Explore the unique accounting challenges faced by healthcare startups. From funding to compliance, learn how accounting impacts the success of these innovative companies.
Big tech companies have been contributing to healthcare for more than six decades. Since the COVID-19 pandemic, there has been a tremendous amount of growth in healthcare startups. These startups introduce technologically advanced products and services into the industry and have been instrumental in filling healthcare gaps that were present even before the pandemic. The industry is estimated to reach over $550 billion by the end of 2027, according to the National Institute of Health.
Besides securing funding and resources and navigating unique compliance considerations in a heavily regulated industry, healthcare startups face a variety of complex accounting considerations.
Capitalized Software
Software is often a healthcare startup’s largest and most important investment. Startups rely on the development of proprietary software to serve their customers. Accounting Standards Codification 985-20 provides authoritative guidance on software solutions that are often referred to as “external-use software,” while ASC 350-40 provides authoritative guidance on “internal-use software.” Therefore, in order to assess how to account for the costs, the startup must first determine whether there is a substantive plan to market their software externally, or if such a plan will be created during the development period.
Internal-Use Software
Costs identified as internal-use have both of the following characteristics:
- The software is acquired, internally developed or modified solely to meet internal needs.
- During development or modification, no substantive plan exists or is being developed to market the software externally.
The timeline for developing internal-use software is divided into three stages: preliminary, application development and postimplementation. It is crucial for a startup to be able to identify these stages to determine whether or not incurred costs are capitalizable.
External-Use Software
Instead of developing a solution that will provide a service to its customers, a startup may wish to market or sell its software solution. These solutions are commonly referred to as external-use software and are often in the form of a perpetual or subscription license or a software-as-a-service (SaaS) solution. In a SaaS the customer accesses the solution—normally through an online portal—and does not take possession. The costs of developing the SaaS solution, including the formation of ideas, design and testing are all considered internal-use costs.
For software that is to be marketed or sold, ASC 985-20 identifies technological feasibility as the moment in which costs incurred may be capitalized. Technological feasibility is established when all planning, designing, testing and coding activities necessary to establish that the product can be produced to meet its design specifications have been completed. Technological feasibility typically occurs much later in the development life cycle of external-use software than it does for internal-use software and therefore generally results in a smaller amount of costs eligible for capitalization.
Revenue Recognition
Another critical accounting consideration that must be addressed is revenue recognition. Healthcare startups often have various revenue streams, including, but not limited to, SaaS, licensing and processing and billing medical claims. Proper revenue recognition is necessary for accurate financial reporting and compliance with regulatory requirements. Healthcare startups should familiarize themselves with the guidance under ASC 606 and apply it consistently. Startups should implement a comprehensive revenue recognition policy that is clearly documented, regularly updated, reviewed and followed.
Healthcare startups often have complex contracts with multiple performance obligations and variable consideration. Step 2 of the 5-step revenue recognition model: “Identify the performance obligations in a contract,” is one of the most critical steps since it establishes revenue recognition and strongly aids in determining whether the entity is a principal or agent. This step can be difficult due to healthcare startups often having bundled goods/services within their contracts, particularly in software contracts.
Variable consideration is often found in contracts in the form of discounts, rebates, refunds, credits, price concessions, incentives, usage-based fees in SaaS arrangements, and performance bonuses or penalties. Variable consideration must be estimated upfront and can be done using one of two methods: expected value or most likely amount. Management’s best estimate is not an acceptable method to estimate variable consideration. Contracts may also include certain nonrefundable up-front fees that are paid in conjunction with the execution of the contract, such as set-up fees for SaaS contracts or hosting arrangements.
Capitalization of software and revenue recognition are just two significant areas where accounting can be unique and complex for healthcare startups. Consultation with professionals is highly recommended to ensure compliance with accounting standards and to ensure all unique accounting considerations have been addressed.
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