In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers, later codified as Accounting Standards Codification (ASC) Topic 606. This major overhaul of revenue recognition (effective for fiscal years starting after December 15, 2017 for public companies) affects almost every industry, and health care is no exception. The complex arrangements between healthcare providers, patients, and insurance companies pose some of the most difficult issues for the new standard. Due to various payment methodologies, self-pay patients, and numerous services that may be involved in a single contract, application of the five-step revenue-recognition model can be particularly complicated.
The AICPA and the major accounting firms have assembled industry task forces to research the industry-specific accounting issues within ASC 606, and we will draw from the guides they have published as we provide a brief explanation of the key issues the health care industry faces when applying ASC 606. For more information on any of these issues, see:
- AICPA, Audit & Accounting Guide: Revenue Recognition
- Deloitte, New revenue standard issued: Potential challenges in the health care industry
- KPMG, Revenue for healthcare providers
- PwC, Revenue from contracts with customers: Heath care services industry supplement
- EY, Technical Line: How the new revenue standard affects health care entities
We will also provide references to other RevenueHub articles for more detailed explanations of related ASC 606 topics. For general information on the basics of revenue recognition, see our RevenueHub article, The Five-Step Method.
The following are the issues that companies in the health care industry commonly face:
1. Determining whether there is a contract (Step 1) and what the transaction price is (Step 3) when patients are uninsured or have high co-payments and deductibles
Many healthcare service providers are required by law to treat patients with emergency conditions regardless of the patient’s ability to pay. Often these patients will be either uninsured or insured under a plan that requires high co-payments or deductibles. Determining whether a healthcare provider has a contract with such a patient (Step 1) and estimating the transaction price of that contract (Step 3) may be very complex. In emergency situations, it is often difficult to determine whether the provider entered into a contract with the customer because no formal agreement was reached. Determining the transaction price of such a contract is also difficult when providers are unsure whether they will ever receive payment.
ASC 606-10-25-1(a) requires that “the entity and the customer must approve the contract in either written or oral form.” If a patient signs any forms prior to their treatment, such as a responsibility form acknowledging the services they will receive, then the provider may determine that the parties have entered into a contract. When a patient does not sign such a form before treatment, the provider must consider whether it has any oral contracts, such as a patient scheduling an appointment ahead of treatment. If the patient was admitted while they were unconscious or against their will, the provider must consider the specific facts and circumstances surrounding the treatment to determine whether a contract exists.
If the provider concludes that a contract exists, it must also determine the transaction price of that contract. This can be difficult when patients are uninsured or have high co-pays or deductibles because these patients often fail to make payments. ASC 606-10-55-102 through 105 illustrates that a contract may not exist until a provider has obtained enough information about the patient to determine that it is probable the patient will pay the consideration the provider is entitled to. When a provider treats an uninsured patient, they may try to qualify the patient for Medicaid or the health care provider’s charity care policy (contracts under charity care policies are not within the scope of ASC 606). If the patient qualifies for Medicaid, the provider should use the amount it expects to receive from Medicaid as the transaction price. If the provider operates in a state in which qualifying for Medicaid takes a considerable amount of time, the provider may use historical information to evaluate the likelihood of the patient qualifying in order to estimate the consideration to which it is entitled.
2. Implicit price concessions
Another issue that poses difficulties for healthcare providers is determining whether amounts not likely to be collected should be considered implicit price concessions. As stated previously, many healthcare providers are required by law to treat patients with emergency conditions, regardless of the patient’s ability to pay. Often these patients will either be uninsured or insured under a plan that requires high co-pays or deductibles. Providers also provide services in non-emergency situations to patients who are uninsured or face high self-pay balances, and these patients may not pay for their services in full.
According to ASC 606-10-32-7, a healthcare provider needs to consider the following to determine if it has provided an implicit price concession: (1) based on the provider’s customary business practices, policies, or specific statements, does the customer have an expectation that the provider will accept an amount that is less than the contract price and (2) do facts and circumstances indicate that when the provider entered into the contract, it was their intention to offer a price concession? If, for example, a provider’s ordinary business practice is not to perform a credit assessment prior to services or if a provider continues to provide services to a patient even though historically the provider has not collected from that patient, then the provider would likely conclude that it has offered an implicit price concession.
Relevant RevenueHub Articles: Price Concessions
3. Application of the portfolio approach to contracts with patients
Applying the portfolio approach to revenue recognition can provide great relief to healthcare providers that currently account for each patient separately. According to the FASB and the AICPA, “Health care entities may use a portfolio approach as a practical expedient to account for patient contracts if… the financial statement effects are not expected to materially differ from an individual contract approach.” It is worth noting that providers must exercise reasonable judgment in applying the portfolio approach to ensure that patients are being grouped by types of services, payment methods, and time periods.
Relevant RevenueHub Articles: Contract vs. Portfolio Method
4. Identification of performance obligations
Within the health care industry, contracts commonly include multiple commitments. For example, a provider may arrange a multiple-night stay in a hospital, perform a surgery, administer medication, and provide out-patient physical therapy. In contracts with multiple commitments, it is important for providers to identify whether certain performance obligations are distinct or should be bundled in order to properly allocate the transaction price and recognize revenue.
Under the new revenue recognition standard, a good or service is distinct if it is both (1) capable of being distinct, and (2) distinct within the context of the contract. The first criterion is met if the customer can benefit from the good or service on its own or with readily available resources. The second criterion is satisfied if the benefit the customer can derive from the good or service is not dependent on or interrelated with the other goods and services within the contract. If a promised good or service is not distinct within the contract, the entity should combine it with the other goods or services in the contract until a distinct performance obligation is formed.
Continuing care retirement communities (CCRC) are examples of contracts that include multiple performance obligations. CCRCs are long-term care facilities that cater to a resident’s specific needs. These care facilities generally enter into long-term contracts that promise patient care and use of CCRC facilities. CCRC contracts often involve many different interrelated obligations, such as providing for and maintaining patients’ living quarters, administering medication, conducting physical therapy, arranging constant patient supervision, and providing meals and entertainment. These interdependent obligations create difficulties when determining whether obligations are distinct or should be bundled. To make this assessment, providers must consider whether a patient could benefit from each obligation in isolation or if certain services are only beneficial to the customer in connection with other services the CCRC is providing. For example, a patient may be able to benefit from medication independent of other services, but may not be able to benefit from the living quarters without constant supervision.
Relevant RevenueHub Articles: Identifying Promised Goods & Services
5. Recognizing upfront payments and periodic fees related to CCRCs
CCRC agreements usually begin with a large one-time payment and are then upheld by monthly payments. Under ASC 605, providers recognized the monthly payments on their due dates and amortized the large upfront payment over the estimated time the patient would be under the provider’s care. However, under the new revenue recognition standard, CCRC’s will need to change the timing of the recognition of revenue related to patient care and facility use.
With regards to the nonrefundable upfront payment, ASC 606-10-55-51 states:
an entity should assess whether the fee relates to the transfer of a promised good or service. In many cases, even though a nonrefundable upfront fee relates to an activity that the entity is required to undertake at or near contract inception to fulfill the contract, that activity does not result in the transfer of a promised good or service to the customer… Instead, the upfront fee is an advance payment for future goods or services and, therefore, would be recognized as revenue when those future goods or services are provided. The revenue recognition period would extend beyond the initial contractual period if the entity grants the customer the option to renew the contract and that option provides the customer with a material right.
In accordance with this guidance, a CCRC should include the initial payment in the transaction price of the contract and allocate the payment to the two performance obligations the CCRC is providing in connection to the upfront payment: (1) the right to access the CCRC and (2) the option to renew the contract through recurring payments. The amount allocated to the right to access the CCRC will be recognized over the first year, while the amount allocated to the option to renew will be recognized when the customer either renews or the option expires.
Providers should recognize the periodic or recurring fees associated with CCRCs ratably over the period for which they are paid. For example, if a CCRC requires customers to pay a $50 yearly fee to remain a CCRC member then the CCRC will recognize the $50 ratably over the year in which it is paid.
Relevant RevenueHub Articles: Nonrefundable Upfront Fees
6. Disclosure requirements
ASC 606 requires additional disclosures that were not necessary under ASC 605 in many cases. Healthcare providers will now need to disclose a disaggregation of revenue, information about changes in contract assets, contract liabilities, costs, and amounts allocated to performance obligations that have not yet been satisfied. Providers will also continue to disclose healthcare provided for charitable purposes.
Relevant RevenueHub Articles: Disclosures
7. Accounting for contract costs
Under the new standard, healthcare providers will be required to capitalize and amortize incremental costs that they incur to obtain (e.g., sales commissions) and fulfill a contract. The costs of obtaining a contract are recognized as an asset if the provider expects to recover them. As a practical expedient, providers may immediately expense the costs if they would have been fully amortized in one year or less. The provider should only capitalize and amortize the costs to fulfill a contract if (1) the costs relate directly to a specific contract, (2) the costs generate or enhance resources that will be used to satisfy performance obligations in the future, and (3) the provider expects to recover the costs. The costs capitalized by the provider should be amortized as the provider transfers the goods or services designated in the contract to the customer
For example, a CCRC may incur certain costs when obtaining a contract with a new customer such as sales commissions, legal fees, and actuarial fees. CCRCs often have employees who are paid commissions for the patients that they sign with the retirement communities. These commissions would not have been incurred if the CCRC did not obtain a specific contract, and therefore, if the CCRC expects to recover the costs over the life of the contract, the commissions should be capitalized. The legal and actuarial fees, however, should be expensed, because whether or not the CCRC obtained the contract, the CCRC would have incurred the fees assessing the patient.
Relevant RevenueHub Articles: Costs to Fulfill a Contract
8. Third party settlements
Accounting for revenue from third party settlements will not change drastically between the old and new revenue recognition standards. However, the new standard is more specific and intentional regarding the method entities should use to estimate the amounts they will receive from third parties. Under the previous standards entities were required to use their best estimates as to the amount they would receive from a third party, while under the new standard entities will be required to consistently apply a most-likely-amount method or an expected-value method when estimating the amount they will receive. This change will likely have little effect on the estimations providers calculate. However, providers should reassess their estimation processes to ensure they are applying the new standard appropriately.
9. Recognition over time or at a point in time
Healthcare providers often have payment arrangements with third-party payers like insurance companies, which may affect the time at which revenue is recognized. For example, if an insurance company reimburses a provider on a fee-for-service basis, then the provider may recognize revenue as it provides the promised service. However, if the insurance company compensates the provider for providing healthcare over a period of time, then the provider should recognize revenue pro-rata over that time period, not as it provides specific services.
It is likely that many other issues and questions will arise within the health care industry as entities adopt ASC 606. This article serves as a base reference point for your research into some of the focal issues anticipated by industry experts. Similar industry-specific issues, discussions, and resources are available on the RevenueHub site for major industries identified by the AICPA. Click on the following link for a list of these articles: Industry-Specific Issues.