On May 28, 2014, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) issued substantially converged final standards on revenue recognition. These final standards are the culmination of a joint project between the Boards that has spanned many years. The FASB’s Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606), was issued in three parts: (a) Section A, “Summary and Amendments That Create Revenue from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs—Contracts with Customers (Subtopic 340-40);” (b) Section B, “Conforming Amendments to Other Topics and Subtopics in the Codification and Status Tables;” and (c) Section C, “Background Information and Basis for Conclusions.”
The new standard will be effective for reporting periods beginning on or after January 1, 2017, with earlier application permitted. Companies can choose to apply the standard retrospectively or use a modified approach in the year of application. It is the result of a convergence project with the US Financial Accounting Standards Board (FASB) that began in 2002. Almost fully converged, the most significant differences between IFRS and US GAAP relate to interim disclosures and timing of adoption.
In this discussion, we dig in to highlight key impacts of the new standard which should be of particular interest to those in the healthcare provider sector. Many more complexities exist and there is a lot of guidance available to explore in detail. Today, we’re all about healthcare.
How might the new standard affect the health care sector?
The timing of revenue and profit recognition may be significantly affected by the new standard. Whereas previously IFRS allowed significant room for judgement in devising and applying revenue recognition policies and practices, IFRS 15 is more prescriptive in many areas relevant to the healthcare provider sector. Applying these new rules means new consequences and changes to the profile of revenue, and in some cases cost, recognition.
Companies will need to consider wider implications, work on preparing the market and educate analysts. Such changes might include:
- Changes to key performance indicators and other key metrics
- Changes to the profile of tax cash payments
- Availability of profits of tax cash payments
- Availability of profits for distribution
- For compensation and bonus plans, impact on the timing of targets being achieved and the likelihood of targets being met; and
- Potential non-compliance with loan covenants
Current accounting systems and processes may require changes to cope with the new standard.
What are the most significant changes?
The most significant point to note is when variable or uncertain revenue should be recognized.
In certain situations, it is not uncommon for heath care providers to render patient services without actually knowing how much they will ultimately be paid. For example, a hospital may have to provide emergency services to a patient prior to knowing the amount paid by a private insurer, the government or the patient himself. It is possible for the transaction price differ in these situations depending on is the party responsible for payment. Additionally, the amount ultimately paid may be adjusted as a result of negotiation or dispute and businesses will need to apply judgement to determine whether the adjustment should be accounted for as a concession or as a bad debt.
How should revenue be allocated to the different goods and services?
Given the earlier lack of guidance in IFRS, there was greater room for judgement when identifying the goods and services within a contract and then allocating the revenue to those goods and services. Entities may need to amend their current accounting policies as a result of the more detailed guidance in IFRS 15 and, in particular, the new rules on how revenue is allocated between different items. There may be practical implementation issues in the health care business, particularly where services are often integrated. Patients may be charged for a number of services, diagnosis, pathology and so on.
Which cost relating to a contract will need to be capitalized?
At present, different entities capitalize different costs associated with a contract distinguishing between costs associated with obtaining a contract and those associated with fulfilling it t. In the health care sector, this may be an issue in which significant costs are incurred that are directly attributable to obtaining contracts with customers. Entities will need to exercise judgement to determine the appropriate basis and time period for this amortization.
Finally, anything else that might change?
In addition to those discussed, the new standard introduces detailed guidance in many different areas regarding the reporting of new revenue. Companies will need to ensure they’ve considered all of these when assessing the extent to which their accounting policy for revenue may need to be amended.