# The attached April 26, 1999 Dear Certified Public Accountant (CPA-99-01) letter supplements guidance in the July 1997 SFA Audit Guide on the 85/15 (now 90/10) revenue test. The letter does not require practioners to submit any additional reports. We are in the process of updating the SFA Audit Guide and expect: (1) to have that Guide available in June, and (2) to clarify the reporting process on the 90/10 revenue test. 

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# CPA-99-01

# April 26, 1999

Dear Certified Public Accountant:

Practitioners performing financial statement audits of proprietary
institutions in accordance with the July 1997 updated Audit Guide,
*Compliance Audits (Attestation Engagements) of Federal Student
Financial Assistance Programs at Participating Institutions*, must
ascertain the validity of the institution's 85/15 percent revenue
calculation[^1]. The Audit Guide refers to the calculation as the 85/15
revenue test. The 85/15 revenue test determines an institution's
compliance with the requirement that no more than 85 percent of the
institution's revenues for tuition, fees and other institutional charges
to students in eligible programs are derived from Title IV Student
Financial Aid programs.

The U. S. Department of Education, Office of the Inspector General
(ED/OIG) has identified mistakes in the calculation of the 85/15 percent
revenue test in audited financial statements submitted to ED which
indicated that the institutions met the revenue requirement when they
had not. While, as noted above as footnote 1, proprietary institutions
will after October 7, 1998 be subject to a 90/10 revenue test, the same
calculation principles apply. Therefore, the guidance in this letter
applies equally to audits of the 90/10 revenue test applicable in future
years. This letter addresses some of the mistakes and gives guidance to
the CPA community auditing the 85/15 percent revenue test. Specific
examples of mistakes were: (1) institutional scholarships being counted
as revenue and (2) failure to account for institutional loans and other
amounts on a cash basis when counting them toward non-Title IV revenue.

Because the 85/15 revenue test is a critical determination affecting the
institution's continued eligibility, it is important that practitioners
examine the underlying information supporting the footnote disclosures
and perform the necessary procedures to satisfy the applicable auditing
standards. Audits found to be substandard relating to the 85/15 revenue
test may result in rejection and referral of the CPA to the American
Institute of Certified Public Accountants and the appropriate State
licensing board for disciplinary actions. In addition, practitioners who
are referred may be subject to suspension and debarment from Federal
programs and/or civil actions.

**Background**

The Higher Education Act of 1965, as amended, (HEA) requires all
institutions to obtain annual financial and compliance audits of their
participation in the Title IV HEA programs. The financial statements
must be prepared in accordance with generally accepted accounting
principles and audited in accordance with the standards for financial
audits of the U. S. General Accounting Office's *Government Auditing
Standards (GAS)*, issued by the Comptroller General of the United
States. Regulations require that procedures for conducting the audits be
available in audit guidance developed and issued by ED/OIG.

The July 1997 Audit Guide, *Compliance Audits (Attestation Engagements)
of Federal Student Financial Assistance Programs at Participating
Institutions*, states that the 85/15 revenue test is to be a footnote to
the financial statements and instructs CPAs that the calculation is on a
***cash basis*** and must be computed in accordance with 34 CFR 600.5.

**Scholarships and Institutional Loans**

The preamble to the regulations, Federal Register/Vol. 59, No.
82/Friday, April 29, 1994, states that institutional scholarships and
loans may be included in the revenue test but also clearly states that
all revenue must be accounted for on the cash basis in order to meet the
definition of revenue. (See Enclosure) Thus, current regulations require
that scholarships and loans included as revenue to the school must
result in an actual inflow of cash to the institution.[^2]

**Working Papers**

The CPA is expected to determine whether the 85/15 percent calculation
is fairly stated in all material respects and have adequate evidence in
the working papers to support his/her conclusion. Government Auditing
Standards, Paragraphs 4.34 through 4.37 require that working papers
contain sufficient information to support the CPA's significant
conclusions and judgments, of which the 85/15 calculation is one. AU
326.23 discusses the evaluation of evidential matter by the CPA.

Working papers must support the CPA's determination that the 85/15
calculation was made using the cash basis of accounting, that only cash
revenues from eligible programs and locations are included in the
calculation, and that the presumption of Title IV funds being applied to
tuition and fees first is used. The CPA is expected to evaluate
management's financial statement assertions against specific criteria.
The criteria for evaluating management's assertions are found at 34 CFR
600.5 (a) and (d).

CPAs should be aware that materiality for 85/15 rule has a different
threshold than the basic financial statement assertions because failure
to meet 85/15 makes the institution completely ineligible to participate
in Title IV programs. For example, a small error in accounting for cash
could be immaterial to the financial statements taken as a whole, but
could be the difference between meeting or not meeting the 85/15
requirement.

**Quality Control Reviews**

CPAs should be aware that the financial statement audits are subject to
quality control review (QCR) by ED/OIG. QCRs of working papers
supporting audited financial statements which reveal serious
deficiencies in a CPA's audit work that results in the Department of
Education relying on the institution passing the 85/15 revenue test when
it did not, may result in:

-   rejection of the financial statement audit;

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-   referral of the CPA to the American Institute of Certified Public
    Accountants and appropriate State licensing boards for any
    disciplinary actions they might impose;

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-   suspension and debarment of the CPA from Federal government
    programs; and/or

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-   civil actions against the CPA.

In addition, the Office of Student Financial Assistance Programs,
Institutional Participation and Oversight Service may itself reject
financial statement audits that are substandard.

Questions pertaining to this letter may be directed to Jim Burley in the
Dallas Office at 214 880-3031 or may be faxed to 214 880-2492.

> Sincerely,
>
> Robert G. Seabrooks
>
> Acting Assistant Inspector General
>
> for Audit

Enclosure

# ENCLOSURE

Page 1 of 2

**Requirements**

The 1992 reauthorization of the HEA added a provision to the Act
requiring that a proprietary institution (Federal Register/Vol. 59, No.
82/Friday, April 29, 1994):

> *"...has at least 15 percent of its revenues from sources that are not
> derived from funds provided under this title, as determined in
> accordance with regulations prescribed by the Secretary."* [^3]

Federal regulations were issued that prescribe the formula for
calculating the percentage. Title 34, Code of Federal Regulations (CFR)
Section 600.5(d)(2)(i) specifies that:

"...the title IV, HEA program funds included in the numerator and the
revenue included in the denominator are the amount of title IV, HEA
program funds and revenues received by the institution during the
institution's last complete fiscal year."

In the Preamble to the Final Rule, the Secretary clarified that:

"...since institutions must report and account for title IV, HEA program
funds on a cash basis, the institution must also account for revenue in
the denominator on a cash basis. Under a cash-basis of accounting the
institution reports revenues on the date that the revenues are actually
received."

The Financial Accounting Standards Board (FASB) defines revenue in its
Statement of Financial Accounting Concepts No. 6 as:

"...inflows or other enhancement of assets of a entity or settlements of
its liabilities (or a combination of both) from delivering or producing
goods, rendering services, or other activities that constitute the
entity's ongoing major or central operations."

Therefore, since revenues must be reported on a cash basis, the revenue
that would be recognized for the 85/15 percent calculation must only be
those revenues that result in an actual inflow of cash (revenue
received).

ENCLOSURE

Page 2 of 2

Further, 34 CFR 600.5(d)(1) is clear that only revenue from eligible
programs can be included in the 85/15 percentage calculation:

"...Title IV, HEA program funds the institution used to satisfy tuition,

> [fees, and other institutional charges to students]{.underline}

The sum of revenues generated by the institution from: Tuition, fees,
and other institutional charges for students enrolled in **eligible
programs** as defined in 34 CFR 668.8; and activities conducted by the
institution, to the extent not included in tuition, fees, and other
institutional charges that are necessary for the education or training
of its students who are enrolled in those **eligible
programs**."(emphasis added)

Requirements for eligible programs are listed in 34 CFR 668.8. Eligible
programs can only be offered at eligible Title IV locations \[34 CFR
600.10(b)\].

Also, for the purposes of the calculation, institutions must presume
that title IV funds are used to pay institutional charges. Title 34 CFR
Section 600.5(d)(2)(v) states that:

"...any title IV, HEA program funds disbursed to or on behalf of a
student shall be presumed to be used to pay the student's tuition, fees,
or other institutional charges, regardless of whether the institution
credits those funds to the student's account or pays those funds
directly to the student...."

[^1]: This provision was contained in HEA Section 481(b)(6). The 1998
    Amendments to the HEA that were enacted on October 7, 1998 changed
    this provision to require that after that date a proprietary
    institution have at least 10 percent of revenue from non-Title IV
    sources. Therefore, 85/15 is now 90/10.

[^2]: ^2^ The 85/15 revenue calculation rules are part of the current
    negotiated rulemaking process. Until such time as new regulations
    are finally adopted, current calculation rules as outlined here are
    in force.

[^3]: This provision was contained in HEA Section 481(b)(6). The 1998
    Amendments to the HEA that were enacted on October 7, 1998 changed
    this provision to require that after that date a proprietary
    institution have at least 10 percent of revenue from non-Title IV
    sources. Therefore, 85/15 is now 90/10.