As your Life Plan Community (CCRC) begins to evaluate the effect of the revenue recognition standard, Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606), it would help to visualize peeling back an onion’s layers. One’s intentionality, diligence and timeliness may determine the amount of tears this particular onion causes.
The first layer to deal with is the standard’s effective date for your organization. Topic 606 affects all organizations—not just CCRCs—but whether your organization is a public entity determines when the standard is effective. Check out this resource to help determine if your debt obligation(s) meets the definition of a public entity, i.e., a not-for-profit entity that has conduit debt.
Not-for-profit conduit debt obligors that meet the definition of a public entity are subject to the new revenue recognition standard effective for years beginning after December 15, 2017. For example, if your organization is on a calendar year-end, the standard is effective for your interim financial reporting beginning in January 2018. If your organization doesn’t have public debt obligations, the standard is effective for years beginning after December 15, 2018. For organizations on a calendar year-end, this would mean the reporting period starting January 2019.
Once this outer layer has been peeled back, the next layer revealed is the accounting and disclosures related to how revenue is recognized. Revenue now will be recorded using a collectibility threshold that must be met. In the simplest of terms, this means you would no longer have contractual adjustments or bad debts because you’re only recording revenue to the extent it is probable that the revenue is collectible. Careful consideration will need to be given to the recognition of revenue on the front end of your accounting cycle instead of relying on history and the aging of accounts receivables to set allowances for uncollectible items. If there’s a change in your credit assessment, it’s still possible you’ll have an amount recorded to bad debts; however, to know if the subsequent event is a bad debt or a change in revenue, you would need to determine if there’s a change in the credit assessment or if it’s a change in transaction price. Similarly, disclosures have been expanded to include both qualitative and quantitative disclosures. While there’s no prescribed method you must follow in your disclosures, you must disaggregate the revenue. CCRCs may choose to do this by service type, payor type, contract type or any other breakout that’s helpful to readers of the financial statements.
On to the next layer. For those CCRCs with Type A contracts, the new standard brings a complexity in how entrance fees are recorded. The American Institute of CPAs Health Care Entities Revenue Recognition Task Force (RRTF) just released a white paper on the different options to consider in recognizing revenue for CCRCs. The white paper is in draft form and will be exposed for a 60-day comment period. While the option of ‘straight-line’ amortizing these deposits into revenue over the expected lives of the resident(s) is still allowed, the interpretive guidance from the RRTF allows for a ‘pattern of transfer’ form of revenue recognition. This alternative recognizes more revenue in later years when the resident is actuarially estimated to move to a higher level of care. Each progressively higher level of care (assisted living and long-term care) recognizes a higher proportion of the resident’s deposit(s) as revenue. This new option could potentially lower an organization’s future service obligation over time. Organizations that should consider this option are those with a future service obligation liability or small surplus.
Another onion layer is to consider if your entrance fees contain an element of a significant financing component. If a CCRC deems a nonrefundable entrance fee arrangement actually contains a material financing component, the organization will need to record the financing component separate from the transaction price. See the white paper referred to above for more details on the consideration of a significant financing component.
We’ve now arrived at the onion’s core, which reveals that Topic 606 requires organizations to consider the different types of costs incurred to obtain and fulfill a contract and whether an asset should be recognized for those costs. If a cost is incremental to obtaining a contract, that cost would be capitalized as an asset. For example, if a sales commission is only paid when a unit is sold, the commission is incremental to obtaining the contract and, therefore, would be capitalized and expensed over the estimated life of the resident. The RRTF released a white paper on February 1 that covers the changes in contract acquisition costs.
As you prepare your first reporting period subject to the new revenue recognition standard, it’s important to understand all the intricacies of the new standard and which elections and disclosures your organization may want to elect. While we’ve peeled back a little of the onion for you in this article, the next step is to dice the onion by understanding the five-step model that is the core of the new revenue standard. If you’d like to further understand how these developments will affect you, contact us today.
Keep an eye out for future articles that will cover this important topic in greater detail.