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 being included in the AICPA’s revenue recognition guide.
In our previous article, we examined the effect the Standard would have on the primary revenue streams of CCRCs, as well as the effect on monthly service fees and entrance fees. This article focuses on two additional items that are likely to affect most CCRCs as they work through implementing the Standard.
Contract Costs (Deferred Marketing Costs)
Under previous accounting guidance, CCRCs could capitalize certain costs incurred to obtain new CCRC contracts. These costs were defined as those essential to acquiring initial contracts (costs incurred through the date of substantial occupancy or one year following completion) and included costs of processing contracts, soliciting potential initial residents and salaries, wages and benefits related to initial contract acquisitions. These capitalized costs were then amortized over the shorter of the average remaining life expectancy of the residents from the initial contracts or the contract period on a straight-line basis.
With the changes under the Standard, only the “incremental costs of obtaining a contract with a customer” can be capitalized. Incremental costs are defined in FASB Accounting Standards Codification (ASC) 340-40-25-2 as “those costs that an entity incurs to obtain a contract that would not have been incurred had the contract not been obtained.” Specific examples of costs that can be capitalized are items such as sales commissions, contingent legal fees paid only upon successful negotiation of a contract and other similar costs.
In other words, expenses a CCRC incurs, whether or not a contract is obtained, can no longer be capitalized even if those costs directly relate to the acquisition of a contract. For example, marketing costs associated with getting a unit ready to show a potential resident are no longer allowed to be capitalized under the new guidance. However, if there are capital improvements made to a unit in order to sell the unit, the organization would still follow the fixed asset capitalization rules.
One additional change related to contract costs is that incremental costs must be capitalized when incurred to obtain any new CCRC contract, not just those for initial contracts (new construction). This allows for costs such as sales commissions paid for new resident contracts, even at existing CCRCs, to be capitalized.
Contract costs meeting the requirements under the new guidance are to be amortized on a “systemic basis that is consistent with the transfer to the new customer of the services or goods to which the asset relates.” Based on this guidance, amortization of contract costs should mirror the methodology used to amortize nonrefundable entrance fees based on the options reviewed in our previous article on the effect of ASC 606 on CCRC accounting.
This change in the accounting for contract acquisition costs will likely mean many of the previously capitalized costs, such as marketing salaries and wages, would no longer meet the requirements under the Standard and will need to be expensed.
To account for existing deferred contract (marketing) costs upon adoption of the new standard, CCRCs should write off any remaining unamortized deferred costs that wouldn’t meet the requirements under the new guidance. Consideration should be given to materiality related to these previously capitalized costs, and CCRCs should consider reviewing payroll records for items allowed to be capitalized under the current standard, such as sales commissions, as a basis for what to maintain as deferred marketing costs under ASC 606. This write-off will need to be done as a cumulative-effect adjustment to beginning net assets of the earliest period presented in the period of adoption.
Future Service Obligation
The Standard doesn’t change the guidance from FASB ASC 954-440 for the required calculation by CCRCs of the obligation to provide future services and use of facilities to current residents. However, this future service obligation (FSO) calculation could be affected by certain changes addressed above related to implementation of the Standard.
First, the potential for a change in the timing of revenue recognition for nonrefundable Type A contracts if a CCRC changes its amortization methodology to be over the pattern of transfer of services rather than straight-line could result in a different unamortized deferred revenue amount to be included in the FSO calculation. In addition, changes to the guidance for accounting for contract costs described above could change the timing of when such costs are recorded as expense.
CCRCs should evaluate the impact of these items on their financial statements as well as the new required disclosures for all entities regarding revenue recognition. Implementation of these changes should be assessed as early as possible, as there are several aspects of the Standard that could have a significant effect on CCRCs and may take some time to gather the necessary information to apply the Standard correctly.
If you have questions about the Standard’s effect on your CCRC, contact Becky or your trusted BKD advisor today.