New bad debt accounting standards likely to remake community benefit reporting
It's the end of bad debt as we know it.
A new accounting standard dramatically narrows what hospitals can report as bad debt, or payments they anticipated but never received. The majority of what used to qualify as bad debt won't be reported as such under new U.S. generally accepted accounting principles, which most health systems started using Jan. 1.
That could throw a wrench into how hospitals report their community benefits.
Although the Internal Revenue Service does not consider bad debt a part of community benefits, some hospitals still include the figure in broader categorizations that include things like charity care and Medicaid and Medicare shortfalls. The Minnesota Hospital Association, for example, reported in its 2017 Community Benefit Report that its members had incurred $374 million in bad debt expense the previous year.
"That is something that has been top of mind with organizations, where that number is going from what was a fairly significant number down to a much smaller number," said Marc Scher, healthcare audit leader with KPMG.
The standard, called Revenue from Contracts with Customers, or Topic 606, is designed to help investors and other stakeholders compare companies across industries, including healthcare. It's also designed to align U.S. accounting standards with international ones.
The amount of uncompensated care hospitals provide won't change as a result of the revised standard, what will change is how they report it.
Under the former—or current, for some—guidance, some hospitals report bad debt as the difference between what they billed patients and the amount those patients ultimately paid, even if the hospitals did not expect to receive the full billed amount. In many cases, those bills included discounts from their gross charges for uninsured patients and based on contracts with insurers. If a hospital billed an uninsured patient $100, for example, and the patient paid $10, many hospitals would report $90 as bad debt.
Under the new standard, hospitals can only report bad debt if there was an adverse event that prevented a patient from being able to pay the expected amount. It is reported as a reduction from the predicted payment amount.
Under the new standard, if the hospital expected to receive $10 for the previous encounter based on its historical experience and received $10, it would not report any bad debt from that encounter. Instead, it would record $10 as revenue. Alternatively, if the patient paid $8, the $2 difference could only be reported as bad debt if there was an unexpected event like a bankruptcy or loss of employment.
"In one extreme example, bad debt expense could almost entirely go away under this new standard," Scher said.
The amount of revenue that's reported will decrease, too, under the new standard, so it's important that hospitals evaluate the impact on revenue-based performance metrics, which are important for analysts, lenders and other stakeholders, said Brian Murray, managing director in Crowe Horwath's healthcare group. Health systems will need to communicate how the new standard impacts their financial reporting, he said.
That creates a problem, though, because that bad debt calculation has been an important number for many hospitals in trying to justify their tax-exempt status.
Rick Kes, audit senior manager with RSM US, said many hospitals will simply switch out the term bad debt for another one: implicit price concession, which refers to effectively the same thing.
"It isn't a required disclosure, however, but we believe not-for-profit health systems will want to disclose that number in their footnotes of financial statements so that they could then use that number for their community benefit reporting," he said.
Tax-exempt hospitals report bad debt expense on their IRS Form 990, but it's unclear if they'll continue to do so, Kes said. It's possible the American Hospital Association or state hospital associations will lobby the IRS to replace the 990's bad-debt line with a broader option that allows for either implicit price concessions or bad debt, he said.
The AHA declined to comment for this article, instead referring questions to the Healthcare Financial Management Association. State and local governments have their own reporting community benefit requirements. It's unclear how those will change.
Hospitals can use implicit price concessions if they've met one of two conditions, under the new accounting guidance: They continue to care for patients even if a historical analysis shows those patients are unlikely to pay, or they do not perform credit assessments on patients before delivering care, Kes said.
Brian Conner, national practice leader with the accounting firm MossAdams' hospitals and health systems practice and chair of the HFMA's Principles and Practices Board, pointed out that financial statements and tax forms aren't the best way to show community benefit anyway, as much of it takes the form of outreach, activism and population health initiatives in local communities.
Most hospitals don't expect the new accounting standard will have a noteworthy effect, if any, on their finances, but nonetheless they've done a lot of work preparing for the changes and ongoing compliance work. Some are working with their electronic health record vendors to develop portfolios for payment estimates, Kes said.
Steve Filton, CFO of Universal Health Services, said in an interview this month he does not expect the new standard to have a material impact on the King of Prussia, Pa.-based hospital chain's financial statements.
"There could be some shifts between bad debt and other categories of uncompensated care like charity care and uninsured discounts, but I don't view those as terribly meaningful," he said.
Moving forward, the guidance also directs hospitals to report disaggregated revenue, which Scher said will be meaningful for investors and other stakeholders, but will take a lot of work to produce.
The standard took effect for annual reporting periods beginning after Dec. 15, 2017, for the majority of large health systems, including public companies and some not-for-profits. For most others, it takes effect after Dec. 15, 2018.
Send us a letter
Have an opinion about this story? Click here to submit a Letter to the Editor, and we may publish it in print.