SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation (Including Debt Restructuring)

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All inter-company transactions and balances have been eliminated. Unless otherwise specified, any reference to a “year” is to a fiscal year ended June 30.

The Company has experienced deteriorating results from operations over the last several fiscal years, which coupled with the use of cash, created uncertainty as to the Company's ability to continue as a going concern. The Company has entered into the following agreements and taken the following actions to mitigate these risks:

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an amendment agreement dated September 5, 2014 (the "Amendment Agreement"), with the holders of in excess of 98% of the term loan facilities and 100% of the revolving credit facility (collectively, the "Consenting Lenders") pursuant to which, among other things, (i) the maturity on the revolving credit facility was extended from June 1, 2015 to July 2, 2015, (ii) the Consenting Lenders under the revolving credit facility agreed to accept payment of interest in kind rather than cash through June 30, 2015, (iii) the Consenting Lenders holding term loans agreed that no amortization payments will be payable through June 30, 2015 and to accept the payment of interest in kind rather than cash through June 30, 2015, (iv) EDMC became a guarantor and granted a lien on substantially all of its assets to secure the obligations under the agreement, (v) compliance with the financial covenants was waived through June 30, 2015, and (vi) the security agreement governing the credit facility was amended such that the collateral proceeds “waterfall” set forth therein now provides that obligations owing to any lenders that are not Consenting Lenders shall be paid only after satisfaction in full of obligations owing to Consenting Lenders and swap counterparties who have executed the RSA (as defined below);

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a supplemental indenture dated September 5, 2014 (the "Supplemental Indenture"), pursuant to which the Indenture governing the cash pay/PIK notes due 2018 (the "Cash Pay/PIK Notes") was amended (i) to require the Company to offer all holders of the Cash Pay/PIK Notes the opportunity to receive the same consideration in the Debt Restructuring (as defined below) as holders of the Interim Notes (as defined below), (ii) to provide for (a) the release of EDMC’s guarantee and (b) the termination of certain covenants and certain events of default, in each case upon the completion of the exchange of Cash Pay/PIK Notes and Interim Notes contemplated by the Debt Restructuring and (iii) to provide that if Education Management LLC is no longer subject to the reporting requirements of Section 13 or Section 15(d) of the Securities Exchange Act of 1934, it will not be required to file reports with the Securities and Exchange Commission but instead will be required to distribute annual, quarterly and current reports to the trustee under the Indenture and hold a conference call within 20 business days of furnishing required annual and quarterly reports;

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an exchange agreement dated September 5, 2014 (the "Exchange Agreement"), pursuant to which the holders of 86% of the outstanding Cash Pay/PIK Notes exchanged their Cash Pay/PIK Notes for a like principal amount of new Senior PIK Toggle Notes due 2018 (the "Interim Notes" and together with the Cash Pay/PIK Notes, the "Notes"), whose terms are substantially similar to those of the Cash Pay/PIK Notes, except that their interest is payable entirely in kind for the two interest periods ending September 30, 2014 and March 30, 2015;


•	a new indenture dated September 5, 2014 (the "New Indenture"), pursuant to which the Interim Notes were issued; and

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a Restructuring Support Agreement dated September 4, 2014 (the "RSA"), pursuant to which the Consenting Lenders, holders of in excess of 65% of the outstanding Notes (the "Consenting Noteholders"), certain of the Company's swap counter-parties and holders of in excess of 72% of the Company's outstanding common stock (the "Consenting Shareholders") agreed to support a comprehensive debt restructuring ("Debt Restructuring") as described below.

Pursuant to the Debt Restructuring:


•	$150 million of revolving loans under the existing revolving credit facility will be repaid in cash at par, with such amount available for re-borrowing under a new revolving credit facility;


•	the remaining portion of the Company's $1.5 billion of outstanding indebtedness, including the Interim Notes, will be exchanged for two first lien senior secured term loans due July 2, 2020 in the aggregate principal amount of $400 million, mandatorily convertible preferred stock, optionally convertible preferred stock and warrants for common stock; and

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the Company’s current shareholders will retain their outstanding common stock, which in aggregate will equal 4% of the Company’s outstanding common stock after giving effect to the conversion of all of the preferred stock described above and subject to further dilution by a management incentive plan (the "MIP") and warrants (including those described in the next sentence) to be awarded pursuant to the Debt Restructuring. In addition, current shareholders will receive warrants for 5% of the Company’s common stock (subject to dilution by the MIP).

In addition to these actions, management has developed a plan to reduce cash outflows in fiscal 2015 in order to maintain sufficient liquidity to allow the Company to meet its obligations as they become due. While no assurance can be given that management’s plan will be fully implemented in fiscal 2015, based on the agreements executed and management’s projected cash flows for fiscal 2015, management believes that cash flow from operations and available cash on hand, supplemented from time to time with borrowings under the revolving credit facility, will provide adequate funds for ongoing operations, required debt service and other obligations as they become due during the next twelve months.

The accompanying consolidated financial statements have been prepared on the assumption that the Company will continue to operate as a going concern and do not include any adjustments that might result from the Company not being able to continue as a going concern. Accordingly, assets and liabilities are recorded on the basis that the Company will be able to realize its assets and discharge its liabilities in the normal course of business.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires management to make estimates that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management bases these estimates on assumptions that it believes to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

Cash and Cash Equivalents and Restricted Cash

The Company considers all highly liquid instruments purchased with a maturity of three months or less to be cash equivalents. These investments are stated at cost, which approximates fair value.

The Company’s institutions hold funds from the United States government under various student aid grant and loan programs in separate bank accounts, and serve as trustee for the U.S. Department of Education or respective lender or student borrower, as applicable. The Company does not record funds held in these bank accounts as cash or restricted cash until the authorization and disbursement process has occurred. Once the authorization and disbursement process to the student has been completed, the funds are transferred to unrestricted accounts and become available for use in current operations, except as noted in footnote two to the table below. This transfer generally occurs for the period of the academic term for which such funds were authorized, with no term being more than 16 weeks in length.

Restricted cash consisted of the following at June 30 (in thousands):



	2014		2013
Cash secured letters of credit ⁽¹⁾	$	210,000	$	210,000
Title IV funds received in excess of charges applied ⁽²⁾	50,406		56,595
Surety bonds ⁽³⁾	7,275		—
Escrowed in connection with student lending program ⁽⁴⁾	2,500		2,500
Endowments ⁽⁵⁾	1,500		1,500
Escrowed in connection with operating lease	—		745
Restricted cash	$	271,681	$	271,340

(1) Includes liens on certain of the Company's cash deposits, which equal 105% of the aggregate $200.0 million of outstanding letters of credit under the Company's cash secured letter of credit facilities further explained in Note 8, "Short-Term and Long-Term Debt." Such cash is not available for any purpose other than to reimburse drawings under the letters of credit or to pay related fees and obligations.

(2) U.S. Department of Education regulations require Title IV program funds received by the Company’s educational institutions in excess of the charges applied to the relevant students at that time to be, with these students’ permission, maintained and classified as restricted. In addition, some states have similar requirements. Such funds are recorded as restricted cash due to legal restrictions on the use of the funds and as advance payments on the Company’s consolidated balance sheets. The balances also include $35.1 million and $39.3 million at June 30, 2014 and 2013, respectively, related to Title IV amounts that the Company has already received for courses that fully-online students attending Argosy University and South University have not begun. Since these students take classes under a non-term academic structure, the cash is classified as restricted because the Company does not intend to use the funds for operating purposes until a student successfully demonstrates academic progress with respect to each course the student attends in the student’s program of study.

(3) Relates to amounts required to be maintained on deposit in connection with surety bonds primarily provided to state regulatory agencies as described in Note 14, "Commitments and Contingencies."

(4) Relates to an account required to be maintained in connection with the Company's student lending program further described in Note 6, "Student Receivables."

(5) Relates to endowments required by state law at certain of the Company's schools.

Revenue Recognition

The Company’s net revenues consist primarily of tuition and fees, student housing fees, bookstore sales, restaurant sales in connection with culinary programs, workshop fees and sales of related study materials. Net revenues are reduced for student refunds and scholarships. The Company derived approximately 93% of its net revenues from tuition and fees in each of the fiscal years ended June 30, 2014, 2013 and 2012.

The Company bills tuition and housing revenues at the beginning of an academic term and recognizes the revenue on a pro rata basis over the term of instruction or occupancy. Some of the Company’s academic terms have starting and ending dates that differ from the Company’s fiscal quarters. Therefore, at the end of each fiscal quarter, the Company has tuition from academic terms with respect to which the associated revenue has not yet been earned. Such amounts are recorded as unearned tuition, which is a current liability in the accompanying consolidated balance sheets. Advance payments are generally refundable and relate to payments received for future academic periods and are also recorded as a current liability in the accompanying consolidated balance sheets.

If a student withdraws from one of the Company’s schools, the extent of his or her obligation for tuition and fees depends on when that student withdraws during an academic term. The Company reduces the student's obligation depending upon its refund policies, which vary by state and institution and take into account the refund requirements of the U.S. Department of Education, most state education authorities that regulate the Company’s schools, the accrediting commissions that accredit the Company’s schools and the Company’s institutional policies (collectively, “Refund Policies”). In the vast majority of situations, if a student withdrew from school after attending classes for at least 60.0% of a term of instruction, he or she would not be eligible for any reduction in tuition under the Company's Refund Policies. Accordingly, the student would have to pay the Company the balance of tuition and fees that has not been received already either in the form of financial aid or payments from the student. However, if a student withdraws from school prior to attending classes for at least 60.0% of a term of instruction, the Company may reduce the amount of a student's obligation for tuition and fees based on a tiered approach under which, in general, the greater the portion of the academic term that has elapsed at the time the student withdraws, the greater the student’s obligation is to the school for the tuition and fees related to that academic term.

Based on the application of its refund policies, the Company may be entitled to incremental revenue on the day the student withdraws from one of its schools. Prior to fiscal 2014, the Company recorded this incremental revenue, related student receivable and an estimate of the amount it did not expect to collect as bad debt expense during the fiscal quarter a student withdrew. Effective in fiscal 2014, the Company reassesses collectability when a student withdraws from the institution (i.e., is no longer enrolled) and records incremental revenue after a student's withdrawal from school based on cash received. This correction in policy had the effect of reducing net revenues and student receivables by $36.7 million and bad debt expense and the corresponding allowance for doubtful accounts by $33.2 million, which resulted in an increase to the loss before taxes of $3.5 million in the fiscal year ended June 30, 2014. Prior year amounts were not corrected because the effects were not material.

Student Receivables

The Company records student receivables at cost less an estimated allowance for doubtful accounts, which is determined on a quarterly basis based on the likelihood of collection considering students' enrollment status and historical payment experience. Historical collection experience is analyzed by disaggregating the student receivable balances based on predominant risk characteristics, such as whether the student is currently in-school, recently withdrew from school, or has not made a payment for a longer period of time. This level of disaggregation of student receivables results in individual pools of receivables which management believes appropriately differentiates credit risk in the portfolio and provides a reasonable basis to compute the estimate of loss. When certain criteria are met, which is generally when receivables age past the due date by more than four months, and internal collection measures have been taken without success, the accounts of former students are placed with a collection agency. Student accounts that have been placed with a collection agency are almost fully reserved and are written off after collection attempts have been unsuccessful.

During fiscal 2013, the Company reduced the number of days since last payment after which accounts placed with a collection agency are written off. This change did not impact the statement of operations or net student receivables as the applicable accounts were already fully reserved. Refer to Note 6, "Student Receivables," for more information.

Inventories

Inventories consist mainly of textbooks and supplies held for sale to students enrolled in the Company’s educational programs and are presented in other current assets in the accompanying consolidated balance sheets. Cost is determined using the average cost method and inventories are valued at the lower of cost or market.

Leases

The Company leases certain classroom, dormitory and office space, as well as equipment and automobiles under operating leases. Before entering into a new lease, an analysis is performed to determine whether a lease should be classified as capital or operating.

Certain of the Company’s lease agreements include tenant improvement allowances. Once the lease agreement is signed, these tenant improvement allowances are recorded as other current assets with the offset to deferred rent liabilities on the consolidated balance sheets. Concurrent with the expenditures for lease improvements, the Company records increases to leasehold improvement assets in property and equipment. Other current assets are reduced once the landlord reimburses the Company. The deferred rent liabilities related to tenant improvements are amortized over the term of the lease as a reduction to rent expense upon possession of the lease space.

Many of the Company’s lease agreements contain escalation clauses under which, if fixed and determinable, rent expense is recognized on a straight-line basis over the lives of the leases, which generally range from five to 15 years with one or more renewal options. For leases with renewal options, the Company records rent expense over the original lease term, exclusive of the renewal period. When a renewal occurs, the Company records rent expense over the new lease term.

Property and Equipment and Finite-Lived Intangible Assets

Property and equipment is recorded at its cost less accumulated depreciation. Depreciation policies for such assets are as follows:


•	Buildings are depreciated over an estimated useful life of 30 years using the straight-line method;


•	Leasehold improvements are amortized using the straight-line method over the shorter of the remaining lease term, exclusive of any renewal periods, or their estimated useful lives; and


•	The remainder of the Company’s property and equipment is depreciated over estimated useful lives ranging from three to 10 years using the straight-line method, depending on the asset.

Finite-lived intangible assets primarily relate to curriculum developed for fully-online courses which are amortized over a two-year useful life.

The Company records impairment losses on property and equipment and finite-lived intangible assets when events and circumstances indicate that the undiscounted cash flows estimated to be generated by those assets or asset groups are less than their carrying amounts. Events and circumstances that could trigger an impairment review include changes in the regulatory environment, deteriorating economic conditions or poor operating performance at individual campus locations. Any resulting impairment loss would be measured as the difference between the fair value of the assets or asset groups and their carrying value with the loss recorded as an operating expense in the consolidated statement of operations in the period incurred. Refer to Note 4, "Property and Equipment," for more information.

Goodwill and Indefinite-Lived Intangible Assets

In connection with the Transaction, property, equipment, intangible assets other than goodwill and other assets and liabilities were recorded at fair value. The excess of the amount paid to acquire the Company at the time of the Transaction over the fair values of these net assets represented the intrinsic value of the Company beyond its tangible and identifiable intangible net assets and was assigned to goodwill.

The Company formally evaluates the carrying amount of goodwill for each of its reporting units on April 1 of each fiscal year. In addition, the Company performs an evaluation on an interim basis if it determines that recent events or prevailing conditions indicate a potential impairment of goodwill. A significant amount of judgment is involved in determining whether an indicator of impairment has occurred between annual impairment tests. These indicators include, but are not limited to, overall financial performance such as adverse changes in recent forecasts of operating results, industry and market considerations, a sustained decrease in the price of a share of EDMC Common Stock, updated business plans and regulatory and legal developments.

Goodwill is impaired when the carrying amount of a reporting unit’s goodwill exceeds its implied fair value, as determined under a two-step approach. In the first step, the Company determines the fair value of each reporting unit and compares that fair value to each reporting unit’s carrying value. The Company estimates the fair value of its reporting units using a combination of the discounted cash flow method (income approach) and the guideline public company method (market approach), which takes into account the invested capital and associated earnings multiples of publicly-traded peer companies. If the results of the first step indicate the carrying amount of a reporting unit is higher than its fair value, a second step must be performed, which requires the Company to determine the implied fair value of goodwill in the same manner as if it had acquired the reporting unit in an arm’s length transaction as of the testing date. This second step is performed by deducting the estimated fair value of all tangible and identifiable intangible net assets of the reporting unit from the estimated fair value of the reporting unit. If the recorded amount of goodwill exceeds this implied fair value, an impairment charge is recorded for the difference as an operating expense in the period incurred.

Indefinite-lived intangible assets, consisting of the licensing, accreditation and Title IV program participation assets for all reporting units and The Art Institute trade name, are also evaluated annually on April 1 for impairment and on an interim basis if events or changes in circumstances between annual tests indicate that the asset might be impaired. Trade names are valued by the relief from royalty method (income approach), which focuses on the level of royalty payments that the user of an intangible asset would have to pay a third party for the use of the asset if it were not owned by the user. The Company uses a combination of the cost and income approaches to establish the asset value of licenses, accreditation and Title IV program participation assets. On the impairment testing date, if the fair value of the intangible asset is less than its carrying value, an impairment loss is recognized for an amount equal to the difference. The intangible asset is then carried at its new fair value.

Income Taxes

The Company accounts for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities result from (i) temporary differences in the recognition of income and expense for financial and income tax reporting requirements, and (ii) differences between the recorded value of assets acquired in business combinations accounted for as purchases for financial reporting purposes and their corresponding tax bases. Deferred income tax assets are reduced by a valuation allowance if it is more-likely-than-not that some portion of the deferred income tax asset will not be realized.

The Company recognizes the tax benefit from an uncertain tax position only if it is at least more-likely-than-not that the tax position will be sustained upon examination by the taxing authorities based on the technical merits of the position. The amount of the tax benefit that is recognized is measured as the largest amount of benefit that is more-likely-than-not to be realized upon effective settlement. The Company classifies interest and penalties accrued in connection with unrecognized tax benefits as income tax expense in its consolidated statement of operations.

Refer to Note 11, "Income Taxes," for more information.

Derivative Financial Instruments

Education Management LLC ("EM LLC"), an indirect wholly-owned subsidiary of the Company, utilizes interest rate swap agreements, which are contractual agreements to exchange payments based on underlying interest rates, to manage a portion of its floating rate term debt. The swaps are accounted for as an asset or a liability in the consolidated balance sheets at fair value. The Company uses “Level Two” inputs to value its interest rate swaps, which are defined in Note 10, "Fair Value of Financial Instruments." The application of these Level Two inputs is based on LIBOR forward curves and an assessment of non-performance risk based upon published market data. If interest rate swap agreements are deemed highly effective for accounting purposes and are designated as cash flow hedges, the changes in their fair values are recorded in other comprehensive income (loss), net of tax. If they are not deemed highly effective, the changes in their fair values are recorded in interest expense in the consolidated statements of operations. The Company does not use derivative financial instruments for trading or speculative purposes. Refer to Note 9, "Derivative Instruments," for more information.

Foreign Currency Translation

The financial position and results of operations of the Company’s foreign subsidiary are initially measured at its functional currency, which is the Canadian dollar. Accordingly, the assets and liabilities of the foreign subsidiary are translated to U.S. dollars using the exchange rates in effect at the balance sheet date. Revenues and expenses are translated into U.S. dollars using average monthly exchange rates. Translation adjustments resulting from this process are recorded as a separate component of equity designated as accumulated other comprehensive income (loss) in the consolidated balance sheets. Translation gains and losses were not material in fiscal 2014, 2013 or 2012.

Share-Based Compensation

The Black-Scholes-Merton option pricing model is used to determine the fair value of all of the Company’s stock-options at the grant date. The Company recognizes compensation costs on time-based options and restricted stock units on a straight-line basis over the requisite service period, which is generally the vesting term, net of expected forfeitures. See Note 12, “Share-Based Compensation,” for more information.

Contingencies

The Company accrues for contingent obligations when it is probable that a liability has been incurred and the amount is reasonably estimable. As facts concerning contingencies evolve and become known, management reassesses the likelihood of probable loss and makes appropriate adjustments to its financial statements.

Costs and Expenses

Educational services expense consists primarily of costs related to the development, delivery and administration of the Company’s education programs. Major cost components are faculty compensation, administrative salaries, facility occupancy costs, bad debt expense, costs of educational materials and information systems costs. These costs are expensed as services are provided to the Company or as incurred.

General and administrative expense consists of marketing and student admissions expenses and certain central staff costs such as executive management, finance and accounting, legal and consulting services, corporate development and other departments that do not provide direct services to the Company’s students. These costs are expensed as services are provided to the Company or as incurred.

Marketing costs are expensed in the fiscal year incurred and are classified as general and administrative expense in the accompanying consolidated statements of operations. The Company’s marketing expense was $255.9 million, $255.0 million and $296.9 million during the fiscal years ended June 30, 2014, 2013 and 2012, respectively.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, “Revenue from Contracts with Customers." The standard outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance. ASU 2014-09 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, and early adoption is not permitted. The Company is currently evaluating the impact that the standard will have on its financial condition, results of operations, and disclosures.

In April 2014, the FASB issued amendments to guidance for reporting discontinued operations and disposals of components of an entity. The amended guidance requires that a disposal representing a strategic shift that has (or will have) a major effect on an entity’s financial results or a business activity classified as held for sale should be reported as discontinued operations. The amendments also expand the disclosure requirements for discontinued operations and add new disclosures for individually significant dispositions that do not qualify as discontinued operations. The amendments are effective prospectively for fiscal years, and interim reporting periods within those years, beginning after December 15, 2014 (early adoption is permitted only for disposals that have not been previously reported). The implementation of the amended guidance is not expected to have a material impact on the Company's consolidated financial statements.

In July 2013, the FASB clarified the presentation of an unrecognized tax benefit when a net operating loss or tax credit carryforward exists. The clarification requires that an unrecognized tax benefit be presented as a reduction of a deferred tax asset for a net operating loss or tax credit carryforward when settlement of the unrecognized tax benefit using those carryforwards is available pursuant to existing tax law. The Company's adoption of the FASB clarification had no impact on its consolidated financial statements.