A proposed statement of position issued by the Health Care Committee (HCC) of the AICPA1 reduces reported earnings of continuing-care retirement communities by recommending that entry fees not be treated as current income, but be amortized over extended future periods. If adopted, the accounting practices would increase liabilities and decrease operating income for long term care facilities that require a fee in anticipation of service and the use of facilities. The recommendation is particularly significant for an industry beset by capital formation problems.

Continuing-care contracts usually extend for the life of the resident and identify the residential and health care services to be provided. The organizations offering these services in living units and nursing centers are known as residential care facilities and confinuing- care retirement communities (CCRC). They offer a variety of living arrangements and supportive services. The living units may be apartments or houses. Available services may include nursing, dining, laundry and recreation. The services are provided under a contract which may require an advance fee and also periodic fees which may be fixed or adjustable.

Because the concept of continuing-care is relatively new, there is considerable diversity incurrent financial reporting. The sizable advance fees are particularly controversial. Should these fees be considered income? If so, when? According to the HCC, it depends on whether the fees are refundable, nonrefundable, or repayable. Advance Fees-Refundable

Residential care facilities frequently require an advance fee prior to admission. Whether any part of the fee is refundable is determined by the contract. Refund policies vary and may provide refunds based on the period of occupancy, processing fees, and whether the living unit is reoccupied.

When should these fees be considered income to the facility? Few would contend that refundable fees should be recognized as income at time of receipt. However, considerable diversity exists as to the timing of revenue recognition. Clearly, the timing issue significantly impacts reported income in any given year. Some facilities recognize a liability when the advance fees are received because a portion of the fee is refundable under defined circumstances and the facility has the obligation to provide future services to the resident. Other facilities treat the advance fees as deferred revenue because the fees will be earned in the future.

The HCC calls for refundable fees to be reported as a liability. When the conditions of the contract have been met and a portion of the advance fee is no longer refundable, that amount is to be reclassified as deferred revenue and amortized to income over the expected life of the individual resident. Exhibit I shows the computation of annual income, the liability for the refundable amount, and deferred revenue applicable to the advance fee. The deferred amount is the unamortized fee less the refundable amount.

Exhibit 1 assumes that each resident is required to pay a $50,000 advance fee. This fee is refundable during the first 36 months, but the refundable amount is reduced by 2% for each month of residence. At time of payment, the full fee is recognized as a liability to be reclassified and amortized according to the terms of the contract. Resident A in Exhibit 1 has an unamortized advance fee of $40,000 at the beginning of the year. Part of this amount will be recognized as operating revenue and part will be reclassified as deferred revenue. The income for the year is $8,889 based on the life expectancy of Resident A, leaving an unamortized advance fee at year end of $31,111 ($40,000 - $8,889). At year end, $26,000 of this unamortized fee is refundable, and therefore classified as a liability. The difference of $5,111 between the unamortized fee, $31,111, and the $26,000 liability is reclassified as deferred revenue.

The refundable portion of the advance fee is determined by contract and clearly measures the amount of liability. The treatment of the nonrefundable portion of the advance fee as deferred revenue, to be amortized over the life of the resident, is less obvious. An alternative is to recognize revenue and deferred revenue over the average life expectancy of all the residents. The use of average life expectancies rather than individual life expectancies eliminates the distortions to income caused by deviations from mortality tables. If the sample data included in Exhibit 1 were based on average life expectancy rather than individual life expectancies, annual income would increase and deferred revenue would decrease. (See Exhibit 2.)

A third alternative is to recognize the deferred amount as income. This method appears to fail for lack of support from the matching principle. Advance Fees-Nonrefundable

Existing accounting practice includes recognizing the nonrefundable amount as current period income. Those who favor current period income recognition maintain that a sale has taken place and the matching convention requires revenue recognition at time of sale. They believe their position is supported by the fact that future periodic fees are intended to cover future operating costs. Their position is enhanced by the fact that these periodic fees can be adjusted during the contract period.

Others contend that nonrefundable fees should be recorded as deferred revenue because the fees entitle the resident to future services and the use of facilities. Accordingly, the fees should be amortized over some future period. Advance fees are considered supplementary to future periodic fees. The matching convention requires deferral of the fees because all contract services are yet to be provided.

Assuming the fees are classified as deferred income, what should be the amortization period? Some believe an appropriate matching is achieved if amortization is based on individual life expectancies. During this period the facility has the obligation to provide the services specified in the contract, and the nonrefundable advance fee is best amortized to income as the services are rendered. Other facilities amortize these fees using a group method. Residents are grouped by entry date, type of unit, or average age. The life expectancy of the group is then used to amortize the fee.

The HCC is of the opinion that nonrefundable advance fees should be amortized over the period service is to be provided. The HCC recommends amortizing the nonrefundable fees over the term of contract using the actuarily determined life expectancy of the individual resident. The balance of the unamortized fee is to be recognized as revenue at the time of death of the resident. Exhibit 3 demonstrates the preferred treatment. Advance Fees-Repayable

Another possibility considered by the HCC is the repayable portion of the advance fee. As an inducement, some continuing-care contracts provide for the recovery of a portion of the advance fee from the reoccupancy proceeds of a living unit. This provides a source of funds to the occupant or his or her estate when the facility is no longer used. This amount is described as a repayable fee. The payment is made from the advance fee paid by the subsequent resident. The possibility of a repayable arrangement would presumably continue with regard to a unit for the life of the facility.

Accordingly, the Committee recommends classifying the amount repayable as deferred revenue and amortizing it to revenue over the expected life of the facility. The committee rejects treating the repayable amount as a liability, an equity contribution, or a cost reduction.

Supporters of the liability classification maintain that an obligation has been created. In this view, uncertainty exists but will be resolved by future events. Nevertheless, an obligation exists. Others argue that the repayable amount should be considered an equity contribution or a reduction in the cost of the facility. They feel the actual repayment will be a transaction between the former resident or the estate of a deceased resident and a future resident. The facility is under no obligation to make such a payment unless and until the living unit is reoccupied and a repayable fee is collected or becomes due from the new occupant.

The HCC contends that the portion of the advance fee which is repayable if a unit is reoccupied should be considered deferred revenue because the repayment is dependent on reoccupancy. As a result, there is economic benefit to the facility. Because this benefit extends over the life of the facility, it should be amortized over the life of the facility and not the lives of the residents. The HCC example is based on an advance fee of $100,000, 25% nonrefundable and 75% repayable. At the time of receipt the full $100,000 is classified as deferred revenue. Assuming the fee is paid on the first day of the year by the initial occupant of the unit and that the facility has a 30-year useful life, $2,500 (75,000/30 years) would be taken into income until the unit was reoccupied. The nonrefundable portion of the fee ($25,000) would be amortized over the life expectancy of the resident. By requiring that the repayable amount be amortized over the life of the facility, the committee has deferred the recognition of revenue over the longest possible time period.

The proposed statement of position issued by the HCC distinguishes among the refundable, nonrefundable, and repayable portions of advance fees under continuing-care contracts. In each case the HCC recommends the deferral of revenue recognition, a position which is likely to generate considerable debate, but which is consistent with conservative income recognition concepts.

Frank R. Probst

Correction

The gremlins were at work in the August 1989 issue Accounting column, in the article by Frank H. Tiedemann entitled "College Accounting- What a Mess!" The following replaces the three paragraphs above the Conclusion in the first column on page 49, beginning with "The Statement Of Changes in Fund Balances."

"The balance sheet and statement of changes in fund balances prescribed by the Guide are meant to, and do, present financial position and changes in fund balances. But these statements are difficult for the average non-accountant to read. It has been suggested that a combined balance sheet would be easier to read and that the statement of changes in fund balances should summarize funds into three categories: unrestricted, temporarily restricted, and permanently restricted. See FASB Concepts Statement No. 6, Elements of Financial Statements, December 1985. Such a summary would be more meaningful to the average reader, who probably is not concerned as to whether a temporarily restricted gift is held in a current restricted fund or an unexpended plant fund. Furthermore, the segregation of unexpended plant funds from current restricted funds may suggest that unexpended plant funds are less current than current restricted funds, which is not necessarily the case. Recommendations

In my opinion, published financial statements of colleges and universities should consist of the following:

Balance sheet, prepared as suggested by FASB Concepts Statement No. 6;

Statement of changes in fund balances, prepared as suggested by FASB Concepts Statement No. 6;

Statement of income, expense and unrestricted funds balances."