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Calculating Contractual Adjustments and Allowances for Implicit Price Concessions

For healthcare organizations, accurately determining net revenue and accounts receivable can be difficult. Given each organization’s unique payor mix, contracts with third-party payors, and patient demographics, there is not a one-size approach to make the calculation. ASC 606-10-32-2 outlines how to establish a transaction price. It states, “The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties.” For healthcare organizations, only a portion of their gross billings ends up being paid due to the contracted price with third-party payors, patients, and others.

Ultimately, net revenue needs to match the actual/expected cash collected on the rendered services during the year end and net accounts receivable needs to reflect the amount of cash that will likely be received in the future. To calculate the net revenue and accounts receivable balance for the year-end, contra revenue and accounts receivables accounts, such as contractual adjustments and allowances for implicit price concessions, must be accounted for.

Contractual Adjustments

The known difference between the billed charges and the contracted price with a third-party payor is a contractual adjustment.

For example, most third-party payors negotiate a discounted price with a healthcare organization. The difference between the established rates set by the healthcare organization and the negotiated discounted rate with a third-party payor would be recorded as a contractual adjustment at the time of billing or payment. Another example is a discount applied to self-pay patients or patients who are family of an employee. In these cases, the reduction of charges is also a contractual adjustment.

Please note that patients that qualify for charity care are not included in the transaction price calculation.

Allowances for Implicit Price Concessions

Unlike contractual adjustments, with which the organization knows a certain portion of the charges will not be paid, allowances for implicit price concessions reflect the portion of the charges that the organization estimates will not be paid. For charges associated with an uninsured patient in which the healthcare organization does not perform credit assessments prior to providing services, the full transaction price is subject to an allowance for implicit price concession. For insured patients, the allowances for implicit price concessions only apply to the patient’s responsibility of the transaction price. Please note that the allowance for implicit price concessions is not reflected as a deduction in a patient’s billing statement, as the healthcare organization will continue their efforts to collect the unpaid balance.

It would be onerous to estimate the allowance for implicit concession on a patient-by-patient basis; therefore, organizations can use a portfolio approach. With this approach, patients can be grouped into different buckets based on similar characteristics. For example, patients with the same insurance provider, patients with no insurance, or patients with certain amounts of co-payments and deductibles can all have different portfolios. Further, different subgroups can be created from these. To apply this approach, the healthcare organization must be sure the collection probability is similar for all patients within a given portfolio.

Another simple approach that many organizations take is to evaluate the accounts receivable balance by aging bucket and apply a reserve percentage to each bucket. For example, the “0 – 30 day” bucket might only be reserved by 5% since the likelihood of collection is at its highest. Whereas the “90 – 120” bucket might be reserved by 100% since there is a low likelihood of collecting the accounts receivable at that point.

Each organization should have their own tailored methodology to calculate their allowance for implicit price concessions. The methodology should be reevaluated on an as-needed basis. Healthcare organizations will need to revisit their methodology when the historical accounts receivable balance does not agree to actual cash collections. If there are changes to initial collection estimates, those changes would be accounted for as an increase or decrease in revenue in the period in which the estimate changes.

Recording Contractual Adjustments and Allowance for Implicit Price Concession

Look at the following example: A healthcare organization has a contract with a third-party payor, that for a service they will reimburse the healthcare organization $500. The gross charges for this service is $1,000. The healthcare organization has a history showing that they only collect about 10% of the patient co-payments balance and has a policy of reserving 100% of self-pay accounts receivable balances after 90 days. For this example, the following entries would be recorded:

To recognize the gross revenue and to account for the negotiated discounted rate at the time of service:

Dr. Accounts receivable                                                                                $500

Dr. Contractual adjustments (contra-revenue)                                             $500

Cr. Revenue                                                                                                    $1,000

The third-party payor ended up paying only $400 out of the contracted $500 and noted that the remaining $100 was patient responsibility. The remaining $100 balance would be billed to the patient. However, the allowance for implicit price concessions needs to be accounted for, as the healthcare organization has a history of only collecting 10% of the patient co-payment balances. Therefore, the following would be recorded to reduce the transaction price:

Dr. Implicit price concessions (contra-revenue)                                             $90

Cr. Allowance for Implicit price concessions (contra-receivable)                 $90

Subsequently, if the patient hasn’t made payment within 90 days, then the organization would record the following in accordance with their policy:

Dr. Implicit price concessions (contra-revenue)                                             $10

Cr. Allowance for Implicit price concessions (contra-receivable)                 $10

Please click here for more information and examples of implicit price concessions from the Healthcare Financial Management Association.

If you have questions about the information outlined above, McKonly & Asbury’s experienced professionals are here to help. Learn more about our Healthcare practice by visiting our Healthcare industry page or by contacting the director of our Healthcare practice, Janice Snyder, Partner.

About the Author

Jesse Diamond

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