How Signing a New Lease Can Hurt Your School’s Composite Score

Growth is exciting. Whether it’s moving campuses, opening new programs, or expanding facilities, signing a new lease often feels like progress. But for institutions that participate in Title IV funding, that lease could come with an unexpected cost: a lower Composite Score Ratio (CSR).

Thanks to changes in lease accounting under ASC 842, lease agreements now show up on the balance sheet — and that can directly affect the Primary Reserve and Equity Ratios, two major components of the Composite Score used by the U.S. Department of Education (ED) to assess financial responsibility.

A misstep here can push your score below the 1.5 passing threshold — or worse, below 1.0, which may trigger provisional certification or require a Letter of Credit. Either outcome ties up critical resources and complicates federal aid eligibility.

Where Institutions Get Caught Off Guard

Many schools don’t assess Composite Score implications until after a lease is signed — often not until their next financial statement audit. By that point, it’s too late to restructure terms to avoid lasting impacts.

Leadership and finance teams are typically involved in lease planning but may not fully understand how lease accounting affects the CSR. That gap can result in well-meaning growth efforts backfiring financially. Let’s review the two primary ways a new lease can put pressure on the CSR.

Tenant Improvement Allowances – New Fixed Assets without Debt

For most businesses, a landlord offering to cover part or all of the cost to renovate new space with Tenant Improvement Allowances (TIA) makes a lot of sense. The company avoids large cost outlays prior to being able to generate revenues. They also avoid adding debt to the company. While TIAs typically lead to higher rent payments, these mostly come later in the lease after the revenue base has been built.

However, the CSR formula can make TIA less attractive for institutions. Part of the Primary Reserve Ratio calculation includes:

Total Equity – Less PPE + Plus Debt obtained to purchase PPE = Total Adjusted Equity

When recording the lease under ASC 842, the TIAs are recorded as leasehold improvements, which increases Property, Plant and Equipment (PPE). However, the higher future rent payments to reimburse the landlord for the TIAs are not reflected as debt so there is nothing to offset the increase in PPE for CSR purposes. This leads to a smaller amount of Total Adjusted Equity compared to obtaining a loan to finance the build-out of the new space.

The TIAs impact on the Primary Reserve Ratio varies based on how the amount of the TIAs compares to Total Equity. A company with significant equity might not be impacted at all, while a company with less equity could see the Primary Reserve flip from contributing to the CSR to being a reduction.

ROU Assets Raise Total Assets and Can Sink Equity Ratio

Under ASC 842, long-term leases create Right-of-Use Assets (ROU Assets) and corresponding Lease Liabilities on the balance sheet. For most companies, increasing both sides of the Balance Sheet in equal amounts is a neutral transaction and has little impact for users of their financial statements. However, because the Equity Ratio incorporates total assets, the CSR can decrease significantly.

Equity Ratio = Adjusted Equity / Total Assets

The ROU asset inflates Total Assets but doesn’t increase Adjusted Equity — dragging the ratio down. Because ROU Assets represent the present value of all payments in a lease, the impact can be especially significant for longer leases. Adjusted Equity must be 50% of Total Assets to obtain a score of 3.0 and 25% for a score of 1.5. Depending on the size of a school, a new lease has the potential to create ROU Assets that are a multiple of any other assets on the balance sheet.

Once the lease is signed, increasing equity is the primary solution to improving both the Primary Reserve and Equity Ratios, which means a capital contribution from ownership or waiting for profitability to rebuild equity for the institution over time.

Incorporating ‘Free Rent’ into Operational Budget Correctly

Landlords often use abated or ‘free’ rent as a way to encourage tenants to commit to signing a lease. This can be a great way to improve cashflows, especially while building the student population for a new program or new campus.

Accepting the abated rent doesn’t impact the CSR in the same way that TIAs or ROU Assets do, but it’s important for schools to project rent expense properly when projecting profitability. Under ASC 842, rent expense is still recognized straight-line over the life of the lease based on the total payments that will be required. This typically means that rent expense for the first few years of a lease is greater than the cash payments made to the landlord. This difference is exaggerated when months of rent are abated and can cause projections to overstate profitability, which directly impacts the Net Income Ratio, while also influencing the Primary Reserve and Equity Ratios as Total Equity is overstated. As a result, operational budgets must model rent expense per the accounting standards not on the cash basis.

Don’t Let a New Lease Dictate Your CSR – We Can Help!

Before committing to a lease, it’s crucial to determine how a new lease will be recorded under ASC 842 and then model the impact on your Composite Score. At McClintock & Associates, we help postsecondary institutions bring compliance foresight into operational decisions. Whether you’re leasing new space or renewing a current one, we can provide suggestions for how to structure and negotiate the new lease with the Composite Score in mind.
Early modeling lets you adjust terms, restructure costs, or reconsider the timing — potentially avoiding long-term compliance and funding headaches.

Analyze how a new or renewed lease could affect your Composite Score before terms are finalized.
Advise on accounting treatments for tenant improvement allowances and rent abatements.
Educate landlords about how lease terms can impact an institution’s CSR

Let’s discuss how to safeguard your institution now — before new leases are finalized.

Schedule a consultation today or reach out to our team to get started.

How Signing a New Lease Can Hurt Your School’s Composite Score

Where Institutions Get Caught Off Guard

Tenant Improvement Allowances – New Fixed Assets without Debt

ROU Assets Raise Total Assets and Can Sink Equity Ratio

Incorporating ‘Free Rent’ into Operational Budget Correctly

Don’t Let a New Lease Dictate Your CSR – We Can Help!

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