Clarification Updates on Financial Responsibility for Title IV Schools

On December 20, 2024, the Department of Education updated its guidance on components of the composite calculation with the treatment of long-term debt and leases. This guidance clarifies the Department’s Q&A that was provided back in August 2020 for changes that went into effect that year. While institutions have dealt with these rules through a number of audit cycles since 2020, the nuances involved have prompted the Department to offer clarification with five scenarios on long-term debt as well as general notes on leases. Let’s dive into those scenarios so your Title IV institution can avoid surprises on the composite score and achieve financial responsibility.

Debt Scenario #1

An institution’s last financial audit submitted to the Department prior to July 1, 2020 establishes the baseline for the pre-implementation property, plant and equipment (PPE) and pre-implementation long-term debt. This is important to note, as it establishes the grandfathered amount of long-term debt that offsets the property and equipment subtracted from equity to arrive at the adjusted equity in the primary reserve ratio portion of the score.

Pre-implementation long-term debt can only offset pre-implementation property and equipment in the primary reserve ratio. Any long-term debt acquired after this cutoff can only offset property equipment if it was specifically used to acquire property and equipment. Therefore, property and equipment have to be classified into categories of pre-implementation, post-implementation acquired with long-term debt and post-implementation not acquired with long-term debt. Long-term debt, as a result, must be classified into pre-implementation, post-implementation used to acquire PPE and post-implementation not used to acquire PPE. Within the post-implementation acquired with long-term debt category, specific assets have to be further linked and tracked with the debt used to acquire them.

Debt Scenario #2

In this scenario, an institution refinances its pre-implementation long-term debt for a larger amount than its current balance. This approach should be avoided, as it is an easy trap for an institution to fall into. Pre-implementation long-term debt, by definition, cannot increase from the baseline amount. Refinancing the debt is possible; however, an institution cannot refinance the debt for a larger amount without tainting the debt and losing that valuable pre-implementation status. There can be no new money or proceeds with the refinancing of pre-implementation debt; otherwise, that preferential status will be lost.

Debt Scenario #3

This is the same example as Scenario #2, but in this, an institution refinances pre-implementation debt for an increased amount and uses those proceeds to acquire PP&E. There is the same loss of the pre-implementation status for the original debt amount. The Department does clarify that the new proceeds can count as post-implementation long-term debt used to acquire property and equipment. The Department also explains that the PPE acquired has to be purchased prior to year-end. This is one of the first times the Department has provided guidance on the timing of when debt is taken out and proceeds are used.

Debt Scenario #4

This example covers an institution with $200,000 in pre-implementation property and equipment and none in pre-implementation long-term debt. Any pre-implementation PPE without pre-implementation long-term debt means no pre-implementation PPE for intents and purposes. The example then discusses that new debt taken out with pre-implementation PPE as the collateral does not count as post-implementation long-term debt used to acquire property and equipment.

The Department further clarifies the four key points with refinancing pre-implementation debt:

• Refinanced debt does not need to be refinanced with the same lender/creditor.
• Refinanced debt must reflect an arm’s-length transaction.
• Refinanced debt may not be a credit facility or a related party debt.
• Refinanced debt does not need to have the same repayment terms. Original debt with a balloon payment can be refinanced over a new extended period of time or with another future balloon payment.

Debt Scenario #5

The new composite score rules specifically include construction in progress (CIP) as a subtraction to arrive at the adjusted equity in the primary reserve ratio. The rules allow for short-term loans and lines of credit to be added back with the understanding that it would be termed out or converted to long-term debt when the project was completed and placed in service.

General Notes on Leases

The Department also took a grandfathered approach to applying the implementation of the new lease standards (ASC 842) into the composite score. Leases are classified into two categories:

1. Any leases entered into by an institution prior to December 15, 2018 are pre-implementation leases.
2. Any leases entered into or modified by an institution on or after December 15, 2018 are post-implementation leases. 

The right of use assets and liabilities for pre-implementation leases are excluded from the composite score calculation.

If an institution doesn’t categorize its leases into the pre- and post-implementation statuses, it is effectively opting out of the preferred treatment. Instead, it is treating all of its leases as post-implementation. Changes in ownership or control occurring on or after July 1, 2020 will cause all pre-implementation leases to lose that preferential status.

The standards state that the signing date of the renewal option won’t cause that lease to lose its pre-implementation status for leases with renewal options, if there is no change in the value of the option from when the right of use asset and liability were first recorded. If the lease entered into prior to December 15, 2018 included renewal options, the institution expected to exercise those options and included them in its right of use asset and liability when ASC 842 was implemented. In these cases, signing an option on its own won’t affect the pre-implementation status.

Key Takeaways

An announcement clarifying five-year-old changes to the composite provides insight into the Department’s guidance. And it clarifies challenges institutions should avoid in maintaining financial responsibility. Make sure to discuss any concerns or questions on your financial responsibility with one of Sikich’s Title IV audit experts.