The New Revenue Recognition Standard and the Healthcare Industry – Chapter 1: What do We Know Thus Far?

Background of the New Standard

The revenue recognition standard, ASU 2014-09 – Revenue from Contracts with Customers, was originally issued in May 2014 and subsequently amended for extension of adoption dates and clarifications. It will become effective for public business entities and certain not-for-profit entities for fiscal years beginning after December 15, 2017. For all other entities, the effective date for fiscal years beginning after December 15, 2018. The standard was a result of the Financial Accounting Standards Board (the “FASB”) and the International Accounting Standards Board (the “IASB”) working together to develop one converged all-inclusive principles based standard to be used across all industries. The objectives of the new standard were to remove inconsistencies in existing standards, provide a framework to fall back on to address issues not specifically addressed in the standards, improve comparability, provide more useful disclosures and simplify the preparation of the financial statements by having one standard.

The new revenue standard is based on five step model:

1. Identify the contract(s) with a customer.
2. Identify the performance obligations in the contract.
3. Determine the transaction price.
4. Allocate the transaction price to the performance obligations in the contract.
5. Recognize revenue when (or as) the entity satisfies a performance obligation.

The core principle of the standard is to depict the transfer of goods or services to the customer in an amount that reflects the consideration that the entity expects to be entitled to in exchange for those goods or services.

What does this new standard mean for the Healthcare Industry?

The American Institute of Certified Public Accountants (the “AICPA”) has developed several industry task force groups to identify and provide guidance on significant revenue recognition adoption issues. The Health Care Entities Revenue Recognition Task Force (the “Task Force”) has identified the following healthcare industry issues thus far:

1. Issues with self-pay balances:
1. How to apply Step 1 (determine if there is a contract) and Step 3 (determine the transaction price).
2. How to handle implicit price concessions.
2. How to apply the portfolio approach with self-pay and third party transactions.
3. Continuing Care Retirement Communities (CCRCs):
1. Identifying and satisfying the performance obligation(s) and recognizing the monthly/periodic fees and nonrefundable entrance fees under Type A or “life care” contracts for continuing care retirement communities.
2. Identifying the performance obligation(s) and recognizing the performance obligation(s) to provide future services and use of facilities.
3. Determining how CCRCs will assess whether a significant financing component exists in defining the transaction price for its resident contracts, as well as how CCRCs and other healthcare entities will assess whether a significant financing component is applicable to patient and third-party payer amounts in arrears.
4. Judgments related to disclosure requirements.
5. Accounting for contract costs.
6. Consideration of third party settlement estimates.

The Task Force has published two working drafts with wording to be included in the AICPA’s Revenue Recognition Guide publication addressing the first two issues above. A brief summary of those two drafts are in the next two sections of this article and a full copy of both can be found on the AICPA’s website.

Issue 1 – Self-Pay Balances

Certain health care entities may be required by law to provide services to patients regardless of ability to pay (for example, through an emergency department). In addition, not-for-profit health care entities have requirements to maintain their tax exempt status including providing services to patients regardless of their ability to pay or providing financial assistance. Historically, these factors have caused many healthcare entities to collect amounts substantially less than what is initially charged to the patients for services. Consequently, the new revenue standard introduces new factors to consider when recording revenue for self-pay patients. The AICPA draft includes guidance and various examples of revenue recognition before and after application of the new standard, which are summarized below.

Example 1 – Uninsured self-pay patient with no uninsured discount: A hospital treats a patient in the emergency room and does not assess the patient’s ability to pay at the time of service. The standard charges for services provided to the patient are $10,000. The hospital intends to pursue collection and may even engage the use of an external collection agency. However, based on the hospital’s experience, it only expects to collect $1,000 from this patient. The facts indicate that the hospital has the intention to grant an implicit price concession because it is required to provide emergency services even though it does not expect to collect the entire amount. Under this circumstance, the transaction price (and revenue and receivable recorded) is deemed to be $1,000. Subsequently, if the hospital collects more or less than the $1,000, it would generally account for this difference as an adjustment to revenue. If the hospital received less, and it had obtained any adverse information about the patient’s ability to pay, an impairment loss may exist (i.e. bad debt expense).

Example 2 – Uninsured self-pay patient with an uninsured discount: A hospital treats a patient in the emergency room and determines the patient qualifies for a charity care discount of 75%. The standard charges for services provided to the patient are $10,000. The hospital intends to pursue collection of the 25% due and may engage the use of an external collection agency. However, based on the Hospital’s experience, it only expects to collect $1,000 from this patient. The facts indicate that the hospital has the intention to grant an implicit price concession because it is required to provide emergency services even though it does not expect to collect the entire amount. Under this circumstance, the transaction price (and revenue and receivable recorded) is deemed to be $1,000.

Example 3 – Using the portfolio approach to uninsured patients: The hospital elects to use the portfolio approach with regard to the uninsured self-pay customer class. During the period, the hospital has total gross charges of $1,000,000 for this self-pay portfolio. The hospital determines that these patients qualify for uninsured discounts of 75% (i.e. $750,000). Based on its collection experiences with patients in this customer class, the hospital expects to collect $50,000. Under this situation, the transaction price (and revenue and receivable recorded) is deemed to be $50,000. Subsequent changes to the transaction price would be accounted as adjustments to revenue unless, in the case of collecting less, it had obtained any adverse information regarding the financial condition of the patients in the portfolio.

Example 4 – Insured patient with high deductible coverage: An urgent care clinic treats an insured patient with a high deductible plan but does not assess the patient’s ability to pay the deductible prior to performing the service. The charges for the services to the patient are $5,000 but the contract with the commercial payer provides a discount of $3,000. The remaining $2,000 is due from the patient as they had not met their deductible. The clinic has a history of providing services to patients and collecting amounts less than what is contractually due. The clinic’s experience is that they expect to collect only $200 from the patient. Under this example, the revenue recorded would be $200. Any subsequent changes to expected or actual collection amounts would be handled similar to Example 1 above.

Example 5 – Portfolio approach to insured patients with high deductible coverage: An urgent care clinic identifies a portfolio of patients with high deductible plans insured by Insurance Company A. The total gross charges in the portfolio are $500,000 and the expected contractual adjustment is 60% (i.e. $300,000). The clinic has a practice of providing services to patients with high deductible plans even though it historically collects amounts that are substantially less than what is owed. Based on its experience, the clinic expects to collect $80,000 for this class of customer. In this example, the revenue recorded would be $80,000. Subsequent changes to the expected or actual collections would be handled similar to Example 3 above.

Example 6 – No implicit price concession with an uninsured patient: A patient schedules an elective cosmetic surgery at an outpatient surgery center that has a policy of performing a credit assessment prior to providing elective surgery to its patients. The standard price for the surgery is $4,000 but prior to the surgery, the center assesses the patient’s ability to pay and grants special pricing of $3,000. The center has a policy of collecting 50% upfront and expects to collect the remaining amount from the patient. Under this circumstance the center would initially record $3,000 of revenue. However, based on subsequent changes in facts and circumstances, the surgery center determines that it only expects to collect $500 of the $1,500 balance from the patient. In this circumstance, the remaining $1,000 represents an impairment loss and would represent bad debt expense.

Example 7 – Implicit price concession with a portfolio of insured patients with a co-payment: A healthcare entity provides services to patients covered by Insurance Company B under policies with a co-payment. Because of its non-profit mission, the healthcare entity does not have the policy of assessing patients’ intent and ability to pay prior to providing the service. The portfolio of these patients totals $1,000,000 and the contractually agreed upon discount with Insurance Company B is 50%. The balance due of $500,000 includes $25,000 of deductible balances due from patients and $475,000 from Insurance Company B. Based on its experience, the healthcare entity expects to collect 40% (or $10,000) of the deductibles and the full amount from the insurance company. Under this example, the healthcare entity would recognize $485,000 (i.e. the $475,000 due from the insurance company and the expected deductible collections of $10,000). Any subsequent adjustments to the amounts expected to be collected would be handled consistently with the examples above.

Issue 2 – Application of the Portfolio Approach

The new revenue standard is generally applied to an individual contract with a customer. However, as a practical expedient, an entity may use a portfolio approach to a similar group of contracts (as depicted in examples 3, 5 and 7 above). The portfolio approach may be used as long as it is reasonable to expect that it would result in the same result as if the standard was applied to each individual contract.

Healthcare entities may need to revise their systems to summarize patient accounts to ensure that they have met the requirements of the homogeneity of the data within a portfolio and the sufficiency of the historical information of a portfolio. An acceptable approach could also be to consider historical cash collections and then group contracts into portfolios with similar collection history and reimbursement rates. Regardless of how data is aggregated, the portfolio approach will require ongoing monitoring of historical data and more often than what is currently necessary.

For self-pay patient balances, the portfolio approach may involve aggregating data in many different portfolios. For example, patients accessing the healthcare system via an emergency room visit would likely have a different aggregate collection pattern than patients who access the system via scheduling a surgery or outpatient visit in advance.

The portfolio approach is not required and healthcare entities will have the option to apply this approach to one class of patients and not others. If a portfolio approach is not used, the healthcare entity will need to apply the standard on a contract by contract basis. Once again, systems may need to be revised and built for healthcare entities with a high volume of patients whether or not they choose to use the portfolio approach or not.

Conclusion – What will change based on the above?

Based on the examples provided above under issue 1, you would expect healthcare entities to record much less bad debt expense. In all of the examples, the net amount of accounts receivable on the balance sheet is still at net realizable value, which is very similar to today. The big difference is in the initial recording of revenue at a transaction price that includes implicit price concessions. Amounts that historically would have been reserved within the allowance for doubtful accounts and bad debt provision are never included in the initial accounts receivable and revenue that are recorded.

In addition, many healthcare entities provide a high volume of services so you would also expect that the portfolio approach with be the most utilized method for revenue recognition. This may require accumulating patient balances and activity differently than today. Healthcare entities should start preparing now for the impact of this standard.

It will also be important to monitor the ACIPA Task Force activities as they continue to address the remaining issues identified. We will keep you posted in future editions of this article as the AICPA publishes the results of its research on issues 3 through 6 noted above.