As the clock ticks toward public companies’ 2018 compliance date with the FASB’s sweeping new revenue rules, the board is highlighting the major changes in store for certain industries. For healthcare companies, the new accounting standard will result in a change to how they recognize bad debts — the money they do not expect to collect from patients.
Hospitals, clinics, and other healthcare organizations are in for big changes when they implement the FASB’s sweeping new rules to calculate the top line in their income statements.
One of the more significant changes ushered in by the revenue standard affects how they assess bad debts — and investors and analysts need to be prepared, the FASB says.
Under existing GAAP, a healthcare service provider records revenue using the amount it bills for a service, even if it does not expect to collect that amount. A hospital, for example, may charge $1,000 for a procedure but may end up billing an uninsured patient for much less. The difference is recorded in the income statement as a provision for bad debt expense and helps calculate net revenue.
The FASB’s revenue recognition standard, published in May 2014 as Accounting Standards Update (ASU) No. 2014-09, Revenue From Contracts With Customers (Topic 606), eliminates these sector-specific presentation rules, leading to a major change to how healthcare organizations present their revenues.
The bottom line: Bad debt expense will no longer be a separate line item on the face of a company’s income statement. Instead, total revenues will already include the amount the hospital or healthcare company does not expect to collect from patients, FASB officials said in an October webcast on the new accounting standard.
“So the provision for bad debt will likely decrease,” FASB senior investor liaison Jeff Brickman said.
Any provision for bad debt will be recorded as an operating expense rather than a contra-revenue figure, Brickman said.
For example, a medical procedure may have a list price of $1,000, but an insurance company may have a negotiated rate of $800 for its customers. This means the clinic gives an explicit discount of $200 and under the new rules, the clinic recognizes $800 in revenue for the procedure.
The FASB published ASU No. 2014-09 in May 2014, alongside the IASB’s IFRS 15, Revenue from Contracts with Customers, and the two standards are largely converged. Public companies must comply with the standards in 2018, while private companies have an extra year to follow them.
The goal of the revenue standards was to get rid of pages of industry-specific U.S. GAAP rules and come up with a near-universal way for most organizations to calculate the top line in their income statements. It was not sustainable, the standard-setters reasoned, to keep adding rules to U.S. GAAP and IFRS on a sector-by-sector basis, especially in a rapidly changing global economy with new industries and technologies emerging.
The FASB and IASB standards require companies to follow five steps to calculate revenue. First, they must evaluate whether there is a substantive contract, then identify the promises made to the customer and whether they should be accounted for separately. The third step requires determining the purchase price and assessing what the company expects to receive, including estimating any contingencies. The company then allocates money to each promise in the contract. Finally, the organization records the revenue, either all at once or over time, as it satisfies the promises made to the contract.
As the clock ticks toward the standard’s effective date, the FASB has been turning its attention to how the standard will change investors’ and analysts’ views of financial statements. The board has been producing webcasts on different industries and sectors in an attempt to highlight the most significant changes.
For in-depth analysis of the FASB’s revenue recognition standard, please see Catalyst: US GAAP — Revenue Recognition , also on Checkpoint.
Additional analysis of the revenue standard can be found on Checkpoint in the Accounting and Auditing Update Service and the SEC Accounting and Reporting Update Service [SARU No. 2014-21] (June 2014): Special Report: Comprehensive Coverage of the New U.S. GAAP Revenue Recognition Requirements.