Highlights of the Draft Health Care Audit Guide

1. Kimberly McKay, Partner BKD, LLP Highlights of the Draft Health Care Audit Guide

2. AICPA’s Health Care Audit Guide • Published on the AICPA website on April 6, 2011 • http://www.aicpa.org/InterestAreas/AccountingAndAuditing/Resources/AcctgFinRptg/AcctgFinRptgGuidance/Pages/WorkingDraftHealthCareOrganizations.aspx • Comment Period was open until June 6, 2011 • Only 11 comment letters submitted and 9 were on a CCRC issue • Anticipated production date by September 30, 2011

3. AICPA’s Health Care Audit Guide • First comprehensive revision since 1996 • FASB Accounting Standards Codification (ASC) changed the structure of all accounting & reporting standards

4. Objectives of the Guide • Supplemental guidance, not a complete set of GAAP or GAAS • Highlights issues prevalent to health care organizations • Improve clarity & reduce variance in practice • Improve user friendliness

5. Objectives of the Guide • Guide is no longer authoritative, references ASC throughout • GASB has not finalized their codification project at this time • Describes FinREC’s understanding of certain issues & may indicate FinREC’s preference

6. Preview of the Health Care Audit Guide

7. Chapter 1 – Unique Considerations of Health Care Organizations • Scope of the Guide – Who is included • Senior Independent Living – Exercise judgment • Does not apply to Foundations • Regulatory environment • General discussion of Health Care Reform • 501(r) regulations • Updates will be made as necessary

8. Chapter 2 – General Audit Considerations • General auditing guidance • Example footnote – Audit procedures do not include testing of tax exempt status, Medicare & Medicaid regulations. Management is responsible for compliance • HIPPA Business Associate Agreements • SOP 00-1 on auditing third-party revenues • Risk-based capital requirements

9. Chapter 3 – Unique Considerations for Not-for-Profit Organizations (NEW) • Discusses the performance indicator (revenues over expenses) & what is excluded • Provides for the flexibility of having other intermediate subtotals • Can report natural or functional classification of expenses on the statement of operations • If you report natural classifications, ASC 958-205-55 requires functional classification in the footnotes

10. Chapter 3 – Unique Considerations for Not-for-Profit Organizations (NEW) • CCRCs can have an unclassified balance sheet • Puts into words what the example financials used to provide • Source of publicly available example financial statements

11. Chapter 3 – Unique Considerations for Not-for-Profit Organizations (NEW) • Subsequent event disclosures (ASC 855) • Conduit debt obligors • If the debt has not begun trading in a public market – Evaluate subsequent events up through the date financial statements are available to be issued • Public trading – Evaluate subsequent events through the issuance date of the financials

12. Chapter 4 – Cash & Investments • Centralized cash management arrangements – Subsidiaries would show a receivable from an affiliated organization not cash under ASC Topic 230 (FAS 95) unless the subsidiary has legal title to the deposit • Would be an investing activity on the cash flow statement • Cash from restricted donations not reported separately unless required by ASC 954-305-45 (i.e., designated for long-term purposes)

13. Chapter 4 – Cash & Investments • Election of trading securities ASC 320 • Trading securities unrealized gains & losses are within the performance indicator & therefore OTTI would not apply • Additional guidance on impairment of investments • Election of fair value option ASC 825 • Unrealized gains & losses would be within the performance indicator

14. Chapter 4 – Cash & Investments • Additional guidance on alternative investments • Cost, Equity or Fair Value methods – See table in Chapter 12 • ASC 820-10 practical expedient for using NAV as fair value

15. Chapter 5 – Derivatives (New) • ASC Topic 815-30 (FAS 133) & ASC Topic 815-25 (FAS 161) • Cash Flow Hedges vs. Fair Value Hedges • Statement of operations presentation considerations • Fair Value Hedge – In the performance indicator • Cash Flow Hedge – Effective portion excluded from the performance indicator & ineffective portion is included in the performance indicator

16. Chapter 5 – Derivatives (New) • Guidance on when a hedge is terminated or cash flow hedging is terminated • Examples • Hedges • Embedded derivatives • Puts & calls • Swaps

17. Chapter 6 – Property & Equipment & Other Assets • Intangibles ASC 350 • Types of intangibles • Evaluation goodwill for impairment • Capitalized Interest ASC 835-20 • Two different methods – tax-exempt debt for the project or outstanding borrowings • Does not apply to construction acquired with restricted contributions

18. Chapter 6 – Property & Equipment & Other Assets • Asset retirement obligations • Asbestos & other environmental remediation obligations • Impairment of long-lived assets • Discontinued operations • ASC 350-40 internally developed software costs

19. Chapter 7 – Municipal Bond Financing (NEW) • Definition of a public entity for reporting purposes (traded in a public market) • EMMA (Electronic Municipal Market Access) • Obligated group statements • Classification of remarketing & variable rate demand bonds • Extinguishment of debt & defeasance guidance • Arbitrage • Guidance on auditor association with municipal debt offerings

20. Chapter 7 – Municipal Bond Financing (NEW) • Unresolved Issue – How should debt be recorded on a stand alone entity that is a member of an obligated group is there is joint and several liability? • Stay tuned………….

21. Chapter 8 – Contingencies & Other Liabilities • ASU 2010-24 Gross presentation of insurance recoveries • Effective date for fiscal years beginning after December 15, 2010 (calendar year-end 2011)

22. Chapter 8 – ASU 2010-24 • In current practice, health care organizations show liability for many common contingencies net of insurance recoveries (i.e., offsetting) • Decision is that net presentation should not be permitted & a receivable from the insurance company should be evaluated & presented separately, if appropriate

23. Chapter 8 – ASU 2010-24 • Any difference between recognized liabilities & insurance receivables will be recognized as a cumulative effect adjustment • Retrospective application is permitted • Need to evaluate if you have a system to capture appropriate information to record insurance claims & recoveries at gross

24. Chapter 8 – Contingencies & Other Liabilities • Malpractice Accruals – ASC Topic 954-450-25-2A indicates that accruals should not be on funding amounts because the risk of adverse deviation does not meet criteria of a liability • Discussion of discounted versus undiscounted liability

25. Chapter 8 – Contingencies & Other Liabilities • When discounting may be appropriate • Liability is fixed or reliably determinable • Amount & timing of cash payments is fixed or reliably determinable • Expected insurance recoveries are also discounted • Auditor should consider tests of estimates & timing of payments

26. Chapter 8 – Contingencies & Other Liabilities • FinREC believes that if an entity discounts accrued malpractice claims they should disclose in footnotes • Policy on timing of recoveries • Policy for discounting claims • Interest rate used • Undiscounted amounted of accrued claims

27. Chapter 8 – Contingencies & Other Liabilities • Claims made insurance accruals – ASC Topic 720-20-25-14 – Recognize an IBNR if loss is probable & reasonably estimated • 720-20-30-2 states purchasing tail coverage is not relevant in determining loss to be accrued (cannot net an insurance receivable) • Need to consider the need for an IBNR on claims made insurance accruals

28. Chapter 8 – Contingencies & Other Liabilities • Physician guarantees • Minimum revenue guarantees • Record a liability initially measured at fair value • Most entities also record an intangible asset that is amortized over life of the contract • Financing transactions • Accounted for as loans

29. Chapter 8 – Contingencies & Other Liabilities • Compensation related liabilities • Deferred compensation arrangements • Post retirement & employment benefits • Tax considerations for not-for-profit entities, including uncertain tax positions

30. Chapter 8 – Contingencies & Other Liabilities • Provider fees – TPA 6400.30 • If there is a guaranteed return by the state it should be recorded as a receivable • If monies go into a pool – Payments should be recognized as an expense • Subsequent reimbursements from the pool should be recognized as revenue when payment is assured & entitled

31. Chapter 9 – Net Assets (Equity) • Net asset classifications • Releases from restriction • Temporarily restricted funds must be used first unless the expense is directly attributable to another source of revenue (i.e., a cost reimbursed contract) • ASC 954-210-50 restrictions on contributions of long-lived assets are satisfied when the asset is placed in service • UPMIFA disclosures • Noncontrolling interest of a consolidated subsidiary should be a separate component of net assets

32. Chapter 10 – Health Care Service Revenue & Related Receivables • Different revenue arrangements (capitated, episodic, fee for service, etc.) • SOP 00-1 Auditing third-party revenues • Retroactive adjustments – Reasonable estimates should be made based on entity specific information • 954-605-35-1 requires differences in original estimates & final settlements to be disclosed • Settlements can only be netted if a right of offset exists

33. Chapter 10 – Health Care Service Revenue & Related Receivables • FinREC recommends additional disclosures • Disclose settlements from each significant third-party payor • Provide a summary of activity for each operating period • Disclose status of third-party settlement claims

34. RAC Accruals • Will not be specifically addressed in the Health Care Audit Guide • HFMA Principles & Practices Board white paper

35. Chapter 10 – ASU 2010-23 • Charity care – Current guidance requires disclosure of charity care revenue recognition policy & amount, if material • Effective for fiscal years beginning after December 15, 2010, early adoption permitted

36. Chapter 10 – ASU 2010-23 • Costs should be determined on the basis of direct & indirect costs related to providing the service • Required disclosures • Subsidies received intended to compensate an entity for providing charity care, i.e., uncompensated care fund • Description of the method used to determine the costs of providing charity care

37. ASU 2011-07 Disclosure of Bad Debts • Revenue recognition project – Not complete so excluded from the Guide • Heard at March 18, 2010 EITF meeting, (EITF Project 09-H) • Current practice – Revenue recorded at gross charges, then uncollectible amounts are deducted as an expense (except for GASB)

38. ASU 2011-07 Disclosure of Bad Debts • Presentation of Bad Debts net against revenue • Ratified by FASB December 1,2010 • Rescinded December 8, 2010, & re-exposed • Re-issued July 2011 • FASB will still continue with their revenue recognition project.

39. ASU 2011-07 Disclosure of Bad Debts • Bad debts will be shown as a separate line under patient service revenue when an entity does not assess a patient’s ability to pay • Two exceptions • Bad debts on items other than patient service revenue, ie. Rent revenue • If a health care entity only records revenue to the extent it expects to collect that amount.

40. ASU 2011-07 Disclosure of Bad Debts • Additional disclosure requirements • Policies for recognizing revenue and determination of bad debts by major payor source • Qualitative and quantitative information about significant changes in the allowance for doubtful accounts, which may include the amount of write-offs by payor class, significant changes in underlying assumptions or estimates • Effective for non-public entities the first annual period ending after December 15, 2012 with early adoption permitted

41. ASU 2011-07 Disclosure of Bad Debts • Stay tuned for additional guidance when consolidated entities have different practices in evaluating collectability • i.e. Hospital and an a surgery center

42. Chapter 11 – Contributions Received & Made • Contributions of long-lived assets • Contributions vs. exchange transactions • Pledges & promises to give • Not-for-profit organizations that raise or hold contributions for others • Split-interest agreements

43. Chapter 12 – Reporting Entity & Related Entities • Mergers & acquisition guidance • Diversity in practice • Necessary due to the elimination of pooling of interest method • Subsequent accounting for goodwill & intangibles • Noncontrolling interests

44. Accounting for Mergers • Carryover basis at merger date • GAAP assets & liabilities carry over • Carry forward classification & elections • Exceptions • Merger results in modification of a contract • Reclassification necessary to conform accounting policies

45. Acquisition Method • If a transaction is accounted for as an acquisition • Same as acquisition under ASC Topic 805 (FAS 141(R)) • Steps • Identify acquirer • Determine acquisition date • Generally the closing date • Recognize assets acquired & liabilities assumed at FV • Recognize & measure goodwill or contribution received

46. Chapter 12 – Reporting Entity & Related Entities • Comprehensive table on various types of relationships & how to account for them • Consolidation guidance • Equity transfers & transactions • Investor-owned entities • Variable interest entities

47. Chapter 13 – Managed Care Services • Presentation & disclosure considerations • Accounting for health care costs • Accounting for loss contracts • Premium revenue is expected to cover health care costs – Losses should be recognized when probable • Accounting for stop-loss insurance • Amounts recoverable from stop-loss insurers should be recorded as a receivable

48. Chapter 14 – CCRC’s • Guidance on refundable fees paid only from re-occupancy • Most controversial • If the resident agreement does not stipulate that the refundable amount is limited to re-occupancy the advance fee will be reported as a liability • Guide was re-instated to delete the above sentence • White paper has been drafted to go to the EITF which discusses different alternatives. Leans towards getting rid of the re-occupancy language

49. Chapter 14 – CCRC’s • CCRC’s can show an unclassified balance sheet • FINrec believes that CCRC’s should disclose • Amounts classified as current & noncurrent for deferred revenues • Any applicable state regulatory requirements • Amount of advance fees that are subject to repayment based on the resident’s ability to terminate the agreement

50. Chapter 15 – Unique Considerations of Government Health Care Entities • GAAP Hierarchy • Category A – GASB statements • Category B – GASB technical bulletins & if cleared by GASB AICPA Audit Guide & SOPs • Category C – AICPA Practice bulletins • Category D – Implementation Guides published by GASB staff