Changes to the Financial Responsibility Ratio

The U.S. Department of Education (ED) finalized borrower defense rules on September 23, 2019, establishing new regulations that will have a significant impact on institutions that participate in federal student loan programs. The regulations center on borrower defense to repayment, but a substantial portion of the rules also focuses on financial responsibility standards that were revised in response to significant new accounting standards (Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) 2016-14, Presentation of Financial Statement of Not-for-Profit Entities and FASB ASU 2016-02, Leases). This article highlights key changes to the financial responsibility ratio triggered by the new FASB standards.

Appendix B to Subpart L of Part 668 provides the ED’s definitions and terminology from Section 1 of Appendix B. Because institutions have used these definitions and terms to calculate ratios since the original regulation in 1997, the historical definition and new definition are highlighted below. Changes to the new definition are in red text, while changes to the old definition are highlighted in yellow.

1. Primary Reserve Ratio = (expendable net assets)/(total expenses without donor restrictions and losses without donor restrictions)
   1. Expendable net assets
      1. New Definition: (net assets without donor restrictions) + (net assets with donor restrictions) – (net assets with donor restrictions: restricted in perpetuity) – (annuities, term endowment and life income funds with donor restrictions) – (intangible assets) – (net property, plant and equipment) + (post-employment and defined benefit pension plan liabilities) + (all long-term debt obtained for long-term purposes, not to exceed total net property, plant and equipment) – (unsecured related-party receivables)
      2. Former Definition: (unrestricted net assets) + (temporarily restricted net assets) – (annuities, term endowment and life income funds that are temporarily restricted) – (intangible assets) – (net property, plant and equipment) + (post-employment and retirement liabilities) + (all long-term debt obtained for long-term purposes, not to exceed total net property, plant and equipment) – (unsecured related-party receivables)
   2. Total Expenses Without Donor Restrictions and Losses without Donor Restrictions
      1. New Definition: 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 annuities
      2. Former Definition: The total unrestricted expenses taken directly from the audited financial statements
2. Equity Ratio = (modified net assets)/(modified assets)
   1. Modified net assets
      1. New Definition: (net assets without donor restrictions) + (net assets with donor restrictions) – (intangible assets) – (unsecured related-party receivables)
      2. Former Definition: (unrestricted net assets) + (temporarily restricted net assets) – (intangible assets) – (unsecured related-party receivables)
   2. Modified assets
      1. New Definition: (total assets) – (intangible assets) – (unsecured related-party receivables)
      2. Former Definition: (total assets) – (intangible assets) – (unsecured related-party receivables)
3. Net Income Ratio = (change in net assets without donor restrictions)/(total revenue without donor restrictions and gains without donor restrictions)
   1. Changes in net assets without donor restrictions
      1. New Definition: Total revenue (which includes net assets released from restriction) plus total gains. With regard to gains, investment returns are reported as a net amount. and there will be need to aggregate these two amounts to determine if there is a net investment gain or a net investment loss (net investment gains are included with total gains)
      2. Former Definition: Total unrestricted revenue is taken directly from the audited financial statements and includes net assets released from retraction during the year

If you have any questions in the calculation of the financial responsibility ratio, contact a member of the Schneider Downs Not For Profit or Higher Education Industry Groups.