Article: Hospitals - Accounting for Financial Challenges

HOSPITALS FACE FINANCIAL CHALLENGES – HOW WILL YOU ACCOUNT FOR THEM?

NEW ACCOUNTING STANDARD REQUIRES NOT-FOR-PROFIT ENTITIES TO TEST GOODWILL FOR IMPAIRMENT

The Financial Accounting Standards Board recently issued Statement of Financial Accounting Standards (SFAS) No. 164, Not-for-Profit Entities: Mergers and Acquisitions, which establishes accounting principles and reporting requirements governing combinations of not-for-profit entities. The new statement also amends SFAS No. 142, Goodwill and Other Intangible Assets, to make it fully applicable to not-for-profit entities, thus significantly altering the accounting and reporting requirements for not-for-profit entities’ goodwill and other intangible assets subsequent to an acquisition. The new statement impacts most healthcare not-for-profit entities with previously recognized goodwill as follows:

• Goodwill will no longer be amortized.
• Goodwill must be tested for impairment on at least an annual basis.
• Entities have a six month initial application period to complete the first step of a transitional impairment evaluation; any impairment resulting from this testing is recorded “below the line” as the effect of a change in accounting principle. The transitional evaluation must be completed by the end of the fiscal year of adoption.

Not-for-profit entities that are predominantly supported by contributions and returns on investments will be required to write-off existing goodwill.

SFAS No. 164 provides specific accounting guidance for a not-for-profit entity’s combination with one or more other 
not-for-profit entities, businesses, or 
nonprofit activities, including the following topics:

• The determination of whether a combination is a merger or an acquisition
• The application of the “carryover method” in accounting for a merger
• The application of the “acquisition method” in accounting for an acquisition, including determining which of the combining entities is the acquirer
• The required disclosures to enable users of financial statements to evaluate the nature and financial effects of a merger or an acquisition

The provisions of SFAS No. 164 primarily address not-for-profit entities involved in a combination. Its amendment of SFAS No. 142 will have morewidespread impact, affecting all not-for-profits with previously recognized goodwill. Not-for-profits will now follow SFAS No. 142, which became effective for most for-profit entities in 2002, and at which time goodwill and other intangible assets arising from combinations involving not-for-profit organizations were excluded from its scope. Until the implementation of the new statement, not-for-profit organizations have continued to follow the existing guidance in APB Opinion Nos. 16 and 17, as amended by pronouncements such as SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, even though that statement was superseded for for-profit entities by subsequent pronouncements.

SFAS No. 142 provides specific guidance for testing goodwill for impairment. Under previous guidance, intangible assets, including goodwill, were tested for impairment only if and when certain events and circumstances existed. Once the new statement becomes effective, goodwill must be tested for impairment at least annually using a two-step process that begins with an estimation of the fair value of a reporting unit. The first step is a screen for potential impairment, and the second step measures the amount of impairment, if any. However, if certain criteria are met, the requirement to test goodwill for impairment annually can be satisfied without a re-measurement of the fair value of a reporting unit.

Not-for-profit entities with previously recognized goodwill or other intangible assets on their balance sheets need to take note of the new pronouncement. While many of the smaller voluntary health and welfare organizations will likely not be affected, the new statement is expected to have a significant impact on not-for-profit healthcare organizations, particularly hospitals. Not-for-profit hospital systems have traditionally been active in mergers and acquisitions and need to plan ahead to ensure a smooth, “no surprises” transition to SFAS No. 164.

Fee-for-service not-for-profits with previously recognized goodwill will need to implement the new requirements using the following summarized action steps:

1. Establish reporting units based on the entity’s internal reporting structure. (At times, only one reporting unit may exist for the entire entity.)
2. Assign all previously recognized goodwill to one or more of the reporting units.
3. Subject the previously recognized goodwill in each reporting unit as of the beginning of the fiscal year to a “transitional impairment evaluation.” An entity has six months from the date of initial application (the first day of its fiscal year beginning after December 15, 2009) to complete this first step of testing of goodwill for impairment.
4. If the carrying amount of a reporting unit’s net assets (including goodwill) exceeds the fair value of that reporting unit, the second step of the transitional goodwill impairment test must be completed as soon as possible, but no later than the end of the fiscal year.
5. Reassess useful lives of any previously recognized intangible assets other than goodwill, and adjust the remaining amortization periods as necessary. This reassessment should be completed before the end of the first interim period of the fiscal year in which the statement is initially applied. Intangible assets deemed to have indefinite useful lives should be tested and any resulting impairment should be accounted for in the same manner as the procedures outlined for goodwill described above.

It is critical that the transitional goodwill impairment test be performed timely and accurately. Any impairment loss recognized as a result of the transitional goodwill impairment test should be recognized as the effect of a change in accounting principle, and therefore presented “below the line” in the statement of activities above the caption “change in net assets.” A transitional impairment loss will also be presented outside any performance indicators or intermediate measures of operations. Impairment losses recognized after the initial implementation must be presented as a line item within results from operations. It is also imperative that entities planning a merger or acquisition become familiar with the new statement.

The recent economic conditions have led to a significant number of asset impairments recognized by public companies in many industries during 2008. It is anticipated that this trend will continue throughout 2009. Hospitals across the country are facing similar issues from the recession. The economy, bond downgrades, the changing regulatory environment, the increase in uninsured and yes, healthcare reform are all catalyst for impairment. With the application of SFAS No. 142 to not-for-profit organizations, CFOs, CEOs and boards will have to evaluate and wrestle with accounting for goodwill during the coming fiscal year. The first reaction may be one of denial, but it does not relieve the organization of the obligation to look. With the one-time transition evaluation opportunity, organizations are encouraged to address this issue sooner rather than later.

Lastly, organizations need to be aware that the AICPA’s independence guidelines generally preclude an entity’s external auditor from performing the appraisal and valuation services inherent in the goodwill impairment testing process. A successful implementation of the new standard will involve experienced valuation professionals who will work with your internal staff as well as your external auditors.
 Decosimo has teamed its healthcare assurance and valuation professionals to provide assistance in addressing not-for-profit healthcare organizations with the adoption of SFAS No. 164. For more information, call or email Ken Conner, CPA; Cole Powell, CPA, FHFMA; or Shannon Farr, CPA·ABV.