Accounts Receivable Values – Part II Don’t be Surprised

• The value of receivables are estimates. Estimates need to be reasonable and well documented with a combination of historical performance and real time insight.
• Accounts Receivable values directly correlate to Net Revenue and therefore, financial performance, valuation and budgeting.
• The first place to start is with a subsequent payment test. There is no better check on accounts receivable value than to see what was collected.
• For larger organizations, subsequent payment by financial class should be considered.
• Establish a lag report showing the month of service within in the month of collection.
• Large accounts, special collection issues and credit balances can skew value and should be reviewed separately.

First, let’s all acknowledge that the valuation of receivables is a group of estimates based on historical performance, general experience and gut instinct. Estimates can be influences by biases, revenue cycle team performance, expectations both good and bad  and unfortunately, in some cases pressure to report better results. The reporting of financial statements requires timely estimates, whether monthly or at year-end. Time is too short to really dig deep in preparing an estimate each month.  Rather, estimates and assumptions must be an ongoing process. Further, estimates are just that estimates, and they may be high or may be low. But there are consequences to bad estimates. If receivables are overstated in one year the correction will have to be absorbed in the next year’s earnings or future budgets may be based on the higher than actual revenue.
[1]In Part I of this series (click here), we looked at some of the issues leading to errors in the valuation of accounts receivable and revenue recognition. But more importantly than how the errors happen is, how do you monitor accounts receivable values in a current manner.

To address timeliness, calculations supporting estimates need to be planned, tracked over time, constantly considering changing payments from third parties, charge increases, payor mix and collection rates. The supporting calculations should be well documented. Monitoring changes of   receivables composition and variables throughout the year is critical.

Throughout my career, whether it be as a CFO, supporting a financial audit, representing a healthcare entity in a sale or providing buy-side due diligence, the first thing, I checked, was revenue recognition and accounts receivable valuation.

  • As a CFO, I needed to know the status of accounts receivable, not only for financial reporting but to address, weaknesses in the revenue cycle.
  • As an auditor, revenue recognition is the highest area of risk in a healthcare audit.
  • As an adviser to the seller, I wanted to find the overstatement before the buyer to protect my client from unexpected adjustments or find the understatement so that the client got true value.
  • In due diligence, the buyer client expects a thorough review and much like the audit, it was a high-risk area. More than any other area, receivables are a place where the buyer can impact the sales price by identifying overstated revenue.

Subsequent Payment Test

The first place to start is to understand if previous values were reasonable. There is no better check on historical accounts receivable values than to see what was ultimately collected. A subsequent payment test will compare the reported value of receivables to the actual collections, six, nine and twelve months later. Subsequent payment testing will validate methodology or expose errors in estimates and calculations. When used in transactions the testing can confirm historical revenue in a quality of earnings review and minimize post-closing disputes over net working capital.

The challenge is getting good data out of information systems. Accounting professionals looking to do the analysis need to work closely and communicate clearly with the IT group to design the right queries of payment data. Say the hospital year end wants to look back and test accounts receivable estimates from  June 30th. Then, the query needs to contain payments made for dates of service prior to July 1st but collected after June 30th. Defining payments can be tricky, depending on the complexity of the system, clarity of data fields and the strength of the report writer. Somethings that you want to consider in the query:

  • Report the collections by financial class. This will allow a focus on where the estimate may be too high or too low. This also requires consideration of patients changing financial class during the collection cycle.
  • Distinguish payment between the patient or 3rd party payor.
  • Include a review based on the last payment date, to understand the length of time from the date of service to collection and the gap between an insurance payment and a remaining patient liability.
  • The query may filter out patients who were inpatient on the cut-off date. Payments on these accounts may need to be prorated.
  • Evaluate alternative measurement of any outsourced collection service.

Once the subsequent payment testing is complete, objectively consider what was different about the actual results and the original estimates, one or more financial classes, changes related to a particular payor, declines in patient liability, higher denial rates among a payor(s), shifts between inpatient and outpatient, increases or decreases in the use of a particular service.

Monitoring in “Real Time” –

Understand that as charges are increased contractual adjustments go up and as payments increase contractuals go down. Knowing how and when to change collection percentage assumptions is critical to maintaining good estimates.

Establish a lag report as an ongoing monthly report. A lag report will track collections matching the month of collection to the month of revenue, calculating completion rates compared to the original estimate. The lag report allows the provider to develop expectations on how quickly claims are collected and how long the run-out or completion process is. For example, what is the expected and actual completion percentage at 30, 60, 90 days? The lag report can be done for receivables in total or for specific payor classes.

By updating a lag report monthly, the healthcare entity is effectively creating both a rolling look-back at subsequent payments and developing a rolling average collection rate based on the age of an account.

The lag report is especially useful when evaluating the receivables of a cash basis entity. Cash basis providers do not maintain estimates of accounts receivable value. A lag report allows the buyer to estimate receivables being acquired based on the historical time to completion.

Keep Receivables as Clean as Practical –

Resolving accounts quickly provides, not only more timely cash but, a clearer picture of what is collectible or what is not collectible. Resolving charity patients quickly is one way to get a clearer picture. All healthcare providers, for-profit or not-for-profit, can benefit from clearing out bona fide charity patients as quickly as possible. Qualified charity patients pay little or nothing, clog up the system, consume resources and inflate receivables. A strong charity program with timely resolution is not only a compliance issue for not-for-profits but will reduce the potential for misstatement from charity accounts and identify non-charity accounts that require immediate collection efforts. Timely addressing charity patients will improve reporting and impact payment based on Medicare Cost Report Schedule S-10.

The same is true of determining when an account is uncollectible and should be written-off to bad debt or transferred to a collection agency to be separately monitored.

Credit balances can understate the value of receivables but may also alter the calculation of contractual adjustments or bad debt allowances. A credit balance arises from an overpayment (almost always due back at 100%) or a misposting (almost always worth nothing). These two extremes distort the value of account receivable, net of contractuals and uncollectibles. For example, assume that a refund of $1,000 is due and included in a financial class with 50% collectability. By including the credit balance in accounts receivable, the impact on the adjustment is to understate the contractual by $500. Consider what the impact would be, if credit balances are $100,000 or more. It is strongly suggested that whatever the methodology used to estimate receivables, the estimates should be based on accounts receivables excluding any credit balances.

Adjusting to Account Specific Conditions

The subsequent payment test and the use of a lag report are the first steps to understanding the collectability of accounts receivable. But there are some accounts that by their very nature have a long collection cycle or other factors. Some areas of accounts receivable may be better evaluated on an account by account basis. Large disputed or delayed collection account skew results.  It may be appropriate to exclude or track these large accounts separately in adjustment calculation.

Consider some of the following issues as either adjustments to any estimate or requiring separate consideration:

  • Denials of coverage for medical necessity – Early monitoring of these will also allow the entity to engage the payor, the patient or the clinical service lines to reduce the issue going forward.
    • Payor practices.
    • Large accounts.
    • Type of denial.
  • Legal claims where there may be third party liability –
    • Nature of the claim.
    • Other available coverage and subjugation rights.
  • Patients paying over time
    • Consider aging from date of last payment to identify accounts not paying as promised.
    • Monitor compliance based on original balance, size of periodic payment, use of automatic draft.
  • Chapter 13 bankruptcies and expected recoveries
  • Out-of-network claims –
    • Nature of service – emergency or elective can affect the payor view of coverage.
    • Fairness of payor payment rates and success resolving with payors.
  • Unique arrangements with 3rd parties, particularly newer arrangements in the evolving use of value-based payments.

Receivables will always require monitoring and verification. Regular monitoring of receivables will identify no only changes to the contractual adjustment but issues affecting collectability.  Even the best methodology can vary due to changes in payor mix, case mix, staff turnover, contract updates, local economies and 3rd party behavior.

NOTE: This article is focused on the practical aspects of measuring collectability. It does not attempt to address issues related to new accounting standards on revenue recognition. You should consider reviewing revenue recognition standards with your auditor or other accounting professional.

For questions or help in reviewing these or other complex healthcare financial issues, contact us at

[1] Changes in accounting estimates are recorded in the period that they are corrected. Accounting errors will give rise to a restatement of a prior year. The year to year changes in estimates are not errors. Errors are and should be a rare occurrence. However, occasionally an estimate is so bad that it is an error.

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