by Kim Harrison, Financial Analyst
The goal of the accounting function in any business, including healthcare, is to report on a company’s transactions of economic substance. Financial reporting should be communicated in a way that is accurate, consistent, and timely. In the United States, accounting practices must adhere to generally accepted accounting principles (GAAP), which are organized and communicated through the Accounting Standards Codification (ASC). ASC is maintained by the Financial Accounting Standards Board (FASB). Revenue recognition for most healthcare companies is currently governed by ASC Topic 606, Revenue from Contracts with Customers.
Revenue recognition — which “identifies the specific conditions in which revenue is recognized and determines how to account for it” — is an essential concept for all healthcare companies, especially those looking to make an exit. Investors will want to know that revenue is recognized in a manner consistent and appropriate for the healthcare industry. Not adhering to revenue standards may affect the earnings on which your transaction is priced and can have a significant impact on your net proceeds.
Recent changes in accounting standards, including those relating to revenue recognition, move towards principles-based accounting as opposed to traditional, rules-based accounting. Principles-based accounting, the most popular system globally, is founded on the belief that it is better to adjust accounting principles to a company’s transactions rather than adjust a company’s operations to accounting principles. This gives companies more freedom in reporting and less complexity than rules-based principles. The framework standardizes revenue recognition across industries, making it easier for investors and other consumers of financial statements to compare results.
The framework of ASC 606 recommends that healthcare companies recognize revenue when control of goods or services transfer to the customer in the amount of consideration the healthcare organization expects to receive. The FASB has defined a five-step approach that healthcare companies should follow when applying this standard:
- Identify the contract(s) with a customer
- Identify the performance obligations
- Determine the transaction price
- Allocate the transaction price
- Recognize revenue when/as performance obligations are satisfied
Below we will take a closer look at each of these steps. Before we do so, it should be noted that this standard does not apply to insurance contracts, lease contracts, financial instruments, guarantees, and nonmonetary exchanges. It also excludes contributions and collaborative agreements. Healthcare companies that fall under ASC Topic 954: Health Care Entities and their insurance-driven revenue are included in the scope of ASC 606. Insurance entities engaged in administrative services only (ASO) contracts must adhere to ASC 606 for those contracts.
