New Revenue Recognition Standard Effective for Private Companies
By Tammy Goldstrich, Senior Manager, Assurance Services
A new accounting standard for revenue from contracts with customers took full effect in 2019. Healthcare entities should be reviewing their current contracts to determine whether applicable criteria have been met and whether they are required to recognize revenue from those contracts.
On May 28, 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606). While the new standard has been effective for public companies since 2018, the standard became effective for all entities for years beginning after December 15, 2018, or January 1, 2019 for calendar-year entities.
The new standard replaces the transaction and industry-specific revenue guidance with a more principles-based approach for revenue recognition. More judgment and estimation will be required than in the previous standards.
Healthcare entities are subject to the following criteria requiring revenue to be recognized:
- Both parties have approved the contract;
- Both party’s rights to transfer the goods can be identified;
- The payment terms can be identified;
- Contract has commercial substance; and
- It is probable that the entity will collect the consideration to which it will be entitled.
Revenue should be recognized only if all five criteria are met. In the absence of any one criterion, 100% of the revenue should be deferred until a contract is established.
Providers need to consider the specific facts and circumstances of each contract to determine if their agreements with patients create legally enforceable rights and obligations. For patients with commercial or government-funded insurance, contracts are typically in place between the healthcare provider and third party payor for services to be provided. For uninsured patients, healthcare entities must determine if a contract was present and, if so, will need to assess the collectability of fees incurred. If possible (except in emergency situations), providers should evaluate the patient’s intent and ability to pay at the time services are provided, by verifying insurance coverage and status. If collectability is uncertain, revenue should be deferred until an evaluation is completed.
As a practical expedient to evaluating contracts, entities may be permitted to use a portfolio approach and may group contracts with similar characteristics. For example, a portfolio could be established based on the service provided or type of payor (i.e., Medicare or Medicaid), co-pays and deductibles, uninsured and self-pay, charity and other third party payors. Collectability of the portfolio should be based on historical collection data from that service or payor class. The portfolio approach is often helpful due to the large volume of patients served by most healthcare organizations in a given period.
In accordance with the new standards, healthcare entities need to identify the performance obligations transferred to their patients. Services provided in an in-patient setting may result in a different determination of performance obligation than services provided in an out-patient setting, or services provided in a physician’s clinic. The terms of the contractual arrangement with various payors will impact the performance obligation. For example, revenue under fee-for-services arrangements would be earned as services are provided; revenue under episodic payments would be earned ratably over the episodic period; and capitation revenue would be recognized based on the passage of time.
Another new concept is that revenue is now recognized based on the transaction price as opposed to the stated contract price. The amount expected to be paid in exchange for transferring the performance obligation to the patient must be estimated in order to determine the transaction price. Consideration may be fixed or variable. Healthcare revenue derived from third party payors such as Medicare and Medicaid, which are subject to retroactive adjustment in subsequent periods, would be variable consideration.
Healthcare entities should estimate variable consideration using either the expected value (i.e., a probability-weighting of alternative outcomes) or the most likely amount, whichever is the best predictor of the future outcome. Variable consideration should be recognized as part of the transaction price to the extent it is probable that a significant reversal will not occur. Many contracts allow payments to be adjusted retroactively, based on future outcomes.
The transaction price should be allocated to each performance obligation. If more than one performance obligation exists, consideration should be allocated based on the relative stand-alone selling price of each good or service at the contract’s inception. This requirement is particularly challenging at facilities such as continuing care retirement communities (“CCRC”), which enter into contracts that may consist of several rights and obligations including leasing and healthcare.
Two acceptable approaches can be used when adopting ASC 606 – the full retrospective and the modified retrospective approach. When using the full retrospective approach, all prior periods presented will be restated. When using the modified retrospective approach, there is no restatement on contracts from the prior periods reported, and a cumulative effect is presented as of the date of initial application through current year equity.
Regardless of whether the new standard has a significant impact on the amounts of revenue recognized, healthcare entities should evaluate each of their revenue streams and ensure that adequate IT and internal control systems are in place to capture information required for proper financial statement presentation and disclosure.