By: Michael T. Wherry, CPA
As part of the July 25, 2018 proposed regulations related to Borrower Defense to Repayment (BDTR), the U.S. Department of Education (ED) proposed some key changes to the composite score ratio (CSR) calculations. These changes are a result of the discussions from the financial responsibility subcommittee which was formed as part of the BDTR negotiated rule-making process. These proposed changes have both positive and negative impacts on the CSR calculation. Key changes are as follows:
- As a result of Accounting Standard Update 2016-02 – Leases (ASU) which will become effective in the next couple of years, leased right-to-use assets will be treated as property, plant and equipment (PPE) and the related lease liability will be treated as long-term debt in the Primary Reserve Ratio. Thus, no impact in the Primary Reserve Ratio should occur. However, the treatment as PPE will increase Total Assets which is the denominator of the Equity Ratio and, as such, lowers this component of the CSR. ED’s treatment could have been more onerous and, as such, we believe this is a fair compromise. See M&A’s past published article on the impact of this ASU on the CSR. (https://www.mcclintockcpa.com/new-lease-standard-perfect-storm-failing-composite-score-ratio/).
- ED will allow institutions to utilize the higher CSR as measured by utilizing the new lease standard or an alternative composite score under the old lease standard. This alternative composite score would be available to be used for a six-year period of time following the implementation of the new lease standard, or if revised CSR regulations are promulgated, whichever is shorter. ED indicated that the transition period will partially defer and not adequately address consequences of the accounting changes and how these changes are reflected in the composite score. That future negotiated rule making will be required to update the CSR. ED is concerned the changes could encourage some institutions to make changes in their business model that could have negative consequences for students. For example, institutions entering into shorter leases which may be more expensive and cause frequent change in locations. M&A believes that revisiting the entire CSR calculation is prudent since it is over twenty years old and accounting standards along with the financial status of the entire post-secondary industry has changed significantly.
- ED proposed that a long-term line of credit (LOC) would not be treated as “debt” unless it was specifically used to fund the purchase of PPE, and that specific disclosures must be reported in the footnotes to the financial statements. The disclosures would include the issue date, term, nature of capitalized amounts, and the amount capitalized. The results of this is that a long-term LOC could not be added-back in the Primary Reserve Ratio unless the institution could clearly prove the proceeds from the long-term LOC were used to acquire PPE. If the long-term LOC cannot be added-back, this lowers Adjusted Equity which is the numerator of the Primary Reserve Ratio and thus lowers the ratio. This revised treatment is partially a result of the February 24, 2017 Inspector General Audit Report regarding Federal Student Aid’s handling of Corinthian’s composite score ratio. M&A believes this treatment while allowed under the current regulations was not in the “spirit” of the CSR calculations and imposing this additional restriction on a long-term LOC is a reasonable position.
- Similar to the long-term LOC requirements, ED proposed that all long-term debt must be specifically utilized for the acquisition of PPE to be treated as debt in the Primary Reserve Ratio. The same disclosures would apply as required in the long-term LOC proposed regulations. M&A believes this additional disclosure may cause some complexities for institutions to “link” long-term debt to specific PPE acquisitions. In our opinion, conceptually, most long-term debt is usually for the purpose of PPE acquisitions and not operations, and thus specifically requiring it to be linked to PPE acquisitions is a burdensome requirement. We believe ED should reconsider its position on this proposed regulation.
- Construction in progress (CIP) will be included as PPE in the Primary Reserve Ratio and historically, CIP has not been included until the project was completed and the assets were placed in service as PPE. This change is detrimental to an institution especially if the CIP is a significant project (i.e. building) and the related construction loan or line of credit used to fund the project is deemed to be short-term debt. ED is silent in the proposed regulations regarding these types of funding and how they should be accounted for in the CSR. In these situations, the Adjusted Equity in the Primary Reserve Ratio would be decreased by the amount of the CIP with no add-back for the short-term construction loan or LOC which would lower the ratio.
- A new supplemental schedule will be required in the audited financial statements which will reconcile the numbers utilized in the CSR calculation to where these numbers are included in the financial statements (balance sheet, statement of income, and footnotes). This should be fairly simple to prepare, and it should eliminate confusion and differences between an institution’s calculation of the CSR and ED’s calculation of the CSR.