Auditing a Healthcare Practice: Patient Revenue and Contractual Adjustments

A medical practice bills at its charge master rates and collects a fraction of them. The gap between the two is not bad debt, and it is not a single number. It is made up of contractual adjustments agreed with payers, concessions the practice expects to give patients, and amounts that later turn out to be uncollectible. Revenue is reported net, and the audit is largely a test of whether the net figure is right. This guide covers revenue from patient services in a physician practice, group or outpatient clinic. Hospital-level topics, including cost reports and charity care policies, are in the hospital guide.

How revenue is measured

Patient care contracts fall within ASC 606. The performance obligation is satisfied as services are rendered, and the transaction price is the amount the practice expects to be entitled to, not the amount on the charge master. Three things reduce charges to that price:

• Contractual adjustments. The difference between charges and the amount allowed under a payer's fee schedule or contract. These are explicit.
• Implicit price concessions. PwC's health care guide explains that an implicit concession exists when the provider customarily does not assess ability to pay before service, or continues to treat patients when collecting substantially all of the bill is not probable. Implicit concessions reduce the transaction price, so they reduce revenue. The glossary entry on implicit price concessions covers the mechanics.
• Variable consideration from payers. Retroactive adjustments, recoupments after payer review, and risk-sharing bonuses or penalties are estimated using the expected value or most likely amount method, whichever better predicts the outcome. PwC notes the method is not a policy choice.

Amounts that become uncollectible after a valid receivable has been recorded are bad debt, recognized when credit deteriorates, for example through bankruptcy or job loss. Later collection shortfalls on patient balances are generally treated as changes in the implicit concession, adjusting revenue, unless there is specific evidence of deterioration. Baker Tilly's guidance for hospitals draws the same line.

Providers may apply the guidance to portfolios of similar contracts, grouped by payer class, service type and timing, as a practical expedient where the financial statement effect is not materially different from contract-by-contract accounting. Care provided under a charity care policy is outside ASC 606 and is not reported as revenue or receivables.

Risk areas

• Estimates of net realizable revenue. Contractual allowances and implicit concessions are estimates, and revenue is the account the auditor presumes carries fraud risk. See fraud risk assessment under AU-C 240.
• System-generated reports. Charges, adjustments and agings come from the practice management system. They are information produced by the entity and need testing before the auditor relies on them.
• Cutoff. Services rendered in December are charged and coded in January in many practices. Unbilled services at year-end belong in revenue at their estimated net amount.
• Payer mix changes. A shift toward high-deductible plans or self-pay raises patient responsibility and implicit concessions on the same gross charges.
• Overpayments and recoupments. Medicare rules require that an identified overpayment be reported and returned. Under 42 CFR 401.305, the deadline is 60 days after the overpayment was identified, or the date any corresponding cost report is due if later. An overpayment is identified when the provider knowingly receives or retains it, and the rule reaches back six years from receipt. Retained beyond the deadline, it becomes an obligation for purposes of the False Claims Act. A practice that finds a billing error during the audit period has a recognition question and a legal question.
• Coding and documentation. Revenue that depends on coding intensity can be recouped later, so a rise in higher-level visit codes needs an explanation.

Procedures

1. Reconcile the pipeline. Tie charges in the practice management system to the general ledger, then to the clinical schedule or encounter log for a sample of days. Test completeness from encounters to charges, and from charges to claims.
2. Test contractual adjustments. Select claims by major payer, trace the charge to the claim, then to the remittance advice, and recompute the allowed amount against the contracted fee schedule. Exceptions suggest the system's allowance rules are stale.
3. Test the allowance model. Obtain the historical collection data by payer class. Recompute the expected collection rates, challenge the look-back window, and compare to cash collected on prior-year balances.
4. Test patient balances. Age patient-responsibility balances separately from payer balances. Self-pay and post-insurance balances are where implicit concessions concentrate.
5. Subsequent cash. Compare cash received after year-end with year-end receivables by payer. Use the accounts receivable aging and allowance workpaper.
6. Cutoff and unbilled. Test charges entered after year-end for dates of service before it. Estimate and test accrued unbilled revenue.
7. Payer refunds and recoupments. Read payer correspondence, audit requests and refund logs. Inquire of management and counsel, and compare liabilities recorded to what was requested.
8. Disclosures. Revenue by payer class, significant judgments, and the charity care policy where one exists.

Worked example

These figures are illustrative. A practice's annual patient charges and estimated net revenue by payer class:

Reported net revenue is $795,000, which is under half of gross charges. The self-pay line shows why the payer split matters: $100,000 of charges becomes $12,000 of revenue. Suppose the audit tests subsequent collections on the self-pay balances and finds that $6,500, not $12,000, was collected, with no further payments expected. The $5,500 shortfall is an adjustment to revenue and the allowance, not an addition to bad debt expense, because it reflects an implicit concession that was underestimated. The same finding would require re-examining the collection percentages used for earlier years' balances.

If the contractual adjustment rate on Commercial were set at 35 percent instead of 40 percent, revenue would be overstated by $45,000. That is why the fee schedule recomputation in step 2 matters more than a flat-percentage analytic.

PBC items

• Charge master and fee schedules by payer, with effective dates
• Payer contracts and amendments for the larger payers
• Practice management system reports: charges, payments, adjustments and aging, in native format
• Remittance advice files for sampled claims
• Allowance and implicit concession model with supporting collection history
• Unbilled services and charge lag reports
• Payer audit, recoupment and refund correspondence
• Compliance program materials and the log of internal billing reviews

Red flags

• Adjustments entered manually at period end to reconcile to cash
• Write-offs classified differently from year to year
• Collection percentages unchanged despite changes in payer mix
• Large unapplied cash or credit balances
• Refund requests from payers that were not accrued
• Revenue per visit rising faster than the fee schedule changes

Sources

• PwC Viewpoint, Health care guide, section HC 3.3 (variable consideration, implicit price concessions, government payer programs), https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/health-care/health_care_guide/chapter_3_revenue/3_3_variable.html
• Baker Tilly, New Revenue Recognition Standard for Hospitals, https://www.bakertilly.com/insights/new-revenue-recognition-standard-for-hospitals
• RevenueHub, Common ASC 606 Issues: Health Care Entities, https://www.revenuehub.org/article/revenue-recognition-issues-health-care-industry
• HFMA Principles and Practices Board Statement 15, Valuation and Financial Statement Presentation of Charity Care, Implicit Price Concessions and Bad Debts by Institutional Healthcare Providers (June 2019), https://hfma.org/wp-content/uploads/2024/11/yr2-dy12-hfma-statement-15.pdf
• 42 CFR 401.305, Requirements for reporting and returning of overpayments, https://www.law.cornell.edu/cfr/text/42/401.305

CORAA prepares ready-to-review audit files for US CPA firms; see /us.

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error