Each type of not-for-profit organization tends to retain some unique elements of financial reporting that have evolved over the years. Voluntary health and welfare organizations, as mentioned earlier, must report a statement of functional expenses. Probably the most dis- tinctive version of not-for-profit accounting belongs to health care organizations. From a quantitative perspective, the providers of health care services have many thousands of insti- tutions in operation throughout the United States; virtually every city and town has hospi- tals, nursing homes, and medical clinics. The large number of these enterprises is not surprising; health care expenditures now make up roughly 16 percent of the gross domestic product in this country.14Because of society’s focus on health care, a wide array of organi- zations including for-profit endeavors, governmental operations, and not-for-profit entities have emerged.
One major factor influencing the financial reporting of health care organizations is the presence of third-party payors such as insurance companies, Medicare, and Medicaid. These organizations, rather than the individual patient, pay some or all of the cost of medical services that the patient receives. Because of the significant monetary amounts involved, third-party payors have historically sought reliable financial data, especially concerning the sources of revenue and the costs of patient care.
Accounting for Patient Service Revenues
The largest source of health care revenues normally is patient services. For example, The King’s Daughters’ Hospital and Health Services of Madison, Indiana, reported in 2008 that
$114.3 million of its total revenue of $115.0 million came from net patient service revenue.
These amounts include fees for surgery, nursing services, medicine, laboratory work, X-rays, blood, housing, food, and so forth.
Reductions in Patient Service Revenues
For a variety of reasons, health care entities often receive much less in total payment than the amount they normally charge for specific patient services. Bad debts and other fee reductions can be significant. However, to provide complete financial data about their operations, these organizations initially record revenues at standard rates. Then they report each of the various reductions in a specified manner to best reflect these activities.
Assume, as an illustration, that patient charges for the current month at a local hospital total
$750,000. Of this amount, $170,000 is due from patients, and the remaining $580,000 was billed to third-party payors: Medicare, Medicaid, and various insurance companies. Regard- less of expected receipts, the hospital initially should record these revenues through the fol- lowing journal entry:
Accounts Receivable—Third-Party Payors . . . . 580,000 Accounts Receivable—Patients . . . . 170,000
Patient Service Revenues . . . . 750,000 To record accrual of patient charges for current month.
This hospital reports the entire $750,000 as patient service revenue although complete collec- tion is doubtful. This approach is considered the best method of allowing the health care or- ganization to monitor activities during the period.
Assume that the hospital estimates that $20,000 of the patient receivables will be uncol- lectible. Furthermore, not-for-profit hospitals and other similar entities often make no serious attempt to collect amounts that indigent patients owe. In many cases, these facilities were orig- inally created to serve the poor. The King’s Daughters’ Hospital and Health Services explains its policy: “The hospital provides care to patients who meet certain criteria under its charity
LO7
Describe the unique aspects of accounting for health care organizations.
14Catherine Rampell, “U.S. Health Spending Breaks from the Pack,” July 8, 2009, http://economix.blogs.
nytimes.com/2009/07/08/us-health-spending-breaks-from-the-pack/.
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care policy without charge or at amounts less than its established rates. Amounts determined to quality as charity care are reported as deductions from revenue.” Assume, therefore, that an- other $18,000 of the accounts receivable will never be collected because several specific pa- tients earn incomes at or below the poverty level.
Thus, to mirror these anticipated reductions, the hospital records two additional entries.
As the following shows, the handling of the two reductions is not the same. The bad debts create an expense as in a for-profit business, but the revenue and receivable for the charity care are removed entirely so that no financial reporting is shown. If the work was performed with no intention to seek collection, no basis exists for recognizing either a receivable or revenue.
Bad Debt Expense . . . . 20,000
Allowance for Uncollectible and Reduced Accounts . . . . 20,000 To record estimation of receivables that will prove to be uncollectible.
Patient Service Revenues . . . . 18,000
Accounts Receivable—Patients . . . . 18,000 To remove accounts that will not be collected because patients’ earned
income is at the poverty level.
Contractual Agreements with Third-Party Payors
The adjustments in the preceding entries reflect amounts that the entity will not collect from patients. Such organizations make an additional reduction in connection with receivables due from third-party payors. Organizations such as insurance companies and Medicare often es- tablish contractual arrangements with health care providers stipulating that they will pay set rates for specific services. The entity agrees, in effect, to accept as payment in fullan amount that the third-party payor computes as reasonable (based normally on the average cost within the locality in which the service was rendered).
IS THIS REALLY AN ASSET?
Mercy Hospital is located near Springfield, Missouri. A religious organization created the not-for-profit hospital more than 70 years ago to meet the needs of area residents who could not otherwise afford adequate health care. Although the hospital is open to the pub- lic in general, its primary mission has always been to provide medical services for the poor.
On December 23, 2010, a gentleman told the hospital’s chief administrative officer the following story: “My mother has been in your hospital since October 30. The doctors have just told me that she will soon be well and can go home. I cannot tell you how relieved I am. The doctors, the nurses, and your entire staff have been just wonderful; my mother could not have gotten better care. She owes her life to your hospital.”
“I am from Idaho. Now that my mother is on the road to recovery, I must return immedi- ately to my business. I am in the process of attempting to sell an enormous tract of land.
When this acreage is sold, I will receive $15 million in cash. Because of the services that Mercy Hospital has provided for my mother, I want to donate $5 million of this money.” The gen- tleman proceeded to write this promise on a piece of stationery that he dated and signed.
Obviously, all of the hospital’s officials were overwhelmed by this individual’s generos- ity. This $5 million gift was 50 times larger than any other gift ever received. However, the controller was concerned about preparing financial statements for 2010. “I have a lot of problems with recording this type of donation as an asset. At present, we are having seri- ous cash flow problems; but if we show $5 million in this manner, our normal donors are going to think we have become rich and don’t need their support.”
What problems are involved in accounting for the $5 million pledge? How should Mercy Hospital report the amount?
Discussion Question
798
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Accounting and Reporting for Private Not-for-Profit Organizations 799
For example, a note to the 2009 financial statements for Duke University explains that the Duke University Health System (DUHS)
has agreements with third-party payors that provide for payments to DUHS at amounts that gen- erally are less than established rates. Payment arrangements include prospectively determined rates per discharge, reimbursed costs, discounted charges and per diem payments. Accordingly, net patient service revenue is reported at the estimated net realizable amounts from patients, third-party payors, and others. . . .
Thus, although a health care entity charges a patient $30,000, for example, it might collect only $27,000 (or some other total) from a third-party payor if the lower figure is determined to be an appropriate cost. The entity must write off the remaining $3,000, which is commonly referred to as a contractual adjustment.
Because of the current cost of health care, contractual adjustments can be huge. For exam- ple, a note to the 2008 financial statements for Parkview Health System reports that the patient charges for the year amounted to $1.49 billion, but contractual adjustments for the same period were $765 million or more than half of the amount charged.
An alternative method of determining the amount to be paid is known as a prospective payment plan.Under this system, reimbursement is based not on the cost of the health services being provided but on the diagnosis of the patient’s illness or injury. Thus, if a patient suffers a broken leg, for example, the health care entity is entitled to a set reimbursement regardless of the actual expense incurred. Such plans were developed in an attempt to encourage a reduc- tion in medical costs because the facility collects no additional amount if a patient remains longer than necessary or receives more expensive treatment.
The health care entity should estimate and recognize these reductions in the same period that it earns the patient service revenue. In the example previously presented, the hospital probably does not anticipate collecting the entire $580,000 billed to third-party payors. As- sume, for illustration purposes, that this hospital projects receiving only $420,000 of the
$580,000 charge. To establish a proper value for the hospital’s revenues, the entity must record another $160,000 adjustment:
Contractual Adjustments . . . . 160,000
Allowance for Uncollectible and Reduced Accounts . . . . 160,000 To recognize estimated reduction in patient billings because of contractual
arrangements made with third-party payors.
Summary 1. Financial statements for not-for-profit organizations are designed to provide users, including contributors, with an overall view of the organization’s financial position, results of operations, and cash flows.
2. The required financial statements for private not-for-profit organizations include a statement of financial position, statement of cash flows, and statement of activity and changes in net assets.
Voluntary health and welfare organizations also are required to issue a statement of functional expenses.
3. The statements must distinguish among assets, liabilities, revenues, and expenses that are perma- nently restricted, temporarily restricted, and unrestricted. Restrictions are donor imposed. Tem- porarily restricted assets are expected to be released from restriction after the passage of time or the not-for-profit’s performance of some act. That release causes an increase in unrestricted net assets and a decrease in temporarily restricted net assets. Permanently restricted net assets are expected to be restricted for as long as the organization exists.
4. Not-for-profit organizations should report expenses as reductions in unrestricted net assets by their functional classification such as major classes of program services and supporting services. Pro- gram services are goods or services provided to beneficiaries or customers that fulfill the organiza- tion’s purpose or mission. Supporting services are general administration and fund-raising.
5. Reporting requirements have been established for contributions, which are unconditional transfers of cash or other resources to an entity in a voluntary nonreciprocal transaction.
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6. Not-for-profit organizations recognize contributions, including unconditional promises to give, as revenues in the period received at fair value. Pledges to be received more than one year into the fu- ture must be reported at present value.
7. These private organizations recognize contributed services as revenues if they either create or en- hance nonfinancial assets or require a specialized skill (for example, accounting, architecture, or nursing) and would have to be purchased if not provided by donation.
8. Not-for-profit organizations can sometimes receive donations that must be given to a different ben- eficiary. While such organizations hold the gift, they normally record it as an asset with an accom- panying liability. However, if the organization is given variance power to change the beneficiary, the not-for-profit records a revenue rather than a liability.
9. Not-for-profit organizations can join together by creating either an acquisition or a merger. In an ac- quisition, one party gains control of the other, and the accounting is much like that used in the con- solidation of for-profit businesses with all identifiable assets and liabilities of acquired organization reported at fair value. As one exception, goodwill is charged off immediately (rather than capital- ized) if the acquired organization is predominantly supported by gifts and investment income. In a merger, the two organizations come together under the control of a newly formed not-for-profit with a different governing body. When a merger occurs, the financial information is combined using the carryover method, which retains the previous book values.
10. Health care organizations frequently receive less than the full amount of patient charges. These en- tities show contractual adjustments with third-party payors as deductions from revenue in reporting net patient service revenue.These entities estimate bad debts and report them as expenses. Charity care charges are not recorded as revenue.
800 Chapter 18
Comprehensive Illustration PROBLEM
(Estimated time: 30 to 45 minutes) Augusta Regional Health Center is a private not-for-profit hospital offering medical care to a variety of patients, including some with no ability to pay for the services re- ceived. In addition, the hospital sponsors a consortium on childhood diseases with the financial support of a private foundation. The hospital also holds an endowment, the principal of which must be main- tained. However, the earnings are available to provide charity care. During 2010, the hospital has the financial transactions listed here.
Required:
a. Prepare the journal entries for each of the following:
1. The hospital rendered $950,000 in services to patients, of which it charged $700,000 to third-party payors. The administration estimated that only $800,000 would be collected. Of the $150,000 differ- ence, $85,000 represented estimated contractual allowances with insurance and Medicare providers,
$20,000 is for charity care, and $45,000 is estimated for bad debts.
2. A local business donated linens with a $3,000 fair value.
3. Cafeteria sales to nonpatients and gift shop receipts totaled $76,000.
4. The hospital incurred expenses of $12,000 in connection with the childhood disease consortium.
Funding for this consortium had been received as a restricted donation in 2009.
5. The hospital received unrestricted, unconditional pledges of $12,500. The administration expected to collect only 80 percent of them. In addition, it received securities with a fair value of $8,000 that the donor designated for the endowment.
6. A computer consultant donated services to upgrade several of the hospital’s computer systems.
The value of these services was $3,000 and would have been acquired if not donated.
7. The hospital incurred the following liabilities:
$102,000 for purchase of supplies
$699,000 for salaries
$50,000 for purchase of equipment
8. End-of-year adjustment included supplies expense of $99,000 and depreciation expense of
$72,000.
b. Prepare a schedule showing the change in unrestricted, temporarily restricted, and permanently restricted net assets.
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Accounting and Reporting for Private Not-for-Profit Organizations 801
SOLUTION
a. 1.
Accounts Receivable—Patients . . . . 250,000 Accounts Receivable—Third-Party Payors . . . . 700,000
Patient Service Revenues (Unrestricted) . . . . 950,000 To accrue billings for the current period.
Contractual Adjustments . . . . 85,000
Allowance for Contractual Adjustment . . . . 85,000 To recognize estimated amounts not expected to be collected from
third-party payors.
Patient Service Revenues (Unrestricted) . . . . 20,000
Accounts Receivable—Patients . . . . 20,000 To remove the amount for charity care for which no expectation
to collect exists.
Bad Debt Expense . . . . 45,000
Allowance for Uncollectible Accounts . . . . 45,000 To recognize estimated amounts not expected to be collected from
patients.
2.
Inventory of Supplies . . . . 3,000
Unrestricted Net Assets—Contribution of Materials . . . . 3,000 To recognize fair value of donated items.
3.
Cash . . . . 76,000
Unrestricted Net Assets—Revenues—Cafeteria and Shops . . . . 76,000 To record cafeteria and gift shop revenue.
4.
Consortium Expenses . . . . 12,000
Cash . . . . 12,000 To record expenses in connection with the childhood disease consortium.
5.
Pledges Receivable . . . . 12,500 Investments . . . . 8,000
Allowance for Uncollectible Pledges . . . . 2,500 Unrestricted Net Assets—Contributions . . . . 10,000 Permanently Restricted Net Assets—Contributions . . . . 8,000 To record pledges and investments received at estimated fair value.
6.
Expenses for Professional Services . . . . 3,000
Unrestricted Net Assets—Contributed Services . . . . 3,000 To record donated services.
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802 Chapter 18
7.
Supplies Inventory . . . . 102,000 Equipment . . . . 50,000
Accounts Payable . . . . 152,000 To record goods received.
Salaries Expense . . . . 699,000
Accrued Salaries Payable . . . . 699,000 To record salaries payable.
8.
Supplies Expense . . . . 99,000
Supplies Inventory . . . . 99,000 To record supplies expense for the period.
Depreciation Expense . . . . 72,000
Accumulated Depreciation . . . . 72,000 To record depreciation expense for the period.
b.
Calculation of Change in Net Assets
Temporarily Permanently Unrestricted Restricted Restricted Journal Entry Net Assets Net Assets Net Assets
1 . . . $950,000 (85,000) (20,000) (45,000) 2 . . . 3,000 3 . . . 76,000 4 . . . (12,000)
5 . . . 10,000 $8,000
6 . . . (3,000) 3,000 7 . . . (699,000) 8 . . . (99,000) (72,000) Net assets released from restriction—
childhood disease consortium . . . 12,000 $(12,000)
Increase (decrease) in net assets . . . $ 19,000 $(12,000) $8,000
Questions 1. Which organization is responsible for issuing reporting standards for private not-for-profit colleges and universities?
2. What information do financial statement users want to know about a not-for-profit organization?
3. What financial statements are required for private not-for-profit colleges and universities?
4. What are temporarily restricted assets?
5. What are permanently restricted assets?
6. What two general types of expenses do private not-for-profit organizations report?
7. What ratio is frequently used to assess the efficiency of not-for-profit organizations?
8. Why is a statement of functional expenses required of a voluntary health and welfare organization?
9. If a donor gives a charity a gift that the charity must convey to a separate beneficiary, what is the normal method of reporting for each party?
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Accounting and Reporting for Private Not-for-Profit Organizations 803 10. If a donor gives a charity a gift that the charity must convey to a separate beneficiary, what is the method of reporting for each party if the donor retains the right to revoke or redirect use of the gift?
11. If a donor gives a charity a gift that the charity must convey to a separate beneficiary, what is the method of reporting for each party if the charity receives variance powers enabling it to change the identity of the beneficiary?
12. When does a not-for-profit organization record donated services?
13. A private not-for-profit organization sends a direct mail solicitation for donations. However, the organization also includes other information with the mailing. Under what conditions can the organization report part of the cost of this mailing as a program service cost rather than a fund- raising cost?
14. A private not-for-profit organization receives numerous pledges of financial support to be conveyed at various times over the next few years. Under what condition should it recognize these pledges as receivables and contribution revenues? At what amount should it report these pledges?
15. What is the difference between an unconditional promise to give and an intention to give?
16. When should membership dues be considered revenue rather than contributions?
17. What are the two methods that can be used to report the combination of two private not-for-profit organizations?
18. The Sunshine NFP, a not-for-profit organization, gains control over Dancing Bears NFP, another not-for-profit. The acquisition value of Dancing Bears is $2.3 million, but all of its identifiable assets and liabilities have a total value of only $2.1 million. What recording is made of the $200,000 difference?
19. The Helping Hand NFP is a not-for-profit organization that has equipment with a book value of
$1.1 million but a fair value of $1.4 million. Fancy Fingers is a not-for-profit organization that has equipment with a book value of $1 million and a fair value of $1.2 million. If these two organiza- tions combine, what are the possible amounts that they can report for their equipment?
20. What is a third-party payor, and how does the presence of such payors affect the financial account- ing of a health care organization?
21. What is a contractual adjustment? How does a health care organization account for a contractual adjustment?
Problems 1. A private not-for-profit health care organization has the following account balances:
Revenue from newsstand . . . $ 50,000 Amounts charged to patients . . . 800,000 Interest income . . . 30,000 Salary expense—nurses . . . 100,000 Bad debts . . . 10,000 Undesignated gifts . . . 80,000 Contractual adjustments . . . 110,000 What is reported as the hospital’s net patient service revenue?
a. $880,000.
b. $800,000.
c. $690,000.
d. $680,000.
2. A large not-for-profit organization’s statement of activities should report the net change for net as- sets that are
Unrestricted Permanently Restricted
a. Yes Yes
b. Yes No
c. No No
d. No Yes
LO7
LO1
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