In May 2014, the Financial Accounting Standards Board (FASB) finally issued its new revenue recognition standard after many years of deliberation. When the FASB issued the new standard, Revenue from Contracts with Customers (Topic 606), it completely revamped the rules by creating a new principle-based framework that defines when and how an entity recognizes revenue from customer contracts. Private companies that report under GAAP (Generally Accepted Accounting Principles) need to adopt the new rules after Dec. 15, 2018. If the reporting period for your medical practice begins on Jan. 1, 2019, your company will need to show compliance by that date. Public entities that report under GAAP needed to be in compliance after Dec. 15, 2017.
Why Were the New Standards Created?
The GAAP standard allowed different industries to follow their own procedures to comply with reporting requirements. In fact, there were approximately 180 industry-specific U.S. GAAP rules. As a result, there was a wide discrepancy in accounting for similar transactions. The FASB created the new standards to:
- Provide a more substantive framework to address complex revenue issues
- Provide improved disclosure requirements to users of financial statements
- Reduce the number of regulations companies must comply with during the financial reporting process
- Remove inaccuracies and flaws in the existing revenue reporting framework
- Reform and standardize revenue recognition practices across industries.
What is the New Five-Step Process?
According to the FASB’s core principle for recognizing revenue within the new rules, revenue should be recorded only when services are provided. The standard provides a five-step process for recognizing revenue, as follows:
- Identify the contract(s) with a customer
- Identify the performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price to the performance obligations in the contract
- Recognize revenue when (or as) the entity satisfies a performance obligation
How Do the New Rules Affect Medical Practices?
The new rules have far-reaching impact across the healthcare industry, including long-term health care facilities, hospitals, and medical practices. That means each system and practice will need to determine what constitutes a performance obligation. For example, medical services provided in a hospital will differ from those provided in a physician’s practice.
Under the new standards, health care providers must examine their process for estimating third-party payor settlements, or “variable considerations.” The new revenue recognition standard includes “explicit price concessions,” or reductions from the transaction price. In other words, your practice is expected to collect only the amount that you are contractually obligated to be paid. The transaction price is limited to the amount of expected collection. This takes into account those amounts that are recognized as bad debt expenses.
Under existing U.S. GAAP rules, a healthcare provider records revenue using the amount it bills for a service, even if it doesn’t expect to collect that amount. For example, your practice may charge $600 for a procedure but end up billing an uninsured patient for much less. The difference is recorded in the income statement as a provision for “bad debt” expense and used to help calculate net revenue.
Not so anymore. Under the new standard, these amounts are considered “implicit price concessions,” so they are not considered part of the contract price and not recognized as revenue. If it was never recognized as revenue, it would not be written off as bad debt.
The good news is that health care organizations can create efficiencies by applying the standard to a portfolio of contracts, “if the impact would not materially differ from applying to individual contact.” However, you will be responsible for determining which contracts fall outside of that portfolio, such as uninsured and self-pay patients, Medicaid and Medicare, etc.
What Should My Medical Practice Owners Do Next?
If you haven’t done so already, your financial professionals should inventory your revenue streams and evaluate how revenue will be affected by the new rules. Your accountant can help you prepare controls, processes, and systems to comply with the new standard.
Remember, the new revenue recognition standard becomes effective after December 15. If you have questions about the new rules or other questions related to your medical practice, contact Angie Walters at 214-635-2547 or fill out the form below.
Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article.