Many healthcare organizations have been holding off their efforts to apply the much-discussed Financial Accounting Standards Board (FASB) Accounting Standards Codification® (ASC) Topic 606, Revenue from Contracts with Customers in anticipation of interpretive guidance on how to do so. Consequently, with effective dates quickly approaching, these organizations find themselves little time to apply the new standards and a lot to consider in the process.
It’s possible most healthcare entities (except the continuing care retirement community industry, perhaps) won’t see significant changes to the timing or amount of revenue recognized with the implementation of Topic 606, which was issued in May 2014. However, the implementation is still likely to necessitate changes to how information regarding revenue recognition is gathered, processed, and disclosed.
At the highest level, Topic 606 requires healthcare entities to recognize revenue when promised goods or services are provided to patients, in the amount of consideration the healthcare organization expects to receive.
The FASB embarked on this project with the International Accounting Standards Board (IASB) in large part to provide a consistent framework and improve comparable revenue recognition guidance across entities, industries, jurisdictions, and capital markets. Previous revenue recognition guidance in U.S. generally accepted accounting principles (GAAP) differed from international standards and is composed of broad concepts enhanced with many adjunct revenue requirements for particular industries or transactions.
Revenue Recognition Task Force
To help provide guidance for implementation, the American Institute of Certified Public Accountants (AICPA) formed a revenue recognition task force across 16 industry groups, including health care, to assess industry-specific issues that could be controversial or complex when implementing the standard.
Through this process, the AICPA identified 10 areas specific to health care. Two of these topics—contract portfolios, and self-pay and uninsured patient balances and implicit price concessions—are currently available in the AICPA’s Audit & Accounting Guide on revenue recognition.
Another two—presentation and disclosure requirements, and third-party settlement estimates—have been released by the AICPA for exposure and comment.
The remaining six implementation issues include bundled payments and issues related to continuing care retirement communities, among others. These are expected to be released by the AICPA throughout 2017.
Effective dates for the new standard depend on whether the entity is public or nonpublic, as follows:
- Public entities, including conduit debt obligors, will need to adopt the new standard for annual reporting periods beginning after Dec. 15, 2017.
- Nonpublic entities will need to adopt the new standard for annual reporting periods beginning after December 15, 2018.
Any entity may choose to adopt the new standard early but not earlier than annual reporting periods beginning after Dec. 15, 2016.
As a reminder, the FASB has outlined a five-step process that healthcare organizations should follow under the new standard, as shown in the exhibit below. Steps one and three are particularly important as they relate to self-pay revenue recognition.
FASB’s Five Steps
Step One: Identify the Contract. To be considered a contract within the scope of ASC Topic 606, a contract must meet four criteria:
- The parties must have approved the contract either in writing (patient responsibility or consent form), orally (e.g., a scheduled appointment), or implicitly, based on the healthcare organization’s customary business practices (emergency department [ED] visits, for example).
- Each party’s rights and the contract’s payment terms must be identified.
- The contract must have commercial substance.
- Collection must be probable.
Before applying the standard’s model to a contract, the healthcare organization must have determined that collecting substantially all of the consideration to which it’s entitled is probable. A healthcare organization may make this determination based on past experience with either a specific patient or a class of similar patients—the latter of which is known as the portfolio approach. If this collectability threshold isn’t met, a patient contract doesn’t exist within the scope of the standard.
Consider this example: A patient presents to the ED and is unresponsive. The hospital determines the patient is uninsured and attempts to assist the patient in qualifying for Medicaid. If the hospital has historical information on the ultimate financial class for this individual—for example, Medicaid or self-pay—the contract is within the scope of the standard. And if the hospital doesn’t have historical information on financial class, the contract falls within the scope of the standard once the patient’s financial class is confirmed. If, however, the financial class is determined to be charity care, the collectability threshold isn’t met, and the contract doesn’t fall within the scope of the standard.
Evaluating collectability involves determination of the transaction price, defined as the amount of consideration to which the healthcare organization expects to be entitled in exchange for providing promised goods or services to a patient. It includes the effects of variable consideration—such as discounts and price concessions—and may be less than the stated contract price.
Step Three: Determine the Transaction Price. To determine transaction price, a healthcare organization should consider all historical, current, and forecasted information that’s reasonably available, including historical cash collections from the identified financial class. The organization also should review all reasonably available information to estimate variable consideration, whether applied on a contract-by-contract basis or using a portfolio approach. The ultimate transaction price should reflect both explicit and implicit price concessions.
The healthcare organization has provided an implicit price concession, even if it continues to attempt to collect the full amount of discounted charges, if either of two circumstances are present:
- The organization’s customary business practice is to deliver services prior to performing a credit assessment (for example, the organization has an obligation to provide medically necessary or emergency services regardless of patient’s intent or ability to pay).
- The organization continues to deliver care to patients and patient classes, despite historical experience indicating it won’t collect substantially all the charges determined after applying explicit price concessions.
Once a healthcare organization determines it has provided an implicit price concession, subsequent changes to the estimate of variable consideration should generally be accounted for as changes in the implicit price concession and a direct adjustment to patient revenue.
If, in the process of estimating the transaction price, the healthcare organization determines it hasn’t provided an implicit price concession but has elected to accept the risk of default by the patient, that uncollectible amount represents an impairment loss and is recorded as bad debt expense. Additional impairment losses may be taken and recorded as bad debt if there are facts and circumstances—such as bankruptcy or job loss—that indicate the patient’s creditworthiness has deteriorated.
Application of Revenue Guidance to Portfolios
As a practical expedient, a healthcare organization may apply the revenue guidance to a portfolio of contracts with similar characteristics. Examples of characteristics a healthcare organization should consider when grouping contracts for inclusion in a portfolio include:
- Type of service—inpatient, outpatient, skilled nursing, or home health
- Type of payer—insurance contract, governmental program, or uninsured self-pay
- Whether the contracts were entered into on the same or very nearly the same dates
Variable Consideration and Third-Party Settlements
Steps one and three of the model are also impactful when considering payment arrangements with insurers, particularly for those agreements with government programs (e.g., Medicare and Medicaid) under which revenue may be subject to potential retrospective adjustments in future years.
When identifying the contract, the AICPA regards the “contract with the customer” as referring to the arrangement between the provider and the patient, although separate contractual arrangements exist with third-party insurers. The latter arrangements establish that these third parties will pay for services on behalf of the patient and aren’t considered contracts with customers. Rather, they are arrangements that should be considered in determining the transaction price.
When third-party agreements involve potential retrospective adjustments, the amount of the transaction that’s subject to adjustment is another variable component to consider. According to FASB ASC 606-10-32-8, there are two methods to use when estimating variable consideration: the expected value method and the most likely amount method.
A healthcare entity should use the method that better predicts the amount of consideration to which it will be entitled. The method selected should be applied consistently to contracts with similar characteristics and circumstances.
The most-likely-amount method is similar to existing practice as described in the AICPA Audit and Accounting Guide Health Care Entities. The expected-value method involves a probability-weighted analysis of multiple potential outcomes.
Topic 606 does contain guidance regarding whether a significant financing component might exist for arrangements with payments over a sufficient duration such that the time value of money would be a factor in determining the transaction price. The AICPA, however, preliminarily believes that a financing component isn’t applicable to third-party settlement estimates because the timing of payments is at the discretion of the third-party insurer and not the customer (patient).
Presentation and Disclosures
Topic 606 requires an entity to “disclose sufficient information to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.” Significant components of the presentation and disclosure requirements include disaggregation of revenue and qualitative information relating to the nature of and changes to contract balances, contract costs, and performance obligations. The AICPA’s working draft of Implementation Issue 8-6, Presentation and Disclosure, which was released for comment Aug. 1, 2017, includes robust disclosure examples for healthcare organizations as they consider the effects of the standard on their financial statements.
Before the standard goes into effect, healthcare organizations also will need to decide whether a full or a modified retrospective transition makes the most sense for their circumstances. When deciding which transition approach to use, healthcare organizations should consider the various optional practical expedients included in the standard.
Under the full retrospective approach, all reporting periods presented are reported under the new standard, and a healthcare organization is required to disclose any adjustment to prior-period information. Under the modified retrospective approach, the initial period of adoption is reported under the new revenue model, while previous periods are presented under existing GAAP.
It is unclear whether the new revenue recognition standard will pose significant changes to a healthcare organization’s financial statement balances. However, the standard is certain to change how an organization processes and gathers the information it’s required to report under the standard. Substantial commitment will ne needed to identify contracts and portfolios, determine collectability and variable consideration constraints, and establish quantitative and qualitative information to meet disclosure requirements.
Healthcare organizations should begin work now to understand the likely impact of ASC Topic 606 on their financial statements and performance metrics, budgeting and planning processes, and debt covenant compliance.
Brian Conner, CPA, is a partner and national practice leader for the hospitals practice at Moss Adams LLP, Stockton, Calif., a member of HFMA’s Northern California Chapter, and the chair of HFMA’s Principles and Practices Board.