FARS CASE

FARS CASE
COLD CASE 3 CASE 3: Charitable Contributions and Debt: A Comparison of St. Jude Children’s Research Hospital/ALSAC and Universal Health Services CASE TOPICS OUTLINE 1. St. Jude Children’s Research Hospital/ALSAC A. Primary Objective B. Sources of Capital C. Reporting Practices 2. Universal Health Services A. Investor-Owned Hospital B. Debt Including Leases 3. Comparison Hospitals are an industry in which both not-for-profits and investor-owned facilities operate. The sources of capital available to the not-for-profits include charitable contributions and debt offerings—unless they are governmental, in which case, higher taxes are also an alternative. Debt availability is always, in part, a function of performance, and just as failures have arisen in both sectors, about one-third of the investor-owned hospitals have been described as losing money. Of interest is how can one effectively evaluate such an industry, with this type of diversity in organizational forms and capital availability? A necessary prerequisite to such an evaluation is to have a firm understanding of how charitable contributions are presented. St. Jude Children’s Research Hospital/ALSAC has the mission of finding cures for children with catastrophic diseases through research and treatment. For the fiscal year 1999, this entity reported total assets of $221,664,232 and income of $177,071,890. A Web site at http://www.stjude.org, as well as Guidestar’s listing, references a Form 990 (Return of Organization Exempt from Income Tax) filing, availability of audited financial statements upon request, and information that the hospital has 2,100 employees and 350 volunteers. Founded in 1962, the organization seeks funds from contributions and grants for unrestricted operating expenses, specific projects, buildings, and endowments. More than 4,000 patients are seen annually, with a hospital maintaining 56 beds. The Form 990, Part III states that the hospital provided 15,231 inpatient days of care during the fiscal year and patients made 40,982 clinic visits. ALSAC is the American Lebanese Syrian Associated Charities, Inc., the fund-raising arm of St. Jude Children’s Research Hospital. It reported 1999 total assets of $1,007,699,320 and income of $274,123,399. This organization reports the number of employees as 565 and the number of volunteers as 800,000. With its sole focus on the hospital, ALSAC’s self-description explains that no child has ever been turned away due to an inability to pay for treatment and explains key accomplishments in the research area achieved by St. Jude’s research and treatment of children with catastrophic diseases. What is borne out by the example of St. Jude is the fact that a review of the Form 990 filed for the fiscal year ending 6/30/99 indicates in Part VI the names of related organizations: ALSAC and St. Jude Hospital Foundation, both of which are tax exempt. To gain a sense of capital availability to a not-for-profit entity, affiliated entities must be considered. In addition, the role of volunteers is a source of human capital not effectively captured within the framework of financial statements for not-for-profits, as reflected in the Form 990 for the fiscal year ending 6/30/99 for ALSAC, which states in Part VI: Unpaid volunteers have made significant contributions of their time, principally in fund-raising activities. The value of these services is not recognized in the financial statements since it is not susceptible to an objective measurement or valuation and because the activities of these volunteers are not subject to the operating supervision and control present in an employer/employee relationship. Hence, as one evaluates capital sources and uses by not-for-profits, care is needed to consider affiliated organizations’ role, total contributions, and the effect of volunteerism on the comparability between not-for-profit and investor-owned operations. Universal Health Services, Inc. filed its 10-K on March 28, 2001, for the calendar year 2000, which includes comparative information for 1999. Analysts have described the company as the most aggressive company in the industry over the 1999–2001 time frame in making acquisitions, particularly of not-for-profit operations and investor-owned operations experiencing losses. The company is praised for it high operating leverage, the relatively small number of shareholders relative to the magnitude of total revenue, and stock price as a multiple of earnings. The company operates 59 hospitals and, as of 1999, had an average number of licensed beds of 4,806 at acute care hospitals and 1,976 at behavioral health centers, with patient days of 963,842 and 444,632, respectively. Of interest is a commentary on the competition found in the company’s filing: Competition In all geographical areas in which the Company operates, there are other hospitals which provide services comparable to those offered by the Company’s hospitals, some of which are owned by governmental agencies and supported by tax revenues, and others of which are owned by nonprofit corporations and may be supported to a large extent by endowments and charitable contributions. Such support is not available to the Company’s hospitals. Certain of the Company’s competitors have greater financial resources, are better equipped and offer a broader range of services than the Company. Outpatient treatment and diagnostic facilities, outpatient surgical centers and freestanding ambulatory surgical centers also impact the healthcare marketplace. In recent years, competition among healthcare providers for patients has intensified as hospital occupancy rates in the United States have declined due to, among other things, regulatory and technological changes, increasing use of managed care payment systems, cost containment pressures, a shift toward outpatient treatment and an increasing supply of physicians. The Company’s strategies are designed, and management believes that its facilities are positioned, to be competitive under these changing circumstances. (Source: 10-K filed 3/28/2001) Financial information is provided in Tables 5.3-1 and 5.3-2 for both the not-for-profit and the investor-owned hospitals. Table 5.3-1: Financial Comparisons of the Not-for-Profit Entities Fiscal Year Ended 1999 St. Jude Children’s Research Hospital Form 990* American Lebanese Syrian Associated Charities, Inc. (ALSAC) Form 990* Contributions, gifts, grants and similar amounts received: Direct public support $91,978,426 $231,793,748 Indirect public support 2,906,934 Government contributions (grants) 31,469,447 Program service revenue, including government fees and contracts (i.e., health insurance revenue) 46,034,710 Accounts receivable 24,217,029 4,230,764 Pledges receivable 23,604,748 Allowance for doubtful accounts 9,363,328 Program service expenses 99,282,906 Program service expenses: Research 87,225,830 Program service expenses: Education and training 5,471,186 Program service expenses: Medical Services 93,735,602 Reconciliation of revenue, gains, and other support to audited numbers: net unrealized gains on investments −4,023,815 65,891,269 Deferred grant revenue 1,857,628 (Statement 5) Support from American Lebanese Syrian Associated Charities, Inc. 91,978,426 (Statement 7) 91,978,426 (paid per Statements 4, 6) Excluded contributions 2,746,295 (Statement 1) Excess or (deficit) for the year −10,933,191 120,521,982 Net assets or fund balances at end of year 199,707,440 994,501,910 Temporarily restricted 15,715,890 Permanently restricted 14,000,000 247,147,826 Total liabilities 21,956,792 7,017,192 Schedule of deferred debits & credits by contract (FAS 116 adjustment noted to result in this deferred revenue) 157,628 The GuideStar.org Web site (http://www.guidestar.org) provides access to Forms 990 in .PDF format. Table 5.3-2: Universal Health Services, Inc.’s Financial Excerpts* Income Statements (in thousands) Reported 1999 Calendar Year Net revenues $2,042,380 Operating charges 1,913,346 Components: Salaries, wages, and benefits 793,529 Provision for doubtful accounts 166,139 Lease and rental expense 49,029 Interest expense, net 26,872 Net income 77,775 Total assets 1,497,973 Total liabilities 856,362 Total retained earnings 482,960 Capital stock 306 Paid-in capital in excess of par 158,345 The 10-K filing as of 3/28/2001 at EDGAR (http://www.sec.gov/edgar.shtml) provides financial statement information for 2000 and 1999. Requirement A: Recording Revenue 1. What is meant by the reference in Table 5.3-1 to an FAS 116 adjustment? 2. How are contributions recorded? Is there a distinction between pledges receivable and accounts receivable? 3. Are there circumstances when financial statements can quantify volunteers’ services? 4. Can financial statement users of not-for-profit hospitals’ financial statements expect to be fully informed regarding affiliated parties, such as the linkages between St. Jude Children’s Research Hospital, ALSAC, and the foundation cited? Explain. Requirement B: Revenue Mix (Strategy-Related Considerations) The 10-K filing of Universal Health Services, Inc. describes the mix of revenue sources, as depicted in Table 5.3-3. Table 5.3-3: Patient Revenue Mix PERCENTAGE OF NET PATIENT REVENUES 2000 1999 1998 1997 1996 Third Party Payors Medicare 32.3% 33.5% 34.3% 35.6% 35.6% Medicaid 11.5% 12.6% 11.3% 14.5% 15.3% Managed Care (HMOs and PPOs) 34.5% 31.5% 27.2% 19.1% N/A Other Sources 21.7% 22.4% 27.2% 30.8% 49.1% Total 100% 100% 100% 100% 100% N/A-Not available (Source: 10-K filed 3/28/2001) 1. How does this revenue mix compare with the revenue blend of the not-for-profit entity, St. Jude Children’s Research Hospital (ALSAC)? Access the latest SEC filing and compare the reported revenue mix; has it changed? 2. What does that imply as to the strategies of investor-owned hospitals in managing risk and ensuring adequate capital relative to not-for-profit entities? An opportunity exists to explore the greater social and political questions that are frequently debated about the compatibility of profit-oriented entities and quality of health care, relative to not-for-profit entities. As background, identify what the latest SEC filings report concerning charity care. Directed Self-Study Access the 10-Q (from sec.gov) for the quarterly period ended June 30, 2006 and explain how Hurricane Katrina affected Universal Health Services. The same 10-Q reports on a funding commitment the company has made to the alma mater of the Chairman of the Board of Directors and Chief Executive Officer. Describe the disclosure and explain why the event is an “Other Related Party Transaction.” [Download the 10-Q in text format and apply the Find capability in your word processor. Also access FARS and identify the guidance relevant to each event.] Health Insurance, Public Policy, and Backdating A key factor in the health care industry is health insurance. Public policy has debated universal health care, changes to governmental programs such as Medicare, adjustment of tax policy regarding employers’ and employees’ deduction for premiums, and alternative approaches to this sector of the economy. State and local governments, under a new accounting rule, have recently estimated their total retiree health bill to be about $1.1 trillion. Over the past decade, some governmental units used pension funds to help pay for double-digit growth in health care for retired public workers. Explain how accounting interacts with public policy. Use FARS as a resource, according particular attention to FAS 158. Health insurer UnitedHealth has been the focus of media coverage involving what is known as the “options backdating scandal”. UnitedHealth’s internal probe estimates its past decade exposure at half a billion dollars (“UnitedHealth Faces Formal Probe,” Wall Street Journal, December 27, 2006, p. B8). Is there a relationship between the magnitude of the restatement and the nature of the health care sector of the economy? Explain. The SEC’s Division of Corporation Finance shared a “Sample Letter Sent in Response to Inquiries Related to Filing Restated Financial Statements for Errors in Accounting for Stock Option Grants” dated January 2007 (http://www.sec.gov/divisions/corpfin/guidance/oilgasltr012007.htm.) How helpful do you find such guidance?