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Navigating health reform
New Revenue Recognition Standard Hits Health Care Entities
In May 2014, the Financial Accounting Standards Board (FASB) completely rewrote the rules for revenue recognition. Accounting Standards Update (ASU) 2014-09 – Revenue from Contracts with Customers created a new principle-based framework to determine when and how an entity recognizes revenue from its customer contracts. The effective date for the changes under ASU 2014-09 has been pushed back one year from the original date due to implementation issues. Effective dates are set to begin after December 15, 2017, for public entities, including entities with conduit debt, and after December 15, 2018, for all others.
New framework based on core principle
FASB established a core principle for recognizing revenue within the new rules: revenue should be recorded only when services are provided or goods are transferred to customers at the agreed price.
FASB provides five steps for organizations to determine how to recognize revenue from customers:
- Identify the contract(s) with a customer.
- Identify the performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price to the performance obligations in the contract.
- Recognize revenue when (or as) the entity satisfies a performance obligation.
Implementation challenges for health care industry
The American Institute of CPAs (AICPA) Health Care Entities Revenue Recognition Task Force is one of 16 industry task forces created to identify potential implementation issues and provide guidance. Although no formal guidance has been issued yet, the task force has begun to identify significant issues that may affect the health care industry. These issues will be submitted to various AICPA and FASB committees for consideration.
The intent of the new rules is to establish a core principle for revenue recognition across all industries. While this concept may not appear to be overly complex at first glance, the different sub-industries within health care have a variety of contractual arrangements with customers to provide services and goods (performance obligations). The numerous ways that entities are paid may make implementation challenging.
The greatest impact of the new rules will be on transactions that overlap at the end of the reporting period (typically year-end); therefore, organizations should focus their efforts on the revenue recognition issues related to those transactions.
Variations by health care sub-industry
The new revenue recognition model will have an impact across the health care industry, from hospitals to continuing care retirement communities (CCRCs). Each health care sub-industry will have challenges unique to their field.
Continuing care retirement communities
Under current standards, nonrefundable entrance fees are amortized over the expected lives of residents, while monthly service fees are recognized immediately. Under the new standard, a CCRC will likely need to estimate the transaction price that includes both amortization of the nonrefundable entrance fee and the expected monthly service fees the organization receives under the resident contract. The implementation issues will include identifying the performance obligation or obligations and transaction price, then recognizing revenue as the performance obligation(s) are satisfied.
CCRCs will need to assess whether there is a financing component (an interest free loan) in the advance entrance fee the organization receives, which would increase the transaction price with the imputed interest. Given the various plan options that are available, the answer may differ from one organization to the next. One key area that implementation committees should focus on is understanding the impact of the new revenue framework on each type of contract, which ranges from life-care to fee-for-service.
Hospital and health systems
Hospitals face many challenges as well. For example, when providing emergency services to uninsured or self-pay patients, they must determine when a contract is created, and when and how the transaction price is determined. Hospitals will also need to apply the standard’s concept of “implicit price concessions,” such as adjustments to gross charges for third-party payers, or the amount the hospital expects to be entitled to for their services in estimating the transaction price. After the transaction price is determined, the probability of collection will need to be determined for revenue recognition. These considerations will impact both the timing of revenue recognition and the amount that is recognized.
Third-party payor settlements
Health care providers will need to address the process for estimating third-party payor settlements as “variable consideration” under the new standard. The current estimate is broadly based on knowledge and experience. Under the new standard, the estimate will need to be based either on the expected value (probability weighted amounts in a range) or the most likely outcome, if the outcomes are limited.
Other considerations for health care providers
Organizations can apply the new standard to a portfolio of contracts with similar characteristics “if the impact would not materially differ from applying to individual contracts.” This can create consistency and efficiencies during implementation and future revenue recognition. Health care providers will be able to determine what detail of disaggregation of portfolios is needed, such as life-care or fee-for-service contracts, uninsured and self- pay patients, co-payments and deductibles, charity care, Medicaid and Medicare, or other third-party payers. Organizations can immediately begin developing portfolios of revenue contracts in preparation for implementation of the standard.
How we can help
FASB, AICPA, and several trade associations have begun studying these issues, but formal guidance is not expected soon. In addition, because the effective date of these new rules has been deferred, many have taken a “wait and see” attitude. Unfortunately, the date for implementation will eventually arrive.
Both public and nonpublic companies should prepare to adopt the new requirements by inventorying their revenue streams and evaluating how revenue will be affected by the new rules. CliftonLarsonAllen professionals have deep insight into issues in the health care industry and understand how these rules are likely to impact the industry in general, as well as individual clients. We can help you understand how these changes impact your organization, so that you can embrace the changes with confidence.