The changes in revenue recognition present two major issues. In this month's article, Maria will address the first issue. Next month she will complete this two part series.
Contract insurance payments create complexity for revenue recognition under the new revenue recognition guidance due to the 3 party relationship between insurance provider, healthcare provider, and patient. In addition, they create complexity as the amount that a healthcare provider can charge is different depending on which parties are involved, whether or not a deductible has been met, etc.
Under the older revenue recognition standard, Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) section 605—Revenue Recognition, revenue is recognized when it is realized or realizable and earned. This was typically determined using the criteria found in Staff Accounting Bulletin 104, Topic 13—Revenue Recognition. The core principle of the new revenue recognition standard, ASC 606—Revenue from Contracts with Customers, is the recognition of revenue to depict the transfer of promised goods or services to customers in an amount that reflects consideration to which an entity expects to be entitled in exchange of those goods or services.
The main difference between the two standards is that the new standard focuses on the transfer of control whereas the old standard focuses on delivery of goods and services. Although the new standard presents several implementation issues for healthcare organizations, among the most pervasive are those that include transactions with contract insurance payers.
Issue 1: Does a contract exist within the scope of ASC 606 between the entity and the insurance payer?
According to the new standard, an enforceable contract exists if all of the following criteria are met:
- The parties to the contract have approved the contact.
- The entity can identify each party’s rights regarding the goods or services to be transferred.
- The entity can identify the payment terms for the goods or services to be transferred.
- The contract has commercial substance.
- It is probable that the entity will collect substantially all of the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer.
The new standard only applies to contract with customers, which exclude contracts with third-party payers such as insurance providers, Medicare and Medicaid. Additionally, in evaluating the probability that an entity can collect the amount, the entity can only consider the customer’s ability and intention to pay. So how should a healthcare organization account for third-party payments under the new standard?
As a practical expedient, an entity may combine contracts with similar characteristics if the entity reasonably expects that the effect on the financial statements of applying the guidance would not differ materially from applying the guidance to the individual contracts. This means that a healthcare organization’s contract with a patient and contract with an insurance provider can be combined to determine the revenue to recognize, even though different parties are involved [ASC 606-10-10-4]. This is known as the portfolio approach, which can be applied to a large volume of contracts with similar types of customers, services, and payers.