New rule will change how bad debt is reported
New FASB rule will alter how bad debt is reported
One of the promises of healthcare reform is that expanding insurance coverage will lower the amount of bad debt that hospitals need to write off for unpaid patient bills. A full two years before the reform act boosts coverage, however, the Financial Accounting Standards Board will make bad-debt expense disappear—from healthcare organizations’ income statements, at least.
In July, FASB (pronounced “FAZ-bee”) issued a new rule in its generally accepted accounting principles, or GAAP, that is specific to healthcare organizations for their accounting treatment of bad debt. Rather than report bad debt as an expense item to be subtracted from net revenue, the estimate of amounts that a hospital operator doesn’t expect to collect must be deducted from gross patient revenue as part of the calculation of net patient revenue. The new rule also requires greater disclosure of the processes the organization uses to estimate bad debt, such as its review of collections history.
The change goes into effect for fiscal years that begin after Dec. 15 for any healthcare organization that has public securities, such as investor-owned hospital companies’ equity or tax-exempt systems’ municipal bonds. Organi- zations with no public securities get an additional year to make the change. Healthcare organizations are allowed to adopt the rule early. Vanguard Health Systems, Nashville, adopted the new treatment for its fiscal year that began July 1, for example.
For Christus Health, FASB’s change is just catching up to what the Irving, Texas, system already believed was best practice, says Kim Reynolds, system senior director of financial reporting and corporate controller. Christus has been providing revenue on a cash collections basis, or cash revenue, as an additional measure to its board members, ratings agencies and bond investors for four years, Reynolds says.
“I think it’s a more appropriate treatment, and that’s why we’ve been doing it that way for a while for anybody who would listen,” she says. “It will really reflect from the revenue perspective what you actually expect to collect. It was a little misleading before. Revenue was higher, but there was this big expense.”
The new accounting rule is actually a case of going back to the future, says Rick Gundling, vice president of healthcare financial practices at the Healthcare Financial Management Association. In the early to mid-1990s, FASB changed the accounting treatment of bad debt to make it an expense, he says. “The change in the ’90s was made to make it comparable to other industries,” Gundling says, “but in healthcare, the number grew so large that it was just distorted.”
Prior to that change, accountants netted out bad debt from gross revenue just as they net out contractual allowances from gross charges for managed-care payers and charity care in order to produce net revenue, Gundling says. The new rule essentially treats bad debt the same way, but requires it to be a separate line item above net revenue and also requires greater disclosure about policies for recognizing revenue by payer class and any significant changes to the qualitative or quantitative measures by which a healthcare organization estimates its allowance for doubtful accounts, according to FASB.
The HFMA agreed with changing the presentation of bad debt in its comment letter to FASB on the recent change, Gundling says. Bills for uninsured patients always have been questionable under GAAP revenue recognition standards, which include that the collectibility of revenue be reasonably assured in order to book the revenue, he says.
Darren Lehrich, a healthcare stock analyst and managing director for Deutsche Bank Securities, says two trends in the industry have, over time, distorted the bad-debt expense reported on income statements and made them less useful metrics. “I think that’s what this change is all about,” Lehrich says.
One trend is that many companies are applying managed-care-like discounts to uninsured patients when they believe there is at least a chance of collecting part of the bill, Lehrich says.
Tenet Healthcare Corp., Dallas, was the first investor-owned company to start a discount program, which it implemented in 2004, and over the next few years, most of the rest of its peer companies followed suit. The result of these policies, Lehrich says, is to significantly lower bad-debt expense as a percentage of net revenue, which is the traditional way that analysts have looked at bad-debt expense to compare investor-owned hospital companies.
Before, for example, if the bill was $10,000, the company would book $10,000 of revenue, and then end up writing off $6,500 as bad debt if it collected only $3,500, he says. Now, the company might apply a 60% discount, so it books $4,000 of revenue and collects $3,500, and bad debt is only $500.