New Revenue Recognition Standards Loom

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

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.

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

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.

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.

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.

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.