San Diego New rules for revenue recognition are working their way through the life-sciences industry, and diagnostics companies and labs stand to be significantly impacted—especially in how they evaluate the following:
• Contract components and terms
• Timing and extent of collectability of payments
• Transaction pricing
As with any business decision that needs to recognize both rules and reality, judgment on the part of leadership will be required.
Legacy guidance mandates the application of the concept of persuasive evidence, such as an agreement or purchase order, to provide evidence of the ultimate understanding between customer and seller regarding the terms and nature of a transaction. The new standard alternatively requires an entity identify contracts with customers.
Although persuasive evidence may have already been in the form of a traditional contract, it also might have been a purchase order or another document that demonstrated both sides understood the nature of a transaction. Evaluating these items is key to adhering to the new guidance.
Five Elements of a Contract
Contracts may be written, verbal, or implied, but they must contain five key components:
• Approval of a contract and commitment to perform
• Identifiable rights between both parties
• Identifiable payment terms
• Definition of probable collection
• Evidence of commercial substance
Judgement must be exercised when determining whether an agreement is a contract. Most diagnostics providers have some record of their patient relationships. Those providers will need to evaluate those documents to determine whether a contract exists and whether it’s enforceable. The complexity lies in the provider, patient, and payer relationship.
Determining Payment Collectability
Reasonably assured collectability of full payment from a customer is no longer required to recognize revenue. Instead, it’s the customer’s intent and ability to pay that matters.
Under the new standard, a provider that may not be paid the full amount of its contract price may still be able to recognize the revenue under the arrangement. Factors that may be considered when determining collectability include the following:
• Patient’s past payment history
• Patient’s eligibility for coverage under Medicare or similar government subsidies
In evaluating collectability, diagnostic providers don’t need to evaluate individual tests or accessions. Instead, they can allocate delivered tests into portfolio groups based on similar collection history or reimbursement rates—by payer and test type, for example—to determine whether the collectability standard has been met.
Establishing Transaction Prices
Because the cost of services can often influence a patient’s intent and ability to pay, the method by which companies set transaction prices are changing.