Revenue Recognition Changes in the Healthcare Industry Part 3: Third-Party Payor Settlements

October 2018 | Article

As discussed previously, revenue recognition guidance under FASB is effective for public business entities and not-for-profit entities that have issued, or are conduit bond obligors for, securities that are traded, listed or quoted on an exchange or an over-the-counter market for fiscal years beginning after December 15, 2017.

There are four key matters to consider that may have the greatest impact on the health care industry:

In this article, we will focus on third-party payor settlements.

Third-Party Payor Settlements
Third-party payor arrangements and contracts should be reviewed to determine potential or known retroactive settlements. These have historically been reviewed and tracked by health care entities. However, it’s now important to understand potential estimated settlements, because they may result in differing accounting treatments under the new guidance. For example, treatment of the annual cost reimbursement estimate of a critical access hospital may be considered differently than a disproportionate share (DSH) settlement or a Medicaid/uninsured waiver program settlement, especially in the first year.

The new revenue recognition guidance provides two methods to determine the amount to record: the most likely method and the expected value method.

Most Likely Method
The most likely method is the single most likely amount in a range of possible consideration amounts. This method should generally be utilized when the number of possible outcomes is lower. For example, either the entity will get a DSH settlement, or it will not.

Expected Value Method
The expected value method is the sum of probability-weighted amounts in a range of possible consideration amounts. This method is generally utilized when there is a range of many potential settlement values.

Entities should select the method they believe will best predict the consideration amount that needs to be paid. Once a method is selected, entities are required to apply the same method to similar contracts and circumstances. Therefore, the initial determination made upon implementation will create the entity’s policy for similar settlement estimates. Within the health care industry, it is generally expected that the most likely amount method will be utilized due to history with third-party payor settlements.

The final determination that needs to be applied to the estimate once either method is put in place is the potential to “constrain” the estimate of variable consideration. Under the new revenue guidance, the calculated estimate should reflect the probability that the cumulative amount of revenue recognized would not result in a significant revenue reversal. Factors to consider in making this determination include:

  • The susceptibility of matters outside the entity’s influence.
  • An entity’s experience with similar types of contracts.
  • The expected timeline until resolution.
  • General practices of offering concessions or changes in terms of the contract.
  • The number of possible consideration amounts.

Consistent with historical treatment, subsequent changes in estimates of third-party payor settlements should be recorded in the period in which revisions are made. Ultimately, the new guidance may have a more conservative result after application of the revenue constraint.

Other special contract considerations should be identified, such as bundled payments, risk-based agreements, prepaid health contracts, etc. These types of arrangements have unique implementation issues. Each specific contract will need to be reviewed in the context of the 5 step revenue recognition approach and related guidance. The AICPA health care audit and accounting guide includes an illustrative example specifically related to the Centers for Medicare and Medicaid Services Comprehensive Care for Joint Replacement model. This may be useful as an analogy to the specific contracted reimbursement methodology identified.

The full guidance should be reviewed to determine if there are any other potential impacts specific to your organization.

Questions about revenue recognition changes and how they affect your organization? Contact an Eide Bailly professional today.

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This series will discuss ways the revenue recognition standards are impacting the healthcare industry.

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