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1、Nonprot classication decisions inresponse to a change in accounting rulesLeslie Eldenburg a , Cynthia C. Vinesb, *aAccounting Department, Eller College of Business and Public Administration, University of Arizona, USA b School of Accountancy, Gatton College of Business and Economics, Room 355P,Unive

2、rsity of Kentucky, Lexington, KY 40506-0034, USAAbstractThis study analyzes the response of nonprot managers to a change in accounting regulation. A 1990change in hospital accounting rules disclosed new information about bad debt and charity care expenses. This change provided managers with incentiv

3、es to reclassify some bad-debt expense to charity care. Using univariate and multivariate analyses, we nd that nonprot managers respond to their current cash position when making classication decisions to disclose bad-debt expense and charity care amounts. While we expected that charity care levels

4、would inuence these managers dierentially, cash levels appear to be more important in their disclosure decision making. 2003Elsevier Inc. All rights reserved.Keywords:Reclassication; Financial ratios; Nonprot hospitals; Charity care; Bad debt1. IntroductionAccounting researchers have accumulated a b

5、ody of evidence in for-prot rms suggesting that factors such as compensation contracts, political regu-lation, closeness to debt covenants, and changes in accounting regulation inuence the manipulation of accounting disclosures (forexample McNichols and Wilson, 1988; Jones, 1991; and D Souza, 1998.

6、Similar research results *Corresponding author. Tel.:+1-859-257-4675;fax:+1-859-257-3654.E-mail address:(C.C.Vines.0278-4254/$-see front matter 2003Elsevier Inc. All rights reserved. doi:10.1016/j.jaccpubpol.2003.11.001Journal of Accounting and Public Policy 23(2004 122have been found i

7、n nonprot rms. For example, Leone and Van Horn (2003nd that nonprot hospital managers smooth income around zero and manage earnings to avoid losses. Krishnan et al. (2003nd opportunistic cost shifting in nonprot organizations to manage program service and fund-raising ratios. We add to this literatu

8、re by analyzing nonprot managers disclosure decisions in response to a change in accounting regulation.A 1990change in hospital accounting rules aects the classication of bad debt and charity care expense and creates an unusual opportunity to examine disclosure management for the following reasons.

9、First, the change in accounting regulation is an exogenous event that provides new information about hospital operations. Because information is asymmetric prior to the change, managers have an opportunity to respond by engaging in reclassi-cation behavior. Second, many states keep hospital database

10、s with annual budgetary information that ties to audited nancial statements. These data include details that are aggregated in the nancial statements and are not easily available to the public but are accessible to researchers. These data record the actual classication decisions of managers. Thus, e

11、ach hospital acts as its own control when we examine changes in the budgetary information before and after 1990.Prior to 1990, all patient charges for hospital services were recognized as revenue regardless of reimbursement expectations. Bad-debt expense and charity care (i.e.,the normal hospital ch

12、arges for services provided gratis to indigent patients were combined as uncompensated care and deducted from gross revenue. 1Since 1990, hospital accounting guidelines require charity care disclosure in a footnote rather than as revenue because there is no expectation of reimbursement. In addition,

13、 a provision for bad debt is deducted as an operating expense instead of the actual write-os being deducted from revenue. Net income is unaected by these new rules, but new information is provided about operations (Table6. 2Factors that are likely to aect the classication decision under the new rule

14、s include bad debt and charity care levels as well as the cash position of the rm. Other factors include stakeholder perspectives. For example, local, state and federal regulatory bodies want hospitals to maintain or increase levels of charity care. Donors often provide nancial support earmarked for

15、 charity1This practice probably developed because hospitals were originally organized to provide free care for the poor, and also because it can be dicult to distinguish between patients who cannot pay and patients who will not pay.2Several performance ratios are also aected by the change because re

16、venue is in the denominators. For example, the operation margin ratio could potentially be negatively aected. Because earnings are not aected and these ratios are usually close to zero in nonprots, we assume there are few incentives around these ratios. However, we do analyze operating margins in se

17、nsitivity analysis (Table6.2L. Eldenburg, C.C. Vines /Journal of Accounting and Public Policy 23(2004122care. However, CEOs, employees, suppliers and physicians are more likely to be interested in cash levels because nonprot hospitals have limited access to short-term and long-term cash (Kauerand Si

18、lvers, 1991. Thus, the response to the new accounting rules likely diers across organizations. Because re-classifying bad debt to charity care eliminates hospitals abilities to collect on the debt, we predict that nonprot hospitals with high cash levels will tend to reclassify to a greater extent th

19、an hospitals with low cash levels. Reclassifying bad debt to charity care is a relatively low cost means of maintaining or increasing charity care. Overall, we expect low charity care, high cash hospitals to be most likely to reclassify because they appear to have the strongest incentives with the l

20、owest cost.Univariate and multivariate tests are performed to analyze these predictions. The univariate test results show that bad debt as a percent of uncompensated care signicantly decreases after the change in disclosure rules. Bad debt as a percent of revenue also signicantly decreases, indicati

21、ng that the proportional decrease in uncompensated care is not due to decreased revenues. Uncom-pensated care as a percent of revenue remains unchanged. This nding indi-cates that there is no change in hospitals operating decisions around uncompensated care because the same level is provided in both

22、 years. It is only the classication decisions that have changed. Charity care as a percent of revenue did not change signicantly. We also nd a negative and signicant correlation between the change in bad debts as a percent of revenue and the change in charity care as a percent of revenue for both gr

23、oups. This negative correlation provides evidence of reclassication.We incorporate into the model the levels of charity care and days of cash on hand before the 1990accounting change and perform regression analysis to test our predictions. We nd that managers in nonprot hospitals with high cash leve

24、ls appear to reclassify to a greater extent than others. 3We also partition the sample on charity care levels because we expect nonprot managers to be sensitive to their current charity care levels. However, we nd no evidence of reclassication in hospitals with low charity care levels. For robustnes

25、s, we replace the low charity care dummy variable with a low operating margin dummy and nd that high cash, low operating margin hospitals reclassify to a greater extent than others.A possible explanation for our results is that hospitals are more eective in collecting bad debts while providing incre

26、asing levels of charity care after 1990. However, if this were the case, we would be unlikely to nd the systematic3We assume managers behave rationally, so uncompensated care levels in 1989were optimal and reected the operating decisions of managers. We also assume that when charity care levels are

27、negatively related to bad-debt expense levels, some amount of reclassication is taking place (bad-debt expense decreases as charity care increases.L. Eldenburg, C.C. Vines /Journal of Accounting and Public Policy 23(20041223patterns that arise for specic sample partitions, such as high cash and low

28、operating margin.We extend the accounting choice literature by providing new information about nonprot managers classication decisions. In addition, our study provides information about management of disclosures other than earnings in nonprot organizations. Section 2describes the original and revise

29、d hospital accounting requirements and presents background information on hospital accounting. In Section 3, our hypotheses are developed. Section 4describes the empirical tests. Finally, conclusions are drawn.2. Background information on hospital accounting methodsPrior to 1990, standards for reven

30、ue recognition in hospitals were at odds with generally accepted accounting principles (GAAPin other industries. While GAAP requires that revenue be recognized only when there is a high probability of collection, hospitals were required to record as revenue all charges for patient services regardles

31、s of whether payment was expected. Originally, hospitals were organized to provide free medical care for the poor and were supported through donations (Rosenberg,1987. Donors wanted measures of service rather than of revenues so gross patient charges provided the most useful information.In 1965, Med

32、icare and Medicaid began paying for much of the care that had been previously provided as charity. As a result, the capacity and number of hospitals increased (Feldstein,1983. In 1972, the AICPA (AmericanInstitute of Certied Public Accountants, 1972 issued the rst hospital audit guide. The release o

33、f the guide followed a recommendation by the American Hospital Association (1969that hospitals prepare their nancial statements according to GAAP because the nancial statements were used increasingly by creditors, government agencies and the community. Over the years, the 1972guide was revised sever

34、al times. The early editions emphasized control over charges for any services that were provided, rather than expectation of payment because government agencies, donors, and communities were most interested in audited information about the amount of services provided.In the late 1980s, for-prot hosp

35、itals and other organizations competing with nonprot hospitals pressured the Internal Revenue Service and state governments to regulate nonprot hospitals more closely to reduce the abuse of tax-exempt status (Wolfsonand Hopes, 1994. In 1985, the Financial Accounting Standards Board (FASBencouraged n

36、onprot organizations to use accounting methods that conformed more closely to GAAP by issuing Statement of Financial Accounting Concepts (SFACNo. 6, Elements of Financial Statements (FinancialAccounting Standards Board, 1994/1995.To 4L. Eldenburg, C.C. Vines /Journal of Accounting and Public Policy

37、23(2004122bring hospitals into conformance with SFAC No. 6, a revision of the AICPA Audit Guide for Hospitals was issued in 1990.The 1990audit guide denes charity care as health services that were never expected to result in cash inows (AICPA,1989/1990,p. 257. The guide further states that charity c

38、are results from a provider s policy to provide health care services free of charge to individuals who meet certain nancial criteria. Bad-debt expense is dened as the provision for actual or expected uncollectibles resulting from the extension of credit. 4Additionally, eective July 15, 1990, the new

39、 guide requires that patient service revenue be recognized net of all deductions (includingcharity care. In addition, a bad-debt provision should be deducted as an operating expense, and charity care should be dis-closed in the notes to the nancial statements. 5In Table 1, income statements under th

40、e 1972and 1990hospital audit guidelines are compared. Charity care and bad-debt expense are aggregated and deducted from gross revenue as uncompensated care under the 1972guide. However, they are reported separately after 1990with charity care relegated to the footnotes and the provision for bad deb

41、ts reported as an operating expense. Overall, the changes in reporting requirements have no eect on net income. However, because net patient service revenue increases by the amount classied as bad-debt expense and operating expenses increase by the same amount, several ratios are aected by the chang

42、e.When uncompensated care was reported in the nancial statements, dier-entiating between charity care and bad debt was relatively unimportant. 6 Garner and Grossman (1992,p. 58 suggest this was common practice because . the information seemed to be of little interest to anyone other than gov-ernment

43、al programs and also because it is dicult to dierentiate between bad debts and charity care.Once a determination is made that a patient qualies for charity care, col-lection on the receivable is foregone. Some hospitals may attempt to collect when there is any chance of receiving partial or full pay

44、ment. Further, Medi-care and some insurers pay for their clients bad debts when co-payments are part of the reimbursement scheme. This practice provides hospitals with incentives to classify some charity-care patients as bad debt.To qualify for Medicare reimbursement, hospitals are required to admit

45、 pa-tients to their emergency room without considering ability to pay. Admission4While these denitions are not substantively dierent from the original 1972guide, they are more precisely stated.5We concentrate on the changes in revenue disclosure that brought hospital accounting methods into conforma

46、nce with the conceptual framework of SFAC No. 6and do not address other changes mandated by the new guide.6While this information is required on the nonprot tax return Form 990, the threat of IRS audit was not high for many years (Gauland Borowski, 1993.L. Eldenburg, C.C. Vines /Journal of Accountin

47、g and Public Policy 23(200412256L. Eldenburg, C.C. Vines /Journal of Accounting and Public Policy 23(2004122 Table 1Example of dierences in the method of accounting for revenue under the 1972versus 1990health care services audit guidesExample of hospital statements of revenue and expenditures1972gui

48、de 1990guideGross patient service revenue $60,000,000Deductions from revenueUncompensated care 5,500,000Courtesy and contractual adjustments 28,500,000Total deductions $34,000,000Net patient service revenue $26,000,000$29,000,000Other operating revenue 700,000700,000Total operating revenue $26,700,0

49、00$29,700,000 Operating expensesSalaries and related expense 18,000,00018,000,000Peer Review Organization fees 1,250,0001,250,000Supplies 3,300,0003,300,000Provision for bad debts 3,000,000Other expenses 400,000400,000Total operating expenses 22,950,00025,950,000Income (lossfrom operations $3,750,00

50、0$3,750,000 Nonoperating revenue net 200,000200,000Net revenue over expenditures $3,950,000$3,950,000The 1990nancial statements would include the following footnote regarding charity care:Note 1: Charity care included as gross patient service revenues and deductions from revenue under the 1972 guide

51、 totaled $2,500,000.The basis for this example was taken from Healthcare Financial Management (Bitterand Cassidy, 1992, a practitioner journal for the Healthcare Finance Management Association.*This amount includes charity care of $2,500,000and bad debts of $3,000,000.Charity care and bad debt expen

52、se were shown in aggregate on hospital nancial statements prior to 1990.*Hospitals have the option to disclose contractual and courtesy allowances in footnotes to the nancial statements after 1990. Contractual adjustments are the dierence between charges and payment for Medicare, Medicaid and other

53、insurers, and courtesy allowances are any services rendered without charge to employees, clergy, and others, such as physicians and families (Audit Guide for Hospitals, 1987.and discharge procedures, especially in the emergency room and for outpatient services (thetwo primary admission sources for c

54、harity-care patients, seldom have admitting processes for identifying charity-care patients (Garnerand Grossman, 1992, p. 59.Prior to 1990, some hospitals had no formal charity care policies or criteria, decisions were made on a case by case basis (Rode,1991. Many hospitals included a statement abou

55、t charity care in their mission statements, but had only very general guidelines about criteria. Rode (1991,suggests that a fewinstitutions . incorporated a statement on charity care in their published credit policies. However, under the 1990guide, all hospitals are required to establish a policy cl

56、early dening the criteria for patients to qualify for charity care. In response to the new disclosure requirements, the Healthcare Financial Management (1993Association released Statement No. 15in 1993which suggested criteria for determining which patients are eligible for charity care. The statemen

57、t recognized the diculty inherent in the classication decision:A number of factors must be considered, all of which require judg-ment. Thus, adoption of rigid criteria is undesirable. Dierent pro-viders may apply similar criteria dierently. For example, a patient with catastrophic hospitalization co

58、sts but with substantial net worth may be eligible for charity service by one provider, but an-other provider may require that net worth in excess of a threshold be used to pay for healthcare services before the patient is eligible for charity service (p.55.In our discussions with hospital controlle

59、rs, we learned that a patient s classication may change prior to discharge, depending upon the determina-tion of the nal amount of patient charges. Uninsured patients that require minimal treatment would be more likely to pay and thus their charges would not be classied as charity care. However, if the