New Jersey Chapter of HFMA Spring Education Event April 2016 ASC 606, Revenue from Contracts with Customers Overview for Healthcare Providers

New Jersey Chapter of HFMA Spring Education Event April 2016 ASC 606, Revenue from Contracts with Customers Overview for Healthcare Providers How Will Revenue be Recognized Under Contracts? Albert Deana, CPA, Partner, Baker Tilly Virchow Krause, LLP Heather Weber, CPA, Partner, Baker Tilly Virchow Krause, LLP Rod Martin, Director, Baker Tilly Virchow Krause, LLP www.bakertilly.com/healthcare

Presentation objectives 1 Key concepts of ASC 606 2 Provide a better understanding of Steps 1 & 3 of the 5-Step Revenue Recognition Process including application of the Portfolio Approach 3 Practical examples related to healthcare organizations 4 An update of the issues identified by the AICPA Healthcare Entities Revenue Recognition Task Force 5 Discussion of revenue cycle best practices that will aid in implementation of ASC 606 2

ASC 606 : Objectives The goal of ASC 606 was to develop a FASB/IASB converged standard addressing revenue recognition for all industries that would: KEY CONCEPTS I II III Remove inconsistencies and weaknesses in current guidance Provide a more robust framework for addressing revenue recognition issues Improve comparability across entities, industries, etc. IV Provide more useful information to users with enhanced disclosure requirements V Simplify the preparation of financial statements by reducing the number of requirements in which an entity must refer 3

ASC 606: Who is impacted? > Affects all entities that enter into contracts with customers to transfer goods or services or for the transfer of nonfinancial assets Unless the transfer of nonfinancial assets are within the scope of other standards, such as insurance contracts or lease contracts 4

ASC 606: When is this effective? For public entities, including not-for-profit entities that is a conduit bond obligor Annual periods beginning after Dec. 15, 2017, including interim reporting periods within that period (i.e., 12/31/18 and 6/30/19) All other entities Annual periods beginning after Dec. 15, 2018, and interim reporting periods within annual reporting periods beginning after Dec.15, 2019 (i.e., 12/31/19 and 6/30/20) 5

> Full retrospective Restate all prior periods presented ASC 606: Transition methods > Simplified method Cumulative effect change through equity/net assets in the year of change with prior period presented without change Disclosure required to state the amount of change in each line items of financials as if presented under prior accounting 6

Entities should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. ASC 606: Core principle 7

ASC 606: 5 step process Step 1 Identifying the contract(s) with the customer Step 2 Identify the performance obligation(s) in the contract Step 3 Determine the transaction price Step 4 Allocate the transaction price to the performance obligation(s) in the contract Step 5 Recognize revenue when (or as) the entity satisfies a performance obligation 8

Contract requirements 1Approval and Identification commitment of 2the rights Identification of the 3payment terms The contract has 4commercial substance It is probable that the entity 5will collect the consideration 10

> If you meet the criteria for a contract, you do not need to reassess unless there is a significant change in the facts and circumstances. > If you do not meet the criteria for a contract, continue to assess to determine if they are subsequently met. Step 1 - Identifying the contract(s) with the customer 11

Contract requirements Probable It must be probable that the entity will collect substantially all of the consideration in exchange for the good or service provided Collectability threshold If collectability threshold is not met, a contract DOES NOT exist. Past experience May make this determination based on past experience with the patient or resident or class of similar patients and/or residents 12

Step 1 Identifying the contract(s) with the customer Parties and rights > Identify the parties to your contract Patient or resident Service provider(s) Third-party payer(s) > Identify each party s rights regarding the goods and services to be transferred 13

Step 1 Identifying the contract(s) with the customer Enforceability and duration > Enforceability is a matter of law > Contracts can be: Written Oral Implied based on the entity s customary business practices > Duration No fixed duration Can be terminated by either party at any time Automatic renewals 14

> The review of the patient or resident s information may include determining if they have insurance coverage, a copayment, or a deductible. > If a patient or resident has no insurance or if a portion of the balance is due from the patient or resident (for example, a deductible), the entity evaluates their ability and intent to pay. Considering whether any negative evidence exists with respect to the entity s history with that particular patient or resident or similar patients or residents. Step 1 - Identifying the contract(s) with the customer 15

> A situation in which services were previously provided to the patient or resident and no consideration was collected may provide strong evidence that the patient or resident does not have the intent or ability to pay. > However, if no such evidence exists, the entity may be able to conclude that its expectation related to collectability for that patient or resident is no different than for any other patient or resident in the customer class. Step 1 - Identifying the contract(s) with the customer 16

Step 1 Identifying the contract(s) with the customer Uninsured patients or residents > Evaluate if the patient or resident can perform his or her obligation under the contract (i.e., pay for the services provided) > Determine if it is probable that you will collect the consideration to which you are entitled > If the patient or resident is not committed to perform his or her obligation or it is not probable you will collect the consideration then you do not have a contract. 17

Step 1 Identifying the contract(s) with the customer Uninsured patients or residents > Uninsured patients or residents may be assessed to determine if they qualify for Medicaid or other financial assistance > Process can take several weeks to over a year > Party responsible for payment has not been determined > Estimate transaction price based on historical information > No historical information may determine a contract does not exist 18

Step 1 Identifying the contract(s) with the customer Uninsured patients or residents >If a patient or resident qualifies for charity care, a contract does not exist for purposes of applying ASC 606. 19

> If you receive consideration prior to meeting the criteria for a contract, you recognize a liability until such time as either of the following criteria are met: No remaining obligation to transfer goods or services to the patient or resident and all or substantially all of the consideration has been received The contract has been terminated and the consideration received is nonrefundable Step 1 - Identifying the contract(s) with the customer 20

Step 1 Identifying the contract(s) with the customer Combination of contracts > Combine two or more contracts entered into at or near the same time with the same patient or resident if the following criteria are met: Contracts are negotiated as a package with a single commercial objective Amount of consideration to be paid in one contract depends on the price or performance of the other contract Goods or services promised in the contracts are a single performance obligation 21

Step 1 Identifying the contract(s) with the customer Contract modifications > Change in the scope or price (or both) of a contract > Creates new or changes existing enforceable rights and obligations > Can be approved: Writing Oral agreement Implied based on customary business practices 22

Step 1 Identifying the contract(s) with the customer Contract modifications (cont.) > If you have a change in scope but have not determined the change in the transaction price, you should estimate what the change would be. > Contract modifications are considered a new contract if the following criteria are met: The scope increases because of the addition of promised goods and services that are distinct; and Price increases by an amount of consideration that reflects the entity s standalone selling prices. 23

> If a contract modification is not accounted for as a separate contract, an entity shall account for the promised goods or services not yet transferred as of the date of the contract modification in one of the following ways: As a termination and creation of a new contract, if the remaining goods or services are distinct from those previously transferred. As part of the existing contract if the remaining goods and services are not distinct and the adjustment to the transaction price would be an adjustment to revenue. If the remaining goods and services are a combination of items, then the entity shall account for the modification on the unsatisfied performance Step 1 - Identifying the contract(s) with the customer 24

Step 3 Determine the transaction price To determine the transaction price an entity should consider: Variable consideration Constraining estimates of variable consideration The existence of a significant financing component Noncash consideration Consideration payable to the customer 26

Variable consideration > Explicit price concessions Stated in the contract > Implicit price concessions Arise when a patient/resident has an expectation that you will accept an amount less than charges based on customary business practices or published policies. Requires more judgement > The accounting is the same for both > These are estimates Subsequent changes in the estimate should generally be accounted for as increases or decreases in variable consideration, and adjusted through net patient or resident service revenue 27

Step 3 - Determine the transaction price > Factors to consider when determining if implicit price concessions exist: Current market economic conditions Experience with similar patients/residents or portfolios of patients/residents Length of time to collect consideration from similar patients/residents Current policies, i.e. uninsured discount or prompt-pay discount The number of possible consideration amounts > Must be probable that the cumulative amount of revenue recognized would not result in a significant revenue reversal. 28

Step 3 Determine the transaction price > Under the current model, hospitals recognize revenues and receivables for services provided to uninsured patients or residents. This typically results in the recognition of revenue for which collectability is doubtful followed by recognition of an allowance for doubtful accounts and bad debt expense. Unlike other industries, health care providers are not required to assess whether collectability was reasonably assured before recognizing patient/resident service revenue. > Under the new standard, bad debts will be the exception not the norm. In determining the transaction price, bad debts are recognized as a reduction of the initial variable consideration recognized. 29

Step 3 - Determine the transaction price > In estimating the transaction price, an entity may determine that it has not provided an implicit price concession. > In these situations, uncollectible amounts may better represent impairment losses or bad debts. 30

Step 3 Determine the transaction price Application methods > Contract-by-contract basis > Portfolio approach Contracts with similar characteristics Reasonably expects that the effects on the financial statements of applying this method would not differ materially from applying on a contract-by-contract basis Uses estimates and assumptions that reflect the size and composition of the portfolio 31

Step 3 Determine the transaction price Portfolio approach considerations > Type of service Inpatient, outpatient, skilled nursing, elective, emergency department, etc. > Type of payer Insurance contract, governmental, uninsured self pay > Type of patient responsibility Uninsured self-pay, deductible/copay, size of co-pay or deductible may also be considered > Were the contracts entered into near the same time 32

Portfolio approach > All organizations are unique; you will need to make the final determination regarding portfolios that are applicable to your organization based on the patients you serve and the capabilities of your patient accounting system > For most organizations, a logical starting point is evaluation of portfolios by payers > Many healthcare organizations currently use a process similar to the portfolio method 33

Portfolio approach considerations > What historical payment information do you have? > Is your historical payment information sorted by primary payer, or current payer? > Are there large swings in collection rates for the portfolios you are considering? > How is payer information currently getting coded in the system? > Are you currently gathering the information you are going to need at admission? Are process changes needed? > In addition to considerations related to payers, do you have any significant service lines that have reimbursement that varies significantly from other service lines? > Will you adopt the portfolio approach system-wide, or adopt a tailored approach for each entity? 34

Self pay portfolios > Do you have a single portfolio of self-pay accounts, or various portfolios of self-pay accounts? > Do you have sufficient payment history to determine if there is consistency in payment patterns? Variability in payment patterns could indicate additional portfolios for consideration. > Potential considerations for self-pay portfolios Traditional uninsured self-pay High deductible patient responsibility Deductible/co-pay patient responsibility Medicaid pending Elective procedures not covered by insurance Payment plans 35

Step 3 Determine the transaction price Updating estimates of variable consideration > Must update at the end of each reporting period to represent the circumstances present at that time and the changes during the reporting period. > Regardless of whether the entity determines the transaction price based on an individual contract or a portfolio of similar contracts. > If using the portfolio approach, will need to consider additional information about patients/residents in the patient/resident class that may result in a change in the estimate. 36

Step 3 Determine the transaction price Subsequent changes in the estimate of transaction price > FinREC believes changes in the entity s expectations of the amount it will receive from the patient/resident will be recorded in revenue unless there is a specific event that is known to the entity that suggests the patient/resident no longer has the ability and intent to pay the amount due. In these instances, changes in the estimate of variable consideration would be considered an impairment or bad debt. 37

Practical examples related to healthcare organizations 38

Illustrative 1 example A patient is admitted to the emergency room and is nonresponsive. Uninsured selfpay patient No uninsured discount The entity is obligated to provide services to the patient as required by law. Hospital does not assess the patient s ability to pay at the time of service $$$$$$$ $$$$$$$ $$$$ At discharge it is determined the patient does not have insurance coverage and does not qualify for financial assistance. Therefore patient is considered uninsured self-pay. 39

1 Illustrative example cont d $$$$$$$ $$$$$$$ $$$$ Standard charges for services provided are $10,000 and a bill is sent to the patient for this amount. Hospital intends to pursue collection of the entire billed amount. Uninsured selfpay patient No uninsured discount $1,000 Based on experience with similar uninsured self-pay patients, hospital only expects to collect $1,000. Facts and circumstances indicate an implicit price concession to the patient. The hospital concludes that it is probable that it will collect $1,000 (transaction price) and the other criteria in ASC 606-10-25-1 are also met. Hospital records net patient revenue and accounts receivable of $1,000. 40

Illustrative 2 example Same facts related to the patient as Example 1. Hospital makes reasonable efforts to determine if patient is eligible for assistance under its financial assistance policy. Uninsured selfpay patient Uninsured discount It is determined the patient qualifies for financial assistance and is given a 75% discount (explicit price concession). Standard charges for services provided are $40,000 Given the qualification for the financial assistance policy the hospital discounts the charges 75% or $30,000. Bill is sent to the patient for $10,000. 41

2 Illustrative example cont d Hospital intends to pursue collection of the entire billed amount. Based on experience with similar uninsured self-pay patients, hospital only expects to collect $1,000. Uninsured selfpay patient Uninsured discount Facts and circumstances indicate an implicit price concession to the patient. The hospital concludes that it is probable that it will collect $1,000 (transaction price) and the other criteria in ASC 606-10-25-1 are also met. Hospital records net patient revenue and accounts receivable of $1,000. 42

Illustrative example Illustrative 3 3 example Insured patient High deductible plan Patient is insured with a high deductible plan After providing service, the patient supplies insurance information and the Hospital determines the deductible has not been met. Hospital does not determine if the patient has a patient responsibility (whether or not deductible has been met) and, if so, whether the patient has the ability to pay it prior to providing service. $5,000 Standard charges for services Based on the contract with the commercial payer the hospital determines there is a contractual adjustment of $3,000 (explicit price concession). 43

Illustrative example Illustrative 3 3 example cont d Bill is sent to the patient for $2,000. Hospital intends to pursue collection of the entire billed amount. Insured patient High deductible plan Based on experience with similar insured patients, hospital only expects to collect $200 (transaction price). $$$$$$ $$$$$$ $$$$$$ $$$$$$ $ Facts and circumstances indicate an implicit price concession to the patient. Hospital records patient revenue and accounts receivable of $200. 44

Illustrative 4 example A hospital elects to apply the portfolio approach to revenue recognition for uninsured self-pay patients. Uninsured selfpay patients Implicit price concession based on portfolio approach $$$$$$$ $$$$$$$ $$$$ The hospital performs an analysis that shows the uninsured self-pay customer class has similar collection patterns based on historical information. Hospital concludes that the expected outcome of using the portfolio approach is not expected to materially differ from the individual contract approach During the month, gross charges for this portfolio total $1,500,000. Based on historical experience and published policies, the hospital determines that these patients qualify for charity care and uninsured discounts representing approximately 80% of gross charges or $1,200,000. This is an explicit price concession. 45

4 Illustrative example cont d $$$$$$$ $$$$$$$ $$$$ Discounted charges for services total $300,000 Hospital intends to pursue collection of the amounts billed to patients. Uninsured selfpay patient Implicit price concession based on portfolio approach $45,000 Based on experience with similar uninsured self-pay patients, hospital only expects to collect approximately 15 percent of discounted charges within the portfolio, or $45,000. The hospital concludes that it is probable that it will collect $45,000 and the other criteria in ASC 606-10-25-1 are also met. Hospital records net patient revenue and accounts receivable of $45,000. Facts and circumstances indicate implicit price concessions to the patients. 46

Illustrative 5 example Same facts related to example four. Hospital updates its estimate of the transaction price, including updating assessment of whether the estimate of variable consideration is constrained at the end of each month. Uninsured selfpay patient Implicit price concession based on portfolio approach Based on recent payment patterns of this portfolio, the hospital determines it will collect $50,000 instead of $45,000 initially estimated. Reduction of implicit price concession (increase in estimated transaction price) is adjusted through net patient service revenue (resulting in an increase of $5,000 in net patient service revenue) 47

Illustrative 6 example Same facts related to example four. Hospital updates its estimate of the transaction price, including updating assessment of whether the estimate of variable consideration is constrained at the end of each month. Based on recent payment patterns of this portfolio, the hospital determines it will collect $35,000 instead of $45,000 initially estimated. Uninsured selfpay patient Implicit price concession based on portfolio approach Hospital required to evaluate whether it has obtained adverse information regarding financial condition of patients in the portfolio to determine if an impairment exists. It is determined that adverse information regarding patients financial condition is obtained; impairment losses totaling $7,000 are identified. Impairment loss of $7,000 is recorded as a bad debt expense, and increase in implicit price concession (decrease in net patient service revenue) of $3,000 is recorded. 48

Considerations related to third-party payer settlements 49

Considerations related to third-party payer settlements Cost report settlements related Medicare and Medicaid programs have potential for significant retrospective adjustments. Final settlements may not be known for several years. Under the new standard, recognize amounts only to the extent it is probable that a significant reversal of cumulative revenue will not occur. 50

Frequently asked questions 51

Frequently asked questions How is this estimation process different than what I do now? The initial estimate of the transaction price is determined at the time the revenues are recognized. In many cases, organizations perform this assessment at the end of a reporting period for certain services and therefore can be a retrospective assessment. The net revenues recognized may not result in significantly different amounts however it will represent a change in the process to develop and document estimates. 52

Frequently asked questions How can I best prepare our organization for the implementation of this standard? Review your current processes related to admissions, contract management, and historical collection experience to ensure you have the information to properly estimate the transaction price at the time the services are provided. Give consideration to your current processes and determine how you will identify a change in estimate versus an impairment of your original estimate. 53

AICPA guidance for revenue recognition 54

AICPA guidance the process AICPA established industry-specific task forces, one of which is the Revenue Recognition Task Force (RRTF) for Health Care Entities, to address ASC 606 Once issue papers are drafted and approved by the RRTF, they are passed along to the Revenue Recognition Working Group (RRWG) for review and approval Once approved by the RRWG, the issue papers are passed along to the Financial Reporting Executive Committee (FinREC) for review and approval http://www.aicpa.org/interestareas/frc/accountingfinancialreporting/revenuerecognition/pages/rrtf-healthcare.aspx 55

AICPA guidance the process Once approved by FinREC, the issue papers are exposed for public comment for a 60-day period All comments received are considered; changes, if any, in response to comments are incorporated into issue papers Review and approval process (RRTF to RRWG and RRWG to FinREC) Issue papers are finalized and become part of the AICPA Guide Revenue Recognition http://www.aicpa.org/interestareas/frc/accountingfinancialreporting/revenuerecognition/pages/rrtf-healthcare.aspx 56

Issues identified for healthcare > Issue #1 Consideration of the following regarding self-pay balances: Application of step 1 (determine if there is a contract) and step 3 (determine the transaction price) for healthcare services provided to self-pay patients, including uninsured patient balances and self-pay patient balances arising from co-payments and deductibles. This implementation issue addresses evaluating whether a contract exists and what (including consideration of implicit price concessions) the transaction price is for healthcare services provided to self-pay patients and balances arising from co-payments and deductibles. Status: Finalized; to be included in a future edition of the AICPA Guide Revenue Recognition (projected to be April 15, 2017) 57

Issues identified for healthcare > Issue #2 Application of the portfolio approach to contracts with patient This implementation issue addresses how to apply the portfolio approach to revenue from self-pay patients and third party payors. Status: Finalized; to be included in a future edition of the AICPA Guide Revenue Recognition (projected to be April 1, 2017) 58

Issues identified for healthcare > Issue #3 Identifying and satisfying the performance obligation(s) and recognizing the monthly/periodic fees and nonrefundable entrance fees under Type A or life care contracts for continuing care retirement communities (CCRCs) This implementation issue will address the performance obligation(s) under a typical Type A (life care) CCRC resident agreement and, given this performance obligation(s), how a Type A CCRC will estimate a transaction price and recognize nonrefundable entrance fees and monthly/periodic fees received from residents under the new model. Status: Re-submitted to AICPA RRWG 59

Issues identified for healthcare > Issue #4 Identifying the performance obligation(s) and recognizing the performance obligation(s) to provide future services and use of facilities for CCRCs This implementation issue will describe the changes to a CCRCs calculation of the obligation to provide future services and use of facilities as a result of the new model Status: Submitted to AICPA RRWG 60

Issues identified for healthcare > Issue #5 Significant financing component - CCRC contracts, and patient and third-party payer amounts in arrears This implementation issue will address the factors that need to be considered when CCRCs assess whether a significant financing component exists for its resident contracts, as well as how other healthcare entities will assess whether a significant financing component is applicable to patient and third-party payor amounts in arrears. Status: Re-submitted to AICPA RRWG 61

Issues identified for healthcare > Issue #6 Disclosure requirements This implementation issue will address judgments related to disclosure requirements under ASC 606. Status: Submitted to AICPA RRWG 62

Issues identified for healthcare > Issue #7 Accounting for contract costs This implementation issue will address how healthcare organizations will account for certain costs of acquiring and fulfilling contracts under the new model. Status: Submitted to FinREC 63

Issues identified for healthcare > Issue #8 Third party settlements This implementation issue will address considerations related to third party settlement estimates under the new model. Status: Paper is being drafted 64

Issues identified for healthcare > Issue #9 This implementation issue will address considerations for accountable care organizations, bundled payment arrangements, and other risk sharing arrangements under the new model. Status: Paper is being drafted 65

Issues identified for healthcare > Potential Issue #10 Disclosure requirements of ASU No. 2014-09 This implementation issue will specifically address the disclosure requirements related to performance obligations. Status: Necessity of this paper, which would supplement Issue #6, is currently being evaluated 66

Revenue cycle best practices 67

High performance revenue cycle 68

High performance revenue cycle > The key functional areas of a highly performing revenue cycle that impact portfolio management are highlighted 69

Revenue cycle best practice considerations Patient access > Timely identification of payer Preferably during scheduling activities Includes determination of estimated patient responsibility Reduce recalculations due to eligibility/cob errors > Financial counseling works with patient upfront if there is a patient responsibility to needs to be managed Use automated patient responsibility determination and exception based workflow to ensure compliance > Insurance verification process has dedicated staff and technology in place to work exceptions efficiently 70

Revenue cycle best practice considerations Revenue integrity > Contract management module in place to incorporate terms of contracts to determine expected payment > Decision to leave accounts at gross or net must be made; pros and cons to each Just keep in mind that ASC 606 requires determination of net consideration to be received; you do not always receive the contracted amount so you will need a process in place to make final determination of net revenue amounts > Case management and other clinical services must make timely decisions on patient type classifications to ensure proper reimbursement can be determined 71

Revenue cycle best practice considerations Patient financial services > Claim rejections need to be posted electronically in a timely manner, with determination made immediately of avoidable or non-avoidable. > Those rejections that can be appealed should be, and if, overturned should be factored into the applicable portfolio analysis. > Those rejections that can not be appealed, but are avoidable should be reviewed to determine how to avoid in the future and if correctable, then that should be factored into the applicable portfolio analysis. 72

Revenue cycle best practice considerations Visibility and control > Retrospective analytics should be developed in order for the organization to prospectively determine the gross to net revenue ratio for portfolio valuation. Should include at a minimum: - Payment amounts - Contractual allowances - Bad debt write-offs - Avoidable denial write-offs Automated constant re-evaluation of portfolios should be built to ensure 73

In the meantime STAY EDUCATED Continue to educate yourself on the new standard ESTABLISH AN INTERNAL TEAM to oversee the implementation of this new standard and determine the resources needed for that team.most likely will need individuals outside of the finance team CONNECT WITH AUDIT TEAMS Keep an eye out for guidance from Baker Tilly as well as the AICPA and reach out now to your audit teams to discuss. 74

Baker Tilly required disclosure > The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. > Baker Tilly refers to Baker Tilly Virchow Krause, LLP, an independently owned and managed member of Baker Tilly International. 2016 Baker Tilly Virchow Krause, LLP. 75

Questions? 76