A little known specialty within accounting, asset lifing seeks to answer these questions and provide hospitals and health systems millions of dollars in annually recurring benefit to their bottom line.
Experts at Chicago-based Prism Healthcare Partners LTD and Principle Valuation LLC, a member of Prism Healthcare Partners, sat alongside client SCL Health, an 11-hospital health system headquartered in Colorado, to explain how they worked together to realize over $50 million in annual depreciation reductions, which translated into a stronger balance sheet and income statement.
Janice James, managing partner of Prism, and Timothy Baker, managing partner of Principle Valuation, talked about the process and benefits of asset relifing. Lydia Jumonville, CEO and EVP/CFO for SCL Health, and Kyle Engman, vice president, chief accounting officer and controller for SCL Health, discussed why it worked for their organization.
1. What is asset lifing and why does it matter for hospitals?
Timothy Baker: “Asset life sets the stage for the depreciation expense (rate of depreciation) associated with any fixed asset, from a wheelchair to the buildings that comprise a hospital. Until 2001, Medicare incentivized depreciating assets quickly to maximize cost reimbursement. These assets remained on the books and in the hospital long after they were fully depreciated. While this incentive disappeared 16 years ago, many hospital accounting departments continue to use shorter lives and accelerated depreciation.”
“For decades, hospitals have utilized the lives assigned to assets by the American Hospital Association (AHA), which tried to maximize the rate of depreciation due to the old Medicare cost reimbursement methodology. Those guidelines use shorter lives which accelerate depreciation and reduce a hospital’s bottom line.”
“Our study of asset lives at more than 400 hospitals found that actual lives are much longer than the AHA guidelines assign. Relifing assigns a more realistic life for an asset and reduces depreciation expense. While the reduction in depreciation is a non-cash benefit, it increases operating income and can lead to better bond ratings, as well as reduced costs associated with insurance and capital expenditures. Hospital execs are often surprised by the magnitude of benefit we find.”
2. Was SCL Health surprised?
Lydia Jumonville: “Yes. I actually didn’t think the benefit would be that big. Principle Valuation gives conservative estimates, and even the conservative estimate sounded really good. We didn’t expect to see $50 million in annually recurring benefit.”
3. So, why did SCL Health embark on this project?
Kyle Engman: “The motivation on our part was to get a lower depreciation expense through correcting asset lives, and having those lives be a little more realistic. Once we saw how that worked in our pilot at St. Francis Health, where more than $3 million in annual benefit was identified, we made a decision to do it across the entire system.”
Lydia Jumonville: “It also gave us peace of mind. To have somebody come in and clean up our asset records and get some consistency was a big deal. And we also learned how to use Principle Valuation’s study, so we have a standardized asset depreciation methodology across the system for future purchases.”
Kyle Engman: “Especially after merging with Exempla Healthcare in 2009, it was important to work toward standardization. It’s easy to think the AHA guidelines made everything consistent but sometimes it’s not that straightforward. The AHA list isn’t that long. We hadn’t consistently used AHA lives in each system, so this project brought much needed uniformity to our merged system.”
4. Could you give an example of how this works?
Timothy Baker: “Think about a helicopter. The AHA guidelines estimate a helicopter should last four years. Studies show, including ours, that helicopters last 30 years with proper maintenance. Under the old method, the balance sheet of the hospital after four years would show that the helicopter is fully depreciated and has no value. But in reality it should last approximately another 25 years. This is only one of many assets that, without relifing, would cause the balance sheet and many operating ratios to be inaccurately presented. Rating agencies look at these numbers, and you always want them to see your hospital in the best – and most accurate – light.”
“A helicopter is just one line item, but you have to multiply that out across all fixed assets. Our findings are pretty dramatic when it comes to buildings. The AHA guideline is 40 years (average), but we might estimate 70, 80, even 100 years on some building components, such as foundations and frame. With maintenance and remodeling, initial construction components remain intact and last a long time.”
5. Aside from more favorable operating ratios and cleaned up books, are there other benefits?
Janice James: “Writing off assets too quickly can negatively impact the fair market value of a hospital or system and also make it more difficult to borrow money. After relifing, some organizations will see reduced insurance expenses, and keep in mind insurance companies generally won’t issue a new policy for an asset that is more than 50 percent depreciated.” (SCL Health is self insured so this benefit didn’t apply to them.)
“For SCL Health, the biggest benefit of relifing came from improved operating ratios, which affect ratings, and it gave them accurate, consistent books.”
6. Since the project reviewed assets throughout the system, how big was the time burden to your finance staff and others at SCL Health?
Janice James: “We requested asset records for each location and then did a tour of each facility with facility engineers at each care site. The whole process can be completed in weeks.”
Kyle Engman: “It certainly wasn’t overwhelming or intrusive. I’d say any disruption was minimal and worthwhile.”
7. What did your auditors think? Did they agree with the results?
Kyle Engman: “They had questions. They wanted to make sure the lives made sense, but at the end of the day they took no exception to the changes.”
Lydia Jumonville: “From my perspective, they did exactly what they should do. They needed to know there was a rationale and support.”
Timothy Baker: “Principle Valuation reviewed everything with the auditors and explained the study of assets, culled from more than 400 hospitals, that we use to support our findings.”
8. Did you have to restate your financial statements or make any footnotes in the audit report?
Kyle Engman: “No, we did not have to restate our financial statements. This was a change in accounting estimate, which does not require a restatement. The benefits were made retroactive to our financial statement for the entire fiscal year, so we were able to record a full year of benefit. A note in our audit report was made about the assessment and implementation of the asset lifing study due to the significance of the benefit identified.”
9. Would you recommend asset lifing to other healthcare executives?
Lydia Jumonville: “Yes, I already have.”
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