Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606) eliminates industry-specific revenue recognition guidance, replacing it with a principle-based approach.
Five Steps to Follow When Recognizing Revenue
The ASU provides five steps to follow when recognizing revenue:
- Identify the contract with a customer
- Identify the separate performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price
- Recognize revenue when or as the entity satisfies the performance obligation
Given the various revenue streams encountered by entities in the health care industry, the American Institute of CPAs (AICPA) has established a Health Care Entities Revenue Recognition Task Force. The task force has been charged with developing revenue recognition issues, specific to health care entities, that will provide useful information and examples on how to apply the new revenue recognition standard. The 10 implementation issues identified and the status of these issues are listed in the table below, with further discussion of the finalized implementation issues detailed below.
Implementation Issue #1 – Applying the Five Step Model to Self-Pay Balances
Health care entities will first need to determine whether a contract with a customer exists. For a contract to exist, it must be enforceable and it must be probable that the entity will collect the consideration. There are 5 criteria that must be met: 1) both parties have approved the contract (orally or in writing), 2) each party’s rights regarding the services to be transferred can be identified, 3) the entity can identify the payment terms, 4) the contract has commercial substance, 5) it is probably the entity will collect the consideration.
When a health care entity treats a patient, who has insurance (commercial or government-funded), there are typically contracts in place between the insurance company and the health care provider and thus the amount of consideration expected to be collected is included within a contract. When payment is expected to be received directly from a patient (deductible), the health care entity will be required to estimate the transaction price for that revenue and determine if it is probable they will collect the expected consideration. This transaction price is usually based on historical data from patients with similar arrangements.
For uninsured patients, the health care entity must determine if a contract exists. This will be dependent on specific factors related to the health care entity, such as, did the patient sign a responsibility form, did they schedule the surgery, or if admitted to the emergency room, other factors such as customary business practices will need to be assessed for enforceability of and timing of a contract.
A health care entity may be unable to evaluate an uninsured patient’s commitment to the performance obligation or determine if it’s probable it will collect the consideration it is entitled to. If this is the case a contract does not exist. A health care entity can rely on prior history with that patient or historical history on patient’s in similar situations (i.e. pending Medicaid, charity care) to determine if a contract exists.
Implementation Issue #2 – The Portfolio Approach to Contracts with Patients
When estimating the transaction price, a health care entity may do so based on the likelihood of each outcome for the contract (i.e. self-pay, Medicaid and charity care) and the reimbursement rate expected for each. Health care entities can also use a portfolio approach as a practical expedient to account for patient contracts as a collective group, rather than individually. Applying a portfolio approach to contracts is allowed if the health care entity reasonably expects that the effects on the financial statements would not differ materially from applying to an individual contract. This would allow for determining the transaction price for similar contracts (i.e. self-pay) using historical experience from similar contracts. Health care entities should consider the payor and the types of services being provided when applying the portfolio approach as different services (i.e. inpatient, physician visit and emergency room) may have different payment terms from the same payor. This portfolio approach can also be applied when considering the performance obligation.
If a health care entity charges $5,000 for a procedure, but historically receives $1,000 from a self-pay patient for that procedure (based on the portfolio approach), the transaction price is $1,000 and $4,000 would be the implicit price concession. Subsequent changes in the transaction price must also be considered. The ASU requires an entity to update the estimated transaction price, including updating the assessment of whether an estimate of variable consideration is constrained, at the end of each reporting period. A health care entity might receive additional information related to a patient, prior to receiving payment that changes the estimated transaction price. The changes should be treated as changes to the implicit price concessions (an adjustment to patient service revenue). To determine when to record an impairment loss (bad debt expense), a health care entity must consider the effects of customer credit risk after the determination that the arrangement meets the criteria for a contract under the ASU and revenue and a receivable are recognized for the services provided. For example, in impairment loss would be recorded after contract inception for a self-pay patient balance when it was subsequently determined that the patient could no longer pay their portion of the bill for an elective procedure due to loss of employment.
Implementation Issue #6 – Disclosure Requirements
The disclosure requirements include:
- Revenue from contracts with customers should be presented separately from other sources of revenue
- Any recognized impairment loss on receivable should be recognized separately
- Information regarding revenue disaggregated based on the timing of the transfer of goods or services (i.e. overtime vs. at a point in time)
- Qualitative information about how economic factors (i.e. type of customer, geographical location) impact the nature, amount, timing and uncertainty of revenue and cash flows
- Disclosure of the beginning and ending balances receivables, contract assets and contract liabilities
- Disclosure of information about the performance obligations in contracts with customers
- Judgments significantly affecting the determination of the amount and timing of revenue from contracts with the customer and any changes in judgments
- Certain transition disclosures are also required
Implementation Issue #10 – Performance Obligations
A performance obligation represents the transfer of goods and services (or bundle of goods or services) that is distinct. At the inception of the contract with a patient, a health care entity will identify as a performance obligation each promise to transfer to a patient either:
- a good or service that is distinct,
- a series of distinct goods or services that are substantially the same and that have the same patterns of transfer to the patient.
A good or service that is promised to a patient is distinct if:
- the patient can benefit from the good or service either on its own or together with other resources that are available, AND
- the promise to transfer the goods or services to the patient are separately identifiable from other promises in the contract. If a promised service is not distinct, it should be combined with other promised goods or services in a contract as a single performance obligation.
Chapter 7 of the AICPA Revenue Recognition Guide will be updated as these implementation issues are addressed. The guidance is nonauthoritative but will help in the implementation process. For further information on the implementation issues addressed above or other issues not addressed, contact LBMC.
Health Care Industry Revenue Recognition Task Force – Issues List (As of May 15, 2018)
| Issue # | Description of Implementation Issue | Status |
| 1 | Consideration of the following regarding self-pay balances Application of step 1 (determine if there is a contract) and step 3 (determine the transaction price) for healthcare services provided to self-pay patients, including uninsured patient balances and self-pay patient balances arising from co-payments and deductibles. This implementation issue will discuss evaluating whether a contract exists and what (including consideration of implicit price concessions) the transaction price is to arrangements for health care services provided to self-pay patients and balances arising from co-payments and deductibles. | Finalized and included in the AICPA Guide Revenue Recognition |
| 2 | Application of the portfolio approach to contracts with patient This implementation issue will discuss how to apply the portfolio approach to revenue from self-pay patients and third-party payors. | Finalized and included in the AICPA Guide Revenue Recognition |
| 3 | CCRC: 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 This implementation issue will discuss the performance obligations under a typical Type A (life care) continuing care retirement community (CCRC) resident agreement and, given these performance obligations, how a Type A CCRC will estimate a transaction price and recognize nonrefundable entrance fees and monthly/periodic fees received from residents under the new model. | Out for Exposure until April 2, 2018 |
| 4 | CCRC: Identifying the performance obligation(s) and recognizing the performance obligation(s) to provide future services and use of facilities This implementation issue will describe the changes to a continuing care retirement community’s calculation of the obligation to provide future services and use of facilities as a result of the new model. | Out for Exposure until April 2, 2018 |
| 5 | Significant financing component – CCRC contracts, and patient and third-party payor amounts in arrears This implementation issue will discuss how CCRCs assess whether a significant financing component exists in determining 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 payor amounts in arrears. | Out for Exposure until April 2, 2018 |
| 6 | Disclosure requirements of ASU No. 2014-09 This implementation issue will discuss judgments related to disclosure requirements under ASC 606 for healthcare entities. | Finalized and included in the AICPA Guide Revenue Recognition |
| 7 | Accounting for contract costs This implementation issue will discuss how healthcare organizations will account for certain costs of acquiring and fulfilling contracts under the new model. | Out for Exposure until April 2, 2018 |
| 8 | Consideration of FASB ASC 606, Revenue from Contracts with Customers, for third-party settlement estimates This implementation issue will discuss how healthcare organizations will account for revenue earned under arrangements with government programs (for example, Medicare or Medicaid), which typically contain a variable element that requires providers to estimate the cash flows ultimately expected to be received for services provided. | Out for Exposure until September 1, 2017 |
| 9 | Bundled Payments This implementation issue will discuss the interplay between healthcare organizations and healthcare providers that receive a fee for service payments from the Centers for Medicare and Medicaid Services for services provided to Medicare patients. | Out for exposure until December 1, 2017 |
| 10 | Performance Obligations This implementation issue will discuss how healthcare organizations (other than CCRCs) need to identify the promised goods and services in a contract with a patient and determine which of them represent separate performance obligations in order to apply the revenue recognition guidance. | Finalized and included in the AICPA Guide Revenue Recognition |
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