Industry Check-Up: How New Accounting Standards Will Impact Healthcare

3/22/2018 - By Philip de Boer, CPA

Some of the most significant accounting changes in recent years are right around the corner. Two new standards will have a great impact on healthcare and other entities.

Effective When?

The new revenue recognition standard will be effective for all non-public entities for fiscal years starting after December 15, 2018. The new lease standard will be effective for fiscal years starting after December 15, 2019

The Good and the Bad

Now, there IS good news - it is not too late to get familiar with these new standards. You have time to assess the impact they will have on your organization. The bad news – the impact of the new standards might not only affect accounting and financial reporting but also other areas, such as taxes or debt covenants. These standards could require a change of internal processes to capture the needed information.

Impact of New Revenue Recognition Standard

The new revenue recognition standard will impact how health care entities recognize and measure revenue in the future. The standard establishes a five-step process for determining how to recognize revenue:

  1. Identify the contract with the customer
  2. Identify the performance obligations in the contract
  3. Determine the transaction price
  4. Allocate the transaction price to the performance obligations
  5. Recognize revenue when (or as) performance obligations are satisfied

Identifying the performance obligations can be especially challenging for health care entities. The challenge is due to complex arrangements those entities have with third-party payors. The transaction price can be difficult to determine when services are provided to uninsured patients or the entity receives reimbursements from Medicare or Medicaid. In those cases, determining the transaction price will require estimation.

Under the current standard, a hospital records the gross charges for services provided to uninsured patients as revenue and records an allowance for estimated uncollectible amounts.  Under the new standards, determining the transaction price will require estimation.  If a hospital has historically collected only 25 cents on the dollar for services provided to uninsured patients, the transaction price for services would only be ¼ of the gross charges.  In addition, the hospital will have to assess the probability of collecting the transaction price to determine whether revenue and receivables can be recorded.  This will result in significantly lower bad debt expenses and a corresponding reduction in revenues.

Impact of New Lease Standard

The new lease standard will substantially move all leasing activity from the income statement to the balance sheet. The standard continues to distinguish between two types of leases: operating and finance leases (formerly capital leases). Classification of whether a lease is operating or finance remains largely the same. If your organization has agreements that include the use of an identified asset that is not easily substituted, and you control the use of the asset, the agreement will qualify as a lease. 

Under the old standard you record the rent expense and disclose the future lease commitments in the notes to the financial statements.  For an operating lease, the new standard requires you to record a right-of-use asset and a lease liability on the balance sheet in the amount of the present value of the lease payments for all leases with a term greater than one year.  The right-of-use asset and lease liability will be amortized using the effective interest method.

The lease expense will generally be recognized on a straight-line basis, similar to the current guidance.  Income statement treatment for finance leases will differ as the lessee is required to separately recognize interest expense on the lease liability and amortization expense on the right-to-use-asset.  The new right-to-use asset will also be subject to impairment testing.  

Don’t wait until it is too late. These standards will be covered in detail at our upcoming A&A Update, and you can email me or contact a member of our Healthcare team to get ready for the new standards now.

About the Author | Philip de Boer, CPA
Philip is a manager in the Audit & Assurance Services Department of Saltmarsh, Cleaveland & Gund. He has been with the firm since January of 2008. Philip’s primary areas of concentration include providing audit and related assurance services for the firm’s manufacturing, not-for-profit, governmental and employee benefit plans clients.

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