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2.1 Fundamentals of provider revenue cycle
Publication date: 31 Mar 2023
us Health care guide
This chapter discusses fundamental characteristics of the revenue cycle in health care services transactions (i.e., the provision of medical services by health care providers to patients) and discusses the roles of the major participants in those transactions.
The fundamentals discussed in this chapter provide helpful background for HC 3, HC 4, and HC 5 regarding how ASC 606, Revenue from contracts with customers, applies to health care services transactions. In addition, this chapter highlights how different types of relationships among providers, health plans, managed care organizations (MCOs) and other intermediaries (see HC 4), and patients can affect the nature, amount, timing, and uncertainty of provider revenues and cash flows.
2.1.1 Parties to revenue transactions
A unique aspect of health care operations is that revenue transactions typically involve more parties than the traditional buyer (customer) and seller (vendor). Numerous parties may be involved in a transaction involving services to patients, including: (1) the individual who receives the care; (2) the physician who performs the services and/or orders the services on behalf of the patient; (3) the health care facility (e.g., hospital, home health company) that provides the setting (e.g., operating room) or administers the treatment (e.g., nursing or post-operative care); (4) if applicable, a third-party that pays the providers on behalf of the patient (e.g., a health insurance provider, Medicare, a health plan administrator on behalf of a private payer/employer); and (5) if applicable, various intermediaries, such as managed care organizations, physician practice management companies, or accountable care organizations. The patient may not interact or even be aware of these intermediaries, although they may influence both the type of care received and the amounts being paid.
In these transactions, the customer is the patient—the recipient of the health care services—even though services generally must be ordered on the patient’s behalf by a licensed medical professional (rather than by the “customer”) and the patient may have little ultimate responsibility for payment for the services. The party that pays for much of the cost of the services may be the government, through programs such as Medicare or Medicaid, a commercial health plan or a self-insured employer that has a contractual relationship with the patient, or an intermediary, such as a managed care organization that has contracted with a health plan or with the government. Separate contractual relationships may also exist between the payer and providers. The terms of those separate arrangements (individually or in concert) will impact the amount of revenue recognized for services provided to a patient by a provider.
2.1.2 Patient billing systems and “gross charges”
When services are provided to a patient, the standard charges (often referred to as “gross charges” or “established charges”) associated with the encounter are entered into the provider’s patient billing system. In more complex settings, each input used in the process of providing care will be priced based on the established charges. For example, if a patient required stitches for an injury, charges could be generated for a suture kit, local anesthetic, syringe, bandages, and physician time. Thus, gross charges are internally recorded as the services are rendered. The data is used to create itemized bills showing all goods and services provided to a patient during an episode of treatment.
As discussed in HC 2.1.4, health plans and government programs often pay providers on a basis that differs from the provider’s gross charges (e.g., based on episodes of care, diagnosis-related groupings, resource utilization groups, or number of inpatient days). Because the amounts providers are entitled to receive may bear little relationship to the gross charges, the gross charges (and related gross receivables) captured in the patient accounting system must be adjusted to reflect amounts providers are entitled to bill. Said differently, for financial statement purposes, the “gross charges” or “gross receivables” are irrelevant; revenue and accounts receivable are recognized in the financial statements based on amounts the providers are entitled to receive as consideration for the underlying services regardless of the “established charges.”
Many patient billing systems use a contra-revenue account to reduce gross charges to amounts that can be recognized as revenue for financial reporting purposes. Under ASC 606 and for presentation on the statement of operations, patient service revenue is the net amount, after consideration of the contra-revenue adjustments. Predominant industry practice is to separately account for the gross components in the accounting system. The contra-revenue adjustments (and related adjustments to gross patient receivables) should be estimated and recorded in the period in which the services are provided. The contra-revenue accounts would include contractual allowances or adjustments, discounts, charity care, and allowances for implicit price concessions.
- Contractual allowances or adjustments. The difference between the provider’s established rates for services provided and pricing under agreements with third-party payers. In traditional “fee-for-service” payment arrangements, the contractual allowance might be reflected in the individual patient ledger at the time of billing (if known) or it might be reflected later, based on notifications received from a health plan. In capitated payment arrangements (discussed in HC 4), the revenue reported in financial statements relates to the capitation fees for the stand-ready obligation to perform services, not the gross charges associated with the services actually performed.
- Discounts. As a matter of policy, some health care entities offer discounted rates in certain situations (e.g., to uninsured patients who do not qualify for charity care). Reductions to gross charges associated with discounts (that is, differences between the established rates and the reduced amount that, in effect, becomes an agreed-upon sales price) are, in practice, reflected as contra-revenue transactions in the underlying accounting records.
- Charity care. As discussed in HC 5.2.1, some patients may qualify for charity care and be granted a full or partial adjustment to their charges. No revenue should be recognized for the amount of the full or partial adjustment because no compensation is expected for these services. In practice, reductions of charges (estimated or actual) arising from charity care “write-offs” are often reflected as contra-revenue in the underlying accounting records.
- Implicit price concessions. If a provider does not perform credit assessments prior to providing services (and thus, provides the services without knowing whether the patient will be able to pay for the services), or if they provide services knowing that they will not be able to collect some or all of the consideration to which they would otherwise be entitled, expected uncollectable amounts are reflected as a reduction of revenues, rather than as credit losses (bad debt expense) (see HC 5.2.1). In practice, the underlying accounting records may reflect a “provision” or “allowance” for implicit price concessions for tracking purposes.
Revenue adjustments related to contractual allowances, discounts, and charity care are patient-specific; that is, they are reflected directly in individual patient accounts as reductions to the amount billable to the patient (and if applicable, to a third-party payer). The provision for implicit price concessions, on the other hand, is not specific to individual patient accounts as an entity typically will not know how much will be collected (or remain uncollected) from specific patients. Thus, implicit price concessions are typically not “pushed down” to individual patient accounts and, thus, will not reduce the amount billed to an individual patient. A provider would continue to attempt to collect the amounts to which the provider is contractually entitled.
Notwithstanding the fact that gross charges are largely irrelevant for GAAP revenue recognition, they indicate the level of consumption of resources involved in treating a specific patient or class of patients. For example, while a government program such as Medicare might pay a hospital a flat diagnosis-related group (DRG) amount for inpatient care provided to an enrollee, the gross charges associated with that patient’s care will provide an indicator of the volume of resources actually consumed in treating that patient. For this reason, gross charge information is often used as an “input” measure of progress (that is, a methodology in which progress towards satisfying the performance obligation is evaluated based on the extent of resources consumed) when evaluating revenue that is recognized over time, as discussed in HC 3.2.5.1.
In addition, a ratio of costs to charges applied to the amount of gross charges can be used to estimate the costs of delivering a subset of the health care services. For example, as discussed in HC 5.2.2.1, a provider’s financial statements must disclose the estimated costs of charity care it provided during the reporting period. According to ASC 954-605-50-3, multiplying the gross charges written off for charity care by the ratio of costs to charges is a reasonable technique for estimating the costs of charity care.
2.1.3 Health care patients (customers)
In health care services transactions, the fundamental contractual relationship is between the provider and the patient. The provider provides the services and the patient agrees to pay for those services. Unlike customers in other services transactions, however, patients may have little involvement in selecting and paying for the services they consume. This is because services generally are performed, or ordered on the patient’s behalf, by a licensed medical professional, and some or all of the payment often comes from a third-party payer, such as Medicare/Medicaid or private health insurance.
Thus, a critical element of a provider’s revenue recognition process is to classify patients based on the party or parties primarily responsible for payment of services (“payer class”). Payer or financial classes are key considerations utilized in revenue cycle monitoring, including billing and collections. In addition, these assignments typically also have a financial reporting impact as the accounting and reporting for health care revenue transactions under ASC 606 typically involve the use of portfolios disaggregated by payer classification.
Typically, a patient is assigned a payer classification when they first arrive at the provider’s office or facility. A patient with no health insurance coverage might be placed in a self-pay, charity care, or “Medicaid pending” payer class (see HC 2.1.3.2).
If the patient has health insurance or government program coverage, the patient will normally share financial responsibility with the health plan through features such as deductibles, coinsurance, or copayments (see HC 2.1.3.1). In those situations, there is no standardized or uniform approach for classifying the receivable. One entity might carry both the patient’s and payer’s portion of the receivable in the “third-party-payer class” while another might eventually shift the patient-responsible portion into a “self-pay” class (particularly after the primary payer has paid its portion). Still others might classify accounts as either third-party or self-pay on the basis of which party has the greater share of the financial responsibility.
2.1.3.1 Customers (patients) with health insurance
In addition to the contract for services between the health care provider and the patient, the patient may have a separate legal arrangement with a health plan, employer, or government program that specifies the terms under which the patient is entitled to assistance in paying for those services. That separate arrangement will address the types of services that will be covered and the extent to which the patient will share financial responsibility with the health plan through features such as deductibles, copayments, or coinsurance.
If the patient’s health plan has a contractual arrangement with the provider, the provider’s services will be considered “in-network” for that patient (see HC 2.1.4.2). Whether services are “in-network” or “out-of-network” will affect the amount the provider can bill for services, the portion of the bill for which the patient will be responsible (i.e., the cost-share with the health plan), and often, whether the insurance benefits will be paid directly to the provider or to the patient.
For purposes of measuring revenue, amounts due from health plans are generally regarded as fully collectible, while amounts due from patients are less likely to be collected in full. As discussed in HC 3, those collectability considerations enter into the determination of the amount of revenue that can be reported in a health care entity’s financial statements under ASC 606 and what amounts, if any, are recognized as a credit loss (bad debt expense) under ASC 326 or ASC 310.
2.1.3.2 Customers (patients) without health insurance
Providing care to patients who are not covered by insurance is inherent in the health care business model, particularly for hospitals that operate emergency departments. This is due largely to the federal Emergency Medical Treatment and Labor Act, which requires Medicare-participating hospitals with emergency departments to screen and treat emergency medical conditions regardless of a patient’s ability to pay. Essentially, the law establishes a “treat first, ask questions later” policy. As a result, hospital emergency departments often function as a “safety net” provider for patients who lack insurance coverage but require medical attention (including care for routine illnesses).
An uninsured patient that goes to an emergency room for treatment might initially be classified into one of three payer classes: “pending Medicaid,” charity care, or self-pay. If the patient will require costly inpatient care, the hospital may attempt to retroactively enroll them in Medicaid, a state-administered program that provides medical benefits to certain low-income individuals. While the hospital awaits the state’s determination, the patient will be classified as “pending Medicaid.” If the patient is deemed to be eligible, their patient account will be reclassified to an insured payer category (i.e., Medicaid). If a Medicaid application is not made or is not successful, a hospital may evaluate whether the patient will qualify for care at reduced or no charge under its financial assistance (i.e., charity care) policy, if it has one. Although a charity care patient’s gross charges will be accumulated in a patient record just like any other type of patient, in the end, the services will not be countable as revenue for financial reporting purposes. HC 5.2.1 provides additional information on reporting charity care services.
If the patient does not qualify for charity care (for example, because the hospital cannot obtain the necessary financial documentation, or because the patient’s income exceeds the policy’s thresholds), the patient will be assigned to a self-pay payer class. As a matter of policy, hospitals often provide an across-the-board discount to patients in the self-pay class and usually will work with the patient to arrange a plan for payment of their account over time. In general, such services are intrinsically at higher risk for nonpayment than are services where a significant portion of the charges will be paid by a third-party payer. Under ASC 606, this has implications for the amount of revenue that is recognizable for financial reporting purposes related to these services, as discussed in HC 3.3.1.
The above discussion is specific to hospitals with emergency departments. Although not required by law to do so, other providers may voluntarily decide to provide care at little or no cost to indigent patients or assist them with locating alternative sources of care. If the provider has a charity care policy and the patient qualifies, those services are classified as charity care and accounted for as discussed in HC 5.2.1. Otherwise, the patients are classified as self-pay, and revenue will be recognized for financial reporting purposes as discussed in HC 3.3.1.
2.1.4 Payers of health care revenue
Relationships with third-party payers (or when patients are uninsured, the lack of a relationship) play a significant role in how health care is purchased. Consequently, those relationships have a significant impact on how much revenue a provider will earn.
The extent of services covered by third-party payer contracts typically varies by the type of health care provider.
- For hospitals, rehabilitation facilities, home health companies, hospices, physicians, clinical laboratories, and other ambulatory care providers, third-party payers pay for the majority of services provided.
- For skilled nursing facility (SNF) services, health insurance often provides coverage for short stays in SNFs immediately following a hospitalization. Payment for long-term residential care services is usually funded through specialized long-term care insurance policies or Medicaid (which pays for long-term residential care and support services for Medicaid beneficiaries). When no third-party benefits are available, nursing home services are "private pay" or "self-pay" (that is, the individual or their family pays for the care).
- In continuing-care retirement communities, residential SNF care is financed primarily through up-front and/or monthly fees paid by residents.
The largest of all third-party payers is the federal government, which pays for health care services for enrollees in Medicare, Medicaid, Civilian Health and Medical Program of the Uniformed Services (CHAMPUS), and Federal Employee Health Benefits (FEHBP) programs. For additional information on the significant role played by federal and state governments in paying for health care services, see HC 2.2.
Third-party payers typically do not pay the health care entity’s established rates. The amount paid may be based on government regulations (for Medicare, Medicaid, and other government programs), negotiated in-network prices (for services for a particular health plan), or the specific commercial health insurance policy or employer’s plan design.
When a third-party payer is involved, the responsibility of paying for health care services typically is shared between the payer and the patient. The payer’s portion will typically carry a presumption of high collectability; the portion that is the patient’s responsibility, on the other hand, may have significant risk for non-collectability. As discussed in HC 3, under the ASC 606 reporting model, these different collectability profiles will affect the measurement of transaction price (i.e., the amount of revenue that is recognizable) related to these services.
2.1.4.1 Provider payment methods – fee-for-service arrangements
Fee-for-service is the predominant method of payment. Under this model, a provider submits a bill to the patient’s third-party payer to request payment for the services performed (referred to as “filing a claim”). The provider uses standardized medical codes to detail the services provided and lists the provider’s charges for the services. If the payer approves the claim, it pays its share (either to the patient or to the provider) based on the terms of the arrangement and whether it has a relationship with the provider.
If no contractual agreement exists between the provider and the insurer regarding the amounts that will be charged to that insurer’s subscribers, members, or enrollees, the payment will normally be based on “reasonable and customary” charges determined by the health plan for the provider’s geographic service area (or sometimes by reference to the provider’s charges for the services).
If the health plan has negotiated an agreement with the provider (through separate contractual arrangements) to pay discounted rates for care provided to the plan’s subscribers, members, or enrollees, the amount of payment for a particular service might be established on a retrospective or a prospective basis. Retrospective payment typically means that either the payment amount is based in some fashion on the amount the provider normally charges for the specific services billed, or that payment is based on the estimated costs of the services provided (“cost reimbursement”). More often, payers use prospectively-determined payments to incent providers to provide more cost-effective care. Under a prospective payment methodology, the payer’s rates are set in advance for specific treatments or services and are known (or knowable) by the provider in advance of providing the care. The amount of the payment received for that treatment or service will not vary, regardless of the level of resources (for example, labor and supplies) the provider had to employ in treating the specific patient. If the payment does not cover the costs of providing the service, the provider must absorb any excess. Commonly used prospective payment methodologies include:
- Fee schedules. Fee schedules stipulate flat amounts that will be paid for services performed by a physician or allied health professional (e.g., Medicare’s physician fee schedules).
- Per diem. Under a per diem arrangement, the provider is paid a flat rate per day of inpatient care provided, regardless of the level of intensity of the care provided (e.g., Medicare’s per-diem methodology for skilled nursing facility services).
- Per case (per discharge, per encounter, per visit). When payment is made on a per-case basis, the provider is paid a predetermined amount based on the patient's "discharge category"(e.g., Medicare diagnosis-related groups for hospital inpatient services).
In some cases, fee-for-service payment structures might include penalties or bonuses based on “target” levels of service or payments, or adjustments based on quality scores. HC 2.2.1.2 discusses certain such alternative payment models; similar type of adjustments to fee-for-service payments can also be part of a provider’s contract with private sector payers. Additional commentary and examples related to estimating adjustments to amounts payable by providers as a result of bonuses or penalties (i.e., “variable consideration” under ASC 606) under programs that require providers to share risk with Medicare can be found in the AICPA Revenue Recognition Audit and Accounting Guide (AAG-REV 7.6.73 through AAG-REV 7.6.108).
Note that the term “fee-for-service” has two distinct meanings in the health care sector. As used in this discussion of provider revenue, fee-for-service describes a third-party payer’s contractual arrangement to pay a provider for services rendered. That is, third-party payers compensate providers based on the specific underlying services provided, not based on, for example, total population health metrics or per member per month arrangements. “Fee-for-service” may also be used to describe a type of program under Medicare or Medicaid (for example, “fee-for-service Medicaid” as contrasted to Medicaid managed care – see HC 2.2.1). Providers can (and typically do) receive “fee-for-service” payments from Medicare and Medicaid under either the FFS or managed care structures.
2.1.4.2 Provider payment methods - capitation arrangements
Under a capitation arrangement, a health care entity (normally a physician practice or integrated health system) is paid a predetermined amount to “stand ready” to provide covered services that may be needed by enrollees during a specified time period, rather than being paid on a case-by-case basis as individual elements of care are provided. In those arrangements, the provider earns revenue regardless of whether any services are actually provided during the period covered by the capitation payment.
The predetermined amount is typically a fixed amount per enrollee (usually defined as a “per patient, per month” or “PMPM” fee) to provide covered services to a specified group of individuals enrolled in a health plan during an established period. The fixed amount is determined in advance of the contract year.
Accounting for capitation arrangements by health care providers is discussed in HC 4.
2.1.4.3 “In-network” versus “out-of-network” services
Most health plans will establish a network of providers that have contractually committed (through separate arrangements with the health plan) to provide care at discounted rates to the plan’s subscribers, members, or enrollees. The provider’s services are considered “in network” for patients that are covered by the health plan. Network providers are often referred to as “participating providers.”
When a provider is part of an insured patient’s network, the amount the provider can charge and the prospects for collectability of those amounts can be significantly different than for similar services provided to a patient “out-of-network.” The discussion that follows is specific to private sector plans. The guidance for care provided to Medicare enrollees differs slightly and is discussed in HC 2.2.1.1.
Whether services are “in-network” or “out-of-network” will affect the amount the provider can bill for services, the portion of the bill for which the patient will be responsible (i.e., the cost-share with the health plan), and often, whether the insurance benefits will be paid directly to the provider or to the patient. Amounts due from health plans are generally regarded as fully collectible, while amounts due from patients are less likely to be collected in full. As discussed in HC 3, those collectability considerations will enter into the measurement of revenue in a health care entity’s financial statements under ASC 606.
When a provider’s services are in-network, its established charges will be irrelevant for revenue recognition purposes, because the rate negotiated with the health plan will establish the agreed-upon contractual prices for the services. The provider will “write off” the difference between its established charges and the negotiated rate to “contractual allowances” (a contra-revenue account, discussed in HC 2.1.3). Typically, the patient and health plan will share responsibility for payment of the negotiated rate, with the health plan paying a significant portion (e.g., 80%) and the patient paying a much smaller portion (e.g., 20%), referred to as “coinsurance.” The provider’s risk of non-collection of the negotiated rate will usually be limited to the portion due from the patient.
If the provider’s services are considered “out-of-network,” the dynamics surrounding payment (and revenue recognition) differ in several ways.
- Some health plans (for example, HMOs) will only provide coverage for out-of-network services in emergency situations. In those situations, if the provider’s services are not of an emergency nature, the patient is uninsured for those services and will be responsible for 100% of the charges.
- If the health plan provides coverage for non-emergency services, the insurance benefits typically are less than for in-network services. The insurance benefits will be a percentage of a “reasonable and customary” charge determined by the health plan for the provider’s geographic service area. For example, a plan that pays 80% of the negotiated rate for in-network services might pay only 70% of the reasonable and customary charge for out-of-network services.
- The provider normally is permitted to bill the patient for the difference between its established charges and the “reasonable and customary amount.” Thus, the patient will be responsible for paying this amount in addition to their coinsurance (the percentage of the reasonable and customary amount that is the patient’s responsibility).
- Out-of-network benefits often are paid directly to the patient, rather than to the provider. In some cases, the provider may be able to obtain an assignment of benefits from the patient, which is a legal agreement that authorizes the plan to pay the benefits directly to the provider. If the benefits are paid directly to the patient, health care entities should consider any additional collection risk associated with collecting payment directly from the patient instead of the health plan.
Example HC 2-1 illustrates the differences in the recognition of in-network and out-of-network revenue.
EXAMPLE HC 2-1
Comparison of in-network versus out-of-network revenue
Comparison of in-network versus out-of-network revenue
Hospital admits Patient A whose health insurance is provided by Insurer X. Under the Patient A’s terms of coverage, once the patient has met their annual deductible, Insurer X will pay 80% of the negotiated network rate for in-network services, and Patient A’s coinsurance will be 20% of the network rate. Hospital also admits Patient B, whose health insurance is provided by Insurer Y. Hospital is not a member of Insurer Y’s provider network. If Patient B receives out-of-network care, Insurer Y will pay 60% of the “reasonable and customary rates” for the services, and Patient B’s coinsurance will be 40%.
Hospital’s gross charges for both patients’ stays are $40,000. Insurer’s X’s negotiated network rate with Hospital for the services provided to Patient A is $18,300, and the reasonable and customary charges are $19,000. Patient A has met their deductible for the year. Hospital requires patients that are out-of-network to assign their insurance benefits to Hospital (thus allowing Insurer Y to pay its portion directly to Hospital).
What entries would Hospital record related to each patient’s stay?
Analysis
For Patient A, since Hospital belongs to Insurer X’s provider network, Hospital is contractually obligated to accept $18,300 as payment-in-full for Patient A’s stay. The $21,700 difference between Hospital’s established charges and the network negotiated rate ($40,000 less $18,300) represents a contractual allowance (a contra-revenue account). Insurer X is responsible for $14,640, which is 80% of the network negotiated rate ($18,300 x 80%) and Patient A’s coinsurance is $3,660 ($18,300 x 20%).
For Patient B, because Hospital is not part of Insurer Y’s provider network, Insurer Y will pay $11,400, which is 60% of the reasonable and customary fee ($19,000 x 60%) and Patient B’s coinsurance is $7,600 ($19,000 x 40%). However, because there is no contractually-negotiated fee between Hospital and Insurer Y, Hospital may bill Patient B for the difference between its gross charges and the reasonable and customary fee ($40,000 – $19,000 = $21,000). Thus, Patient B’s responsibility will be $28,600 ($40,000 - $11,400). Because Patient B has assigned its benefits under its policy with Insurer Y to Hospital, Hospital will receive Insurer Y’s payment directly.
The following table compares the respective journal entries for related to the fees related to Patient A and Patient B’s care.
Entry |
Patient A (In-network) |
Patient B (Out-of-network) |
Dr. Accounts receivable—Due from health plan |
$14,640 |
$11,400 |
Dr. Accounts receivable—Due from patient |
$ 3,660 |
$28,600 |
Dr. Contra-revenue—Contractual adjustments |
$21,700 |
$0 |
Dr. Contra-revenue—implicit price concessions |
[see below] |
[see below] |
Cr. Revenue—Gross charges |
$40,000 |
$40,000 |
While it may initially appear that the out-of-network services are more lucrative for Hospital, that is likely not the case once the likelihood of collection of the patient portion is considered. Typically, amounts due from health plans are fully collectible, while amounts due from patients carry a higher risk of uncollectibility. For example, if Hospital successfully collects all of the amount due from Insurer X, but only collects $2,000 of the amount due from Patient A, Hospital’s total revenue is $16,640 as a result of providing the in-network services. On the other hand, if Hospital only collects $2,000 from Patient B, Hospital’s total revenue is only $13,400.
Because the amount due from an individual patient is likely to have higher collection risk, Hospital will need to estimate the amount it expects to collect from patient. The difference is not recorded as a bad debt expense, but instead is recorded as a contra-revenue, representing an implicit price concession.
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