New Financial Responsibility Standards

By Michael T. Wherry, CPA | February 8, 2024


Financial Responsibility, as defined by the U.S. Department of Education, is a condition of eligibility for a school participating in FSA programs, requiring that schools submit an audited financial statement to ED each year. Recently, the conditions for meeting these important requirements changed in ways that may add complexity to institutions’ financial reporting processes and pose challenges to compliance. We’ve been tracking proposed and now finalized rules for over a year and have compiled our analysis below. This article breaks down key points of the final regulations and whether these changes were positive, neutral, or negative.

How Did ED’s Financial Responsibility Rules Change?

In October 2023, the U.S. Department of Education (ED) released final regulations which have broad changes related to financial responsibility. These rules go into effect on July 1, 2024. The final regulations were relatively consistent with the proposed regulations though some changes did occur. We have analyzed these developments and their impacts to institutions, focusing on three main areas:

General Standards and Financial Triggers
Change in Ownership
Audit Reports and Submissions

If desired, please use the links above to jump to each section.

General Standards and Financial Triggers

The regulations made significant changes to the general financial responsibility standards and financial triggers. Financial triggers are events which could require immediate reporting to ED. Below, we outline the impacts of these changes, positive, neutral, and negative, that we expect to see for institutions.

Positive changes:

  • Reporting of the various triggers was increased from 10 to 21 days.
  • ED commented that their intention is to not make multiple financial protection requests from one triggering event.
  • A change was made from the proposed rule to make State actions a discretionary trigger and clarify that teach-outs must be related to the whole institution and for financial reasons.
  • A school losing the eligibility to participate in another Federal program was moved from being a mandatory to a discretionary trigger.
  • The rules defined:
    • The monetary actions which relate to the mandatory triggers under 668.719(c)(2)(i)(A) (Legal and Administrative Actions)
    • How the 120-day period works under 131(c)(2)(i)(B)
    • That the trigger at 668.131(c)(2)(i)(C) is ED initiating an action to recover the cost of adjudicated claims under the borrower defense to repayment provisions.
  • The closure of locations or discontinuation of programs was revised to be a trigger only if the changes impact 25% of more of the enrolled students.
  • Eliminated a discretionary trigger from the proposed regulations which would have related to requests for information from other regulatory agencies and moved this to 668.14(e)(10) under Certification.
  • The changes also provide guidance under 668.171(f)(i) for how a school can demonstrate that the trigger has been alleviated.

Neutral changes in new regulations:

  • ED made changes to the general standard for late payment of credit balances, unpaid payroll obligations, and undisputed financial obligations which are unpaid after 90 days. Overall, we don’t believe these changes will have a significant impact on a school which is financially stable.
  • All mandatory triggers under 668.131I(2)(i) require a recalculation except for 668.131(c)(2)(i)(B).
  • The changes defined specific language that contributions made in the 4th quarter of a fiscal year need to remain in the school until 6 months after the fiscal year end. This includes the withdrawal of equity by any means. While this delays the removal of a contribution, it simultaneously provides some safe harbor for management decisions.
  • A school is deemed not to be financially responsible if the audit opinion is adverse, qualified, or disclaimed, even if it meets all of the general standards. This is the case unless ED determines it has no bearing on the school’s financial condition or a footnote disclosure discusses school’s diminished liquidity or ability to continue as a going concern unless alleviated.

Negative changes in the new regulations:

  • The number of mandatory and discretionary triggers has expanded. See Appendix I for a summary of these triggers.
  • The regulations added a discretionary trigger to encompass any other event or condition obtained from the school or other parties, and ED determines whether the event or condition is likely to have a significant adverse effect on the financial condition of the school.
  • The regulations enable ED to “stack” multiple layers of financial protection if a school is experiencing multiple unrelated financial triggers.
  • The regulations enable ED to hold financial protection for two full fiscal years even if the triggering condition has been alleviated. The regulation is designed to provide ED ample time to ensure the condition or event has been alleviated.
  • ED may take an administrative action or deem a school not financially responsible if the school doesn’t report a triggering event or respond to any ED determination or request in a timely manner.
  • A participating school which is not financially responsible solely due to the composite score ratio (CSR) can qualify under the zone alternative if the CSR is in the range of 1.0 to 1.4 for three years. However, a school can’t seek to qualify again under this alternative until the year after the school achieves a CSR of at least 1.5.

Change in Ownership

The regulations mainly codified existing ED practices.

Positive changes in the new regulations:

  • The regulations removed the rules under 668.15 and codified many existing ED guidance under 668.176. These changes are a positive as ED’s practices are now clearly listed in the regulations.

Neutral changes in the new regulations:

  • New owners must submit audited financial statements for the two most recently completed fiscal years. A letter of credit is required as follows: 25% for new owners without audited financial statements and 10% for new owners with only one year of audited financial statements.
  • Owners must submit a same-day balance sheet as of the day after the change of ownership. The SDBS must be issued at the level of highest unfractured ownership, with an acid test ratio of 1:1 and positive tangible net worth or financial protection of at least 25%.

Negative changes in the new regulations:

  • ED now has the discretion to determine that a school isn’t financially responsible if ED believes the amount of acquisition debt payments is inconsistent with available cash based upon prior period enrollments. This is a very arbitrary and subjective standard.
  • The changes introduce a new financial test, evaluated at the ownership level required by ED for the new owner, to determine:
    • If the school had operating losses in either of the last two years which resulted in a decrease of 10% of the tangible net worth at the beginning of the two-year period
    • Whether positive tangible net worth existed for the two most recent fiscal years, and
    • Whether the school had a passing composite score and meets the other financial requirements for most recently completed fiscal year

This new provision potentially enables ED to assess financial protection if the target school has failed any of these test even if the new owner passes the same day balance sheet tests and has two years of audited financial statements.

Audit Reports and Submissions

The final regulations included changes that will impact a school’s fiscal year end and the timing of audit report submissions.

Positive changes from the proposed regulations to the final version:

  • ED eliminated the proposed regulation requiring a footnote in a school’s audited financial statements (except for any requirement under Generally Accepted Accounting Principles) that discloses the amounts spent on recruiting activities, advertising, and other pre-enrollment activities.

Neutral changes in the new regulations:

  • Audit reports must be submitted by the earlier of six months after year end or thirty days after the later of the issuance of the compliance audit report and the financial statement audit report. This is consistent with the standard for nonprofit Single Audit, so M&A doesn’t believe this is unreasonable.

Negative changes in the new regulations

The final regulations require schools to have the same fiscal year for book and tax purposes. ED argued a different year end has led to manipulation of the CSR. We are uncertain as to how a different book and tax year impact the CSR and this is most likely to impact schools with a June 30th fiscal year and a December 31st tax year end. Selfishly this could impose an increased workload on CPA firms from January to June. This rule applies to the fiscal years that begin after the effective date of these regulations, which we interpret as fiscal years beginning after July 1, 2024 (e.g., fiscal year 7/1/2025 – 6/30/2026 for a June 30th fiscal year school). However, this could be applicable for the year beginning July 1, 2024, and we are attempting to gain clarity on this item from ED.

Whether navigating a change in ownership or seeking to minimize issues and triggers when preparing your institution’s financial statement, these recent changes have significant potential impact on a school’s ability to participate in FSA programs. The professionals at McClintock & Associates are here to help. If you have any questions about what these changes could mean for your school, reach out. Visit our contact page to get started.

Appendix I – Summary of the Financial Triggers

Mandatory Triggering Events – 668.171(c)

  • Legal and administrative actions
    1. CSR < 1.5 and enters into a final settlement or judgement / award (impact results in a CSR < 1.0),
    2. After 7/1/2024, institution is sued by Federal or State authority or a qui tam action in with US has intervened (no CSR impact required),
    3. ED initiated claim to recover adjudicated borrower defense to repayment claims (impact results in a CSR < 1.0), or
    4. Institution which submitted a change in ownership application enters into a final monetary judgement or award, or settlement or administrative proceeding through second full fiscal year after the change of ownership (impact results in a CSR < 1.0).
  • Withdrawal of owner’s equity – For a proprietary school with a CSR < 1.5 of any proprietary school through the end of the first full year following a change of ownership, and there is a withdrawal of equity by any means unless required dividend / return of capital (impact results in a CSR < 1.0)
  • Gainful employment – At least 50% of its Title IV aid is from gainful employment programs that are failing.
  • Institution teach-out plans or agreement – Required to submit by a State, ED or other Federal agency.
  • Publicly listed entities
    1. SEC actions
    2. Other SEC actions
    3. Exchange actions
    4. SEC reports
    5. Foreign exchange or oversight authority
  • Non-Federal educational assistance funds – Failure of 90/10 for one year
  • Cohort default rates – Two most recent years > 30% with no challenges
  • Contributions and distributions – Contribution in last quarter of fiscal year and any equity withdrawal in first two quarters in following fiscal year (The offset of the distribution results in a CSR < 1.0)
  • Creditor events – ED action cause institution to be subject to a default or other adverse condition
  • Declaration of financial exigency
  • Receivership

Discretionary Triggering Events – 668.171(d)

  • Accrediting agency and government agency actions – Placed on probation or issues show-cause order that poses risk to accreditation, authorization or eligibility.
  • Other defaults, delinquencies, creditor events, and judgments
    1. Except as noted in the Mandatory Triggers, subject to a default or other adverse condition,
    2. Allows credit to impose financial condition or penalty,
    3. Creditor suspends a loan or calls a balance due,
    4. May be subject to default or other adverse condition as a result of ED action, or
    5. Judgment awarding monetary relief entered against the institution which is subject to appeal or under an appeal.
  • Fluctuations in Title IV volume – Significant variations as deemed by ED.
  • High annual dropout rates – As computed by ED and no current existing standard.
  • Interim reporting – For applicable institutions, indicators of financial concern or significant change in the financial condition
  • Pending borrower defense claims – Pending claims and ED has formed a group process, and, if approved, claims could be subject to recoupment.
  • Discontinuation of programs – Impacts 25% or more of enrolled students.
  • Closure of locations – Impacts 25% or more of enrolled students.
  • State actions and citations – Failure of requirements.
  • Loss of institutional or program eligibility – Loss of participation in another Federal educational assistance program.
  • Exchange disclosures – Disclosure of investigations
  • Actions by another Federal agency – Cited and faces loss of educational assistance.
  • Other teach-out plans or agreements not included in Mandatory Triggers – Other teach-out plans not captured by the Mandatory Trigger including programmatic teach-out plans.
  • Other events or conditions – Catch all of events and conditions.

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