ActionAging.com CCRC learning center

Introduction

Accounting has long struggled with whether it should be a principled professional judgment whether financial statements fairly depict the condition of an enterprise, or whether as an alternative there should be quasi-legislated rules which purport to be principled but the application of which requires less professional judgment than a fully principled approach.

Independence is another challenge for the accounting profession since audit firms' fees are paid by the very managements whose actions they scrutinize.  This creates a clear conflict of interest, which has been resolved in the Insurance sector by Statutory Accounting which is developed and administered by public servants.

For publicly traded enterprises, the Securities and Exchange Commission has threatened to adopt government rules if the accounting profession didn't do so itself.  This has led to rules-based accounting which can fail to disclose embedded financial values in an enterprise, such as an excess of market value over accounting value, and such as hidden factors implicit in pension plans.

These factors make accounting less than valuable for many stakeholders who might be expected to rely on financial statements.  The accountants counter that their work is only for informed users, by which they mean users who have mastered the ambiguities of the accounting rules.

Recently, the Financial Accounting Standards Board (FASB) has struggled to bring greater equity to revenue recognition which particularly affects CCRCs, but many providers do not give full credence to the changes as reflective of the underlying realities, so residents can be misled, and FASB is not the only accounting standards board ruling on healthcare organizations.

These accounting conflicts and premises are of particular concern for prospective residents trying to discern whether a CCRC is financially sound.

Entry fee investments in continuing care contracts represent an act of faith in the integrity of the provider CCRC that calls for a high degree of stewardship.  Accounting for CCRCs has not reflected this high standard for financial care and integrity.  Entry fee CCRC accounting has been given its own set of rules, separate and distinct from the accounting for other industries and for similar types of transactions.

This needs to be said and said clearly.  Today’s entry fee CCRC accounting is misleading and detrimental to the interests of CCRC residents, who are the stakeholders with the greatest vulnerability in the financial soundness of CCRCS.  

CCRC accounting, as it is now promulgated, overlooks the investment aspect of resident entry fees, assigning to net income all of the time-value benefits of the lag between entry and contract performance.  It also allows the advancing of revenue recognition for refundable entry fees that are contingent on re-occupancy proceeds, on the premise that successor residents pay the refunds to their predecessors.  This has the effect of condoning a Ponzi concept which requires perpetual operation so that the refund to the last resident need never be paid.  Both promulgations distort the financial appearances of the accounting statements, which thus depart from the underlying economics of the enterprise, making operations appear artificially favorable during the early years of CCRC operation.

Despite this front ending of revenue recognition, many tax exempt, nominally nonprofit, CCRCs have impaired balance sheets, meaning that they lack sufficient assets to fulfill the liabilities for which the CCRC has contracted.  One often hears industry leaders proclaim that “Cash is king,” as though that were an overriding accounting principle that negates the alternative principle that revenues only be recognized as the commitments that induced their payment are fulfilled.  

Because nonprofit CCRCs don’t have access to equity capital, they have to use either retained earnings from past profits, donations, or entry fees, as the equity cushion for their debt financing – analogous to the down payment on a house.   This overlooks the obvious fact that entry fees are committed contractual obligations and not equity capital in the usual sense.  The use of retained earnings demonstrates the misperception that tax exempt CCRCs adhere to nonprofit principles.

As a result, an impaired CCRC balance sheet is more telling than an impairment would be even if the applicable accounting were principled.  Since it’s not, prospective residents should exercise extreme caution in investing in an entry fee contract with a CCRC which has an impaired balance sheet.  They should only make such an investment if they can afford the prospect that future fees will have to be set at a level to make up the deficiency over time (unless the bondholders voluntarily relinquish the value of their senior secured investment). 

Prospective residents should also be prepared to lose their entire entry fee investment if the CCRC fails financially and has to seek bankruptcy protection.  In the event of bankruptcy, residents are at the bottom of the claimants’ hierarchy, while the executives – who with the board exercise the ownership prerogatives of a nonprofit – and the debt holders have top claim on the bankrupt estate.

Although there is some evidence that FASB, the primary promulgating authority for GAAP, recognizes these defects and is moving slowly toward a more principled accounting, that will take years and FASB has shown reluctance to move too quickly for fear of disrupting businesses that are the clients for CPAs.  In the meantime, it is rare that today’s financial statements for an entry fee CCRC reflect the underlying economic realities of the enterprise.

The National Continuing Care Residents Association (NaCCRA) has long advocated for a rectification of these accounting anomalies. We believe further that serious consideration should be given to bringing entry fee CCRC accounting within the statutory accounting framework of the National Association of Insurance Commissioners, as it applies to insured immediate life annuities, at least, until such time as private accounting standards develop the needed integrity.