Income Statement Update: 5 Things Hospital CFOs Must Know About New Bad Debt Guidance

Last year, the Financial Accounting Standards Board issued new guidance on bad debt for healthcare organizations, including hospitals, and financial leaders may or may not be fully aware of its impact and the potential to misinterpret its applicability.

Essentially, the FASB's guidance, ASU 2011-07, said that if healthcare providers are required to treat patients because they do not have the ability to assess patients' credit risk — in other words, healthcare providers with emergency departments — then they will classify their bad debt expense in a different way.

Jim Grigg, CPA, partner and national healthcare audit practice leader at Crowe Horwath LLP, explains the five most important aspects of the FASB's guidance that hospital and health system financial leadership should understand.


1. Classification of bad debt.
Bad debt expense relating to patient service revenue was previously displayed on hospital income statements as operating expenses. Now, bad debt expense will be displayed as a reduction of gross patient service revenue to arrive at net patient service revenue. (For for-profit healthcare providers, this guidance is effective for fiscal years that started after Dec. 15, 2011; for non-profit providers, the effective date is fiscal years ending after Dec. 15, 2012, but can be adopted early.)

Essentially, healthcare providers are changing where bad debt is reported on the income statement.

Hospital financial leaders must be aware of new bad debt guidance.2. Providers that are affected. The guidance involves a relatively simple change, but it may not impact every healthcare provider. Mr. Grigg says the key phrasing within the guidance is whether a provider can "assess the credit risk" of patients. Providers that must accept patients regardless of the patients' ability to pay are affected by this guidance.

"When this came out a year ago, every healthcare provider that has bad debt — ambulatory surgery centers, rehab hospitals, MRI centers, acute-care hospitals — the initial thought was that bad debts are no longer operating expenses," Mr. Grigg says. "That's not true. That's the first pitfall."

For example, most ASCs, rehab hospitals and other outpatient healthcare providers do not have EDs. They have the ability to assess the credit risk of their patients before performing procedures. Therefore, because a significant amount of their patient service revenue is based on the provider's assessment of the patient's ability to pay, this guidance does not pertain to them. Those providers should still record bad debt as operating expenses.

3. What about health systems with outpatient facilities? Mr. Grigg says there is a technical issue that the guidance does not cover. For example, if a hospital or health system owns and operates an ASC, how should CFOs and other financial leaders record bad debt in the financial statements?

In separate subsidiary statements, acute-care hospitals should present bad debt associated with patient service revenue as a deduction from patient service revenue, according to the new guidance. ASCs, on the other hand, would generally still keep bad debt as an operating expense, assuming they can assess credit risk.

In consolidated income statements for health systems, or at the parent company level, the determination on how to report bad debt would be "an accounting policy election." "If health systems are going to issue consolidated financial statements, they can make a policy election of whether they want to show some bad debt as an offset to revenue [for hospitals] or as an operating expense [for ASCs]," Mr. Grigg says. "It must be disclosed in the footnotes."

4. Ramifications. If hospitals, ASCs and other healthcare providers incorrectly report their bad debt in upcoming fiscal years, there could be some unfavorable consequences.

"The ramifications [of not following the guidance] are that astute lenders would question your financial acumen," Mr. Grigg says. "Second, this would affect comparability. If you have a chain of ASCs, and you adopt this guidance when you shouldn't have, then all of a sudden, you have less operating expenses than other ASCs in the industry. That's going to look odd and could create benchmarking issues."

5. Ways to approach the guidance. Mr. Grigg says there are three primary steps hospital financial leaders should follow to ensure their income statements are up-to-date with the bad debt guidance.

•    Evaluate your methodologies to determine if patient services gross revenue, contractual allowances, charity care and bad debt can be tracked by payor for disclosure purposes.

•    Prepare modified financial statements and disclosures for initial internal evaluation sooner rather than later.

•    Figure out internal/external reporting indicators impacted by changes and discuss this guidance with oversight bodies, rating agencies and other regulatory entities.

More Articles on Hospital Bad Debt:

7 Areas That Will Influence the Finances of Safety-Net Hospitals

New Bad Debt Accounting May Impact Hospital Bond Covenants

Fitch: New Bad Debt Reporting Guidelines Better for Hospitals

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