When Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606) (the Standard), was issued several years ago, there were many questions related to its implications on life plan communities or continuing care retirement communities (CCRC). As the required adoption dates for nonpublic entities approach, the American Institute of CPAs (AICPA) has issued clarification on CCRC-specific topics that were addressed by its Health Care Entities Revenue Recognition Task Force, which is now included in the AICPA’s revenue recognition guide.
This article focuses on the various fees that CCRCs receive in their operations and the Standard’s effect on the accounting for those fees. See the related follow-up article “Revenue Recognition for CCRCs: Marketing Costs & FSO” for an overview of the Standard’s effects on marketing costs and the future service obligation. Furthermore, as CCRCs have some revenue streams that are similar to those of other health care entities (such as patient or resident care revenue), BKD’s white paper on revenue recognition for health care entities also may provide helpful guidance.
Before we jump into the effect of the Standard, review the following key financial terms related to CCRCs, since various terms used in the industry describe similar financial arrangements (for example, entrance fees and advance fees are often interchangeable).
- Entrance fee or advance fee – The fee paid by the resident upon entering the resident contract
- Monthly service fee – Fees to cover various costs of care
- Type A contracts – Also known as life care contracts
- Type B contracts – Also known as modified contracts
- Type C contracts – Also known as fee-for-service contracts
Now let’s look at the effect the Standard will have on these fee arrangements.
Monthly Service Fees
Most CCRC resident agreements require a separate monthly service fee (outside of the entrance fee paid). For Type A contracts, the monthly fees entitle the resident to use the residential facilities and other amenities, as well as have access to health care services. These fees are typically specified in the resident agreement and generally are fixed other than periodic (typically annual) changes based on inflation or increased operating costs. For Type B and C contracts, this monthly service fee is for the use of residential facilities and other amenities but increases when access to higher levels of health care services is required.
The accounting for the monthly service fees, in particular the Type A contract monthly service fees, was an area of focus for the AICPA task force regarding the effect of implementing the Standard. The guidance from the task force is that these monthly fees are included in the transaction price as the monthly options to extend the contract are exercised. Therefore, the monthly service fees on all contract types would be recorded as monthly revenue with no changes from the current approach under the Standard.
Refundable Entrance Fees
Under the Standard, all refundable entrance fees should be recorded as a liability at the inception of the agreement. The amount recorded as a liability should be measured at the amount for which the CCRC doesn’t expect to be entitled and is determined at the inception of the agreement. This will likely be a change for those who (under ASU 2012-01) were amortizing into revenue refundable entrance fees, which were limited by policy to the proceeds from the reoccupancy of the unit.
Nonrefundable Entrance Fees
Under the new standard, CCRCs have options when it comes to amortizing revenue from deferred entrance fees under Type A contracts. The current time-based allocation method of amortizing deferred entrance fees into revenue straight line over the life of the resident may still be appropriate; however, the new standard also provides other options. The method of determining how to amortize the deferred entrance fee will require significant judgment by management and should be disclosed in the notes to the financial statements.
CCRCs can now amortize deferred entrance fees into revenue based on when future estimated costs or services are expected to be provided. This method involves estimating the amount of time and likelihood of a resident using the various levels of service provided by the CCRC. It’s expected that this method of amortization will lead to less amortization in the early stages of the contract (when it’s expected the resident will be in independent living) and greater amortization in the later stages of the contract (during the period it’s expected the resident would occupy an assisted living or skilled nursing unit). This measurement method is more complex than the current straight-line method and may require the use of an actuary to estimate the allocation timing, although it may make sense for startup facilities or existing facilities that are looking to match the amortization of their Type A contract to the service period when reviewing their future service obligation.
After the initial measurement, it may be necessary to make changes to the relevant assumptions used (such as the life expectancy under the first approach above or the amount of time spent by each resident at a specific level of care under the second approach). Since nonrefundable entrance fees are deemed to create a material right for access to future benefits, any changes in estimates would be accounted for prospectively.
Significant Financing Component Consideration
One other consideration for nonrefundable entrance fees under the Standard is the determination of whether or not each contract contains a “significant financing component,” which means it provides a significant benefit of financing to either party (the resident or the CCRC). As most CCRC contracts don’t stipulate what the funds paid for the entrance fee are to be used for, this assessment will require judgment. The concept that entrance fees are an advance payment for services doesn’t inherently mean they have a significant financing component.
The Standard states that “in some circumstances, a payment in advance … in accordance with the typical payment terms of an industry or jurisdiction may have a primary purpose other than financing.” In many cases, residents choose to move into a CCRC for the security it provides, including the availability of all levels of health care for the future if they’re needed. A CCRC effectively agrees to stand ready to provide that care with the payment of the entrance fee. This seems to show that most entrance fees don’t contain a significant financing component, but keep in mind there are certain situations where it may be determined this isn’t the case—for example, in a facility being constructed, it could be possible that entrance fees are being used to cash flow the construction rather than taking out additional financing.
Accounting for the Standard by CCRCs will require some significant planning and consideration. For more information, contact Becky or your trusted BKD advisor.