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3.3 Variable consideration
Publication date: 31 Mar 2023
us Health care guide
Under the ASC 606 framework, variable consideration refers to consideration that is contingent on the occurrence (or nonoccurrence) of future events. For providers, most patient care contracts will involve variable consideration, for reasons such as:
- implicit price concessions provided to patients (see HC 3.3.1),
- the potential for refunds to or recoupment of payments received from third-party payers—for example, compensation under Medicare/Medicaid provider agreements subject to potential retrospective adjustments (see HC 3.3.2), or
- performance bonuses or penalties included in risk-sharing arrangements (see HC 3.3.2).
When a contract contains variable consideration, Step 3 of the ASC 606 model requires the entity to estimate the amount of consideration to be included in the transaction price.
If the consideration promised in a contract includes a variable amount, an entity shall estimate the amount of consideration to which the entity will be entitled in exchange for transferring the promised goods or services to a customer.
The estimate must be made at the inception of the contract using all relevant data (historical data, current data, reasonable projections). ASC 606 provides two approaches—the expected value method (e.g., probability-weighted estimates) or the most likely amount method—whichever is the best predictor of future results.
An entity shall estimate an amount of variable consideration by using either of the following methods, depending on which method the entity expects to better predict the amount of consideration to which it will be entitled:
- The expected value—the expected value is the sum of probability-weighted amounts in a range of possible consideration amounts. An expected value may be an appropriate estimate of the amount of variable consideration if an entity has a large number of contracts with similar characteristics.
- The most likely amount—the most likely amount is the single most likely amount in a range of possible consideration amounts (that is, the single most likely outcome of the contract). The most likely amount may be an appropriate estimate of the amount of variable consideration if the contract has only two possible outcomes (for example, an entity either achieves a performance bonus or does not).
See RR 4.3.1 for a comprehensive discussion of estimating variable consideration. In some health care services arrangements, the expected value method will be the appropriate method because it takes into account the probability of various amounts of payments. The most likely amount method, which uses the single most likely amount in a range of possible consideration amounts, may be appropriate in other health care services arrangements that are limited to one or two outcomes. Importantly, the method selected is not a policy choice; an entity should use the method that it expects will best predict the amount of consideration to which it will be entitled.
Once the estimate is made, it remains possible that the actual consideration may prove to be lower than the amount estimated. To mitigate the risk that revenue is recognized in excess of the amount ultimately realized, which would require negative adjustments to revenue in future periods, variable consideration is subject to a “constraint” imposed by ASC 606-10-32-11. The constraint stipulates that the estimated transaction price must be constrained (capped) to exclude any amount for which it is probable that a significant reversal of revenue would be required in the future if the uncertainty resolves unfavorably.
An entity shall include in the transaction price some or all of an amount of variable consideration estimated in accordance with paragraph 606-10-32-8 only to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved.
When assessing the constraint, entities should consider both the likelihood and magnitude of a revenue reversal. ASC 606-10-32-12 identifies factors that could increase these risks. For example, an entity with limited experience in making estimates involving these contracts may have a higher likelihood of a revenue reversal than would an entity with significant experience. See RR 4.3.2 for a comprehensive discussion of these factors. Importantly, the estimate of variable consideration is not constrained if the potential reversal of cumulative revenue recognized is not significant, or if a potential reversal that would be significant is not probable of occurring. Said differently, there is no basis to defer revenue simply because the amount collectible is uncertain.
When assessing the need to constrain an estimate of variable consideration, a health care entity should also consider whether the estimate inherently incorporates the principles on which the guidance for constraining estimates is based (see HC 3.5.2). In such cases, there is no further needed to separately apply a constraint.
In addition to guidance on the “day one” accounting issues described above—how variable consideration should be estimated and whether it should be constrained—ASC 606 also provides “day two” guidance addressing subsequent changes in the estimate or the constraint. ASC 606-10-32-14 requires an entity to update its estimate of variable consideration at each reporting date.
At the end of each reporting period, an entity shall update the estimated transaction price (including updating its assessment of whether an estimate of variable consideration is constrained) to represent faithfully the circumstances present at the end of the reporting period and the changes in circumstances during the reporting period.
Revisions in estimates are reflected as increases or decreases in the transaction price in the period the change occurs. If the performance obligation to which the change in transaction price relates has already been satisfied—i.e., revenue has already been recognized—then any change in the transaction price, up or down, will result in an immediate increase or decrease in revenue. If an entity experiences frequent subsequent adjustments that result in revenue decreases, it may need to re-assess whether its estimation process, including its application of the constraint, is appropriate.
3.3.1 Implicit price concessions
Health care services provided under fee-for-service arrangements are typically billed to the patient (and if applicable, to the patient’s third-party payer) after the services are provided—that is, they are billed “in arrears.” In most other industries outside the health care sector, businesses that bill in arrears will have screened their customers’ financial condition prior to agreeing to provide the goods or services. In those situations, the entities have chosen to extend credit to their customers based on the customers’ ability to pay and, implicitly, accepted of the risk of nonpayment. In health care, however, providers often will, or are required to, provide services without knowing whether the patient will be able (or willing) to pay for the services or the portion of the bill for which they are responsible. In those situations, providers have not evaluated the patient’s wherewithal to pay and are not extending credit; rather, they are providing services with the understanding that they are not likely to receive all of the compensation to which they are entitled.
This unique aspect of healthcare revenue transactions has two important implications. Ordinarily, if an entity had no basis to assume the collection of the transaction price is probable, a contract would not exist. However, if an entity expects that some amount of consideration will be collected and the entity is likely to accept an amount less than the stated transaction price, an entity can conclude that a contract exists and revenue may be recognized at the lesser amount. which reflects an implicit price concession. The second implication is the distinction between an implicit price concession—which results in a reduction in transaction price (revenue)—and a valid receivable that subsequently becomes uncollectible due to the customer’s (patient’s) credit risk—which results in a credit loss (bad debt expense).
According to ASC 606-10-32-7(b), if facts and circumstances indicate that the entity’s intention when entering into the contract was to offer a price concession to the customer, the consideration is variable. When consideration is variable, the estimate of the transaction price will incorporate the entity’s expectation of collections and thus, amounts not expected to be collectible are excluded from the transaction price. If on the other hand, the entity has chosen to accept the customer’s credit risk, amounts that are not expected to be collected are considered credit losses on recognized receivables (bad debt expense). See HC 5.2.3 for additional discussion of how to distinguish implicit price concessions from bad debts.
AAG-REV 7.6.24 through AAG-REV 7.6.25 provide interpretive guidance for the health care sector that addresses implicit price concessions. That guidance concludes that if either of the following factors is present, an entity has implicitly provided a price concession to a patient (or to patients in a particular patient class):
a) The provider has a customary business practice of not performing credit assessments prior to providing services (for example, because it is required by law or regulation, or has a mission to provide medically necessary or emergency services prior to assessing a patient’s ability or intent to pay).
b) The provider continues to provide services to a patient (or patient class) even when historical experience indicates that it is not probable that the entity will collect substantially all of the billed amount.
Implicit price concessions arise from services provided to insured as well as uninsured patients. With insured patients, the implicit price concession relates to the ‘self-pay’ portion of the charges because the health plan or government program typically does not pay the patient’s entire bill. Providers must collect from patients any deductible and coinsurance amounts, differences between the provider’s charges and amounts allowed by the payer (e.g., insurance company or government program), and insurance payments sent directly to the patient (instead of to the provider).
3.3.1.1 Estimating implicit price concessions
If the provider concludes that it is offering implicit price concessions, it would estimate the transaction price (or the variable portion of the transaction price) using the methodology described in HC 3.3. For services provided to uninsured patients, the entire transaction price would be variable and subject to estimation. For services provided to insured patients, only the portion of the transaction price associated with amounts for which the patient is responsible would be subject to estimation of implicit price concessions.
Under ASC 606, the portfolio approach (see ASC 606-10-10-4 and AAG-REV 7.7.1 through AAG-REV 7.7.15) is typically employed when estimating the transaction price that includes implicit price concessions. The provider’s expectations of cash collections in the aggregate from contracts within a particular payer class or classes, based on historical experience, will inform the estimate of transaction price. For example, a health care entity might establish separate “portfolios” for uninsured self-pay patients, various classes of insured patients with co-payments and deductibles, or subgroups within those classifications based on the level at which they believe there is a meaningful distinction in collectibility expectations.
In order to use that approach, the provider would need to conclude that the expected outcome from using a portfolio approach is not expected to differ materially from an individual contract approach. That is, the provider would need to conclude that its expectations with respect to a specific contract within the portfolio are no different than its expectations with respect to any other contract within the portfolio (said differently, it is as likely to collect the average amount from that patient contract as it is from any other patient contract in a given portfolio, or patient class).
The portfolio concept is based on combining a large volume of contracts with homogeneous characteristics in order to derive an average outcome that is representative of the population. Practically speaking, it would be difficult for changes in an individual contract to make a difference in the performance of the portfolio. AAG-REV 7.7.10 indicates that a contract should be removed from a portfolio if the entity subsequently determines that the contract does not have similar characteristics with the remainder of the portfolio.
As discussed in HC 3.3.2, estimates of the transaction price for health care services revenue should incorporate the entity’s expectations of cash collections at a level at which it is probable that the cumulative amount of revenue recognized would not result in a significant revenue reversal. When estimating variable consideration associated with implicit price concessions, it may not be necessary to separately assess the need for a constraint, as the estimated transaction price (or component of the transaction price) for a portfolio of contracts is based on the amount expected to be collected. Said differently, in those situations, the calculation of the variable consideration inherently incorporates the principles on which the guidance for constraining estimates of variable consideration is based.
Example HC 3-5 illustrates the estimation of implicit price concessions for the uninsured self-pay patient class.
EXAMPLE HC 3-5
Estimating implicit price concessions for uninsured self-pay patients
Estimating implicit price concessions for uninsured self-pay patients
Hospital treats uninsured patients. Hospital offers a 60% across-the-board discount to uninsured patients, and it has a history of collecting 10% (on average) of these discounted charges from patients in this class. Hospital continues to provide services to uninsured patients even when historical experience indicates that it is not probable that Hospital will collect substantially all of the discounted charges.
Hospital has determined it has sufficient historical experience about the uninsured self-pay patient class to apply a portfolio approach in estimating the transaction price. Hospital identifies the “uninsured self-pay” patient class as a portfolio based on qualitative and quantitative factors, including an analysis that shows that the uninsured self-pay patient class shares similar collection patterns based on historical information (that is, variances from reporting period to reporting period in the percentage of collections have been insignificant in the aggregate).
During the most recent reporting period, gross charges for patients in the uninsured self-pay patient class were $2 million. Hospital estimates that 10% of amounts billed to patients in this category are collectible.
Considering implicit price concessions, what is the estimated transaction price for these services?
Analysis
In the period the services are initially provided, Hospital would recognize the following transactions for this patient class (in aggregate):
Dr. Accounts receivable |
$2,000,000 |
Cr. Gross revenue |
2,000,000 |
Gross charges associated with portfolio of self-pay patients |
|
Hospital would first reduce the transaction price for the contracts in the portfolio by the 60% across-the-board discount applied as a matter of policy to uninsured patients (an explicit price concession of $1.2 million ($2 million x 60%)).
Dr. Discounts (contra-revenue) |
$1,200,000 |
Cr. Accounts receivable |
1,200,000 |
To reflect explicit price concession applicable to portfolio of self-pay patients |
The remaining charges of $800,000 ($2,000,000 - $1,200,000) would be billed to the patients. Based on Hospital’s estimate of collectibility, it would calculate that $80,000 ($800,000 x 10% historical collection rate) is the amount of compensation to which it will be entitled for providing these services (that is, the transaction price for the services). Because the facts and circumstances indicate that Hospital’s intention when entering into the contracts with these patients was to provide an implicit price concession, the uncollectible $720,000 ($800,000 billed charges less $80,000 expected collections) would be accounted for as an additional reduction of the transaction price. This is the implicit price concession.
Dr. Implicit price concessions (contra revenue) |
$720,000 |
Cr. Allowance for uncollectible A/R (contra asset) |
720,000 |
To reflect implicit price concession applicable to portfolio of self-pay patients |
|
Hospital would likely not need to separately assess the need for a constraint as the estimate of the variable consideration inherently incorporates the principles on which the guidance for constraining estimates of variable consideration is based.
Example HC 3-6 illustrates the estimation of implicit price concessions for a patient class that has private insurance with typical deductibles and coinsurance provisions.
EXAMPLE HC 3-6
Estimating implicit price concessions for insured patients with traditional deductibles and coinsurance
Estimating implicit price concessions for insured patients with traditional deductibles and coinsurance
Hospital is a participating provider with Health Plan A. Under the terms of the participation agreement, services provided to Health Plan A’s subscribers will be discounted by 40% from Hospital’s established charges. Health Plan A’s traditional health insurance policies state that after deductibles have been met, Health Plan A will pay a portion of a subscriber’s bill for covered health care services, and the subscriber will be responsible for the remaining balance. Based on Hospital A’s historical experience, patients are responsible for 20% of the contracted price.
Based on its historical experience, Hospital expects to collect all of the amount due from Health Plan A, but only a portion of the amount due from the patients. Hospital does not have a policy of assessing patients’ intent and ability to pay the portion of the bill for which they are responsible prior to providing service.
Hospital utilizes the portfolio approach in estimating the transaction price. Hospital identifies the “Health Plan A co-pays” customer class as a portfolio based on qualitative and quantitative factors. This portfolio includes an estimate of deductible and co-pay balances for each patient based on their health plan’s general policies and information obtained during the admissions process. Hospital will not know with certainty how much it will actually collect from these patients until collection efforts have been exhausted. Based on Hospital’s historical experience with patients covered by insurance similar to that provided by Health Plan A (i.e., that patient class), it estimates that it will collect approximately 30% of the remaining amount due from patients after insurance (blend of deductibles and coinsurance).
The established charges for services provided by Hospital to Health Plan A’s subscribers during the reporting period total $1,000,000.
Considering both explicit price concessions (contractual discounts) and implicit price concessions, what is the transaction price associated with these services?
Analysis
The explicit price concession is $400,000 (40% x $1,000,000). Based on the remaining $600,000 ($1,000,000 - $400,000), the implicit price concession is estimated at $84,000 ($600,000 times the estimated patient deductible and coinsurance of 20% times the estimated amounts not expected to be collected of 70%). This yields a transaction price of $516,000 ($600,000 - $84,000).
In the period the services are initially provided, Hospital would recognize the following transactions for this patient class (in aggregate):
Dr. Accounts receivable |
$1,000,000 |
Cr. Gross revenue |
1,000,000 |
Gross charges associated with portfolio of Health Plan A patients |
Hospital would first reduce the transaction price for the contracts in the portfolio by the 40% contractual discount negotiated with Health Plan A (an explicit price concession of $400,000 ($1,000,000 x 40%)).
Dr. Contractual allowances (contra-revenue) |
$400,000 |
Cr. Accounts receivable |
400,000 |
To reflect explicit price concession applicable to portfolio of Health Plan A patient services |
|
The remaining discounted charges of $600,000 ($1 million less $400,000 of contractual adjustment) will be billed to the patients and Health Plan A. Of that amount, $480,000 ($600,000 x 80%) is estimated to be payable by Health Plan A, and $120,000 ($600,000 x 20%) is estimated to be paid by the patients. Based on its historical experience, Hospital expects to collect all of the amount due from Health Plan A, but only $36,000 of the remaining amount due from the patients (30% x $120,000). The $84,000 of patient co-payments that Hospital does not expect to collect ($120,000 - $36,000) represents an implicit price concession because Hospital does not have a policy of assessing patients’ intent and ability to pay their coinsurance amounts prior to providing service. The implicit price concession is accounted for as an additional reduction of the transaction price.
Dr. Implicit price concession (contra revenue) |
$84,000 |
Cr. Allowance for uncollectible A/R (contra asset) |
84,000 |
To reflect implicit price concession applicable to portfolio of Health plan A patients |
|
Subsequent to initial recognition, if Hospital determines it will only collect $500,000 (instead of the $516,000 it initially estimated), it would account for the difference as an increase to the implicit price concession (a reduction to the estimate of the transaction price) in the period that the estimate changes.
Example HC 3-7 illustrates the estimation of implicit price concessions for patients insured by high deductible plans.
EXAMPLE HC 3-7
Estimating implicit price concessions for insured patients in high-deductible plans
Estimating implicit price concessions for insured patients in high-deductible plans
Medical Group Practice (MGP) is a participating provider with Health Plan B. Under the terms of the participation agreement, services provided to Health Plan B’s subscribers will be discounted by 40% from MGP’s established charges. Health Plan B’s high-deductible health insurance policies state that subscribers are responsible for paying the first $7,500 of charges during the year, after which Health Plan B will pay 80% of a subscriber’s bills for covered services with 20% coinsurance from the subscriber.
Based on its historical experience, MGP expects to collect all amounts that are the responsibility of Health Plan B but only a portion of the amounts due from individual patients. However, at the time services are rendered, MGP will not know whether a patient has met its deductible and, therefore, how much they can expect to receive specifically from Health Plan B versus the patient.
During the reporting period, gross charges for services provided to subscribers in Health Plan B’s high deductible plan total $750,000. MGP considers all Health Plan B’s patients in the high deductible plan as a portfolio. Using historical data for services provided to patients covered under similar arrangements as Health Plan B’s high deductible plan, MGP determines that it expects to collect a combined total of $250,000 from Health Plan B and its subscribers.
Considering both explicit price concessions (contractual discounts) and implicit price concessions, what is the transaction price associated with these services?
Analysis
The explicit price concession is $300,000 (40% x $750,000) and the implicit price concession is estimated at $200,000 ($750,000 less $300,000 less estimated collections of $250,000). Thus, the transaction price is $250,000 ($750,000 less $300,000 explicit price concession less $200,000 implicit price concession).
In the period the services are initially provided, Hospital would recognize the following transactions for this patient class (in aggregate):
Dr. Accounts receivable |
$750,000 |
Cr. Gross revenue |
750,000 |
Gross charges associated with portfolio of Health Plan B patients |
|
MGP would first reduces the transaction price for the contracts in the portfolio by the 40% contractual discount negotiated in the contract with Health Plan B (an explicit price concession of $300,000 ($750,000 x 40%)).
Dr. Contractual allowances (contra-revenue) |
$300,000 |
Cr. Accounts receivable |
300,000 |
To reflect explicit price concession applicable to portfolio of Health plan B patients |
|
The remaining discounted charges of $450,000 ($750,000 less $300,000 of contractual adjustment) will be billed to the patients and Health Plan B, who share responsibility for payment as described in the fact pattern. At the time services are provided, MGP will not know whether the Health Plan B subscribers will have met their deductibles; consequently, MGP does not know with certainty the portion of these contracts that will be paid by Health Plan B and the portion for which subscribers are responsible.
The $200,000 that MGP does not expect to collect ($450,000 discounted charges less expected collections of $250,000) would be attributed entirely to the subscriber portions, as (based on experience) MGP expects to collect all amounts that are Health Plan B’s responsibility whereas MGP does not have a policy of assessing patients’ intent and ability to pay their coinsurance amounts prior to providing service. These implicit price concessions would be accounted for as an additional reduction of the transaction price.
Dr. Implicit price concession (contra revenue) |
$200,000 |
Cr. Allowance for uncollectible A/R (contra asset) |
200,000 |
To reflect implicit price concession applicable to portfolio of Health Plan B patients |
|
Therefore, MGP would determine the transaction price to be $250,000 (gross charges of $750,000, less contractual adjustments of $300,000, less the estimated implicit price concessions of $200,000).
Subsequent to initial recognition, any changes in the estimate to reflect amounts actually collected would generally be accounted for as increases or decreases in the implicit price concession (that is, a change in the estimate of the transaction price) in the period that the estimate changes.
3.3.1.2 Subsequent changes in the estimate of price concessions
Subsequent to initially estimating implicit price concessions related to a portfolio of contracts, the provider will continue to attempt to collect the balances on the patient accounts within that portfolio. If the actual collection experience for the portfolio differs from the initial estimates, those subsequent changes are accounted for as increases or decreases in the transaction price. Assuming that the underlying performance obligation to which the change in price relates has already been satisfied, as would be expected in most health care services arrangements, those changes in transaction price are immediately recognized as increases or decreases in revenue (not credit losses (bad debt expense)) in the period in which the estimate changes, consistent with the guidance in ASC 606-10-32-42 through ASC 606-10-32-45g.
In practice, most health care providers employ a portfolio approach to estimating implicit price concessions. If, however, a provider is not using a portfolio approach, judgment will be required to determine whether at inception, a contract exists (i.e., whether the provider believes it is probable that they will collect all of the consideration to which they are entitled) and, if so, whether subsequent changes in the amounts expected to be collected are indicative of implicit price concessions or a credit loss (bad debt). An adverse change in a patient’s creditworthiness (for example, the patient filed for bankruptcy or lost their job) might indicate that the reduction in collections is more appropriately considered a credit loss (bad debt) rather than a reduction in the transaction price (see AAG-REV 7.6.34). These matters are further discussed in illustrative Example 7-6-1 and Example 7-6-3 in AAG-REV 7.6.43. Absent specific information regarding a deterioration in the patient’s financial condition, subsequent reductions in collections will generally be considered an implicit price concession.
3.3.2 Government payer programs
In addition to variable consideration from implicit price concessions associated with individual patients’ amounts, variable consideration also arises from features of government programs that create variability in the amount the programs themselves will pay. Examples of those features include the following:
- For an institutional provider, government payers may also compensate the provider through cost report filings for a portion of the overall reimbursement (i.e., transaction price). Complex laws and regulations on which those payments are based include an ability for the government to retroactively adjust the rates it pays for care-specific charges based upon the filing of the cost report by the provider and subsequent audits by the government payer or its designated auditor. The audit process and the resolution of significant related matters (including disputes on differing interpretations of regulations) might not be finalized until several years after the services are rendered.
- State Medicaid programs must obtain CMS approval for changes to state plans. If a state makes payments to a provider during a given year under a program (or an amendment to a program) that has not yet been approved by CMS, those payments may be subject to clawback or recoupment if CMS does not ultimately approve the program. See discussion of provider tax programs at HC 5.3.
- Claims paid during a contract year that appeared at the time to be valid may be subject to adjustment in future years as a result of examinations by government agencies or contractors, or regulatory investigations. See discussion of recovery audit contractor (RAC) audits at HC 2.2.1.3 and discussion of government investigations at HC 2.2.1.3. These uncertainties might not be resolved until several years after the services are rendered.
- Alternative payment programs that require providers to share risk with Medicare often utilize a retrospective settlement feature linked to a performance-based bonus or penalty. Consequently, the potential for the payment of bonuses or incurrence of penalties pertaining to current year services may not become known until a future period.
3.3.2.1 Estimating variable consideration related to government programs
When a contract contains variable consideration, the amount of variable consideration would be estimated using either the “expected value method” or the “most likely amount method” described in ASC 606-10-32-8 and HC 3.3. With respect to government program payments, the types of variability described in HC 3.4 often will require estimation of amounts that a provider may have to return to a government program, rather than amounts of additional consideration to be received.
The need for providers to exclude amounts that may have to be returned to a government program is similar to a retailer’s estimates for products sold subject to a right of return. If the expected value method is used, it will take into account the probability of various repayment scenarios, while the most likely amount method will consider the single most likely amount in a range of possible repayment scenarios.
A provider can use different estimation methods for different types of uncertainties; for example, it might use one method for estimating amounts to be refunded related to expected cost report adjustments and another for estimating amounts to be refunded under disproportionate share hospital (DSH) payments, whichever better reflects the expected outcome. Importantly, however, the method selected is not a policy choice; an entity should use the method that it expects will best predict the amount of refund for that uncertainty.
Most institutional providers have many years of experience estimating potential adjustments arising from future audits or desk reviews of cost reports. Although the most likely amount method is typically more appropriate in situations when an outcome will be one of two (or very few) possibilities, AAG-REV 7.6.52 indicates that providers may apply this method in other scenarios if they believe it will better predict the amount that the entity will ultimately be required to repay to the program.
All relevant information (historical data, current data, or reasonable projections) is used in making these estimates. Factors to consider include the extent of a provider’s experience with estimates of that type, the historical accuracy of its estimates, its experience with the fiscal intermediary or RAC auditors, and its current charges, allowable costs, and relevant patient statistics.
Approaches vary from entity to entity, depending on individual facts and circumstances, particularly with respect to estimating future cost report settlement adjustments. For example, some health care systems may evaluate settlements on an individual facility and/or individual cost report year basis (that is, evaluating each cost report by facility and by year, individually), while others may use aggregated historical information. As noted in AAG-REV 7.6.61, some third-party settlement issues may apply to multiple cost reports, and health care entities should use all available information regarding the cost report settlement process to evaluate similar third-party settlement issues.
AAG-REV illustrates the estimation of several other situations involving government program retroactive adjustments, as follows.
- AAG-REV 7.6.70 illustrates the expected value method in estimating future cost report adjustments.
- AAG-REV 7.6.71 illustrates estimating amounts repayable in connection with RAC audits.
- AAG-REV 7.6.72 illustrates estimation of an accrual for DSH payments when the current year cost report has not yet been completed.
- Commentary and examples related to estimating adjustments related to performance-based bonuses or penalties under programs that require providers to share risk with CMS can be found in AAG-REV 7.6.73 through AAG-REV 7.6.108.
AAG-REV 7.6.62 states that differences between original estimates and subsequent revisions, including final settlements, represent changes in the estimate of variable consideration and should be included in transaction price (i.e., revenue) in the period in which the revisions are made in accordance with ASC 606-10-32-14.
3.3.2.2 Constraining estimates of variable consideration
The amount of estimated variable consideration to be included in the transaction price is recognized subject to a “constraint,” which requires that the estimated amount be adjusted downward to exclude any amount for which it is probable that a significant reversal of cumulative revenue will occur in the future if the uncertainty resolves unfavorably. Thus, with respect to the potential for government program retroactive adjustments, health care entities will need to ensure that their estimate of variable consideration is constrained to a low enough amount such that it is not probable there will be a significant revenue reversal at the time final settlement is made with the government payer. An estimate of variable consideration does not need to be constrained if the potential reversal of cumulative revenue recognized is not significant, or if a potential reversal is significant but not probable of occurring.
If an entity’s estimation methodology for a particular type or component of government program settlements inherently incorporates the principles on which the guidance for constraining estimates is based, it would not need to separately constrain that estimate. For example, given that many institutional providers have extensive historical experience with estimating cost report settlement adjustments, the constraint parameters may already be inherent in their estimation process.
When assessing the need for a constraint, entities should consider both the likelihood and magnitude of a revenue reversal. ASC 606-10-32-12 identifies factors that could increase these risks. For example, an entity with limited experience in making estimates involving these contracts may have a higher likelihood of a revenue reversal than would an entity with significant experience. See RR 4.3.2 for a general discussion of these factors. AAG-REV 7.6.56 through AAG-REV 7.6.61 and AAG-REV 7.6.93 through AAG-REV 7.6.97 provide relevant commentary that is specific to assessing settlement constraints.
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