Contractual Adjustments

Most health care providers participate in contracts with third-party payers that reimburse the provider less than the amount charged for services. The difference between established rates charged by a health care provider for services rendered to a patient and the amount actually paid for those services by a third party under a negotiated payment contract is recognized in the financial statements as a contractual adjustment. The third-party payer contract may be negotiated with an insurance company, health maintenance organization, preferred provider organization, employer, or state and federal governments.

Contractual adjustments may result from many different types of payment methods, such as contracts that pay a fixed percent of charges, prospective payment contracts that pay a set amount based on diagnosis, contracts with prospective per diem rates, or cost-based contracts that are subject to retrospective adjustments to estimated interim payments. To report patient revenue in the period in which services are provided, which is in accordance with generally accepted accounting principles, health care entities must determine the amount ultimately realizable under terms of a payment contract. Contractual adjustments are estimated, then recorded on current charges, the terms of the contract, and historical payment data for different payment contracts. Gross patient service charges as such are not meaningful in a health care provider's financial statements. Revenue net of the appropriate contractual adjustment is the expected measure for operations.