As the year draws to a close, it’s time for higher education institutions to review operations from 2020 and estimate financial responsibility ratios, including, but not limited to, current ratio or the Department of Education (ED) Composite Score. Once the calendar turns to January, there will be limited options to improve these ratios, so time is of the essence.
First, let’s start with reviewing operations.
Accounting records should encompass all transactions on the accrual basis of accounting. Frequently, records are maintained on the cash basis if the institution is a cash basis taxpayer, however, financial reporting to accreditors and ED should be done on the accrual basis of accounting. This means expenses need to be accrued for goods or services received prior to the end of the year when payments are made after year-end. On the other hand, if payments are made prior to year-end and all or part of the goods or services are yet to be received, the institution has a prepaid expense asset.
Revenues should also be recorded based on a revenue recognition policy that relates to the transfer of goods or services to customers – not when invoices are sent or payment is received. Goods or services billed that will be delivered after year-end should be recorded as deferred revenue (liability) instead of revenues on the income statement.
Finally, lets look at previous audit entries.
Now that the accounting records are ready, it’s time to calculate financial responsibility ratios. The current ratio compares total current assets to total current liabilities. Typically, a ratio of 1:1 or better is preferred. The ED Composite Score consists of the following three ratios combined – primary reserve, equity and net income ratios.
The calculation can result in a score between -1 and 3. A detailed breakdown of the composite score can be found in the Federal Student Aid Handbook. In order to be deemed financially responsible, institutions must score above 1.5. If the current ratio or composite score is below the desired amount, now is the time to act. Operationally, limiting discretionary spending will have a positive impact on these ratios. If this isn’t enough, a capital contribution may be necessary but must be made prior to the end of the year.
To learn more about year-end planning and ED Composite Score calculations, contact the experts at SST today.
Special thanks to SST Senior Audit Manager Aaron Lohman for providing the content for this post.