Congress has included new Medicare payment incentives for hospitals and other providers under the Health Information Technology for Economic and Clinical Health Act. These incentives are designed to encourage the adoption of comprehensive electronic health record (EHR) systems. Many hospitals will undergo expensive software implementation projects over the next few years as EHR readiness deadlines approach. These projects also may require ongoing licensing agreements. Accounting methods for these projects and agreements often are complex and require providers to monitor activities throughout the process.
Implementation Project Costs
Many providers are unclear about which costs can be capitalized vs. those that must be categorized as an EHR implementation expense. Accounting Standards Codification (ASC) Topic 350-40, Internal-Use Software, provides the authoritative guidance for costs related to software developed or obtained for internal use. ASC Topic 350-40 lists three stages of computer software development:
- Preliminary project stage
- Application development stage
- Post-implementation and operation stage
Activities associated with these stages are more common in health care organizations that either develop their own EHR system or customize an “off-the-shelf” package. However, these projects likely will be a significant investment for all health care organizations, including those that acquire ready-to-use software packages. As such, all health care organizations should understand the accounting rules for the activities associated with each stage of a software implementation project.
1. Preliminary Project Stage
Internal and external costs incurred during the preliminary project stage should be expensed as they are incurred. Common activities included in this stage include development of an organization’s EHR strategy and vendor research (such as site visits), interviews and final vendor selection.
2. Application Development Stage
Most costs incurred during the application development stage should be capitalized. The application development stage includes activities such as coding, installation of hardware and testing of software (including running parallel environments).
Common costs that may be capitalized include:
- External direct costs of materials and services consumed in developing or obtaining internal-use computer software
- Payroll and payroll-related costs (for example, employee benefit costs) related to the time employees devote to the project on application development tasks, such as coding and testing. Similarly, external consultant costs related to these activities should be capitalized.
- Interest costs incurred while developing internal-use computer software
Capitalization of costs begins when both the preliminary project stage is completed and management authorizes and commits to funding the project and project completion is probable.
3. Post Implementation and Operation Stage
Finally, costs incurred during the post-implementation and operation stage, such as internal and external training costs and maintenance costs, must be expensed as incurred. Data conversion costs also must be expensed as incurred; however, the cost of obtaining or developing software to assist in data conversion should be capitalized.
Additional Considerations
In many instances, providers will incur costs that fit into one of these three areas concurrently. For example, it is not unusual for training costs and certain data conversion activities to occur throughout the application development stage. It is important to remember that accounting for these costs is based on the nature of the activity or cost, not the time frame in which it occurs.
If software is upgraded or enhanced, capitalization is appropriate only if it is probable the upgrades and enhancements will result in additional functionality. If so, then the guidance discussed above should be followed.
Amortization of the capitalized costs begins when the software is ready for its intended use, regardless of whether the software is placed in service at that time. Computer software is ready for its intended use after all substantial testing is completed and all modules needed to make it functional are complete.
Software Licensing Arrangements
EHR software often includes companion licensing agreements. These agreements may include payment structures that attempt to match cash outflows with anticipated EHR supplemental payments.
Software licensing agreements are accounted for in a manner similar to lease agreements (ASC Topic 840, Leases) and are often classified as operating leases. License fees are expensed on a straight-line basis over the term of the agreement and, if significant, the lessee-licensee should disclose its commitment under the agreement. This straight-line requirement could result in recognition of expenses well in advance of license payments under the agreement.
Accounting for EHR projects and agreements can be complicated and may require additional expertise. Contact your BKD advisor for assistance applying these rules to your specific situation.
