Proposed accounting changes could bring costs, complications

• The accounting rule change would skew long-term hospital debt to appear as more significant short-term obligations.
• Hospitals may need to undertake costly moves to restructure their debt under arrangements still considered long-term.
• In advance of any FASB policy change, hospitals should review the extent to which they use the affected type of arrangement.

Hospital industry advisers who serve on an accounting standards board are warning that proposed rule changes could expose some hospitals that have a certain type of debt to greater costs and complicate their debt outlook.

 As part of an accounting simplification push, the Financial Accounting Standards Board (FASB) has proposed to reclassify variable-rate debt obligations (VRDOs) backed by a letter of credit from long-term debt to short-term debt. The proposal comes despite the arrangement’s longstanding use as an alternative to other long-term financing arrangements.

HFMA’s Principles and Practices (P&P) Board warned the change could have a range of unintended consequences, which include:

• Skewing the metrics of healthcare organizations using the arrangement
• Creating incongruent comparisons of debt metrics among healthcare organizations
• Causing health systems to discontinue the use of the long-term financing arrangement
• Increasing administrative burden
• Producing substantial incremental costs
• Misinforming many financial statement users about organizations’ true levels of working capital and liquidity and their financial outlook

It’s unclear how many hospitals and health systems still have such debt arrangements in effect, said Norman Mosrie, FHFMA, CPA, chair of the P&P board and a partner with DHG Healthcare in Charleston, West Virginia. However, the policy change could affect a large number of hospitals because it was a popular financing mechanism in the past when interest rates were higher. Many hospitals likely still have such outstanding debt, given that many debt issues were associated with major projects such as  campus expansions, in many cases with scheduled maturities of 20 to 30 years.

Peer-data comparisons are common in healthcare, and industry leaders warned the proposed change was likely to unfairly skew the metric results of hospitals that have VRDOs backed by a letter when compared to peers that have utilized other financing mechanisms. Additionally, debt covenants for certain financing arrangements could be negatively impacted, Mosrie said.

Kimberly McKay, CPA, another P&P Board member and a managing partner at BKD in Houston, said healthcare providers have said that, if finalized, the accounting change would push them to refinance their debt or seek a different debt agreement because they want to retain long-term classification of their debt.

“The administrative burden of refinancing that debt could be costly, organizations may have to pay a higher interest rate and they could incur losses to unwind the debt they are currently in,” McKay said. “That is a choice organizations will have to make based on how they perceive the proposed change will affect their financial statement.”

Proposed rules represent a counterintuitive change

The change could force some providers to unwind such arrangements early “so they don’t have to deal with the ramifications of a skewed balance sheet,” Mosrie said. But that step would bring costs, such as those associated with early bond exits.

McKay said the proposed change is counterintuitive since it would allow such debt to be considered long-term only if there was a failed remarketing.

“It’s counterintuitive to think if you failed to remarket, you get the accounting treatment you want because the letter of credit would be activated,” McKay said. “But if the debt does not fail to remarket, you would have to show it all as current even though there is never a situation where you would be required to repay the principal within a year.”

Alternate approaches for FASB to consider

The P&P board plans to submit a comment letter recommending that FASB consider two alternatives to implementing the rule changes as proposed:

• Exempt VRDOs with letters of credit contractually linked to the financing arrangement from the short-term debt treatment
• Grandfather such existing arrangements

“We’re asking as a solution for them to allow this exemption for this contractual linkage, and then if they don’t sign off on that, to at least grandfather the ones that are existing,” Mosrie said.

How to respond

The P&P Board urged hospital and health system CFOs to write FASB about how the change would affect their organization.

The comment letter should be personalized to describe how the organization utilizes such arrangements and the potential impact of the proposed accounting change on the organization.

P&P Board members are concerned their industry colleagues are unaware of the issue, despite the potentially costly impacts on their organizations.

“This [guidance] partly aims to ensure people are aware this issue is out there because I have a feeling a lot of them are not,” Mosrie said.

Public comments are due to FASB by Oct. 28. FASB has not yet identified an implementation date.