Here’s a cautionary tale: It’s early 2020 and Joe the CFO is sitting down with his hospital’s board of directors and independent auditors. Next up on the agenda: Presentation of the 2019 audited financial statements.
The more financially astute board members quickly notice that something is amiss. Bad debt expense has disappeared from the income statement—seemingly overnight. While the elimination of bad debt might sound like a good thing, the auditors are quick to explain that it has nothing to do with a sudden improvement in collection percentages.
The change is due to the FASB’s new revenue recognition standard. The standard’s core principle is that revenue should be recognized in an amount that reflects what the entity actually expects to be paid, with the unpaid balance being recorded as an “implicit price concession.” This principle isn’t entirely new. Healthcare entities were always required to recognize revenue to which they believed they were entitled. But in practice, the new standard turns on its head the way most hospitals and many other healthcare providers account for their receivables.
The new revenue recognition standard went into effect for nonpublic companies (including not-for-profits) in annual reporting periods beginning after Dec. 15, 2018. So in our imaginary scenario, the monthly financial statements that Joe’s board members have been reviewing all year have been out of compliance with GAAP. (That doesn’t look good for Joe.)
The good news for you is that, with some planning and attention to detail, you can avoid this scenario. One important detail to address is bringing your accounts receivable (AR) allowance model into compliance with the revenue recognition standard.
What’s the Matter with the AR Model?
Most hospital AR models include categories for commercial insurance, Medicare, Medicaid, and self-pay. Often, the self-pay group mingles uninsured patients with patients who are insured but owe payment to meet a deductible or for a coinsurance payment. Collection percentages from patients who have insurance differ drastically from those for uninsured patients, so a single allowance that is applied across this broad category is going to be inaccurate.
Hospitals and other healthcare providers now have new incentive to classify their payer accounts more specifically due to the new revenue recognition standard. However, compliance isn’t the only benefit of this segmentation exercise. Understanding the true historical impairment of these accounts also highlights the risks of being too dependent on certain categories of payers.
Prepping Your AR Model for Compliance
To get your AR model ready for the new revenue recognition standard, here are some steps to consider taking:
- Re-segment your payer classes. At a minimum, your model should include the following categories: Medicare, Medicaid, commercial payers, patient-responsible payments due from insured patients, and uninsured patients.
- Estimate collection percentages based on historical data. Payment data by these more specific payer classes can be generated from most billing and collection software. To make accurate estimates, you’ll need data covering at least six months to a year.
- Say goodbye to bad debt and hello to “uninsured discounts and allowances.” For years, hospitals have reported as bad debt expense the difference between the amount they billed their patients and the amount those patients ultimately paid. But under the new standard, “bad debt” can only be reported in cases of bankruptcy or other adverse events. The difference between the list price and the amount of consideration that the entity expects to collect is called an “implicit price concession.” The problem is that bad debt is used as a key indicator in a number of circumstances, including Medicare reimbursements to IRS requirements for not-for-profit hospitals. Hospitals will need to plan for this change. For example, on Medicare and Medicaid cost reports, providers will need to make sure to report all “uninsured discounts and allowances,” in addition to any allowable “bad debt.”
- Monitor and review the accuracy of the AR model. As your hospital’s patient population evolves, so too will your collection percentages. Run reports quarterly to evaluate whether you need to update allowances for self-pay categories.
Wait and see is no longer a viable option for compliance with the revenue recognition standard. This fundamental change in how healthcare providers recognize patient revenue is now in effect for calendar-year entities. Now is the time to get ahead of the challenges and understand the impact on your financial statements and possible tax and reimbursement implications.