Revenue Recognition for Health Care Organizations – Changes on the Horizon
Jeremy Veilleux, Audit Principal
On May 28, 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers. ASU 2014-09 combines existing revenue recognition guidance in U.S. generally accepted accounting principles (GAAP) into a single framework. This article discusses a few of the key areas impacted by ASU 2014-09; however, is not intended to be a comprehensive analysis of the new standard.
Because of the significance of the changes this new guidance may have on U.S. companies, the FASB has delayed the effective date for public organizations to reporting periods beginning after December 15, 2017, and for nonpublic organizations to reporting periods beginning after December 15, 2019. However, the FASB defines public organizations to include not-for-profit organizations that have issued, or are conduit bond obligors for, securities that are traded, listed or quoted on an exchange or an over-the-counter market. As a result, health care organizations that issue public debt may be subject to these rules at the earlier effective date. The new revenue standards can also be adopted early by both public and nonpublic organizations.
Upon implementation of ASU 2014-09, substantially all existing revenue recognition-related guidance currently applied by health care organizations will be superseded. Key provisions that are likely to remain include the accounting for charity care and contributions from fundraising activities.
Under existing guidance, revenue is earned when the organization has provided the services required to entitle it to the revenue. Under the FASB’s new guidance, the actions that must be performed are referred to as performance obligations. A contract may have a single performance obligation (e.g. a routine office visit to a physician), or it may have multiple performance obligations. Many health care organizations enter into bundled payment arrangements, which could further complicate implementation of the new rules. Organizations will be required to evaluate how many distinct goods and services must be provided, and revenue is then to be recognized as each performance obligation is satisfied. Health care organizations may also experience varying payment methodologies, including fee-for-service, episodic, per diem, per case and capitation. Under the new revenue recognition standard, each such contract type may result in differences in timing of revenue recognition as compared to past practice.
Another area that may be substantially impacted involves variable consideration. Although some health care revenue may be based on a ‘fixed price’, other revenue is commonly subject to retrospective adjustments, discounts, incentives and clawbacks. Consideration that is variable must be estimated. The FASB provides new standardized estimation techniques, including a probability-weighted technique and a ‘most likely amount’ technique, with the requirement that the total estimated variable consideration be constrained to the amount for which it is probable that a significant reversal of cumulative revenue recognized will not occur once all contingencies are resolved. This process could change the timing and amount of revenue recognized by a health care organization.
Additionally, many health care organizations recognize revenues for services provided to uninsured patients, ultimately followed by recognition of bad debt expense. The FASB’s new model requires that revenue from uninsured patients be recognized using the concept of an ‘implied price concession’, while also imposing a strict collectibility threshold that must be met to recognize that revenue. The concept of an implied price concession would likely require that the organization initially recognize revenue at the amount the provider expects to be entitled to. Thankfully, the FASB permits the transaction price to be estimated using a portfolio of contracts, based on an average of amounts historically collected from each payor category. Contracts that do not meet the collectibility threshold obviously would not meet the criteria for revenue recognition.
With respect to third-party settlement estimates, it’s not expected that the new rules will materially change the accruals for unsettled cost reports and related items. However, as described above, the methodology management will use to arrive at its best estimate will involve either a probability-weighted or ‘most likely amount’ approach, and again the ultimate amount recognized as revenue will be subject to the condition that it is probable that a significant reversal of cumulative revenue will not occur.
Although the degree to which the timing and amount of a health care organization’s revenue will be affected depends on its own facts and circumstances, it is clear that all health care organizations will need to evaluate whether their revenue recognition and financial reporting systems need to be revised to comply with the FASB’s new guidance. It’s never too early to start those conversations with your public accounting firm.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.