Lease Standards and Proprietary Schools

Steen Morneweck

Dynamic professional with expertise in Title IV reporting, delivering innovative solutions.

​How Lease Standards Affect Proprietary Schools' Finances
The changes to lease accounting rules (ASC 842) have made a big impact on how proprietary schools record leases in their financial statements. What used to be a minor issue —“deferred rent”— now has the potential become a significant factor in a school’s composite score.

Before: Deferred Rent Wasn't a Big Deal
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Under the old rules (ASC 840), schools with operating leases didn’t have to show the full lease liability on their balance sheets. Instead, they recorded “deferred rent,” which was just an accounting entry. This deferred rent didn’t really affect a school’s financial standing or composite score.

Now: Lease Liabilities Matter

With ASC 842, schools must record all long-term leases on their balance sheets, creating out of thin air both a liability (the amount owed for the entire term of the lease) and an asset (the right to use the leased property for the entire term of the lease). These lease liabilities now affect a school’s financial responsibility score, a key metric for maintaining access to federal financial aid.
If a school has long and expensive leases, the increased liabilities can hurt the composite score, making it look less financially stable.

Example (simplified)

A school has a lease for 5 years with the following payment schedule:

​Year 1 $2,000 per month
Year 2 $2,500 per month
Year 3 $3,000 per month
Year 4 $3,500 per month
Year 5 $4,000 per month
 
The average payment per month is $3,000 per month for all 60 months. In year 1, the payment of $2,000 per month means that there is $1,000 per month less than the average payment of $3,000 per month. After the first 12 months, the ‘deferred rent’ is now a Lease Right of Use Liability of $12,000. After year 2, this Lease Right of Use Liability increases to $18,000, in year 3 the average payment is being made so the liability remains $18,000. Then as the payment made is greater than the average in year 4 the ‘liability’ is reduced to $12,000, and then by the end of year 5 the 'liability’ has been paid.
 
Those amounts would have been ‘deferred rent’ in years past, but now that they are ‘Lease Right of Use Liabilities’ – the liability must be treated as if it were a liability on a fixed asset, and since with this calculation the liability will always be greater than the asset – the liability, whatever the amount, will decrease your composite score.
 
What Schools Can Do

Schools need to manage their lease agreements carefully. Since leases now affect the balance sheet, schools should be strategic about lease terms to avoid lowering their financial responsibility score. There is no indication that this change in accounting standard was intended to harm proprietary schools, but there has also been no indication that the Department is going to allow the opportunity to use it as yet another way to put pressure proprietary schools and make achieving a passing composite score harder than it was before this change.
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Accountants should fully understand the new rules to ensure accurate reporting and help schools avoid unnecessary risks.

Conclusion

​The new lease standards have turned what was once a small, deferred rent item into a major factor that can affect a school’s composite score. Schools need to adapt to these changes by carefully managing their leases by either negotiating a shorter lease term, or by negotiating either a flat (or as slightly escalating as possible) payment for the entire term. By managing the terms of a lease a school can manage the amount of damage this change in accounting can have on the composite score.