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Higher education institutions receive scores intended to measure their financial responsibility, and those scores will soon be calculated differently. Learn what this could mean for your institution.

Regulations

Financial Responsibility Composite Score is Getting an Upgrade

  • Liz Towne
  • Yuliya Ostapenko
  • 4/6/2020

Key insights

  • The calculation used to determine your institution’s financial responsibility composite score is changing.
  • As a result, it’s possible your score could change.
  • If a new score means your institution fails the standard, there are implications.

Higher education campuses across the country are closed as a result of the coronavirus, and many are bracing for the impact on their bottom line. Now, the calculation used to measure your institution’s financial responsibility is changing. You’ll need to understand how your composite score could be different with the new calculation — and you’ll want to know before the implementation deadline.

How is the financial responsibility composite score calculated?

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Currently, the primary reserve, equity, and net income ratios are combined into one composite score to measure an institution’s financial responsibility. Due to the implementation of ASU 2016-14, Presentation of Financial Statement of Not-for-Profit Entities, and the upcoming implementation of ASU 2016-02, Leases, the longstanding composite score calculation is getting an upgrade.

Implementation of the new requirements goes into effect for any institutions submitting their eZ-Audit filings after July 1, 2020, so this affects all fiscal year 2020 audits. You can early adopt and implement the changes for the fiscal year 2019 eZ-Audit filing; however, it is not required.

Most important, with this update, you are required to include a supplemental schedule in the audited financial statements. This supplemental schedule must have all financial figures needed to calculate the composite score ratios, with a cross-reference to the financial statement line or note disclosure that contains the figure. This supplemental schedule requires an auditor’s opinion.

Summary of changes to the calculation

The specific changes to the calculation are listed below: 

  • Addresses changes relating to ASU 2016-14, including financial statement terminology and related ratio definitions
  • Addresses changes relating to ASU 2016-02, as implementation of this standard can negatively influence an institution’s equity ratio
  • Clarifies the treatment of endowment appreciation, defined benefit pension, and post-employment obligations
  • Redefines long-term debt
  • Provides updated descriptions of total expenses, losses, revenue, and gains used in the ratio calculations by providing updated formulas and explanations

Interpreting the results

While the details that go into the calculation are changing, the resulting scoring scale remains the same: 

  • Pass: 1.5 – 3.0
  • Zone: 1.0 – 1.4
  • Fail: -1.0 – 0.9

Consequences of getting a “zone” score

If your score falls into the zone category, you’ll be subject to enhanced cash disbursement requirements. In this case, your institution would have to show it has funds in the bank sufficient to cover the required disbursements, disburse the funds, and then — and only then — draw upon the funds from the Department of Education.

New consequences of failing the financial responsibility standard

In the past, a failing school would need an irrevocable letter of credit covering 50% of the previous year’s financial aid funding to continue participating in Title IV programs. Under the new regulation, the institution may continue to participate in Title IV funding programs under provisional certification for up to three years, but will need to provide surety to the Department of Education of at least 10% of the previous year’s funding. This percentage is not a fixed determinant. It will differ from institution to institution and will be determined by the Department of Education on a case-by-case basis.

In addition, the type of surety required is changing as well. Instead of an irrevocable letter of credit, the schools will have an option to earmark the amount of funding they are eligible to receive, prorated over nine-months, until the required amount has been withheld. Other alternatives may become available in the future.

From existing formula to new: bridging the changes

Let’s compare the differences between the new and existing formulas.

Primary reserve ratio

Numerator: Expendable net assets

Existing:
Unrestricted net assets

  • Plus: Temporarily restricted net assets
  • Less: Annuities, term endowments, and life income funds that are temporarily restricted
  • Less: Intangible assets
  • Less: Property, plant, and equipment, Net
  • Plus: Post-employment and retirement liabilities
  • Plus: All debt obtained for long-term purposes, not to exceed total net property, plant, and equipment
  • Less: Unsecured related party receivables
New:
Net assets without donor restrictions
  • Plus: Net assets with donor restrictions
  • Less: Net assets with donor restrictions: restricted in perpetuity
  • Less: Annuities, term endowments, and life income funds with donor restrictions
  • Less: Intangible assets
  • Less: Property, plant and equipment, Net1
  • Plus: Post-employment and defined benefit pension liabilities
  • Plus: All debt obtained for long-term purposes, not to exceed total net property, plant, and equipment2
  • Less: Unsecured related party receivables3

1The value of property, plant, and equipment includes construction in progress and lease right-of-use assets, and is net of accumulated depreciation/amortization.

2
All debt obtained for long-term purposes, not to exceed net property, plant, and equipment, includes lease liabilities for lease right-of-use assets and the short-term portion of the debt, up to the amount of net property, plant, and equipment, and construction in progress short-term lines of credit and notes payable used for construction in progress, not to exceed total construction in progress. If an institution wishes to include the debt, including debt obtained through long-term lines of credit in total debt obtained for long-term purposes, the institution must include a disclosure in the financial statements that the debt, including lines of credit, exceeds 12 months and was used to fund capitalized assets (i.e., property, plant, and equipment or capitalized expenditures per GAAP). If an institution wishes to include short-term lines of credit or notes payable for construction in progress, the institution must include a disclosure in notes to the financial statements.

3
Unsecured related party receivables would be based on the related party disclosures as required by 34 C.F.R 668.23(d): an institution must include a detailed description of related entities that meet FASB’s definition.

Denominator: Total expenses without donor restrictions and losses without donor restrictions

Existing:
The total unrestricted expenses taken directly from the audited financial statements

New:
All expenses and losses without donor
restrictions from the Statement of Activities
  • Less: Any losses without donor restrictions on investments, post-employment and defined benefit pension plans, and annuities4

4For institutions that have defined benefit pension and other post-employment plans, total expenses include the nonservice component of net periodic pension and other post-employment plan expense (FASB ASU 2017- 07), and these expenses will be classified as non-operating. Consequently, such expenses will be labeled non-operating or included with “other changes – nonoperating changes –in net assets without donor restrictions” when the Statement of Activities includes an operating measure.

Equity ratio

Numerator: Modified net assets

Existing:
Unrestricted net assets

  • Plus: Temporarily restricted net assets
  • Plus: Permanently restricted net assets
  • Less: Intangible assets
  • Less: Unsecured related party receivables
New:
Net assets without donor restrictions
  • Plus: Net assets with donor restrictions
  • Less: Intangible assets
  • Less: Unsecured related party receivables
Denominator: Modified assets

Existing:
Total assets

  • Less: Intangible assets
  • Less: Unsecured related party receivables
New:
Total assets
  • Less: Intangible assets
  • Less: Unsecured related party receivables

Net income ratio

Numerator: Change in net assets without donor restrictions

Existing:
Change in unrestricted net assets is taken directly from the audited financial statements

New:
Change in net assets without donor restrictions is taken directly from the audited financial statements
Denominator: Total revenue without donor restrictions and gains without donor restrictions

Existing:
Total unrestricted revenue is taken directly from the audited financial statements
(and includes net assets released from restriction during the fiscal year)

New:
Total revenue (which includes net assets released from
restriction) plus total gains5

5Include the following items if they are gains (have credit balance) only:
- Investment return, net (operating — used for appropriations and
  non-operating — in excess of return used for appropriations)
- Net periodic pension cost other than service cost
  (almost never has credit balance because it is a cost)
- Pension-related changes other than net periodic pension costs
- Change in value of annuity agreements
- Change in value in split-interest agreements
- Change in value of interest-rate swaps
- Sale of fixed assets
- Net assets released from restrictions due to acquisition of long-lived assets
- Other gains

New required disclosure

All institutions will be required to include a new disclosure. Let’s review what you need to include as part of that supplemental schedule.

Don’t wait, take action now

The chances are that you are reading this article in your new “office” in the comfort of your home, because your campus is closed as a result of the coronavirus. That will have a tremendous impact on the financial results of your school. Take action now:

  • Don’t wait until July 1, 2020 — calculate your score now.
  • Dig deeper into the new calculation to see how the changes will impact you. You know your school and you know which of the composite score calculation ratios will be impacted by the current events.
  • Explore a decision on implementing the new leases standard early, if it can have a positive impact on your calculation.
  • Communicate with your audit or other oversight committee to collect questions and suggestions.
  • Communicate with your financial services provider to discuss existing loans, new loans, and/or loans you are considering for refinancing, to understand the impact of existing and changing terms.
  • Communicate with your auditor to collect their recommendations and understand their expectations of the calculation result and supplemental schedule preparation.

How we can help

At CLA, our higher education industry professionals are ready to walk alongside you in understanding the details of the calculation and discussing the impact of various inputs. Watch for an upcoming webinar that will discuss the changes and walk through calculation examples and the new required supplemental disclosure.

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