By Alison Bernhardt, CPA, senior manager, PwC
Revenue from Contracts with Customers (ASC 606) is being termed as the new revenue recognition standard that will replace all existing U.S. GAAP revenue recognition literature for exchange transactions, including all industry-specific guidance previously published. The standard is intended to provide a single, comprehensive principles-based revenue recognition model that will require expanded quantitative and qualitative disclosures. ASC 606 will be effective Jan. 1, 2018, and Jan. 1, 2019, for public and nonpublic companies, respectively.
The core principle of ASC 606 is “Recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” The part of the principle that is extremely important for health care companies is “entity expects to be entitled.” To achieve the core principle, an entity should apply the following five-step model:
Step 1: Identify the contract(s) with a customer.
Step 2: Identify the performance obligations in the contract(s).
Step 3: Determine the transaction price.
Step 4: Allocate the transaction price to the performance obligations in the contract(s).
Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation.
Steps 1 and 3 will impact health care entities more than others, as they relate to health care services revenue.
Once identifying that a contract with a customer exists, the guidance specifies the accounting for an individual contract with a customer. A customer is defined as “a party that has contracted with an entity to obtain goods or services.” In health care services, the patient is considered to be the customer, not a third-party payer that may make a payment on behalf of a patient. There are five criteria that must be met to be considered a “contract with a customer” when using the five-step model:
- All parties have approved the contract.
- The entity can identify each party’s rights regarding the goods or services to be transferred.
- Payment terms are defined.
- The contract has commercial substance.
- Collectability is probable.
Step 3 of the five-step model is “Determine the transaction price.” A component of patient service revenue under ASC 606 could include variable considerations, such as implicit or explicit price concessions and refund obligations (third-party settlements).
The general concept is if a portion of the transaction price is variable or contingent on the outcome of future events, an entity must adjust the transaction price to reflect the uncertainty. This will involve estimating the amount of consideration to which the entity expects to be entitled. When estimating, an entity can use a probability-weighted estimate or a most likely amount expected, whichever is the best predictor. The two elements of patient service revenue that often include a variable element are third-party payer settlements and estimated revenues associated with indigent self-pay patients.
Finally, as part of Step 3, a consideration needs to be made as to whether any refund obligation exists. ASC 606-10-32-10 notes, “An entity shall recognize a refund liability if the entity receives consideration from a customer and expects to refund some or all of that consideration to the customer. A refund liability is measured at the amount of consideration received (or receivable) for which the entity does not expect to be entitled (that is, amounts not included in the transaction price).” Within the health care industry, refund liabilities relate to third-party settlements. At a high level, amounts to which an entity does not expect to be entitled should not be included in the transaction price. Therefore, if a health care provider expects to have refund amounts to a third party, that amount should reduce revenue.
ASC 606 could mean significant changes for an entity. That means preparation is critical. Developing a project plan is key to successfully implementing the model.
An example of such a plan is as follows:
- Establish governance and project management approaches.
- Catalog revenue arrangements.
- Review current policies and practices.
- Identify differences under proposed standard.
- Determine adoption approach.
- Map policy differences to process and systems impacts.
- Consider a dual-GAAP approach, including interim solutions.
- Establish a communication plan.
- Educate and communicate within the organization.
- Effect process and system changes.
- Collect and convert data and perform calculations.
- Draft disclosures (transition and ongoing interim and annual).
Join us June 5-6 at Challenges and Opportunities in the Health Care Industry to learn more about revenue recognition and health care entities.