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.
Countdown to FASB
Blog Post: The Importance of Building Expect Pricing Into Your Revenue Forecast
In today's environment, where many labs do not have contracts with all providers and there are many more tests, forecasting revenue becomes much more difficult.
Blog Post: Overcoming the Challenges of FASB ASC 606 with the Right Tools and Partners
Despite the strict revenue recognition guidelines of the Sarbanes-Oxley Act (SOX), and the latest revenue recognition rules in the Financial Accounting Standards Board (FASB) Accounting Standards Codification® (ASC) 606, many labs still struggle.
This standard has the potential to affect every entity's day-to-day accounting and, possibly, the way business is executed through contracts with customers. The standard will eliminate the transaction and industry-specific revenue recognition guidance under current US GAAP and replace it with a principle-based approach for determining revenue recognition.
American Institute of CPAs (AICPA)
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.
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.
Prepare for detailed reporting requirements
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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Preparing your Lab Company for Big Changes in Revenue Recognition Standards and Audits by Your CPA Firm
Key Differences Between Legacy GAAP and FASB 606 for Diagnostics Providers
Persuasive evidence vs. Contract
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
Collectability: Then and Now
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.
Fixed vs. Variable Consideration
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
Who Is the Customer?
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.
Does the Contract Exist?
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.
Implicit Price Concessions?
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.
Developing an Estimate
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.