Applying the revenue recognition standard in healthcare

Appropriately accounting for revenue is a critical component for any business. This task can be especially complex for hospitals and healthcare clinics, however, given the number of variables — and players — involved in the health pay system.

How to define revenue in healthcare

Accounting Standards Codification (ASC) Topic 606 outlines a precise, five-step process hospitals and clinics should use to recognize revenue: 

1. Identify the contract(s) with the customer (i.e., patient)
2. Identify the separate performance obligations in the contract
3. Determine the transaction price
4. Allocate the transaction price to the separate performance obligations in the contract
5. Recognize revenue when the entity satisfies a performance obligation

Within these steps, nuances and definitions matter. For example, a legally enforceable contract can be written, oral or implied, based on your business practices. Certain hospitals and clinics are required by law (or their own operational standards) to treat patients with emergency conditions regardless of their ability to pay. In such cases, these organizations operate as though they have an implied contract, even if an express contract is not in place.

In addition, contracts must have commercial substance and:

• Outline each party’s rights regarding the services provided.
• Specify the payment terms for provided services.
• Feature approval by both parties, noting their commitment to their respective obligations.

There are several subcategories of revenue classification:

The transaction price is the amount of compensation your organization expects in exchange for goods or services. From a healthcare standpoint, the transaction price is the amount that’s recorded as net revenue for the services provided to a patient or portfolio of patients.

When calculating net patient service revenue, hospitals should consider all the information that’s reasonably available to them, including historical collections from individual patients, settlements from third-party insurance (i.e., cost reports) and risk-based payment arrangements.

Explicit price concessions are the commonly negotiated contractual rates with third-party payers and publicized discounts offered to patients with no insurance (i.e., commonly called self-pay discounts).

The portfolio approach to revenue recognition

The revenue recognition standard is generally applied to an individual contract with a patient. However, hospitals and clinics may apply the revenue recognition standard using a portfolio of contracts that have similar characteristics — if they can reasonably expect that doing so would not materially alter their financial statements.

As a result, many hospitals and clinics use a “portfolio approach” to group patients by type of service (e.g., in-patient or out-patient) or type of payer (e.g., privately insured, uninsured or governmental program participant). Then they use historical data for each payer group or service type to estimate the contractual and bad debt allowances they expect within each reporting period.

Here’re to examples of how a hospital or clinic might use the portfolio approach:

Example 1: Revenue recognition for uninsured patients

Say an uninsured patient walks into a hospital urgent care with a high fever and blurry vision. The patient does not qualify for the hospital’s financial assistance policy or Medicaid assistance. The organization’s customary business practice is to offer a self-pay discount of 40% for medically necessary services to patients with no insurance. After a physician’s assessment and lab work, the total charges for the services provided totaled $1,200. Based upon history for this patient type and the services provided, the organization collects approximately 15% of the total charges.

• The hospital determined it has an implied contract with this patient.
• The organization expects to collect 15% of the gross charge ($1,200 x 15% = $180), so $180 is recorded as net patient service revenue.
• From the gross charges of $1,200, the hospital gave a self-pay discount (i.e., explicit price concession) of 40% ($1,200 x 40% = $480), which results in remaining charges of $720 ($1,200 – 480 = $720).

Since the hospital only expects to collect the $180, the remaining $540 ($720 – 180 = $540) is considered an implicit price concession (which is commonly reflected within a hospital’s provision for bad debts).

Example 2: The portfolio approach to recognize revenue

A hospital provides medically necessary outpatient services to patients covered by Medicare. The hospital identifies these patients as a portfolio of contracts. For this pay period, charges amount to $2,000,000 for Medicare patients. The charges consist of amounts to be paid by Medicare and deductible amounts to be paid by patients.

• The hospital has a contractual agreement with Medicare that results in a 60% adjustment to gross charges (40% reimbursement). At the end of the period, gross receivables totaled $2,000,000, including $1,760,000 due from Medicare and $240,000 in deductibles owed from patients.
• The hospital expects to collect 100% of the balance due from Medicare and 40% of the deductibles, based on historical experience.
• The hospital will record gross charges of $2,000,000 and a contractual adjustment from Medicare of $1,200,000 ($2,000,000 x 60% contractual rate).
• It will also record a contractual adjustment and discount for the implicit price concession of $144,000 ($240,000 x 60% the hospital expects not to collect on the deductibles).

This latter total is commonly reported in the provision for bad debts. The result is a net patient service revenue and a net receivable balance of $656,000.

How Wipfli can help

While the language within the revenue recognition standard is quite technical, hospitals and healthcare clinics who follow it closely can achieve precise and accurate financial reporting — a key foundation for long-term operational success. If you need help, Wipfli can help you establish clear protocols for accurate revenue reporting. Contact us today to learn more.

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