Accounting Losses and Accounts Receivable – Part I; Why am I always surprised?

Every year I can count on seeing reports of hospital experiencing substantial losses. But every year, I am still surprised by the reporting of the losses, going back two, three, four or more years and linked to an overstatement of accounts receivable and net patient revenue. I am surprised because I expect someone in accounting, revenue cycle or with the audit firm to question the value of accounts receivable as various ratios or benchmarks get further out of line or the variance from actual cash collections grow to a point that they are material.

Estimating the value of receivables has always been and will continue to be a challenge to hospitals and other healthcare entities, but complexity is not an excuse for missing the value by so much or for so long.

There are a variety of issues involved in the valuation of accounts receivable, starting with the contractual adjustment. Charges are well above the third-party payments. In my own case, a recent outpatient surgery had charges that were six times more than the managed care payment. Add to that, my deductible was more than $5,000, just figuring out how much to expect on one account is a challenge. My one account was hardly measurable in the total revenues of a 400-bed hospital. But it is not just one contract but four to eight major managed care plans and a host of smaller plans accessing discounts through a variety of fee schedules, Medicare, Medicare Advantage, Medicaid, Champus, Charity, Worker’s comp and so on.

And, contractual rates are always changing. Each time a hospital raises charges a new contractual rate needs to be established. The same goes for including increases from payors, either renegotiated contracts or regulatory adjustments to payments, in the case of Medicare.

Contractual adjustments are getting more complex, as hospitals diversify or expand into physician practices and a variety of outpatient services. And what happens as value-based purchasing, in multiple structures, become a bigger part of the puzzle.

Beyond the contractual, the accounts also need to be assessed for

• Bad debt allowances.
• Charity write-offs.
• Disputes with payors including coverage, medical necessity and primary responsibility.
• Delays in payment related to accurate patient information, including the responsibility.
• Changes in payor mix or clinical service mix.
• A variety of other adjustments unique an entity or service.

Adding to the challenge will be an increase in value-based payment systems.

At the end of the day, hospital management is responsible for the accuracy of the financial statements and responsible for developing a good system for tracking and estimating the value of accounts receivable. Over the course of my career as a hospital CFO, healthcare practice leader in a regional CPA firm and independent consultant, I have seen a host of methods for measuring receivables: good; bad; and ugly. Some have been very detailed and actively monitored to look for changes or delays in payment by financial class or specific payors. Others are basic and seem to rely only on the age of the accounts or a historical collection percentage. Others have used a variety of complex formulas that change over time, are not timely updated or that perpetuate an error from prior period. After layering onto calculation method, the subjective estimate of what is expected by management, the assigned value can vary from the actual value. For example:

• Built-in contractual estimates (not based on actual fee schedule) at the time of billing that were and never trued up to the actual contractual.
• Simple failure to understand payment arrangements with third parties in developing estimates.
• Failure to update payment percentages for changes in charges and payments.
• Locking in an adjustment ‘floor’ at year-end, such that the error is perpetuated into future periods.
• Attempts to calculate a single ‘average’ contractual across multiple billing entities in multiple states with different payors.
• Overly optimistic expectations on the ability to collect denials or patient balances, particularly high deductibles.
• The value of accounts receivable is masked by large credit balances which act to reduce the net value of receivables.
• Not separating non-hospital revenue cycle from traditional hospital revenue, such as the steady increase in hospital owned physician practice or with the new off-site regulations, imaging centers and other outpatient offerings unintentionally overstate or understate the value of accounts receivable.
• Errors arising from simple lack of experience and knowledge.
• Overreliance on past practices.
• A belief (perhaps hope) that things are better than the numbers show.

You may ask, why doesn’t the audit firm identify these problems sooner? The experienced healthcare audit firms do a very good job of assessing revenue and receivables by both challenging and educating clients. But some hospitals will fall through the cracks, for one reason or another:

• The audit firm has limited healthcare audits and performs the audit without significant healthcare experience staff on the engagement.
• The methodology and analysis remain the same year over year, such that the auditor becomes too comfortable or too close to the process.
• A strong management team takes a strong position supporting the recorded balance, rationalizing delays in payment, contract issues, billing delays or impact of computer conversions.

So how does a healthcare entity protect itself against errors in revenue recognition and accounts receivable valuation – The fact is this is complicated and even the best organization with experience staff can make a mistake or get too comfortable. Creating checks and balances on the estimates is the best defense.

For a discussion testing and monitoring receivables look for Part II – Don’t Be Surprised