You have likely heard of the new accounting standard – ASU 2016-13, better known as Current expected credit losses or CECL. CECL impacts all companies following Generally Accepted Accounting Principles (GAAP) financial statements. The standard became effective for calendar year-end entities in January 2023. Companies should review their balance sheets to identify potential financial assets that are in scope under the new standard. These assets include trade receivables (including Medicaid/Medicare receivables), loans and notes receivables, as well as certain leasing arrangements. The purpose of the new standard is to take a proactive approach to determining credit losses opposed to reactive approach under prior GAAP.
CECL requires companies to measure expected losses for financial assets based on historical experience, current conditions, and reasonable supportable forecasts. Just the mere fact that the company doesn’t have bad debt year over year does not mean that there is no requirement to record an allowance for credit losses (formerly an allowance for bad debts). Developing the CECL allowance requires judgment and selection of methods that are appropriate for their industry and their business practices to determine the proper credit loss. However, no matter what the method is it must be developed in a sound and reasonable manner.
There are many factors to consider as part of the methods for calculating an allowance such as the credit risk of your major payors (i.e., Governmental payors, major commercial insurers, etc.). Do you have the correct consideration for credit risk, specifically with regards to your current price concession and any component that is attributable to credit risk (generally self-pay accounts). An additional consideration is the fact that many healthcare entities need to understand the interplay between CECL and ASC 606.
Healthcare entities, under Accounting Standards Codification (ASC) 606, already utilize sophisticated methodologies for calculating the amounts that they expect to collect from contracts with customers based on current contracts with payors, financial aid, and charity care policies. Oftentimes accounts receivables are recorded net of implicit and explicit price concessions. Some entities also may record an allowance for credit losses, to represent risk of loss not contained within the price concessions. This allowance is most commonly applicable for entities that already perform an evaluation of the resident or patient’s ability to pay prior to providing services, such as in a long-term care facility. This allowance is not common in hospitals who provide services regardless of ability to pay. As a result, hospitals now need to consider future factors in determining if an allowance should be recorded in addition to previous price concessions. This is a change to past practices. For instance, many healthcare entities may need to consider current conditions and (especially) the foreseeable (1-2 year) future in determining if an allowance should be recorded. At a minimum, a healthcare entities’ financial statements will change on the face, as well as include additional disclosures to help users understand how credit losses are estimated.
Healthcare entities have always assessed the history of payment, versus financial institutions who did not consider the probability of payments. Trade receivables are often current, and therefore the assessment into the foreseeable future does not have a lengthy forecast horizon as compared to a mortgage or similar.
Some healthcare entities do have certain financing receivables, such as notes receivables with external parties. These financing receivables also need to be assessed for credit risk and loss, and disclosures may need to be added. The items impacting the financial statements of a healthcare entity are expected to be as follows:
- The allowance for doubtful accounts will now be called the allowance for credit losses
- Any reference to bad debt expense should be called credit loss expense
- The amount of the allowance for credit losses should be note on the balance sheet
- A roll forward of the allowance for credit losses should be included in the footnotes
- The policy footnote regarding the calculation of the allowance for credit losses will need to be expanded to include additional detail of management’s methodology for calculating the allowance based on historical experience, current conditions, and reasonable supportable forecasts. This would include detail of the risk characteristics considered (aging categories, customer credit rating etc.)
Things to consider:
What is the credit risk of your major payors? Governmental payors, major commercial insurers, etc.? How much of your explicit and implicit price concession, or historical allowance for bad debts is related to credit risk?
It is feasible that the amount of your current price concession that is attributable to credit risk (generally self-pay accounts) is not material? Be sure to obtain auditor buy-in on this.
What are receivables are in scope, other than trade receivables? Do you have significant financing receivables? Reinsurance receivables?
Are you able to roll forward your allowance for credit losses, as newly defined?
Work with your business office to develop or update your narrative regarding your policy for assessing credit risk.
Have the key users of your financial statements aware of these changes to your financial statements?
Navigating the implementation of CECL can be complex and time consuming. If you need further guidance or have any questions on CECL implementation, we’re here to help. Please do not hesitate to reach out to discuss your specific situation.
This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.
