Chapter 14

1. St. Luke’s Episcopal Health System Chapter 14 Granof & Khumawala-6e Chapter 14 Health Care Providers

2. Learning Objectives • Understand different organizational forms for providing health care services. • Know the authoritative accounting literature that governs health care entities. • Understand accounting and reporting issues for healthcare providers such as accounting for: • Revenues and expenses • Fee for service revenues • Capitation revenues • Bad debts and charity care • Malpractice claims • “Retrospective” insurance premiums • Journalize transactions and prepare the basic financial statements for not-for-profit health care providers. Granof & Khumawala-6e Chapter 14

3. Health Care Organizations (HCOs) • Types of Services: • Clinics and individual (or group) practices • Continuing care retirement communities (CCRC) • Health maintenance organizations (HMOs) • Home health agencies, e.g., hospice • Hospitals • Nursing homes • Rehabilitation centers Granof & Khumawala-6e Chapter 14

4. Classification of Health Care Organizations • Investor-Owned Health Care Enterprises • Not-for-Profit, Business-Oriented Organizations • Governmental Health Care Organizations • Not-for-Profit, Nonbusiness-Oriented Organizations Granof & Khumawala-6e Chapter 14

5. I: For-Profit: Proprietary II: Not-for-Profit: Voluntary III: Governmental: Public Health Care Organizations (e.g. hospital) Structures Granof & Khumawala-6e Chapter 14

6. Examples of Health Care Organizations I) For-profit: • HealthSouth II) Not-for-Profit: • St. Luke’s Health System • Memorial Hermann Healthcare system III) Governmental: • M.D. Anderson Cancer Center Granof & Khumawala-6e Chapter 14

7. Accounting Issues that differ depending upon the Organizational Structure (Government v/s NFP HCO) • reporting entity • contributions • financial statement display • cash flows • deposits and investments (i.e., see • GASB Statement No. 31, SFAS No. 115, • and SFAS No. 124) • operating leases • compensated absences • Debt refunding; risks and uncertainties • pensions and other post retirement benefits Granof & Khumawala-6e Chapter 14

8. GAAP for HCOs GOVERNMENTALHCOs: • Now follows GASB Statement No. 34 • Considered special purpose governments. • May be accounted for as: A) a part of a governmental unit (i.e., as a special revenue, internal service, or enterprise fund) OR B) as a stand-alone business-type activity that uses proprietary fund accounting principles. ALL HCOs: • Follow the AICPA industry audit guide, Health Care Organizationsas Category (b) authority after applying all appropriate FASB and GASB Statements. • This guidance includes: • Using full accrual accounting • Capitalizing long-lived assets and Depreciating those capital assets Granof & Khumawala-6e Chapter 14

9. Fund Accounting Used for: 1) Governmental HCOs 2) Internal Accounting purposes HCOs’ Fund Accounting has: • General Unrestricted Funds --Reports financial resources and fixed assets. • Donor-Restricted Funds (either temporarily and permanently restricted): • Specific Purpose Fund • Plant Replacement and Expansion Fund • Endowments Granof & Khumawala-6e Chapter 14

10. Financial Statements for HCOs • Balance Sheet (Table 14-1A) • Statement of Activities (Table 14-1B) • Statement of Changes in Net Assets (Table 14-1C) • Statement of Cash Flows (Table 14-1D) Granof & Khumawala-6e Chapter 14

11. Equity of a HCO • NPO — unrestricted net assets; temporarily restricted net assets; and permanently restricted net assets. • Governmental— unrestricted net assets; restricted net assets; invested in Capital Assets, net of related debt. • For-Profit — capital stock and retained earnings. Granof & Khumawala-6e Chapter 14

12. Statements of Cash Flows Granof & Khumawala-6e Chapter 14

13. Assets • Current Assets (including receivables with related allowance accounts for contractual adjustments and bad debts) • Assets limited as to use — assets limited by contracts or agreements with outside parties other than donors or grantors, as well as limitations placed on assets by the Board. • Investments (at fair value, per FASB Statement Nos. 115 and 124 or GASB Statement No. 31, as applicable) • Noncurrent assets (e.g., plant property and equipment) Granof & Khumawala-6e Chapter 14

14. Revenues • Revenues are categorized as: • Unrestricted • Patient care revenues • Other revenues • Temporarily restricted • Permanently restricted • Operating income : - Arises from ongoing major activities, such as service revenue. • Non-operating income: - Arises from transactions peripheral or incidental to the delivery of health care, such as investment income and unrestricted contributions. Granof & Khumawala-6e Chapter 14

15. Principle Sources of Revenue for a HCO • Net assets released from restrictions used for operations • --Applies to non-governmental NFP HCOs • Patient service revenue • Premium revenue from capitation fees • --(i.e. fixed fees per person paid periodically regardless of services provided) • Resident service revenue (e.g., maintenance or rental fees) • Other revenue (e.g., sales, fees, rental of facilities, investment income and gains, unrestricted contributions) Granof & Khumawala-6e Chapter 14

16. Revenue • Patient service revenue is reported netof contractual adjustments --(i.e., differences between gross charges and the amount to be paid by third party payors). • Prepaid health care plans that earn revenue from agreements to provide service record revenue at the point agreements are made, not when services are rendered. • Payment often comes from third-party payors, Medicare or Blue Cross or private insurance companies according to allowable costs or predetermined (prospective) rates for services. • Donated services and supplies are reported at their fair value, if material and meet criteria. • Charity services to indigent patients for which payment is never expected is not recorded, but may be reported in the Notes to the Financial Statements. Granof & Khumawala-6e Chapter 14

17. Example 1- Patient Care Revenues During a particular week a hospital records $400,000 in patient charges. It estimates that 80% (320,000) of the charges will be billed to third-party payers who will, on average, discount the invoiced amounts by 30% (96,000). The remaining 20% (80,000) of the hospital charges will be billed to patients who are uninsured. Of this 20%, 60% (48,000) will be uncollectible. Entries: To record one week’s patient revenues: Patient account receivable $400,000 Patient revenues $400,000 Granof & Khumawala-6e Chapter 14

18. Example 1(cont’d) Allowance for contractual adjustments: Revenue from patient services— --estimated contractual adjustments $96,000 Patient A/R—allowance for contractual adjustments $96,000 To establish allowance for bad debts: Bad debt expense $48,000 Patient A/R—allowance for bad debts $48,000 Granof & Khumawala-6e Chapter 14

19. Example 2- Capitation Fee Revenue A physician group receives $300,000 in capitation fees from the Hartford Insurance Company to provide comprehensive health care to members of the company’s health plan. During the month it provides services for which it would bill, at standard rates, $240,000. In addition, it refers patients to hospitals and other health care providers for which it expects to be billed $18,000. Entries: To record capitation fees: Cash $300,000 Revenue from capitation fees $300,000 To record liability for patient referrals: Patient referrals (expense) $18,000 Obligations for patient referrals $18,000 Granof & Khumawala-6e Chapter 14

20. Example 3- Charity Care Question: A hospital values care provided to indigent patients at $300,000, based on standard billing rates. However, it anticipates collecting none for its services. Answer: In this case, the hospital need not make any entry to record the value of the charitable care. However, it should explain its policies and report the total value of the care provided in notes to the financial statements. (This information is also required on Form 990). Granof & Khumawala-6e Chapter 14

21. Expenses • ALL reported within the unrestricted category. • Use full accrual basis of accounting. • Expenses classified by function or object (aka natural) • Functional classification • (e.g. inpatient services and fiscal and administrative services) • Object classification • (e.g. line items such as salaries and supplies) Granof & Khumawala-6e Chapter 14

22. Expenses (cont’d) • Bad debts (FASB) is an expense (NOT a reduction of gross revenue, as it had been in the past). • Bad debts (GASB) is a reduction of gross revenue, • Depreciation is recorded on capital assets and reported in the General (or Unrestricted) Fund. Granof & Khumawala-6e Chapter 14

23. Commitments and Contingencies • malpractice claims • risk contracting • third-party payor payments • obligations to provide uncompensated care • contractual agreements with physicians • as well as others incurred in any business Granof & Khumawala-6e Chapter 14

24. Example 1 – Malpractice Claims Issue: A hospital has been charged with negligence in the death of a patient. Although no claim has yet been filed, past experience indicates that the hospital is almost certain to be sued. Answer: The hospital would be required to charge an expense (a loss) in the period of the incident only if it were able to make a reasonable estimate of the amount. If unable to estimate the amount, it would be required to disclose the details of the incident. Assuming that the hospital was able to estimate the amount of loss ($500,000), the following entry will be made: To record the estimated cost of settling a potential claim: Anticipated legal claims (expense) $500,000 Commitments and contingencies (liability) $500,000 Granof & Khumawala-6e Chapter 14

25. Financing • The health care industry requires capital investment in buildings and equipment which often results in the need for long term debt financing. • Financing assistance may be available through governmental financing authorities, such as the Health and Education Financing Authority, without regard to the legal structure of the HCO. • Financing agreements may include requirements to set aside funds for repayments, in which case these are called Assets Limited as to Use. Granof & Khumawala-6e Chapter 14

26. Diagnosis-related Groups • In 1983, Medicare (the largest purchaser of hospital services) began a system of prospective payment to providers based on DRGs. • Average payments for each of approx. 511 DRGs are determined at the federal level and made to providers no matter what the actual cost of treatment. Granof & Khumawala-6e Chapter 14

27. Prepaid Healthcare Plans • Health maintenance organizations (HMOs) and preferred provider organizations (PPOs) function as brokers between the consumer (patient) demanding the service and the providers of health care (hospitals and health care professionals). • Accounting issues relate to: • Revenue recognition • Accounting for risk contracts Granof & Khumawala-6e Chapter 14

28. Continuing Care Retirement Communities - FYI CCRCs provide residential care in a facility, along with some level of long-term medical care that is less intensive than hospital care. Accounting issues related to: • Entrance fees that include future health care • The obligation to deliver future health services • Periodic fees to cover operating costs • Refundable advance fees Granof & Khumawala-6e Chapter 14

29. Financial and Operational Analysis Decision makers evaluate HCO for different reasons: • Managers are accountable for performance. • Financial analysts determine the creditworthiness of organizations issuing debt. • Third-party payors determine appropriate payment for services. • Patients assess quality of health care services, such as success rate of certain procedures. Granof & Khumawala-6e Chapter 14

30. HCO Performance Measures These measures can be categorized by: • Patient volume (e.g., occupancy rate or daily census and average length of stay) • Patient and payout mix (e.g., Medicare, commercial, private pay) • Productivity and efficiency (e.g., personnel per average daily census) • Debt covenant ratios Granof & Khumawala-6e Chapter 14

31. Affordable Healthcare Act • The Patient Protection and Affordable Care Act (popularly known as the Affordable Healthcare Act), on March 23, 2010 was signed into law by President Obama. • The law puts in place comprehensive health insurance reforms that will roll out over four years and beyond with most changes taking place by 2014. • Changes to note: • 50% discount for name-brand drugs in the Medicare "donut hole" • Expanded coverage for young adults • Small business tax credits • Pre-Existing Condition Insurance Plans • Reforms already in effect: • States to cover more people on Medicaid, • provide small business health insurance tax credits, • provide free preventive care, • allow young adults to stay on their parent’s plan until they turn 26 years of age, • expand healthcare coverage for early retirees and • make information available online via an easy-to-use website (HealthCare.gov) Granof & Khumawala-6e Chapter 14

32. Summary • Health care accounting and auditing is complex. • Complexity is due in large measure to “patient service revenue” being provided by third party payors. • Competency in managerial cost accounting is critical for managers of health care providers. • Health care organizations are distinguished from other types of organizations by several unique revenues and expenses. These include: • Fee for service patient care revenues • Capitation fee revenues • Charitable care. • Malpractice claims. • Retrospective insurance premiums • Fiscal health of health care organizations can be evaluated using analytical tools, such as financial ratios. • Affordable Care Act and its impact. Granof & Khumawala-6e Chapter 14