Fair Value Accounting for Health Care Entities: Impact on Hospital Performance Reporting

Abstract

Fair value accounting principles were extended to not-for-profit hospital financial instruments with readily determinable values starting in fiscal year 1996; their impact on reported hospital and health system financial performance has greatly increased since then. Fair value accounting requires the reporting of unrealized gains and losses on financial instruments, which are usually temporary and are created by short-term capital market behavior. These unrealized gains/losses are often included in hospital annual earnings and profit margins.

Large investment portfolios of many hospitals generate both realized and unrealized returns that often exceed the income generated by hospital operations. Accounting rules allow for significant variation in the way unrealized returns on financial instruments are reported in hospital financial statements, including those used for most health services research. This paper explores the impact on hospital total margins of the unrealized returns themselves, as well as the impact of how those returns are reported. Using three examples, the results suggest that fair value accounting has likely introduced significant “noise” into inter-hospital and time trend comparisons of hospital financial performance. The credibility of critical financial information about our hospitals and health systems is undermined by our lack of knowledge and ability to adjust for current FVA practices.