Hospital Audits: Net Patient Service Revenue, Cost Reports and Charity Care

Hospital revenue is a stack of estimates: gross charges reduced to what payers allow, then to what patients will pay, then adjusted for programs that settle years later. Charity care is excluded from revenue but must be measured and disclosed, and tax-exempt hospitals carry Section 501(r) obligations. A physician practice has a simpler version of these questions, covered in the practice audit guide.

Building net patient service revenue

Net patient service revenue (NPSR) is the transaction price for patient care under ASC 606. It starts at gross charges and takes out:

1. Contractual allowances for Medicare, Medicaid and commercial contracts.
2. Implicit price concessions, which Baker Tilly's hospital guidance describes as arising when a hospital's customary practice is to treat patients before running a credit check, or to keep serving patient classes that historically do not pay substantially all charges after discounts. The estimated collection becomes the recorded revenue and receivable.
3. Variable consideration from government programs. PwC's health care guide identifies cost report settlements, which can take years to finalize, retroactive Medicare or Medicaid adjustments, review audits and government investigations as sources of variability. Estimates focus on amounts the provider may have to return.
4. Charity care, discussed below.

Because implicit concessions reduce revenue, they do not appear as bad debt expense. Impairments after a valid receivable has been recorded, for example because a patient's financial condition deteriorated, are bad debt within operating expenses, not a deduction from NPSR. The glossary entry on implicit price concessions gives the definitions.

Hospitals estimate these amounts by portfolio, grouping contracts with similar collection experience by payer class, service type and timing, where the result is not materially different from contract-by-contract accounting.

Charity care

HFMA's Principles and Practices Board Statement 15 states what the AICPA audit guide, ASC 954-310 and ASC 606 generally require: determine whether an implicit price concession has been provided, classify bad debts as an operating expense, eliminate charity care from revenue and receivables, and disclose the charity care policy and the amount provided.

Three distinctions drive the audit. Bad debt is a patient with capacity to pay who does not. An implicit concession is a discount expected before a credit assessment. Charity care goes to a patient with demonstrated inability to pay, with no payment expected.

Recordkeeping. Services are recorded at full charges and adjusted to what payers owe. The portion later determined to be charity care is written off against an allowance, with a provision recorded as contra-revenue. Where eligibility surfaces during collection, the hospital estimates the allowance and keeps the support.

Policy. The policy is documented and approved by the governing body and communicated to patients and the community. A service is charity care only if the provider makes reasonable attempts to notify the patient and makes no further attempt to collect, except for sliding-scale payments.

Measurement. Disclosure is based on cost, not charges. Under ASC 954-605, charity care cost is measured from direct and indirect costs, and where the cost accounting system cannot attribute costs, management may estimate with reasonable techniques, disclosing the method. The net cost is total cost less any patient revenue from sliding-scale payments or other patient-specific sources.

A discount outside the charity policy, such as a managed care rate reduction or a prompt-pay discount, is not charity care and does not belong in the disclosure.

Medicare cost reports and settlements

Hospitals paid on reimbursable cost file cost reports, and the amounts due to or from the program feed NPSR and third-party settlement balances. Under 42 CFR 413.24, the cost data must be adequate, based on financial and statistical records that qualified auditors can test. Reports are due by the last day of the fifth month after the end of the cost reporting period, and contractors may extend the deadline only in extraordinary circumstances beyond the provider's control, such as flood or fire. Providers may amend submitted information, and determinations can be reopened within the periods in 42 CFR 405.1885.

For the auditor, open years stay on the balance sheet. Request each open year's cost report as filed, contractor correspondence and the hospital's settlement estimate, and compare prior estimates with actual settlements as they arrive. Changes in estimates are recognized as revenue in the period of change.

The overpayment rule adds exposure. Under 42 CFR 401.305, an identified overpayment must be reported and returned by the later of 60 days after identification or the date any corresponding cost report is due. Identification occurs when the provider knowingly receives or retains it, and the rule applies to overpayments identified within six years of receipt. Retention past the deadline is an obligation for False Claims Act purposes. Inquire of compliance and counsel.

Section 501(r) for tax-exempt hospitals

The IRS lists four requirements that hospital organizations must meet facility by facility: a community health needs assessment, a financial assistance policy, a limitation on charges, and billing and collection rules. Failure at any facility may lead to revocation of exempt status, and hospitals report on Form 990, Schedule H.

The financial assistance policy must state eligibility criteria, the discounts available and how to apply. Charges to eligible individuals for emergency or medically necessary care cannot exceed amounts generally billed, and the billing and collection policy must require reasonable efforts to determine eligibility before any extraordinary collection action.

Discounts outside the policy are not financial assistance for Schedule H, and gaps between policy and practice are evidence about the charity care allowance. A governmental hospital follows GASB rather than FASB, and HFMA's statement does not apply to it.

Procedures

1. Obtain the NPSR build by payer class and tie gross charges, allowances and adjustments to the general ledger.
2. Test charge capture and cutoff, then recompute contractual allowances by payer from contracts and remittances.
3. Test implicit concession and collection estimates against cash collected after year-end and prior-year estimates.
4. Evaluate third-party settlement receivables and payables, open year by open year.
5. Test charity care: policy approval, sample determinations, write-offs against the allowance and the cost calculation. See auditing accounting estimates.
6. Review disclosures and evaluate subsequent events, including settlement notices. See subsequent events.

Worked example

These figures are illustrative. A hospital's year shows gross patient charges of $250,000,000. Contractual allowances are $140,000,000, implicit price concessions are $18,000,000, and $9,000,000 of charges are written off as charity care.

For the charity care note, management estimates cost at 30 percent of charges, so cost is $2,700,000. Sliding-scale payments on those accounts were $150,000, so the net cost disclosed is $2,550,000. Disclosing $9,000,000 would overstate the measure, because the note is based on cost. Test the 30 percent against the cost accounting system.

On the settlement side, suppose the balance sheet carries a $1,400,000 Medicare receivable for an open year and a notice after year-end settles it at $900,000. If the notice gives evidence of conditions at the balance sheet date, the $500,000 reduction belongs in the year under audit. The hospital's record of estimates against actual settlements shows whether $1,400,000 was ever likely.

PBC items

• NPSR rollforward by payer, with allowance and implicit concession schedules
• Payer contracts and remittance samples
• Open cost reports, contractor correspondence and settlement estimates by year
• Charity care policy, board approval, determinations and cost calculation
• Financial assistance policy, AGB calculation and Schedule H workpapers
• Compliance reports and overpayment logs

Red flags

• Settlement estimates that are always favorable against actual results
• Charity care write-offs concentrated in the last quarter
• Open cost report years with no estimate or support
• Financial assistance practices that differ from the written policy
• Self-pay share rising with an unchanged collection percentage

Sources

• 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
• Baker Tilly, New Revenue Recognition Standard for Hospitals, https://www.bakertilly.com/insights/new-revenue-recognition-standard-for-hospitals
• PwC Viewpoint, Health care guide, section HC 3.3, https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/health-care/health_care_guide/chapter_3_revenue/3_3_variable.html
• RevenueHub, Common ASC 606 Issues: Health Care Entities, https://www.revenuehub.org/article/revenue-recognition-issues-health-care-industry
• IRS, New Requirements for 501(c)(3) Hospitals Under the Affordable Care Act, https://www.irs.gov/charities-non-profits/charitable-organizations/new-requirements-for-501c3-hospitals-under-the-affordable-care-act
• IRS, Financial Assistance Policy and Emergency Medical Care Policy, Section 501(r)(4), https://www.irs.gov/charities-non-profits/financial-assistance-policy-and-emergency-medical-care-policy-section-501r4
• IRS, Limitation on Charges, Section 501(r)(5), https://www.irs.gov/charities-non-profits/limitation-on-charges-section-501r5
• 42 CFR 413.24, Adequate cost data and cost finding, https://www.law.cornell.edu/cfr/text/42/413.24
• 42 CFR 401.305, Requirements for reporting and returning of overpayments, https://www.law.cornell.edu/cfr/text/42/401.305

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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