Is the following statement true or false? The new revenue recognition standards will have only a minimal effect on my accounting practices and policies.
I hope that statement is true for your organization, but I think for many healthcare systems, the answer is false.
If you have already started your implementation process and have an accurate timeline for completion, I applaud your efforts. Unfortunately, I think many organizations are a little behind the curve. The good news is that everyone still has time to plan, prepare and execute a transition to the new standards.
Why is the transition to the new standards so important? And so full of stumbling blocks?
Here’s a little background. The new standard was adopted by the Financial Accounting Standards Board in 2014. It eliminates the transaction- and industry-specific revenue recognition guidance under current U.S. GAAP and replaces it with a principle-based approach for determining revenue recognition. This standard has the potential to affect every organization’s day-to-day accounting and, possibly, the way business is executed through contracts with customers.
The AICPA established sixteen industry task forces to help develop revenue recognition Accounting Guides for those industries. Healthcare is one of the sixteen industries.
The core principle of the new revenue standard is that revenue is to be recognized to depict the amount that an entity is entitled to receive for providing those services. The standard further assists by providing a “simple” five-step process to evaluate whether revenue should be recognized.
The five steps are:
- Identify the contract(s) with the 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
Simple right? Not much different than we are currently doing, right? Not so fast.
Inherent in those five simple steps are interpretations and challenges that you must address. Here are four issues that will affect your implementation:
1) Interpretation of the Five Steps
The AICPA Health Care Entities Revenue Recognition Task Force found issues with the first step of the process. For example, can you determine if there actually is a contract, and if so, who is it with – the patient or the insurance provider? To date, the task force has identified eight implementation issues throughout the five steps for the FASB and the industry to consider and comment on. Comments were due earlier this month, and we expect additional guidance in the near future.
2) Unique Healthcare Issues with Bad Debts
A unique aspect of the healthcare industry is that services are provided to a patient and then often paid for by a third party. This creates initial complexity that is compounded by the fact that services are often provided to certain patients with no real expectation of payment and certainly not at established rates. The complexity increases because payments received from payers such as Medicare and Medicaid are often subject to retro adjustments years later.
The current accounting is that substantial amounts of revenue are recognized followed immediately by recording significant amounts of bad debt expense. The new standards will dramatically lower the volume of bad debt expense and also result in a corresponding reduction in revenues. The new standard also establishes a collectability threshold of whether it is probable that the entity will collect the consideration to which it will be entitled.
3) New Data Requirements
The detail and formality required for bad debt assessments are expected to be significant and far beyond the information currently available from most providers’ information systems. Because of this, management should start now to determine what information is available and consider carefully the level and disaggregation of portfolios that they use when estimating probability of collection. The health system may need to even change existing IT systems and internal controls in order to capture different information than in the past.
4) Conservative Tone of the New Standards
The most significant difference between the old and new standards could be the underlying tone of ultra-conservatism in the new standards. The amount determined based on estimates should be recognized only to the extent it is probable that a significant reversal of cumulative revenue will not occur. The AICPA does realize that there will always be a true-up of revenue when the uncertainty is resolved and contract is completed. However, FASB wants the true-up to be an increase in revenue instead of a decrease.
Additionally, entities will need to both re-evaluate the information they have from historical results and peer into a crystal ball to determine the effects of new challenges. New payment models, such as bundles and capitation, will have an effect on an organization’s ability to accurately report revenue. Likewise, changes in the timing or amount of revenue recognized may affect long-term compensation arrangements, debt covenants, and key financial ratios.
The standards and the related implementation are significant and complex and need the attention of financial management today. Your best ally in this transition is time. The more time you have, the easier your job will be. Do not delay!
For weekly insights into healthcare, please sign up here: