Technical: Revenue recognition standards – NHS bodies will have to review contracts

But NHS finance managers will need to pay it some attention first.

In general, the standard, which applies to accounting periods starting on or after 1 January 2018, is more prescriptive than existing guidance on how revenue is profiled. As the standard’s name implies, if, when and how much revenue is recognised by an organisation depends on the terms of its contracts. Some commercial organisations are reviewing and rewriting their contracts in anticipation of the standard, which means it is important that those writing and/or signing contracts have an understanding of the accounting implications of those arrangements.

While intra-NHS arrangements use the centrally written NHS standard contract, these include locally drafted schedules. NHS bodies need to be clear on how the new standard might affect current income recognition.

The new standard sets out a logical five-step approach for recognising income. The core principle is that an entity should recognise revenue when it transfers goods and/or services to customers and the amount recognised should reflect the amount to which the entity  expects to be entitled to in exchange for those goods and/or services.

The five steps include the following:

1. Identify contracts with customers. For NHS bodies, this will include all NHS contracts and contracts with third parties.
2. Identify all the separate performance obligations in the contract. This is what has to be done to earn the income – the provision of goods or services – and may take place at a point in time or over time. There may be more than one performance obligation in a contract but they must be separate – one way to think about separability is whether the service would have to be redone if the service provider were changed. For NHS bodies, long-term contracts, contracts for pathways of care and research and development contracts are expected to be the least straightforward. For example:In a maternity pathway, the patient simultaneously receives and consumes antenatal care. The revenue relating to antenatal care is likely to be recognised over the length of the pregnancy. However, any revenue relating to the delivery of the baby is likely to be recognised on the date of delivery. As the antenatal care and delivery do not have to be performed by the same NHS provider, they are separate performance obligations. A pre-operative assessment may be done at one NHS body, but the surgery may be performed elsewhere. If the assessment needed to be redone if the patient moved to a different NHS provider for surgery, then it is not a separate obligation. Research and development contracts may require the NHS body to deliver a report at the end of the process. If the report is not delivered, even though the research has been done, then payment is not due under the terms of the contract. Other research contracts might include staged deliverables so income would be recognised as they are met
3. Determine the transaction price – this is likely to be the price set out in the contract, but it could be different if the contract includes a variable element.
4. Allocate the transaction price to the performance obligations in the contract – this can be more complex where a price has to be allocated to different performance obligations.
5. Recognise revenue when (or as) performance obligations are satisfied.

To implement the standard, all contracts in place on 1 April 2018 should have been reviewed against the new requirements. The impact will be greatest for contracts that are in operation across the year-end as it will be important to recognise revenue in the appropriate financial year. It will also be important to consider revenue recognition when discussing contracting arrangements for new models of care.