FASB 606: New revenue recognition standards loom
The End of Cash Accounting
The purpose of the new Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 606 accounting standard is to replace industry-specific accounting methods with a better, more consistent and comparable picture of revenues. It is arguably the biggest change in accounting standards since the Sarbanes-Oxley Act of 2002, will change how companies book revenue, and will affect everything from earnings and taxes to bonuses, commissions and buyout decisions.
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The Five Step Revenue Recognition Process
FASB 606 requires companies to determine revenue recognition based on a five-step methodology whose core principle is: 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 or services.
Identify the contract(s)
Identify the separate performance obligations
Determine the transaction price
Allocate the transaction price to separate performance obligations
Recognize revenue when (or as) the entity fulfills performance obligations
For healthcare diagnostics providers, it is Step Three–determining the transaction price–that requires further consideration and thought, particularly given the transition to value-based care and the diverse nature of constituents such as hospitals, accountable care networks and post-acute care providers.
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Transition Reporting Adds to the Complexity
There are two transition methods for adopting the new FASB standard. While there are advantages and disadvantages to both, both methods do require an amount of dual reporting (reporting both under the old GAAP rules and the new GAAP that incorporates FASB 606).
Full Retrospective: The laboratory reports 2016 and 2017 under the new revenue recognition standards. The laboratory will need to go back and assess all the contracts that existed during the retrospective period, and determine whether there were changes to revenue recognition and if cumulative adjustments need to be reported in the various periods. This method has the advantage of having full comparability across periods, which is helpful from a financial planning and analysis and budgeting perspective. On the downside, however, the retroactive analysis requires a significant amount of work to evaluate the contracts and revenue streams.
Modified Retrospective: Rather than reporting retrospectively, the laboratory maintains two sets of books for 2018 (2019 for private entities) for comparison purposes. The laboratory would not need to perform the retrospective analysis of contracts. This methodology requires less effort, but does increase risk and effort throughout the year of dual-reporting and causes comparability challenges, if there is material impact from the new standard.
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Key Differences Between Legacy GAAP and FASB 606 for Diagnostics Providers
The legacy guideline uses the concept of persuasive evidence--evidence (such as contract or purchase order) of the final understanding between parties about the specific nature and terms of an agreed-upon transaction as a guide.
The new standard dictates (in Step 1) the laboratory will identify contracts with customers--agreements that create legally enforceable rights and obligations--which may be oral, written or implied.The following criteria are required to constitute a contract:
- Approval of contract and commitment to perform
- Each party's rights are identifiable
- Payment terms are identifiable
- Contract has commercial substance
- Collection is probable
Under legacy guidance, collectability being reasonably assured was one of the four revenue recognition criteria. The entire contract price needed to be reasonably assured before revenue could be recognized.
Under the new standard, collectability is not a separate criteria, but is referenced in Step 1, where the customer's ability and intent to pay is evaluated. Under the new guidance, a company not being paid 100% of its contract price does not negate the contract.
Current guidance dicates that the seller's price needs to be fixed or determinable. If it isn't, then revenue cannot be recognized.
Under the new guidance Step 3, Determine the Transaction Price, there is the new concept of nvariable consideration. If an entity is willing to accept a lower price than the stated amount of its contract, whether through discounts, rebates, refunds, credits, price concessions, or implied through past business practices, then this is factored into the varabile consideration estimate that is part of determining the transaction price. Two methods are available for variable consideration:
Expected Value: take the sum of probability weighted amounts within a range to come up with a best estimate. This is the method most likely to apply to diagnostics providers.
Most Likely Amount: use a range using a single amount that is most likely to occur.
Also introduced in Step 3 is the concept of applying a constraint to preventing over-recognition of revenue that would require a future reversal
Special Considerations for Diagnostics Providers
For diagnostics providers, generally the customer is the patient, and the arrangement can be oral or evidenced through established business practices. But the contract must have commercial substance for the revenue to be recognized, and both parties must have the intent and ability to uphold their respective obligations.
Diagnostics providers need to look at patient enrollment forms or other documents signed by the patient to determine whether a contract exists. This may require an analysis of specific circumstances to assess enforceability. Also important is collectability criteria:
- Past history with that patient or patient class, in terms of payment
- Patient's eligibility for charity care or government subsidy
- If qualified for Medicaid, review historical information for pending Medicaid patients
If there is no history and no evidence of consideration collected, then this would indicate no presence of contract, and therefore the revenue would not be recognizable until a contract exists.
In evaluating collectability, laboratories don't need to look at individual contract or test or accession, but can group payors into portfolio groups and use that as basis for concluding they've met the collectability criteria.
Laboratories need to consider all information that is reasonably available, including historical, current, and forecasted, to estimate the true transaction price for a patient and/or payor. Even if a price concession is only implied, it constitutes a reduction in revenue and needs to be captured that way.
Whereas in the past, such concessions were reflected in bad debt, under new guidance they are taken as a revenue reduction. Bad debt is reserved for impairments such as bankruptcy or change in credit, not "true-ups" to variable consideration.
Use of historical experience to estimate adjustments will be crucial. A portfolio approach enables diagnostics providers to group those with similar collection history or reimbursement rates together.