adjustment, www.cogr.edu/docs/ucaletter.pdf

[^7]: "Academic Research and Development Spending Maintains Growth from
    all Major Sources in FY2001", National Science Foundation, NSF
    03-327, August 2003

[^8]: "Paying for University Research Facilities and Administration",
    Charles A. Goldman and T. Williams, Science and Technology Policy
    Institute, RAND 2000

[^9]: "2002 NACUBO Endowment Study". See Endnote 2