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 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 determining 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.
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 sub-industries within health care have a wide 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 life care Communities. Each health care sub-industry will have challenges unique to their field.
Life care communities
Under current standards, refundable entrance fees are recorded at the contractually refundable amount specified in the resident contract. In addition, monthly service fees are recorded as revenue when earned, and nonrefundable entrance fees under a Type A contract are amortized into revenue over the estimated life expectancy of the resident. While the treatment for refundable entrance fees will not be impacted by the new revenue recognition standard, initial guidance provided by the AICPA suggested that the timing of recognition for monthly service fees and nonrefundable entrance fees would be changed under the new standard.
Preliminary implementation guidance suggested that life plan communities would determine a transaction price at the inception of the Type A resident contract that comprised both the nonrefundable entrance fee and projected monthly service fees. The transaction price would then be allocated using standalone market rates and revenue recognized as the performance obligation is satisfied under the resident contract over the continuum of care. This would result in the recognition of a larger amount of revenue later in the contract rather than consistently over the life of the contract. Additional implementation guidance is expected to provide insight as to the identification of performance obligations, development of significant estimates and assumptions (such as the source of market rates), and the calculation mechanics for the transaction price.
The implementation guidance that will soon be available for comment, however, is expected to reflect an approach that is similar to the current recognition of nonrefundable advance fees and monthly service fees under a Type A contract. Under the expected guidance, a life care community resident has the ability to move out and discontinue paying the monthly fee at any time, so it is considered a monthly contract with an option to renew. As a result, monthly service fee income will continue to be recognized each month as it is earned.
Nonrefundable advance fees will also continue to be recognized consistent with current practice. The expected guidance continues to require an amortization period of the shorter of the resident’s life or length of the contract. However, the allowable amortization methods will include either the straight line method (as currently required) or a method that reflects an estimate of when future costs or services are transferred to the resident. This method would result in recognizing a greater amount of amortization revenue later in a resident contract.
Hospital, health systems, and physician clinics
Health care organizations will need to determine what constitutes the performance obligation. Services provided to an inpatient may result in different determinations of the performance obligation than services provided in an outpatient setting, or those provided in a physician clinic.
When determining the transaction price for a contract, health care organizations must also apply the standard’s concept of price concessions. “Explicit price concessions” occur when the health care organization is aware of a reduction from the transaction price, such as under contracts with third-party payors or other adjustments provided. The expectation is that organizations will collect only the amount to which they are contractually obligated to be paid. “Implicit price concessions” occur when the health care organization intends to pursue collection of the full amount charged to the patient, but they don’t expect to collect the full amount based on historical experience, such as with uninsured or self-pay patients.
Under both price concession scenarios, the transaction price is limited to the amount of expected collection. The price concession approach will impact amounts that are recognized as bad debt expense, as well. Current revenue recognition guidance amounts initially recorded as revenue can be written off as bad debt when it is determined they will not be collected. Under the new standard, however, amounts not collected due to implicit price concessions are not part of the contract price, therefore were never recognized as revenue. As a result, there is no previously recognized revenue to write off as bad debt.
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.
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 payors. Organizations can immediately begin developing portfolios of revenue contracts in preparation for implementation of the standard.
Potential deferral of implementation for nonprofits
Nonprofit entities that are conduit debt obligors may have an opportunity to delay implementation. The AICPA recently issued a Technical Questions and Answers document providing clarification regarding when a conduit debt obligor may not be considered a public business. Nonprofits have a unique set of related concerns.
How we can help
FASB, AICPA, and several trade associations have released implementation guidance for parts of the standard, and more is expected. The time has come to assess the impact of the standard and begin the process.
Both public and nonpublic companies should inventory their revenue streams and evaluate how revenue will be affected by the new rules. CliftonLarsonAllen professionals understand how these rules are likely to impact the industry in general, as well as individual clients. We can help you adapt to these standards so that you can embrace the changes with confidence.