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Mark J. Ross, Partner and Practice Leader, Senior Living Services Audit Practice/Consulting Practice with ParenteBeard LLC., provides a timely update on the recent FASB action on accounting for refundable entrance fees. Mr. Ross recently discussed the FASB proposed changes during the Accounting Practices Update at the LeadingAge Ziegler Senior Living CFO Workshop in April 2012.
At its May 30, 2012 meeting, the Financial Accounting Standards Board (FASB) decided to move forward with its proposed changes to accounting for refundable entrance fees, which are expected to have an impact on a significant number of continuing care retirement communities (CCRC) across the country that have been amortizing refundable entrance fees to income.
If a CCRC does not explicitly state in its Resident Agreements that the refunds of the refundable entrance fees are limited to reoccupancy proceeds, the CCRC would not be permitted to amortize the refundable entrance fees to income in the future.
Further, these CCRCs will be required to restore the refundable entrance fee liability to the full refund amount in the Resident Agreements with a corresponding decrease in equity (i.e., net assets).
These proposed changes do not have any impact on the accounting for nonrefundable entrance fees, which will continue to be amortized to income over the annually adjusted estimated remaining life expectancies of the residents.
In October 2011, FASB proposed changes related to the accounting for refundable entrance fee contracts through the issuance of a proposed Technical Corrections Accounting Standards Update (ASU).
The amendments included in the proposed ASU related to the accounting for refundable entrance fee contracts were addressed in paragraphs 46 and 47.
One of the amendments clarified that "to be able to treat a refundable fee as deferred revenue that is amortized over the life of the facility, any refund payable must be limited to the proceeds of reoccupancy of the unit, and it must be the entity's policy or practice to comply with that limitation."
Another amendment added language to the authoritative guidance (paragraph 954-430-25-1) that stated "when a contract between a CCRC and a resident stipulates that a portion of the fees will be paid to current residents or their designees, only to the extent of the proceeds of reoccupancy of a contract holder's unit, that portion shall be accounted for as deferred revenue, provided that legal and management policy and practice support the withholding of refunds under this condition."
At its May 30 meeting, FASB decided to finalize without change the amendments related to the accounting for refundable entrance fees as proposed, but to include them in a separate ASU to be issued concurrently with the Technical Corrections ASU.
The ASUs are expected to be finalized and issued in the near future.
FASB also decided that the transition for the CCRC amendments should be reported as a cumulative effect of a change in accounting principle as of the earliest period presented and that the CCRC amendments will be effective as follows, with early adoption permitted:
For CCRCs with Type A and Type B contracts, this issue is also expected to have an impact on the calculation of the obligation to provide future services and use of facilities (FSO). The impact of this issue on the FSO was not specifically addressed by FASB.
If the refundable entrance fees are no longer classified as deferred revenue, the refundable entrance fees will no longer be an offset to the FSO.
It would appear that any adjustment to the FSO as a result of restating the refundable entrance fee liability would be also be reported as a cumulative effect of a change in accounting principle as of the earliest period presented.
These changes will have a significant impact on the financial statement presentation for CCRCs that previously amortized refundable entrance fees to income, primarily the presentation of the balance sheet and statement of operations.
It will be important for personnel at CCRCs that interface with existing and/or prospective residents (i.e., marketing personnel) to understand the changes and to be in a position to adequately explain them.
Further, investors, bondholders and other stakeholders will also notice the impact of these changes and may require some education related to them. Because the changes are "non-cash," they are not expected to impact debt covenant calculations, specifically debt service coverage and liquidity ratios.
CCRCs with debt covenants that use equity as a component of the covenant calculation (i.e., debt to equity) should proactively communicate these changes to their lenders in an effort to revise and/or eliminate any equity-based covenant calculations.