Hospitals and health systems began to see a major transformation in 2009 when the Health Information Technology for Economic and Clinical Health (HITECH) Act was signed into law to promote the adoption and meaningful use of healthcare IT. This legislation was intended, in part, to stimulate the implementation of electronic health record (EHR) platforms. Less than a decade ago, many patient records were updated by hand and stored in cumbersome (often manual) filing systems. Today, almost all providers are using some form of EHR, creating a more logical flow of information within a digital healthcare infrastructure.
A chief benefit for patients and their healthcare providers from EHR implementation is enhanced access to timely, relevant patient information that facilitates care coordination across the care continuum. However, this benefit comes at a significant cost. Although the overall costs of EHR implementation will vary depending on the size and type of provider, such costs usually represent significant investments relative to the scale of operations, often amounting to millions of dollars, and in some cases—for large health system, for instance—exceeding a billion dollars.
Physician practices also incurring are significant costs. According to a study funded in part by the Agency for Healthcare Research and Quality, the average cost for EHR implementation was about $32,409 per physician. a Regarding implementation activities alone, the researchers reported more than 480 hours and $28,025 per practice spent. These figures add up quickly for physicians, with more than 45 percent of EHR system users stating they spend over $100,000 per practice on this technology according to a survey by Medical Economics. b
Essentially the cost of the entire system can be split into three primary components: software, hardware (including building improvements in support of hardware), and training costs
The large expenditures associated with the purchase and implementation of EHR systems have left many individuals perplexed about which costs should be expensed and which capitalized. The Financial Accounting Standards Board (FASB) provides guidance on this decision in its Accounting Standards Codification (ASC) 350-40: Internal-Use Software. To this end, the FASB has defined three computer software development stages:
- Preliminary project stage
- Application development stage
- Post-implementation and operation stage
Preliminary project stage—expense as incurred. During the preliminary project stage, internal and external costs should be expensed as incurred, including costs incurred for the following (from ASC 350-40-55-3 and ASC 350-40-20):
- Conceptual formulation and evaluation of alternatives
- Determination of existence of needed technology
- Selection of a vendor, including evaluation of various vendors and site visits
- Evaluation and selection of a consultant to assist in development or installation
- Final selection of alternatives
Application development stage—capitalized costs. This stage begins when management authorizes and commits to funding the selected EHR system. Examples of authorization include execution of a contract with a third party, approval of expenditures related to internal development, and commitment to obtain software from a third party.
Internal and external costs incurred to develop computer software in this stage should be capitalized, including costs to develop or obtain software for converting old data to new systems. However, other data conversion costs, such as purging or cleansing existing data or reconciling old data to data in the new system, should be expensed as incurred. Any training costs incurred in this stage also should be expensed as incurred. Following are examples of capitalized costs in this stage (from ASC 350-40-55-3):
- Design of software (configuration and interfaces)
- Installation to hardware
- Testing, including parallel processing phase
Post-implementation and operation stage. This final stage is when the software is substantially completed and ready for its intended use. Any internal and external training, implementation support, and maintenance costs incurred in this stage should be expensed. After the EHR system is placed in service, many facilities will incur costs associated with upgrades and enhancements to these complex systems. As stated in FASB’s ASC 350-40-25-7, “Upgrades and enhancements are defined as modifications to existing internal-use software that result in additional functionality—that is, modifications to enable the software to perform tasks that it was previously incapable of performing.”
For these costs to be capitalized, it must be probable that they will produce additional functionality.
Maintenance costs should be expensed as incurred. When maintenance is combined with upgrades and enhancements under contractual arrangements, the costs should be allocated between the elements.
Ongoing support and other related services costs should be expensed as incurred. Furthermore, new software development activities require consideration of estimated remaining useful lives of existing software that is being replaced. In many cases, this consideration will result in an acceleration of the amortization. Any remaining unamortized old software costs typically should be expensed when the new software is implemented. However, this guidance may not apply to incremental software updates that are adding to or enhancing existing software, rather than replacing it.
Cloud-based EHR systems are expanding across various sectors of the healthcare industry. Cloud-based computing stores information on a shared online location hosted by an external vendor or service provider, rather than on a personal disk drive or local service. In this environment, software and information is stored on an online network (the “cloud”), with the internet as users’ access point. This approach provides a variety of benefits that non-cloud-based EHR systems cannot provide, including on-demand self-service, agility, broad network access, resource pooling, and rapid elasticity.
The FASB’s Accounting Standards Update (ASU) 2015-05: Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40) provides guidance to providers about whether a cloud-computing arrangement includes a software license. A cloud-computing arrangement includes a capitalizable software license when the hosting agreement includes both of the following criteria:
- The customer has the contractual right to take possession of the software during the hosting period “without significant penalty.”
- The customer can either run the software on its own hardware or host the software via a third-party vendor.
Again, both these criteria must be met; if not, the hosting arrangement is classified as a service contract and capitalization of a license is not permitted, with the result that associated costs should be expensed as incurred. On entering into such hosting agreements, healthcare entities should analyze the agreements’ terms and consider financial reporting implications.
A primary goal resulting from the utilization of EHR systems is to improve the overall quality of health care consistent with the payment shift from fee-for-service to a focus on quality and performance. However, many healthcare providers question whether the benefits of such systems will outweigh the exceedingly steep costs. One way to analyze the cost versus benefit of an EHR system is the in ROI, a common approach to measuring rates of return on money invested in terms of increased profit attributable to the investment. It is calculated as follows:
ROI = (Gain from the Investment – Cost of the Investment) ÷ Cost of the Investment
A single ROI narrative can be difficult to establish because circumstantial differences across the healthcare spectrum produce disparate outcomes. Underlying differences that all play a role in determining ROI include facility type, facility size, the specific practice or field of care, staff size, and EHR products themselves. c
When evaluating the ROI for an EHR purchase and implementation, it is important to consider both the quantifiable and non-quantifiable benefits of the EHR system. Quantifiable benefits include increased revenue and productivity, quality improvement, and improved operational efficiency. Non-quantifiable benefits might include enhanced job satisfaction and employee morale and an improvement in patient satisfaction and overall patient experience—important considerations in today’s consumer-driven marketplace.
Total cost of ownership (TCO) is the purchase price of an asset plus all the additional costs of operation. For EHR systems, these costs include software and hardware maintenance and updates. TCO analysis helps in estimating a reasonable depreciable life of the asset. Some EHR platforms are being depreciated over relatively brief three- to five-year lives, primarily based on American Hospital Association (AHA) historical guidelines for computer hardware and software. However, a shift is occurring, as more hospitals and health systems find better TCO planning and ROI on EHRs with a 10-year forecast. d
Given the significant costs involved and the quality of today’s platforms, it is increasingly unlikely that many organizations, under normal circumstances, will replace their system in less than 10 years. Consequently, many organizations are challenging the useful lives in depreciating EHR platforms, and as a result, assigned useful lives in the seven- to 10-year range are becoming more common.
Typically, the useful lives assigned to the main system installation and upgrades are evaluated separately. Consideration should be given to identifying additional separation of components (e.g., hardware, internally developed software, licensing rights) when evaluating estimated useful lives. At the same time, many providers are questioning the useful lives assigned to other high-dollar capitalized costs and adjusting them based on their individual estimated useful lives versus using standard range guidelines, such as the AHA guidelines for depreciable assets.
Organizations should maintain documentation supporting their rationale for useful lives assigned. By challenging the estimated useful lives and utilizing more entity-specific refined estimates, many organizations should see a favorable impact on their financial operating results.
Time to Revisit Traditional Practice
Given the magnitude of ongoing investment in EHRs and other software and technology, careful consideration should be given to challenging legacy practices for capitalization and depreciation/amortization of these costs. The goal should be to enhance accounting and financial reporting to be more reflective of the true economic asset value to the organization, and to better evaluate ROI and overall strategic value proposition for such a significant investment, both in terms of economic returns and in support of improved care coordination, enhanced quality of outcomes, and higher patient satisfaction.
a. Fleming, N.S., Culler, S.D., McCorkle, R., Becker, E.R., and Ballard, D.J., The Financial and Nonfinancial Costs of Implementing Electronic Health Records in Primary Care Practices, Health Affairs, March 2011.
b. Verdon, D., “Physician Outcry on EHR Functionality, Cost Will Shake the Health Information Technology Sector,” Medical Economics, Feb. 10, 2014.
c. Cosenza, J., “EHR vs. ROI: Is it Worth It?” Blog, Meta Healthcare IT Solutions, March 2017.
d. Swenson, B., “The New 10-Year Standard: Find a More Accurate EHR Total Cost Ownership,” Becker’s Health IT & CIO Report, Jan. 13, 2015.