Maximizing Hospital Financial Health: The Crucial Role of Real Estate in GAAP Principles and Topic 842 Considerations 

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Healthcare executives, the guardians of hospital financial health, are well aware of the critical role GAAP (Generally Accepted Accounting Principles) plays in managing their institutions. However, one often overlooked aspect that can significantly impact a hospital’s financial statements is its real estate strategy.  

Understanding the Basics of GAAP 

Before diving into the real estate aspect, let’s recap the fundamentals of GAAP. These accounting principles are the bedrock of financial reporting for all organizations, including hospitals. GAAP ensures consistency, transparency, and accuracy in financial statements, making it easier for stakeholders to assess a hospital’s financial health. 

Key GAAP Principles for Healthcare Executives 

  • Consistency: One core principle of GAAP is consistency. Hospitals must apply consistent accounting methods and principles from one period to the next. Any changes should be adequately disclosed and justified. 
  • Revenue Recognition: Hospitals recognize revenue when it is earned and realizable. This principle involves careful consideration of patient care, insurance reimbursements, and other revenue streams. 
  • Asset Valuation: Proper valuation of assets is essential for GAAP compliance. This includes not only financial assets but also physical assets, such as buildings and equipment. 
  • Lease Accounting: The new lease accounting standards (ASC 842) are a significant change in GAAP rules, and healthcare entities need to adapt accordingly. 

Healthcare organizations that own or lease real estate typically follow the general principles of GAAP for accounting and financial reporting. Here are some key principles and considerations that influence the financial impact of healthcare real estate: 

  • Asset Recognition: Under GAAP, healthcare organizations must recognize healthcare real estate as assets on their balance sheets if they meet specific criteria. This recognition typically involves assessing whether control of the property exists, and whether future economic benefits are probable. 
  • Depreciation and Amortization: The cost of healthcare real estate is typically capitalized and then depreciated or amortized over its useful life. The determination of useful life and the method of depreciation or amortization may vary based on factors such as the type of real estate (e.g., buildings, land improvements) and local regulations. 
  • Lease Accounting (for lessees): The adoption of FASB Accounting Standards Codification (ASC) Topic 842, “Leases,” brought significant changes to lease accounting. Healthcare organizations that lease healthcare real estate must recognize lease assets and liabilities on their balance sheets, reflecting the present value of future lease payments. 
  • Revenue Recognition (for lessors): If a healthcare organization leases real estate to others, it must account for lease revenue in accordance with ASC Topic 842. This standard provides guidance on how lessors should recognize revenue over the lease term. 
  • Fair Value Measurements: Healthcare organizations may be required to assess the fair value of their real estate assets, especially if they are involved in financial reporting, such as in the case of mergers, acquisitions, or divestitures. 
  • Disclosure: Transparency is a fundamental principle of GAAP. Healthcare organizations are required to provide detailed disclosures in their financial statements, including information about significant real estate transactions, lease terms, and any potential risks or uncertainties related to their real estate holdings. 

Topic 842, which deals with lease accounting, had been a significant change in accounting rules for all industries, including healthcare. These changes were implemented by the Financial Accounting Standards Board (FASB) to improve transparency and provide a more accurate representation of lease transactions in financial statements. Here are some key changes introduced by Topic 842 in the context of healthcare real estate: 

  • Balance Sheet Impact: The most significant change brought about by Topic 842 is the requirement for lessees to recognize most leases on their balance sheets. This means that healthcare organizations leasing real estate must recognize both a right-of-use (ROU) asset and a lease liability on their balance sheets, representing the present value of future lease payments. This change is intended to provide a more accurate picture of a healthcare organization’s financial position. 
  • Expense Recognition: Under Topic 842, lessees continue to recognize lease expenses in their income statements, but the pattern of expense recognition may change. Instead of straight-line expense recognition, lessees typically recognize interest on the lease liability separately from the amortization of the ROU asset. This results in a front-loaded expense pattern, with higher expenses in the early years of a lease. 
  • Classification of Leases: Topic 842 introduces a new lease classification system. Leases are classified as either finance leases (similar to capital leases under the old standard) or operating leases. Finance leases result in a front-loaded expense recognition, while operating leases lead to a more level expense profile over the lease term. The classification is based on specific criteria outlined in the standard. 
  • Disclosure Requirements: The new lease accounting standard also imposes additional disclosure requirements. Healthcare organizations are required to provide more detailed information about their leases, including information about lease terms, lease options, and judgments made in applying the standard. 
  • Transition: Healthcare organizations were required to adopt Topic 842 using a modified retrospective approach, which means they had to adjust their financial statements to reflect the new lease accounting rules as of the beginning of the earliest comparative period presented in the financial statements. This transition method requires restating prior periods, which could have a significant impact on financial statements. 

It’s essential to note that the adoption of Topic 842 could have varied implications for healthcare organizations depending on their lease portfolio. The changes may affect financial ratios, debt covenants, and lease negotiation strategies. 

Boldt has proven lease options to help mitigate the Topic 842 changes and minimize the impact on your balance sheet. Set up a meeting with one of our representatives to talk through how we can help you.    

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