New Revenue Recognition Standard for Hospitals

A new standard requires hospitals to rethink how their accounting functions handle revenue recognition, specifically self-pay revenue.

Issued in May 2014, Financial Accounting Standards Board (FASB) Accounting Standards Codification® (ASC) Topic 606, Revenue from Contracts with Customers, fundamentally changes the way companies across most industries are required to recognize revenue under US generally accepted accounting principles (GAAP), specifically with customer contracts. Leases, financial instruments, insurance contracts, guarantees, and nonmonetary exchanges aren’t impacted by the new guidance in ASC Topic 606.

At the highest level, the new standard requires hospitals to recognize revenue:

  • When promised goods or services are provided to patients
  • In the amount of consideration the hospital expects to receive

Five-Step Process

There’s a five-step process outlined by the FASB that hospitals will follow under the new standard.

Adopting the new standard is a significant undertaking that requires hospitals to start preparing now. Effective dates for the new standard are as follows:

  • Public entities, including conduit debt obligors. These entities will need to adopt the new standard for annual reporting periods beginning after December 15, 2017.
  • Nonpublic entities. These entities will need to adopt the new standard for annual reporting periods beginning after December 15, 2018.

Any entity may choose to adopt the new standard early but not earlier than annual reporting periods beginning after December 15, 2016.

Since hospitals will want to spend the most time understanding how these steps affect self-pay revenue recognition, let’s take a closer look at steps one and three.

Step One: Identify the Contract

To be considered a contract within the scope of ASC Topic 606, a contract must meet these criteria:

  • The parties have approved the contract either in writing (patient responsibility or consent form); orally (perhaps a scheduled appointment); or implicitly, based on the hospital’s customary business practices (emergency room visits, for example).
  • Each party’s rights and the contract’s payment terms are identified.
  • The contract has commercial substance.
  • Collection is probable.

Before applying the standard’s model to a contract, it must be probable the hospital will collect substantially all of the consideration to which it’s entitled. A hospital may make this determination based on past experience with either a specific patient or a class of similar patients—the latter of which is known as the portfolio approach. If the collectibility threshold isn’t met, a patient contract doesn't exist within the scope of the standard.


A patient is admitted to the emergency room and is unresponsive. The hospital determines the patient is uninsured, and attempts to assist the patient in qualifying for Medicaid. If the hospital has historical information on the ultimate payer class for this individual—for example, Medicaid or self-pay—the contract is within the scope of the standard.

If the hospital doesn’t have historic information on the ultimate payer class, the contract only falls within the scope of the standard once the payer class is confirmed. However, if the ultimate payer class is determined to be charity care, the collectibility threshold isn’t met, and the contract doesn’t fall within the scope of the standard.

Evaluating collectibility involves determination of the transaction price, defined as the amount of consideration the hospital expects to be entitled to in exchange for providing promised goods or services to a patient. It includes the effects of variable consideration— such as discounts and price concessions—and may be less than the stated contract price.

Step Three: Determine the Transaction Price

To determine transaction price, a hospital should consider all historical, current, and forecasted information that’s reasonably available, including historical cash collections from the identified payer class. The hospital should also review all reasonably available information to estimate variable consideration, whether applied on a contract-by-contract basis or by using a portfolio approach. The ultimate transaction price should reflect both explicit and implicit price concessions.

Explicit Price Concession Example

In the example above, the patient was determined to be self-paying, and qualifies for the hospital’s uninsured discount policy with a 50 percent discount. This discount is an explicit price concession and reduces the transaction price from the gross charges of $50,000 to $25,000, which is billed to the patient.

Implicit Price Concessions

In determining implicit price concessions, a hospital should consider the following:

  • If its customary business practice is to provide services prior to performing a credit assessment. For example, the hospital has an obligation to provide medically necessary or emergency services regardless of patient’s intent or ability to pay, which makes conducting a credit check before providing services unnecessary.
  • If it continues to provide care to patients and patient classes, despite historical experience indicating the hospital won’t collect substantially all of the charges determined after applying explicit price concessions.

If either of these factors is present, the hospital has provided an implicit price concession, even if the hospital will continue to attempt to collect the full amount of discounted charges.

Implicit Price Concession Example

Continuing with the explicit price concession example above, the gross charges for the services are $50,000, and the amount billed to the patient is $25,000. The hospital intends to pursue collection of the $25,000, but based on historic experience expects to collect only $5,000. The hospital’s calculation of the implicit price concession is based on its commitment to providing services to uninsured self-pay patients and the knowledge that actual cash collections will be substantially less than the amount billed after explicit price concessions are accounted for. Based on these conditions, the hospital would conclude it would probably collect $5,000, and the collectibility criteria in step one is met. The hospital would record patient revenue and accounts receivable of $5,000.

Once a hospital determines it‘s provided an implicit price concession, subsequent changes to the estimate of variable consideration should generally be accounted for as changes in the implicit price concession and a direct adjustment to patient revenue.

If, in the process of estimating the transaction price, the hospital determines it hasn’t provided an implicit price concession, but has elected to accept the risk of default by the patient, that uncollectible amount represents an impairment loss and is recorded as a bad debt expense. Additional impairment losses may be taken and recorded as bad debt if there are facts and circumstances—like bankruptcy or job loss—that indicate the patient’s credit worthiness has deteriorated.

This overview of implicit price concessions is subject to additional due diligence, currently underway with FASB’s Transition Resource Group and the American Institute of Certified Public Accountants (AICPA).

Applying Revenue Guidance to Portfolios

As a practical expedient, a hospital may apply the revenue guidance to a portfolio of contracts with similar characteristics. However, this is allowable only if the hospital reasonably expects the financial statement effects of applying the standard to the portfolio, rather than to individual contracts, wouldn’t be materially different.

A sample of the characteristics a hospital should consider when grouping contracts for inclusion in a portfolio includes:

  • Type of service—inpatient, outpatient, skilled nursing, or home health
  • Type of payers—insurance contract, governmental program, or uninsured self-pay
  • Dates when contracts are entered into are the same or close to each other

A hospital may include a combination of the above considerations and others in its determination of a portfolio. However, it isn’t required to apply the portfolio practical expedient when considering evidence from similar contracts to develop an estimate of variable consideration.

Contract Portfolio Example

A hospital provides services to patients covered by an insurance carrier and doesn’t perform credit assessments prior to providing services. Each patient has a patient responsibility in the form of a co-payment. The hospital identifies these patients as a portfolio of contracts and applies a portfolio approach based on qualitative and quantitative factors.

Standard charges amount to $500,000 for these patients, consisting of insurance and co-payment amounts. The hospital has a contractual agreement with the insurance carrier that results in a 50 percent contractual allowance, representing an explicit price concession. The adjusted charges comprise $225,000 due from the insurance carrier and $25,000 due from patient co-payments. The hospital expects to collect 100 percent of the insurance carrier amount and 40 percent of the co-payment amount based on historical experience.

Based on the above pattern, the contractual adjustment of $250,000 is an explicit price concession, reducing the transaction price. The $15,000 in patient co-payments the hospital doesn’t expect to collect represents an implicit price concession and also reduces the transaction price.

These concessions result in a total transaction price of $235,000 ($225,000 from the insurance carrier and $10,000 from co-payment amounts). The hospital would only use this estimate of variable consideration as the transaction price after consideration of the implicit and explicit price concessions. The hospital would then recognize patient revenue and accounts receivable of $235,000 in applying the revenue recognition model.

Under current guidance, the net patient service revenue booked—$235,000—would be the same as under new guidance. The $15,000 implicit price concession recorded as a bad debt expense under current guidance wouldn’t be recorded as such under new guidance, but would instead be recorded as a revenue reduction.

Self-Pay Example

Under current revenue recognition guidance and using the implicit price concession example, the hospital would record patient revenue of $25,000 (gross charges of $50,000 less the 50 percent uninsured policy discount) and $20,000 of bad debt expense, due to the expected actual collection of $5,000. This bad debt expense would be an offset to net patient service revenue, resulting in net patient service revenue of $5,000.

Under the new guidance, the total net patient service revenue recorded would still be $5,000, but there would be no bad debt expense. However, any future impairments of the $5,000 receivable would be recorded as bad debt expense, which will now be a component of operating expenses rather than an offset to net patient service revenue.

Transitioning and Disclosures

Before the standard goes into effect, hospitals will need to decide if a full or a modified retrospective transition makes the most sense for their particular circumstances. When deciding which transition approach to use, hospitals should consider the various optional practical expedients included in the standard.

With the full retrospective, all reporting periods presented are reported under the new standard, and a hospital is required to disclose any adjustment to prior-period information. Under the modified retrospective approach, the initial period of adoption is reported under the new revenue model, while previous periods are presented under existing GAAP.

Hospitals that choose the modified retrospective approach are required to make a cumulative effect adjustment to the opening balance of retained earnings (or other appropriate components of equity or net assets) and disclose the effects of adopting the new standard on each financial statement line item.

Other required disclosures for public entities, regardless of whether a hospital chooses the full or modified retrospective approach, include but are not limited to:

  • Disaggregated revenue information (for example, by customer type, geographic region, and product lines)
  • Contract asset and liability information, including any significant changes from the prior year
  • Judgments, and changes in judgments, that significantly affect the determination of the revenue amount and timing

The new standard provides nonpublic entities with relief from certain disclosure requirements, including optional elections to exclude some of the more onerous quantitative disclosures. 

Unresolved Implementation Issues

The AICPA Revenue Recognition Task Forces have identified six unresolved implementation issues specific to health care entities. These issues are listed in a summary document released by the AICPA on February 1, 2017, as:

  • Disclosure requirements of FASB Accounting Standards Update (ASU) 2014-09
  • Accounting for contract costs
  • Consideration of ASC Topic 606, Revenue from Contracts with Customers, for third-party settlement estimates
  • Continuing care retirement community (CCRC): Identifying and satisfying the performance obligations and recognizing the monthly and periodic fees and nonrefundable entrance fees under Type A or life-care contracts for continuing care retirement communities
  • CCRC: Identifying performance obligations and recognizing the performance obligations to provide future services and use of facilities
  • Significant financing component: CCRC contracts and patient and third-party payer amounts in arrears

Next Steps

The new revenue recognition standard represents a fundamental change in how hospitals recognize revenue from customer contracts. Recognizing revenue earlier or later than you would have under existing GAAP could impact your financial performance metrics, financing and tax planning, and debt covenant compliance, so you’ll want to get ahead of the changes. To do so, hospitals should begin work now to understand how ASC Topic 606 will affect their financial statements and to determine what the possible tax implications are. 

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For more information on the new revenue recognition standards and how they apply to your company’s financial statements, contracts, or operations, contact your Moss Adams professional.

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