In part one of this series Maria explained the relationsip between contracts and ASC 606 you can read it here.
Under the new standard, an insurance contract is not within the scope of the revenue guidance as it is not considered a contract with a customer. However, an insurance company often pays for all or portion of the healthcare services to the patient. Therefore, a healthcare entity must take into account any consideration received from an insurance company in calculating the transaction price.
The transaction price according to the new standard, is the amount of consideration in a contract to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer. It may include a fixed amount, variable consideration, and non-cash consideration. It must be adjusted for the effect of time value of money if the contract includes a significant financing component and for any consideration payable to the customer.
In healthcare, the transaction price often includes variable considerations related to patient service revenue, price concessions, self-pay, and third-party settlements. The challenge that the healthcare organization will face under ASC 606 is that the variable consideration may only be recognized if it is probable that a subsequent change in the estimate would not result in a significant revenue reversal. The complexities in the multi-party transactions related to the healthcare industry and factors that affect the final “price” for the service provided create complexity for determining the revenue that can be recognized.
Consider that in many cases, a healthcare entity is required to provide services prior to assessing the patient’s ability to pay. For example, a cardiology clinic may provide treatment to an insured patient whose insurance pays 30% of the cost after the deductible is met. The cost of the visit is $1,000, the patient’s annual deductible is $1,000. The cardiology clinic historically receives 70% of the patient’s portion of the cost ($490 = $1,000 X 70% X 70%), and because the clinic has a contractual agreement with the insurance company, it historically receives 100% of the insured amount ($300 = $1,000 x 30%). Therefore, the Clinic would initially record $790 in revenue and receivables ($300 from insurance company and $490 from the patient). Subsequent change to this estimate that increase revenue simply result in additional revenue. Revisions downward result in either a contra-revenue adjustment, or in the case of a written-off receivable, bad debt expense.
The revenues earned under third-party settlements with Medicare and Medicaid are susceptible to reversal due to variable elements related to the review and final settlement of the cost report. According to ASC 606, the variable consideration must be estimated using either the expected-value method or most-likely amount. The expected-value method is the sum of probability-weighted amounts and is the appropriate estimate if an entity has a large number of contracts with similar characteristics. The most-likely amount is the appropriate estimate if the contract has only two possible outcomes. To estimate the transaction price that includes a variable consideration, the healthcare entity must consider all reasonably available information including historical, current, and forecasted collections.
If you have any questions about the new revenue recognition for your healthcare business give us a call today.