Working Draft: Health Care Entities Revenue Recognition Implementation Issue. Financial Reporting Center Revenue Recognition

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1 October 2, 2017 Financial Reporting Center Revenue Recognition Working Draft: Health Care Entities Revenue Recognition Implementation Issue Issue #8-9 Risk Sharing Arrangements Expected Overall Level of Impact to Industry Accounting: Moderate Wording to be Included in the Revenue Recognition Guide: 1. Under this scenario, a health care provider (hereafter referred to as hospital) is responsible for services rendered to the patient in an inpatient hospital stay. Different health care providers (hereafter referred to individually as post-acute provider or collectively as post-acute providers) are responsible for services rendered to the patient after discharge, such as for inpatient care in a nursing home or rehabilitation facility, or outpatient services such as physical therapy or home health, or both. The hospital and the post-acute provider are not related parties. The factors noted herein address the considerations of the hospital. This scenario focuses on payment implications for the hospital (that is, the hospital that performs the surgery). Revenue recognition for post-acute providers is outside the scope of this issue. Background 2. The Comprehensive Care for Joint Replacement (CJR) model is effective April 1, 2016 in 67 metropolitan areas for Medicare beneficiaries undergoing the most common orthopedic inpatient surgeries, which are hip and knee replacements (also called lower extremity joint replacements or LEJR). This model holds participant hospitals financially accountable for the quality and spend of episodes of care associated with hip and knee replacements to encourage hospitals, physicians, and post-acute care providers to work together to improve the quality and coordination of care from the initial hospitalization through recovery. 3. The episode of care evaluated in this model begins with the admission of a patient to a hospital and is ultimately discharged under certain joint replacement diagnostic codes, and ends 90 days after discharge of the patient. The episode of care length is intended to cover the expected period of recovery of the patient. Generally, all episodes that end between January 1 and December 31 are included in a performance year. Although the hospital

2 is held financially responsible for the entire episode of care, the episode includes post-acute services (and other services, with certain limitations) that are often rendered by other post-acute providers. 4. Hospitals and other post-acute providers bill and are paid under usual payment system rules (referred to as feefor-service) for all related services rendered to Medicare beneficiaries who have LEJR procedures. Subsequent to the end of a performance year (that is, the calendar year), actual spending (that is, the total amount paid by Medicare for the related services) is compared to the Medicare target price for the respective hospital for the entire episode of care of each beneficiary. Depending on the hospital s quality and episode spending performance (including spending by Medicare for other providers involved in the episode of care), the hospital may receive an additional payment from Medicare or be required to repay a portion of the episode spending. Settlement of these amounts is expected to occur three to six months subsequent to the end of a performance year. The settlement is not specific to any patient but is based on all of the episodes of care for CJR in the performance year. 5. Under the CJR model, hospitals may also enter into separate agreements with various post-acute providers for the coordination of care of a patient during an episode of care. For example, a hospital provides the initial acute care, a second provider may provide rehabilitation services, and a third provider may provide home care services. Revenue recognition for such agreements is outside the scope of this issue. Considerations Related to Step 1: Identify the Contract with a Customer 6. A health care provider must first determine that the five criteria in FASB ASC have been met in order for there to be a contract with a customer within the scope of FASB ASC 606, Revenue from Contracts with Customers. For purposes of FASB ASC 606, FinREC believes the contract with the customer refers to the arrangement between the health care provider and the patient. 7. Separate contractual arrangements (also referred to as provider agreements or participation agreements) exist between health care providers and third-party payors (for example, the Centers for Medicare and Medicaid Services or CMS), which establish amounts to be paid on behalf of a patient (who is the third-party s beneficiary). These separate contractual arrangements between the health care providers and third-party payors are not considered separate contracts with the customer under FASB ASC 606. However, these agreements should be considered in determining the transaction price for the goods and services rendered to patients. 8. In addition, the separate contractual arrangements between a hospital and other post-acute providers are not considered separate contracts with the customer. If there is no gain or loss sharing in those contractual arrangements, they would not impact the accounting for the contract with the patient. 9. In accordance with FASB ASC (a-e), a contract with a customer exists only when all of the criteria in that paragraph are met. Hospitals should consider the criteria in FASB ASC to determine that a contract with a patient exists and that the contract is legally enforceable. FinREC believes a hospital should consider the following items when evaluating if the criteria in FASB ASC are met: a. Parties have approved the contract (in writing, orally, or in accordance with other customary business practices) and are committed to perform their respective obligations of the contract. A hospital should consider if it has a written contract with the patient by considering whether the patient signed any forms, such as a patient responsibility form, which would be considered a written contract. If the hospital determines it does not have a written contract but the patient schedules the elective surgery in advance, the hospital may consider if it has an oral or implied contract. b. Each party s rights regarding the goods or services to be transferred can be identified. A hospital should consider if it has a right to payment for services provided to a patient based on the contract. c. Payment terms can be identified for the goods or services to be transferred. Under the CJR model, hospitals receive Medicare fee-for-service payments for services provided to patients that are subject to adjustment based on the difference between actual Medicare spend and a pre-determined bundle target price. There may also be a co-pay or deductible due from the patient.

3 d. The contract has commercial substance. The hospital should consider if it expects its future cash flows to change as a result of the services provided. e. It is probable the entity will collect substantially all of the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer. A hospital should consider if it is probable that the entity will collect substantially all of the consideration to which it is entitled in exchange for goods or services transferred to Medicare beneficiaries; this includes amounts due from the Medicare program and deductibles and co-pays due from patients. Refer to the Arrangements for Health Care Services Provided to Uninsured and Insured Patients With Self-Pay Balances, Including Co- Payments and Deductibles section in chapter 7, Health Care Entities, of the AICPA Audit and Accounting Guide Revenue Recognition. Also refer to issue 8-8, Consideration of FASB ASC 606, Revenue from Contracts with Customers, for third party settlement estimates, for additional information related to factors to consider in determining if it is probable that the entity will collect substantially all of the consideration to which it is entitled in exchange for goods or services transferred to Medicare beneficiaries. Considerations Related to Step 2: Identify the Performance Obligations in the Contract 10. FASB ASC provides that at contract inception, an entity should assess the goods or services promised in a contract with a patient and should identify as a performance obligation each promise to transfer to the patient a good or service (or a bundle of goods or services) that is distinct. 11. To be distinct, a performance obligation must meet both of the following criteria in FASB ASC : a. The patient can benefit from the good or service either on its own or together with the other resources that are readily available to the patient (that is, the good or service is capable of being distinct) b. The entity's promise to transfer the good or service to the patient is separately identifiable from other promises in the contract (that is, the good or service is distinct within the context of the contract). 12. FinREC believes that generally, the services performed by the hospital in a CJR episode will meet both of the criteria in FASB ASC and should be considered performance obligations. Accordingly, the hospital will meet its distinct performance obligations as it delivers services to the patient either at a point in time or over time depending on the circumstances. Refer to Issue No.8-10, Performance Obligations, for additional information related to factors to consider in determining when an entity will meet its performance obligations. 13. While there is no contractual requirement, some hospitals may perform certain additional care coordination activities or case management services. A hospital may choose to perform these activities as it may be in the best interest of the hospital in an effort to control costs. Hospitals should evaluate the nature of the care coordination services or case management services that are provided to the patient. These activities may include, for example, the following: a. Providing notification to the patient that the patient is a participant in a bundled payment arrangement b. Providing coordination of the post-acute care plan c. Calling the patient to ensure the patient is taking prescribed medications. FASB ASC provides that promised goods or services do not include activities that an entity must undertake to fulfill a contract unless those activities transfer a good or service to the customer. FinREC believes that generally, these types of care coordination activities do not transfer an additional good or service to the patient and are administrative in nature and would not be considered separate performance obligations. Hospitals should, however, consider if there are implied promises to the patient to provide post-acute transitional services or coordination of care with other post-acute providers. These implied promises could be considered performance obligations if the promises are considered distinct. Based on each hospital s facts and circumstances regarding arrangements in place, a hospital should evaluate if care coordination activities should be considered separate performance obligations in its new contracts with customers based on the criteria in FASB ASC

4 Considerations Related to Step 3: Determine the Transaction Price 14. The transaction price (the amount of consideration to which the hospital expects to be entitled) will be established by the rules and regulations of the Medicare program. As part of Step 5: Recognize Revenue When (or As) the Entity Satisfies a Performance Obligation, revenue associated with CJR procedures is recognized as performance obligations are satisfied. 15. For reconciliation and settlement purposes, CMS will group a hospital s CJR episodes by the performance year (that is, the calendar year) in which the episode ends, and accumulate information on all claims filed by all providers relative to those episodes. Approximately two months after a performance year ends, CMS performs a reconciliation calculation for each hospital, as described in the Background section, and determines an interim settlement for that performance year s episodes in the aggregate (not on a patient-by-patient basis). The actual spending data used in calculating this settlement will be incomplete because claims associated with episodes in the latter part of the performance year may still be in process (and, thus, would not have been filed or processed, or both, as of the reconciliation cut-off date). Twelve months later (that is, 14 months after the end of the performance year), a second reconciliation is performed using complete claims information and the final determination is made as to whether the hospital is entitled to a bonus payment or, instead, has incurred a penalty that is owed back to CMS. 16. For purposes of applying step 3, hospitals will generally group individual patient contracts into portfolios that mirror these CMS performance year groupings, and establish transaction prices on a portfolio basis. 1 Refer to the Application of the Portfolio Approach section in chapter 7, Health Care Entities, of the AICPA Audit and Accounting Guide Revenue Recognition. Variable Consideration 17. An entity is required to estimate variable consideration using either the expected value method or the most likely amount method (as described in FASB ASC ) and include some or all of that estimate in the transaction price to the extent it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the related uncertainty is resolved (as described in FASC ASC ). This limitation on including variable consideration in the transaction price is commonly referred to as the constraint. An entity should consider the factors in FASB ASC when evaluating the extent to which variable consideration should be constrained. 18. The hospital s promised consideration from CMS consists of the normal Medicare Severity-Diagnosis Related Group (MS-DRG) payments for the patient contracts in a portfolio plus or minus a bonus or penalty amount, respectively, determined for the portfolio as a whole. The retrospective settlement feature and its linkage to a performance-based bonus or penalty means that as described in FASB ASC , the transaction price has a variable component. 19. The hospital will continue to report MS-DRG revenue in its books and records in its customary manner. However, the impact of the potential retrospective adjustment will need to be considered at each financial reporting date. Thus, each portfolio of contracts will have an associated adjustment of the transaction price for the amount either potentially repayable or receivable related to the CJR program, along with a corresponding balance sheet account that reflects the estimated amount due to or from CMS for potential CJR program settlements. 20. Estimating the potential bonus or penalty amount associated with a CMS performance year requires consideration of (i) the overall actual episode spending compared to target episode prices, (ii) whether (and, if so, how) the 1 The portfolio basis refers to the use of the portfolio practical expedient as contemplated in FASB ASC For simplicity, this issue assumes that a hospital will establish a single portfolio for each Centers for Medicare and Medicaid Service (CMS) performance year. If a hospital desires to establish multiple portfolios for a performance year for example, separate portfolios by Medicare Severity-Diagnosis Related Group (MS-DRG) or by each of its four target episode prices for that year it must be mindful that the CMS reconciliation (and, thus, the settlement amount) will be performed at the aggregate level.

5 target episode prices used in the calculation will (or are likely to) be adjusted based on the hospital s quality score, and (iii) the extent and financial impact of potential overlaps with other CMS payment models, for which CMS will make adjustments in the final reconciliation. a. Actual episode spending. The actual episode spending for a CMS performance year will be determined after all claims attributable to that performance year (both hospital and post-acute care) have been processed by CMS. A hospital s estimate of this amount will depend on its facts and circumstances, including the extent to which it has visibility into the data associated with the claims that have been filed with CMS by other post-acute providers involved in the episode of care, and its historical information regarding variables such as the total number of expected episodes during the performance year, the severity of each episode (that is, which of the four target prices the episodes will apply), and expectations related to complications and readmissions. b. Quality score. The hospital will obtain its quality score for the performance year from the first CMS reconciliation report, which will be received approximately 4-6 months after the end of the performance year. c. Potential overlap with other models. For example, Medicare shared savings program participants also participating in a program with a bundled payment. In this situation, the bonus or penalty is not associated only with the hospital s own performance; instead, it arises in connection with a risk-sharing activity involving other providers. 21. In accordance with paragraphs of FASB ASC , a hospital is required to estimate the amount of variable consideration by applying the constraint guidance and cannot default to a conclusion whereby no variable consideration is included in the transaction price. If a hospital determines that it cannot estimate this amount such that it is probable that a significant revenue reversal would not occur upon resolution of the final amounts, the portion of consideration that is variable should be excluded from the transaction price until it becomes probable that there will not be a significant reversal of cumulative revenue recognized (refer to the Accounting Considerations When the Transaction Price Is Constrained section of this issue). 22. However, if the hospital has sufficient data such that it is probable that a significant revenue reversal would not occur upon resolution of the final amount, that amount should be estimated using one of the two methods described in FASB ASC (whichever is the better predictor), and the initial CJR program estimate established to reflect that amount. After the performance year ends, CMS performs the first reconciliation and determines an interim settlement amount. In accordance with FASB ASC , a hospital should update the estimated transaction price, including the assessment of whether the estimate of variable consideration is constrained, based on the available information. The hospital should also increase or decrease its estimated amount due to or from CMS to reflect any interim settlements received or paid at the time this becomes known. The hospital should continue to evaluate and update the estimate as necessary based on additional information that becomes known in a period. 23. Approximately 14 months after the end of the performance year, CMS performs the second reconciliation and determines whether the hospital has earned a bonus or incurred a penalty. At that time, the estimated amounts are trued up to reflect the actual bonus or penalty amount, and the final settlement amount is determined. These adjustments represent changes in the estimate of variable consideration and should be included in the period (quarter or annual) in which the change in estimate is made. Uncertainties Associated With the Variable Consideration 24. In accordance with FASB ASC , hospitals should evaluate uncertainties associated with the bonus or penalty calculations that could increase the likelihood or the magnitude of a revenue reversal include the following: a. Whether a hospital earns a bonus or incurs a penalty will depend on the performance of parties other than the hospital and, thus, is largely outside of the hospital s influence b. The large number and broad range of possible consideration amounts

6 c. The extent to which the hospital has timely access to data involving claims filed by post-acute providers d. The CJR program is new with no prior history and available data may have low predictive value e. There are contingencies inherent in the bonus or penalty calculation formula. For example: (1) The hospital s exposure to loss (or upside potential for a bonus) will be determined based on highly aggregated data for all episodes ending within a performance year, and the quantity and severity of episodes and exposure to losses from occurrence of complications or readmissions will not be known until several months after the performance year ends. Thus, for example, costly readmissions close to the end of the performance year could impact a portfolio s overall performance enough to change a hospital from a bonus position to a penalty position. (2) The target episode prices used in the reconciliation might increase or decrease as a result of quality scores earned by the hospital during the performance year. The quality score is based on performance with all patients during the performance year and, thus, is not determined until several months after the end of the performance year. The hospital will be informed of its quality score at the same time it is informed of the results of the first reconciliation (typically, in the second quarter of the calendar year that follows the end of the performance year). 25. Several of these uncertainties directly relate to lack of experience or history with the CJR program. As a hospital progresses through the performance years of the program and obtains experience and data that can produce more reliable estimates, uncertainties associated with the likelihood or magnitude of a revenue reversal should diminish. In addition, to the extent that a hospital uses providers within its own health system to provide the postacute care, the uncertainty associated with performance that is outside of the hospital s influence may be diminished. Accounting Considerations When the Transaction Price Is Constrained 26. Until a hospital concludes it is probable that a significant revenue reversal would not occur upon resolution of the final amount, at each financial reporting date, the reduction of the transaction price (due to the constraint) for the amount potentially repayable associated with the portfolio for that performance year should reflect the maximum amount potentially repayable to CMS under the stop-loss limits applicable to that performance year. The reduction of the transaction price (due to the constraint) will reduce the net patient service revenue associated with CJR to reflect the amount that is at risk of being returned to Medicare. Once a hospital concludes it is probable that a significant revenue reversal will not occur upon resolution of the final amount, at each reporting date, a hospital should adjust the transaction price based on its updated estimate of the amount payable to CMS under the stoploss limits applicable to that performance year. 27. After the performance year ends, a hospital will obtain additional data that might allow it to include more variable consideration in the transaction price. For example: a. If a hospital has robust independent data related to the claims filed across the spectrum of care, 2 a hospital can make an estimate of total spending as soon as all claims have been filed or when it is able to calculate the amount of outstanding claims not yet submitted to CMS by the post-acute provider. For those hospitals, the information provided by the CMS reconciliation reports and the CMS data feed will simply serve as a check or confirmation of the hospital s independent data. b. A hospital without robust independent data could use spending information supplied in the first CMS reconciliation report, which will be made available to hospitals in the second quarter following the end of a performance year. However, because the claims information will be incomplete, this would need to be supplemented with updated information from the quarterly CMS data feed or by an estimate of the missing claims from post-acute providers (if predictive historical information is available). 2 The hospital is likely to have robust independent data related to the claims filed across the spectrum of care if, for example, the post-acute care after discharge is provided by affiliates of the hospital (if the hospital and post-acute providers are part of a health system) or if the hospital has collaboration agreements under which the post-acute providers have agreed to provide information to the hospital.

7 When a hospital possesses the additional data, variable consideration will be estimated in the manner described in FASB ASC and the initial CJR program estimate will be adjusted to reflect the revised estimate. 28. The hospital should use information from the claims data from the post-acute providers to update the estimated transaction price, including the assessment of whether the estimate of variable consideration is constrained. Interim Reporting Considerations 29. When estimates are established related to an estimated bonus or penalty for a performance year, it may be necessary to apportion those amounts among interim periods (for example, because a hospital issues quarterly financial statements or because of a need to include only a portion of a performance year s estimates in fiscal year results). To avoid the possibility of recognizing revenue in one interim period that might be reversed in another, and in light of the fact that the amount of bonus or penalty is based on the outcome of performance for the entire performance year, FinREC believes the estimated bonus or penalty should be determined in each interim period on a pro-rata basis in proportion to the services rendered in the interim period, with each interim period bearing a reasonable portion of the anticipated annual amount consistent with the objective in FASB ASC In accordance with FASB ASC and FASB , the hospital should continue to evaluate and update the estimate as necessary based on additional information that becomes known in a period. Interaction of Portfolios, Performance Years, and Fiscal Years 30. CMS bases bonus and penalty calculations on performance year (that is, calendar year) activity rather than on the hospital s fiscal year activity, resulting in timing differences. Even when the financial reporting year and the CMS performance year coincide, the cases included in the CMS performance year will differ from those included in the financial reporting year due to the 90-day time lag between the patient s discharge from the hospital and the end of the patient s CJR episode. Hospitals must be mindful of these timing differences to ensure that transaction prices appropriately reflect the bonuses or penalties associated with the CJR cases included in revenue for a particular financial reporting period. 31. As a result of differences between the CMS performance year and a hospital s fiscal year, a hospital s revenue recognition process for a fiscal year might involve three portfolios of contracts: one related to the CMS performance year that began during the hospital s fiscal year; one related to the CMS performance year that ended during the hospital s fiscal year; and one related to a prior performance year whose second reconciliation (and final settlement) will occur during the hospital s fiscal year. Chart 1, Activity in Estimates During the Year Ended June 30, 2019, in this issue illustrates, for two June 30 year-end hospitals with different circumstances, how the reduction of the transaction price (constraint) for the amount potentially repayable for each of those portfolios might affect revenue recognition for the fiscal year ending June 30, These interactions add a layer of additional complexity to revenue recognition that must be taken into account in developing systems and establishing internal controls over CJR program processes related to financial reporting. Potential implications include: a. The hospital must ensure that its patients are included in the correct portfolios, taking into account the 90-day difference between the inception of the episode upon discharge from the hospital and the end of the episode (which determines the CMS performance year to which the episode will be assigned). b. Important metrics such as target episode prices, stop-gain or stop-loss limits, and quality scores are unique to a given performance year. Using the incorrect year s metrics when making estimates and establishing estimates could cause a material overstatement or understatement of revenue. c. Hospitals will need to allocate the effects of adjustments to CJR program estimates and, ultimately, the final determination of a bonus or penalty, between fiscal years in a systematic and rational manner. Presence of a Significant Financing Component

8 33. Although the timeframe over which the hospital performs the LEJR procedure, receives the MS-DRG payment, receives or pays an interim bonus or penalty settlement at first reconciliation, and makes final settlement with CMS may cover several years, FinREC believes that a significant financing component does not exist because the timing of the payment is at the discretion of CMS and does not involve the patient (that is, the customer). Refer to issue 8-8 for factors to consider related to determining the existence of a significant financing component in a contract. Considerations Related to Step 4: Allocate the Transaction Price to the Performance Obligations in the Contract 34. For considerations related to Step 4, see Issue No and paragraph 13 herein. Considerations Related to Step 5: Recognize Revenue When (or As) the Entity Satisfies a Performance Obligation 35. For considerations related to step 5, refer to Issue No and paragraph 14 herein. 36. The following example is intended to be an illustration of how the retrospective adjustment associated with CMS Performance Year (PY) 3 (2018) will affect Hospital s financial statements for fiscal years ending June 30, 2018, 2019, and The actual determination of the retrospective adjustment should be based on the facts and circumstances of an entity s specific situation. Example Comprehensive Illustration CJR Step 3 and Step 5 Hospital has a June 30 fiscal year end. This illustration shows how the retrospective adjustment associated with CMS Performance Year (PY) 3 (2018) will affect Hospital s financial statements for fiscal years ending June 30, 2018, 2019, and Note that in the fiscal year ending June 30, 2018, Hospital will need to similarly consider the impact of PY2 (2017), as well as PY1 (2016), if Hospital is entitled to a bonus or is subject to a penalty. During the fiscal year ending June 30, 2018, the Hospital s MS-DRG payment for LEJR procedures is $12,500. The target episode price for PY3, established by CMS in advance of the performance year, is $25,000. The stopgain or stop-loss percentage for PY3 is 10%. As of June 30, 2018 Seventy Medicare patients that received LEJR procedures during the fiscal year ending June 30, 2018, have episodes ending in PY3. Hospital s general ledger reflects $875,000 of patient service revenue ($12,500 MS- DRG payment x 70 patients) for those patients. However, because the MS-DRG revenue will be retrospectively adjusted by the performance bonus or penalty associated with PY3, Hospital must determine how much patient service revenue to include in its financial statements for the year ending June 30, 2018, relative to the 70 patients. The penalty or bonus is determined based on services provided to the patients from the time of admission through the 90 days after a patient s discharge from Hospital. The target episode price established by CMS in advance of the PY3 performance year was $25,000. In PY3, the maximum penalty that can be imposed on Hospital in PY3 is capped at $2,500 per episode (10% of the target episode price). Similarly, the maximum bonus that Hospital could receive is capped at $2,500 per episode (10% of the target episode price). Thus, Hospital s range of potential compensation for each of the 70 patients is $10,000 to $15,000 ($12,500 MS-DRG payment ± $2,500 maximum bonus or penalty). Due to its uncertainty about whether it will have earned a bonus or incurred a penalty when PY3 ends, Hospital determines that the amount of variable consideration included in the transaction price (and, therefore, recognized) should be constrained. Because Hospital is certain to receive at least $10,000 of revenue for each patient, a reduction of the transaction price (constraint) for the amount potentially repayable of $175,000 is established to reduce revenue. The reduction of the transaction price (constraint) for the amount potentially repayable is calculated as follows:

9 Patient service revenue 875,000 Less: Minimum potential compensation per patient 10,000 Number of patients 70 Total minimum potential compensation 700,000 Total reduction of the transaction price (constraint) for amounts potentially repayable 175,000 The journal entry to record the reduction of the transaction price (constraint) for the amount potentially repayable is as follows: Contractual adjustment CJR program PY3 (revenue) 175,000 Estimated liability for CJR program settlement PY3 175,000 At June 30, 2018, the estimated net patient service revenue included in the financial statements for services rendered to the 70 CJR patients would be $700,000. The variable consideration associated with those patients will be reported in subsequent periods. As of March 31, 2019 PY3 ends halfway through Hospital s fiscal year ending June 30, Ultimately, the PY ended December 31, 2018 contained 100 episodes (70 from Hospital s fiscal year ended June 30, 2018 and 30 from the first and second quarters in the fiscal year ending June 30, 2019 that is, the quarters ended September 30, 2018 and December 31, 2018). During the quarter ended March 31, 2019, Hospital determines that it has sufficient data to make a reasonable initial estimate of the PY3 penalty or bonus estimate that was previously constrained. Hospital estimates that the CMS total spending for episodes in this portfolio, including the MS-DRG payments made to Hospital and the amounts billed for services provided by all other post-acute providers associated with the episodes, will be $2,600,000. The original target episode price established by CMS of $25,000 was based on an assumption that Hospital s quality score for PY3 would fall within the acceptable range. The target episode price will be updated to reflect Hospital s actual quality score earned for the PY, which will be provided in the first reconciliation report that has not yet been received. The range of possible prices is: Below acceptable quality adjusted target price 24,500 Acceptable quality adjusted target price 25,000 Good quality adjusted target price 25,500 Excellent quality adjusted target price 26,000 Hospital also estimates the various probabilities associated with the quality scores it will likely receive for PY3 as follows: Below acceptable 5% Acceptable 20% Good 60% Excellent 15% Based on the foregoing, Hospital estimates that its probability-weighted quality-adjusted price per patient will be $25,425:

10 Quality Adjusted Target Price Per Patient Probability Probability Weighted Amounts Below acceptable 24,500 5% 1,225 Acceptable 25,000 20% 5,000 Good 25,500 60% 15,300 Excellent 26,000 15% 3,900 Probability-weighted quality-adjusted price per patient 25,425 The total of the estimated quality-adjusted target episode payments is $25,425 x 100 patients = $2,542,500. The estimated stop-gain or stop-loss amount is $254,250 ($2,542,500 x 10%). The difference between the total estimated CMS spend and the aggregate estimated target episode prices is $57,500 ($2,600,000 - $2,542,500). Because the difference is less than the estimated stop-loss amount of $254,250, Hospital s estimated liability to the program is $57,500 for PY3. Because the penalty is associated with episodes associated with two different fiscal years, Hospital must apportion the penalty among the episodes in each period in a systematic and rational manner. Hospital elects to use a proration based on number of episodes, so 70 out of 100 in the year ended June 30, 2018 = $40,250 ($57,500 x 70/100) and 30 out of 100 in the year ended June 30, 2019 = $17,250 ($57,500 x 30/100). Therefore, the estimate of variable consideration associated with the 70 patients treated in fiscal year ended June 30, 2018 is $40,250. Because Hospital s actual experience was more favorable than the maximum amount recorded in the year ended June 30, 2018, an adjustment to the amount recorded is needed. The amount is calculated as follows: Total reduction of the transaction price (constraint) as of June 30, 2018 for amounts potentially repayable based on prior period estimate 175,000 Revised reduction of the transaction price (constraint) for amounts potentially repayable related to services performed in the year ended June 30, 2018 based on the updated current period estimate 40,250 Amount of the previously-constrained transaction price related to the year ended June 30, 2018 to be recognized as revenue in the current period 134,750 The journal entry to record the adjustment of the transaction price (due to the constraint) for the amount potentially repayable is as follows: Estimated liability for CJR program settlement - PY3 117,500 Contractual adjustment for CJR - PY3 (2019) (revenue) 17,250 Contractual adjustment for CJR - PY3 (2018) (revenue) 134,750 This adjustment is reflected in Hospital s quarter ended March 31, 2019 financial statements. As of June 30, 2019 In the quarter ended June 30, 2019, Hospital receives the first reconciliation report for PY3. The total CMS spending shown on the reconciliation report is $2,300,000; Hospital s actual quality score is good, resulting in a total quality-adjusted target price of $2,550,000 ($25,500 x 100 patients); the stop-gain or stop-loss limit is $255,000 ($2,550,000 x 10%); and Hospital is entitled to an interim bonus payment of $250,000 ($2,550,000 - $2,300,000).

11 Hospital evaluates the impact of this information on its estimate of variable consideration for the year ended June 30, Hospital attributes the spending difference to PY3 claims that have not yet been processed by CMS and determines that its original spending estimate of $2,600,000 should not be revised. However, the aggregate target episode price will need to be adjusted to reflect the outcome of the quality score. As a result, Hospital s revised estimate of the penalty amount is $50,000 ($2,600,000 - $2,550,000). The difference between the original estimate of the penalty and the revised estimate is $7,500 ($57,500 - $50,000). Hospital apportions the required true-up in the same proportions as it did the original estimate 70 out of 100 in the year ended June 30, 2018 = $5,250 and 30 out of 100 in the year ended June 30, 2019 = $2,250. Hospital records the following adjustment: Estimated liability for CJR program settlement - PY3 7,500 Contractual adjustment for CJR - PY3 (2019) (revenue) 2,250 Contractual adjustment for CJR - PY3 (2018) (revenue) 5,250 This journal entry is reflected in Hospital s financial statements as of and for the year ended June 30, The Hospital receives an interim payment, which is recorded as follows: Cash (or Due from CMS) 250,000 Estimated liability for CJR program settlement PY3 250,000 As of June 30, 2020 In the quarter ended June 30, 2020, Hospital receives the second reconciliation report for PY3. The total CMS spending shown on the reconciliation report is $2,525,000, indicating Hospital has earned a bonus of $25,000 for PY3 ($2,550,000 - $2,525,000). Because CMS paid $250,000 in the interim settlement, Hospital will be required to return $225,000 ($250,000 - $25,000) to CMS. Because Hospital had estimated that the hospital would pay a penalty of $50,000, a final adjustment of the estimate to reflect the change from penalty to bonus of $75,000 (allocated consistently with prior periods) is recorded as follows: Estimated liability CJR program settlement - PY3 75,000 Contractual adjustment for CJR - PY3 (2019) (revenue) 22,500 Contractual adjustment for CJR - PY3 (2018) (revenue) 52,500 Hospital closes the PY3 settlement and records the actual final settlement due to CMS as follows: Estimated liability for CJR program settlement - PY3 225,000 Due to CMS 225,000

12 Chart 1- Activity in Estimates During the Year Ended June 30, 2019 In the financial statements for the year ended June 30, 2019, the patient service revenue reported by the two hospitals below will be impacted by estimates of the transaction price (constraint) for the amount potentially repayable associated with three CMS performance years PY4 (2019), PY3 (2018), and PY2 (2017). The patterns in which each hospital has recognized variable consideration are affected by its varying levels of access to data on which to base estimates. PY4 (2019) (begins in year ended June 30, 2019) PY3 (2018) (begins in year ended June 30, 2018) First reconciliation report will be received during April to June 2019 PY2 (2017) (begins in year ended June 30, 20 Final settlement in year ended June 30, 2019 Second reconciliation report received during April to June 2019 Regional Hospital Has an internal system which provides real time visibility into clinical activities and claims filed by postacute providers, in addition to receiving information from CMS on a 2-month lag Estimate settlement amount and record initial estimate True up initial estimate if necessary; reflect adjustment in financial statements for the year ended June 30, 2019 Adjust Due to or from CMS based on first reconciliation payment received or made True up estimate and Due to or from CMS to reflect final bonus or penalty Reflect adjustment in financial statements for the year ended June 30, 2019 Community Hospital Receives information on claims and clinical activities of most postacute providers on a 2- month lag Based on experience and individual facts and circumstances, estimate settlement amount and record initial estimate usually based on maximum possible payback (using PY4 stop-loss limit) and continue to evaluate on a periodic basis Make estimate of settlement amount Adjust estimate and reflect in financial statements for the year ended June 30, 2019 Adjust Due to or from CMS based on first reconciliation payment received or made True up estimate and Due to or from CMS to reflect final bonus or penalty Reflect adjustment in financial statements for the year ended June 30, 2019

13 Comments should be received by December 1, 2017, and sent by electronic mail to Andy Mrakovcic at or you can send them by mail to Andy Mrakovcic, AICPA, 1211 Avenue of the Americas, NY DISCLAIMER: This publication has not been approved, disapproved or otherwise acted upon by any senior committees of, and does not represent an official position of, the American Institute of Certified Public Accountants. It is distributed with the understanding that the contributing authors and editors, and the publisher, are not rendering legal, accounting, or other professional services in this publication. If legal advice or other expert assistance is required, the services of a competent professional should be sought. Copyright 2016 by American Institute of Certified Public Accountants, Inc. New York, NY All rights reserved. For information about the procedure for requesting permission to make copies of any part of this work, please copyright@aicpa.org with your request. Otherwise, requests should be written and mailed to the Permissions Department, AICPA, 220 Leigh Farm Road, Durham, NC