ASC 606, Revenue from Contracts with Customers Healthcare Supplement
Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers, was issued jointly by the FASB and IASB on May 28, 2014. This, together with the later amendments, was codified as ASC Topic 606 (“ASC 606”).The objective of ASC 606 is to eliminate industry-specific guidance and to provide a single, comprehensive revenue recognition model for all contracts with customers in order to improve comparability across all industries on a global level.
ASC 606’s underlying principle is that entities must recognize revenue to depict the transfer of goods or services to customers in a manner that reflects the consideration that the entity expects to be entitled to in exchange for those goods or services. The standard is effective for public entities with annual reporting periods after December 15, 2017, and for non-public entities with annual reporting periods after December 15, 2018. The standard is expected to alter the timing and pattern of revenue recognition for entities across all industries, however the healthcare industry specifically has been identified as a high impact industry.
The healthcare industry is inherently subject to difficulties in standardizing revenue recognition within the industry due to the diversity of its constituents—hospitals and clinics, physician practices, laboratories, skilled nursing facilities, continuing care retirement communities, etc.—and the manner in which they earn revenue. In implementing ASC 606, the same five-step approach must be applied to all revenue streams. The basic provisions for the five step model are described in detail in ASC Topic 606. Below is a highlight of some key considerations for each of the five steps, specific to the healthcare industry.
Step 1: Identify the contact with the customer
- For purposes of the new standard, the most basic definition of “contract with the customer” relates to the arrangement between the healthcare provider and the patient. In the healthcare industry, however, there also often exists separate contractual arrangements between healthcare providers and third-party insurance payers which must be considered.
- The provider must evaluate the patient’s intent and ability to pay for services provided. If a provider is not able to make this assessment at the time that services are provided (e.g., if a new patient is admitted under an emergency situation), the provider must not recognize revenue until additional information about the patient and the anticipated collections on the services performed is available.
Step 2: Identify the separate performance obligations in the contract
- A contract may entail a single performance obligation (e.g., a routine office visit) or multiple performance obligations (e.g., extended care arrangements in retirement community or hospice environments).
Step 3: Determine transaction price
- In most instances, transaction prices in the healthcare industry will vary based on uncertainties, some of which include:
- Potential refunds or clawbacks, such as retrospective adjustments to third party liabilities;
- Events that may or may not occur, such as a performance bonus earned under a risk-sharing arrangement;
- Implied price concessions—typically on uninsured patients:
- Under the new standard, the transaction price is the price that the provider “expects to be entitled to”. In situations where patients are uninsured, providers accept that on average, they will likely collect minimal payments from such patients as a group. The transaction price is permitted to be estimated using a “portfolio of contracts”, based on an average of amounts historically collected from this patient class.
- The new pattern of recognition will substantially reduce the amount of bad debts reported by healthcare entities on uninsured and underinsured patients. This is because revenue and corresponding accounts receivable associated with such payments is no longer permitted to be recognized if collectability is not assured.
- Once a transaction price is determined, the healthcare provider must evaluate the likelihood of collecting that amount. If the collectability threshold is not met, the contract is not considered to be bona fide for revenue recognition and thus revenue would not be recognized. Entities should, however, reassess contracts that were otherwise previously not recognized as revenue should new information arise regarding a patient’s insurance coverage or ability to pay.
- When transaction prices are considered to be variable, they must be estimated. This can be done by one of two methods, a probability weighted technique (expected value method) or a most likely amount technique. The probability weighted technique takes the sum of probability-weighted amounts in a range of possible amount (i.e., the probability that a certain dollar amount will or will not be collected). The most likely amount technique will apply the single most likely amount in a range of possible amounts.
Step 4: Allocate the transaction price to separate performance obligations
- The transaction price for a specific contract should be allocated to the performance obligations within that contract pro rata, based upon the individual selling price of each performance obligation. Prices are to be recognized as performance obligations are satisfied.
Step 5: Recognize revenue when (or as) each performance obligation is satisfied
- Consideration of third-party payer arrangements with providers must be made when considering the method of recognizing revenue. There are several common methodologies by which insurers, managed care companies and governmental programs may pay providers, including fee-for-service, per diem, per case, and episodic, among others.
There are also certain considerations that must be made specific to Continuing Care Retirement Communities (CCRCs) given the complex, long-term nature of continuing care contracts. CCRCs are expected to be among the healthcare organizations whose revenue recognition will be most significantly impacted by the new standard.
- CCRC contracts are typically expected to have a back-end loaded pattern of transfer, providing more services as the resident ages. Accordingly, a CCRC in this circumstance would be required to recognize more revenue in the later years of the contract than in the earlier years.
- CCRCs typically comprise a variety of individual performance obligations, including aspects of leasing, hospitality, and healthcare, thus requiring assessment of how to properly group such performance obligations so that the pattern of transfer is appropriately captured.
- The transaction price must include the aggregate of the entrance fee and the monthly (recurring) Refundable entrance fees are no longer permitted to be treated as non-refundable (i.e., deferred and amortized into income over the contract’s term). Consideration to contracts with declining refunds over time must be made—the liability for the refund must be estimated.
The AICPA Health Care Entities Revenue Recognition Task Force has submitted its position on the above considerations for CCRCs to the AICPA Financial Executive Committee (FinREC) and is awaiting finalization.
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