The Impact of Revenue Recognition on Health Care Organizations

Audit|Health Care|Not-for-Profit

By Erin Abbot

While the new revenue recognition standard will impact many industries and sectors, its immediate effect on health care organizations will be particularly significant.

This new standard is effective for public entities in annual periods beginning after Dec. 15, 2016, including interim periods therein, and for private entities in annual periods beginning after Dec. 15, 2017. Earlier application is prohibited for public entities. Private entities may early adopt the guidance in years beginning after Dec. 15, 2016.

Because of the complexities and nuances of this new standard, health care organizations should work with their financial experts on developing an implementation strategy. As an introduction, however, this article will serve to identify a few components critical to the health care industry.

Health care providers typically have a variety of arrangements with different payor sources.  The new revenue recognition standard:

  • Will impact all health care organizations, including hospitals, continuing care retirement communities and physician practices
  • Will impact how these organizations view their contracts with third-party payors and self-pay accounts
  • May result in significant changes to how a health care provider is recognizing revenue, especially for health care providers currently recognizing significant amounts of patient service revenue and the related bad debt expense when the service is rendered

Key Considerations for Health Care

The impact of this new standard on the health care industry will vary by organization but the steps health care providers need to focus on are identifying the contract with a customer (step 1) as well as determining the amount of revenue to record (step 3).

Step 1 of the revenue recognition model is to identify the contract with the customer.  The biggest question for health care providers when identifying the contract revolves around the collection of consideration being probable.  Currently, most health care providers recognize gross service revenue at the providers established rates at the time of service, regardless of what they expect to collect and then record an allowance for bad debts or they defer the revenue until payment is received because they have concluded collectability is not reasonably assured. The new standard requires that revenue be recognized when the performance obligation (in this case, patient service) is satisfied. For entities that currently recognize revenue from those patients on a cash basis, this will result in earlier revenue recognition in transactions with uninsured patients.

There are multiple and important additional considerations that must be considered by each organization within Step 1, and it is recommended to discuss your options with your financial service provider.

Step 3, determining transaction price, represents the other key factor for health care providers who are beginning to assess the impact of this new standard. Items such as discounts, credits, price concessions or performance bonuses or penalties result in variable consideration.  Currently, health care providers determine their best estimate of third-party settlement, such as Medicare and Medicaid, adjustments based on historical experience and presents these as contractual allowances.  These contract arrangements contain variable consideration and under the new revenue standard the health care provider has to estimate future cash flows for services provided. Variable consideration will now be required to be considered in evaluating both the amount and the timing of the revenue recognition.  In order properly recognize revenue, the health care provider can use one of the following methods to estimate the transaction price: (1) the expected value or (2) the most likely amounts.  The method chosen should be the method that more accurately depicts the amount of consideration. Once the amount is estimated, the health care provider must determine the portion, if any, of that amount for which it is probable that a significant revenue reversal will not subsequently occur and then include that amount as the transaction price.

Health care providers will have to carefully distinguish variable consideration, which are adjustments to the transaction price, from collectability concerns which are reflected as bad-debt expense. Similar to Step 1, the large number of variables associated with Step 3 will make thoughtful review and evaluation essential.

Best Practices

In order to prepare for the implementation of the new standard, health care providers could begin to do the following:

  • Review all revenue sources and contracts and determine the impact the standard will have
  • Consider the impact of the new rules on related company processes and compensation plans
  • Evaluate existing IT systems and discuss with technology providers to assess the systems current capabilities and whether upgrades are necessary and available
  • Begin to develop new processes and related internal controls to monitor estimated variable consideration
  • Establish a training and communication plan

As noted above, the new revenue recognition standard carries complex nuances that must be assess by every health care organization. Speaking with your financial advisors or consultants to develop an implementation approach is an essential advance strategy.

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This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter.

Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.

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