A Comprehensive Change to Revenue Recognition

By: Gwen Moser

For the first time, the United States Generally Accepted Accounting Principles (GAAP) has a comprehensive revenue recognition standard, replacing an estimated 200+ industry-specific and other pieces of guidance. On May 28, 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU/Standard) No. 2014-09,Revenue from Contracts with Customers (Topic 606), and the International Accounting Standards Board (IASB) issued IFRS 15, Revenues from Contracts with Customers. The issuance of these updates completes the joint effort by the FASB and the IASB to create common revenue recognition guidance for U.S. GAAP and IFRS.

Accounting Standards Update (ASU)

The intent of the ASU is to provide greater comparability for financial statement users across industries and jurisdictions by eliminating current inconsistencies which exist in current revenue recognition GAAP. This Standard provides a principles-based approach for determining revenue recognition and supersedes all existing guidance, such as current transaction and industry-specific revenue recognition guidance.

The core principle of the new Standard is that an entity will recognize revenue to depict the transfer of goods or services to customers in amounts that reflect the consideration (that is, payment) to which the entity expects to be entitled in exchange for those goods or services.

The Standard identifies the following five-step process in which entities will recognize revenue. These five steps are intended to encompass the core principles of revenue recognition.
 

• Step 1: Identify the contract with a customer.
• Step 2: Identify the separate performance obligations in the contract.
• Step 3: Determine the transaction price.
• Step 4: Allocate the transaction price to the separate performance obligations in the contract.
• Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation.
   

The standard also requires enhanced disclosures and provides more comprehensive guidance for transactions such as service revenue and contract modifications. Further guidance for multiple-element arrangements is also provided.
 

What Does This Mean to Health Care Industry Accounting?

The impact of the Standard will certainly vary by industry and even by organization. Initial review indicates that the principles of revenue recognition incorporated in Steps 1 and 3 of the Standard may impact revenue recognition for health care organizations.

Step 1 of the process, identify the contract with the customer, requires deliberation of whether collection is probable when determining whether a contract exists under the revenue recognition model. In short, the Standard includes a collectability threshold as one of the criteria a contract must meet before an entity can recognize revenue. The most significant expected impact relates to self-pay or uninsured patients, but could potentially impact all patients as co-payments continue to rise and payment reform changes reimbursement models.

Step 3, determine the transaction price, outlines the transaction price as the amount of consideration to which an entity expects to be entitled as a result of the satisfaction of the performance obligations. The Standard recognizes that entities may have contracts that include a variable amount. The ASU identifies two methods to be used to estimate amounts of variable consideration: 1) expected value - which is "the sum of probability-weighted amounts in a range of possible consideration amounts" and 2) the most likely amount - which is defined as "the single most likely amount in a range of possible consideration amounts." The most significant expected impact relates to retrospective adjustments, such as those with the Medicare and Medicaid programs, however other variable reimbursement models (i.e. bundled payments, hold harmless provisions, etc.) will also need to be analysed.

ASU Effective Dates

For public entities, the ASU is effective for annual and interim periods beginning after December 15, 2016. Early application is not permitted. Note that a not-for-profit entity that has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market is defined as a public entity.

For all other entities (nonpublic entities), the ASU is effective for annual reporting periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018. There are certain elections for early adoption available.

The revenue recognition standard is required to be applied retrospectively.

What Does This Mean to My Organization?

Specific impacts to the industry and specific types of organizations are being researched and considered. We will keep you informed as we continue to study the impact of this Standard on the health care industry and your organization. Stay tuned for further implementation guidance.

In the meantime, if you have specific questions or comments, please share these with Gwen Moser or your Eide Bailly representatives.