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New Revenue Recognition Standard Will Impact Continuing Care Retirement Communities
In May 2014, after years of work between the Financial Accounting Standards Board (FASB), the International Accounting Standards Board (IASB), and other parties, FASB created a global, consistent revenue recognition model. ASU 2014-09, Revenue From Contracts With Customers, was further codified under ASC 606-10. Prior to this, the standards differed across industries. With a single comprehensive recognition model in place, we can begin to explore its effects on the continuing care retirement communities (CCRC) industry. Until final implementation guidance is provided, questions will remain, but it isn’t too early to explore some of the more complex considerations.
What we know for certain about the new standard
The new model provides clarity on several key issues:
- The exception that was allowed for the amortization of refundable entrance fees under ASU 2012-01 will no longer be applicable. ASU 2014-09 has superseded that exception.
- Deferred marketing costs will no longer be shown as an asset on the CCRC’s balance sheet. They will be shown netted with the deferred revenue liability.
- Entities that fall under the definition of a public entity may require significant additional financial statement disclosures.
Core principles of the standard
The core principle of ASU 2014-09 states that an entity should recognize revenue based on expected contract price. To achieve the core principle, there are five steps:
1. Identify the contract with a customer.
2. Identify the performance obligations in the contract.
3. Determine the transaction price.
4. Allocate the transaction price to the separate performance obligations in the contract.
5. Recognize revenue when the entity satisfies the performance obligation.
Residents entering a CCRC typically sign a “residency agreement” which would meet the definition of a contract. Having completed the first step, the next two steps could significantly impact the accounting for contracts within the CCRC industry. This is where the industry is uncertain on the appropriate application of these principals.
Identify the performance obligations in the contract
At contract inception, an entity assesses the goods or services promised in the contract and must identify as a performance obligation each promise to transfer to the customer either i) a good or service (or bundle of goods or services) that is distinct, or ii) a series of distinct goods or services that are substantially the same. A good or service is generally distinct if two criteria are met: i) the customer can benefit from the good or service on its own, and, ii) the entity's promise to transfer the good or service is separately identifiable from other promises in the contract.
Under the currently applied revenue recognition model, it has been assumed that CCRCs have one performance obligation, the continuum of care. However, ASU 2014-09 may require CCRCs to reassess residency agreements, and include a clause in its contract to provide distinct bundles of goods or services that are separately identifiable. For example, these bundles might include:
- Use of an independent living unit bundled with access to or use of available amenities
- Provision of health care services in an assisted living unit
- Provision of health care services in a skilled nursing facility
Determine the transaction price
The transaction price may include fixed amounts, variable amounts, or both. If the entrance fee is considered an advance payment for future goods or services, then it is recognized as revenue when those goods or services are provided. If the contract includes a variable amount, then the entity is to estimate the amount of consideration to which it will be entitled. Variable consideration should be reassessed at the end of each reporting period and then the estimated transaction price should be updated. Changes in transaction prices should be allocated to the performance obligations on the same basis as at contract inception.
In determining the transaction price, the entity would adjust the promised amount of consideration for the effects of the time value of money only if the timing of payments provides the customer with a significant benefit of financing the transfer of goods or services. The entity should use a discount rate that would have been used in a financing transaction with the customer at contract inception. It would reflect the credit characteristics of the residents entering into the residency agreements and would not be updated for changes in rates or credit risk.
Considering the above, we feel there are two potential approaches to accounting for the contract transaction price:
- The first approach is when residency agreements contain both fixed and variable amounts. In this case, the entrance fee is considered a fixed amount paid at the time the agreement is signed and the resident takes occupancy. The monthly fees may be considered variable, as they are contingent on the resident continuing to live at the facility. An estimate may be made of the total transaction price in the CCRC environment by continuing to use the actuarial determined life expectancies of residents consistent with industry. The monthly expected fees to be received over the life of the contract may be estimated using the life expectancy of the resident. Changes in the transaction price would occur as life expectancies are updated and when inflationary increases are implemented in monthly rates.
- The second approach may be a consideration when CCRCs do not offer financing arrangements for residents to pay their entrance fees over time. In essence, residents must pay their entrance fees upon move-in or shortly thereafter. CCRCs also might not consider a financing component in the monthly fees, since these are due each month.
These ambiguities could be mean drastic changes that require new systems, controls, and processes in place to capture, record, and recognize revenue.
Let’s assume for a moment a situation where a CCRC determines that it is acceptable to include one performance obligation, the continuum of care, and where there is no financing component included in the residency agreement. In this scenario, things would be very similar to current industry practice. A community would defer revenue related to the non-refundable portion of entrance fees collected and amortize those fees over the life expectancy of the resident. Refundable entrance fees would be shown as a liability.
A different scenario, one in which the CCRC considers multiple performance obligations, would be significantly more complex. The deferral of the non-refundable portion of entrance fees and the present value of estimated monthly fee collection over the life expectancy of the resident would draw on the fourth core principle of the new revenue recognition model and requires CCRCs to allocate the transaction price to the performance obligations included in the contract. In other words, CCRCs would have to determine how much of deferred entrance fees and monthly fees would be applied to each level of care. To answer these questions would involve complex analysis and processes, including significant input from actuarial models and actuaries.
Deadlines for adoption
The ASU has been codified and is now part of the revenue recognition landscape. For non-public entities, the standard must be adopted for years beginning after December 15, 2017 (calendar year 2018). Public companies must adopt for years beginning after December 15, 2016 (calendar year 2017). The standard uses ASU 2013-13, Definition of a Public Business Entity as a base for determining what is considered a public company. However, the standard goes beyond ASU 2013-13 to include nonprofit entities with conduit debt, and employee benefit plans that furnish financial statements to the SEC as public entities. If you are a CCRC with outstanding bonds, the standard will become effective in two short years; three for those who don’t meet the definition of a public entity.
The American Institute for CPAs’ communications may identify and address some common issues in applying the standard, but will not provide authoritative guidance, which may only be done by the FASB. CCRCs should examine the various ways the standard will affect them, and seek help from an advisor if needed. This will help CCRCs deal with the potentially significant changes in the way they will be recognizing revenue.
CLA can help you understand how these changes impact your organization, so that you can adapt to these standards and embrace the changes with confidence.