[Federal Register Volume 60, Number 123 (Tuesday, June 27, 1995)]
[Rules and Regulations]
[Pages 33126-33137]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-15341]



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DEPARTMENT OF HEALTH AND HUMAN SERVICES
42 CFR Part 413

[BPD-366-F]
RIN 0938-AD01


Medicare Program; Clarification of Medicare's Accrual Basis of 
Accounting Policy

AGENCY: Health Care Financing Administration (HCFA), HHS.

ACTION: Final rule.

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SUMMARY: This final rule revises the Medicare regulations to clarify 
the concept of ``accrual basis of accounting'' to indicate that 
expenses must be incurred by a provider of health care services before 
Medicare will pay its share of those expenses. This rule does not 
signify a change in policy but, rather, incorporates into the 
regulations Medicare's longstanding policy regarding the circumstances 
under which we recognize, for the purposes of program payment, a 
provider's claim for costs for which it has not actually expended funds 
during the current cost reporting period.

EFFECTIVE DATE: This final rule is effective July 27, 1995.

FOR FURTHER INFORMATION CONTACT: John Eppinger, (410) 966-4518.

SUPPLEMENTARY INFORMATION:

I. Background

    Generally, under the Medicare program, health care providers not 
subject to prospective payment are paid for the reasonable costs of the 
covered items and services they furnish to Medicare beneficiaries. This 
policy pertains to all services furnished by providers other than 
inpatient hospital services (section 1886(d) of the Social Security Act 
(the Act)) and certain inpatient routine services furnished by skilled 
nursing facilities choosing to be paid on a prospective payment basis 
(section 1888(d) of the Act.) Additionally, there are other limited 
services not paid on a reasonable cost basis, to which this policy 
would not apply. Section 1861(v)(1)(A) of the Act defines reasonable 
cost as the cost actually incurred, excluding any cost unnecessary in 
the efficient delivery of needed health services. That section of the 
Act also provides that reasonable costs must be determined in 
accordance with regulations that establish the methods to be used and 
the items to be included for purposes of determining which costs are 
allowable for various types or classes of institutions, agencies, and 
services. In addition, section 1861(v)(1)(A) of the Act specifies that 
regulations implementing the principles of reasonable cost payment may 
provide for the use of different methods in different circumstances. 
Implementing regulations at 42 CFR 413.24 establish the methods to be 
used and the adequacy of data needed to determine reasonable costs for 
various types or classes of institutions, agencies, and services.
    Section 413.24(a) requires providers receiving payment on the basis 
of reasonable cost to maintain financial records and statistical data 
sufficient for the proper determination of costs payable under the 
program and for verification of costs by qualified auditors. The cost 
data are required to be based on an approved method of cost finding and 
on the accrual basis of accounting. Currently, Sec. 413.24(b)(2) 
provides that under the accrual basis of accounting, revenue is 
reported in the period in which it is earned, regardless of when it is 
collected, and expenses are reported in the period in which they are 
incurred, regardless of when they are paid.
    As explained in the October 9, 1991 proposed rule (56 FR 50834), 
under the current definition of the accrual basis of accounting, some 
providers have claimed costs without evidence of having incurred actual 
expenditures or the assurance that liabilities associated with accrued 
costs will ever be fully liquidated through an actual expenditure of 
funds. For example, under the terms of some provider employment 
contracts, nonprobationary employees are entitled to accumulate a 
certain number of sick leave days annually and carry forward a maximum 
accumulated amount of unused sick leave time. These sick leave days are 
typically vested (although not funded) but nevertheless are subject to 
forfeiture. That is, unused accumulated sick leave days are subject to 
redemption for cash if the employee retires, resigns, or is discharged 
in good standing, but may be forfeited if the employee is discharged 
for cause. In the latter case, under the current rule, some providers 
have sought Medicare payment for sick leave days for which the provider 
never became liable.
    As a result of the lack of clarification in the regulations 
regarding Medicare payment for certain accrued costs, the Medicare 
program has settled approximately $4.0 million worth of accrued costs 
in sick leave, FICA taxes, deferred compensation, and unpaid mortgage 
interest expense cases. We believe that a clarification to the 
regulations to incorporate longstanding Medicare policy regarding 
timely liquidation of liabilities associated with these accrued costs 
will minimize the unwarranted payment of Federal funds. That is, the 
regulations will clarify that in cases in which a provider does not 
timely liquidate the liabilities, Medicare recovers its payment for the 
accrued costs claimed by the provider.
    As discussed in the proposed rule, an alternative would be to 
forego incorporating in regulations our policy regarding the 
circumstances under which Medicare accepts a provider's claim for costs 
for which it has not actually expended funds during the current 
reporting period.
    However, without a change to the regulations, some providers would 
believe that, for Medicare purposes, they could continue to rely solely 
upon the generic definition of the accrual basis of accounting, whereby 
revenue is reported in the period it is earned, regardless of when it 
is collected, and expenses are reported in the period in which they are 
incurred, regardless of when they are paid. HCFA would have to continue 
to defend the policy without specific support in the regulations. To 
the extent that challenges to this policy were successful, we would be 
forced to pay currently for accrued liabilities that either may not be 
liquidated timely or may never be liquidated. Although we believe that, 
in light of the recent decision of the United States Supreme Court in 
Shalala v. Guernsey Memorial Hosp., 115 S. Ct. 1232 (1995), the 
likelihood of successful challenges has decreased, we believe it is 
appropriate to publish these regulations to avoid any confusion 
regarding the policy.
    In summary, despite the clear statements of Medicare payment 
principles found in Medicare manuals (for example, section 2305 of the 
Provider Reimbursement Manual), the lack of clarification to the 
regulations continues to impair HCFA's ability to defend against 
challenges to the regulations for accrued costs of sick pay, vacation 
pay, FICA and other payroll taxes, owners' compensation, deferred 
compensation, pension plans, nonpaid workers' services, and unpaid 
mortgage interest, as well as other accrued costs. The end result, to 
the extent that HCFA cannot defend challenges to the policy, is that 
the Medicare program makes payments for costs not incurred by 
providers, in violation of section 1861(v)(1)(A) of the Act. 
[[Page 33127]] 

II. Summary of Proposed Rule

    On October 9, 1991, we published a proposed rule (56 FR 50834) to 
revise Sec. 413.24 by adding a new paragraph to describe the conditions 
under which certain accrued costs would be recognized for purposes of 
Medicare payment. Our intention in specifying these conditions was not 
to change policy. Rather, it was to incorporate into the regulations 
our longstanding policy on the timely liquidation of liabilities, as 
contained in sections 704.3, 704.5, 906.4, 2140, 2144.8, 2144.9, 2146, 
2162.9, and 2305 of the Provider Reimbursement Manual. Under this 
longstanding policy, accrued costs are included in Medicare allowable 
costs in the year of accrual, provided the related liabilities are 
liquidated timely, in accordance with the liquidation requirements for 
the particular type of accrued cost. If the liabilities are not 
liquidated timely, an adjustment is required to disallow the costs. 
Generally, the adjustment is made in the year of accrual except for 
vacation and all-inclusive paid days off, in which case the adjustment 
generally is made in the year in which the payment for the accrued 
vacation or all-inclusive paid days off should have been made. (The 
Provider Reimbursement Manual provides additional instructions, not 
incorporated in the regulations, regarding later recognition, if any, 
with respect to costs associated with liabilities not liquidated in 
accordance with the liquidation of liabilities requirements.)
    As we indicated in the proposed rule, we believe this clarification 
will significantly contribute to the uniform application of our 
policies concerning recognizing accrued costs for Medicare payment and 
will preclude misinterpretation of the policies in the future. A change 
to the regulations is necessary to ensure that providers are paid for 
their actual costs as intended under section 1861(v)(1)(A) of the Act, 
and 42 CFR 413.9(c)(3), which state that the reasonable cost basis of 
payment contemplates that providers of services are to be paid the 
actual costs of providing quality care.
    Accordingly, in order for accrued costs to be recognized for 
Medicare payment, we proposed that the following requirements be met 
with respect to the liquidation of liabilities:
     In a new Sec. 413.24(c)(3)(i), we proposed that a short-
term liability generally must be liquidated within 1 year after the end 
of the cost reporting period in which the liability is incurred, with 
an exception in cases in which the intermediary is furnished, within 
the 1-year time limit, sufficient written justification, based upon 
documented evidence, for nonpayment. An extension not to exceed 3 years 
beyond the end of the cost reporting year in which the liability was 
incurred could be granted for good cause.
     In a new Sec. 413.24(c)(3)(ii), we proposed that if the 
provider's vacation policy is consistent for all employees, we would 
require that payment be made within the period provided for by that 
policy. If the provider's vacation policy is not consistent for all 
employees, we would require that payment be made within 2 years after 
the close of the cost reporting period in which the liability is 
accrued. Under this paragraph, we also proposed that the policy 
applicable to vacation pay also would apply to all-inclusive paid days 
off (for example, total time off in a given period for unspecified 
occasions, including illness, vacations, and family bereavement).
     In a new Sec. 413.24(c)(3)(iii), we proposed that if sick 
pay is vested and funded in a deferred compensation plan, liabilities 
related to the contributions to the fund would be liquidated in 
accordance with the policy stated above for a short-term liability. 
However, if the sick leave plan grants employees the right to demand 
cash payment for unused sick leave at the end of each year, we proposed 
that the sick pay be includable in allowable costs, without funding, in 
the cost reporting period when it is earned.
     In a new Sec. 413.24(c)(3)(iv), with regard to 
compensation of owners other than sole proprietors and partners (that 
is, employees, officers and directors owning stock in closely-held 
corporations or with a substantial ownership or equity in publicly-
traded corporations, and certain employees of trusts), we proposed that 
any related accrued liability be liquidated within 75 days after the 
close of the cost reporting period in which the liability occurs.
     In a new Sec. 413.24(c)(3)(v), we proposed that 
obligations incurred under a legally-enforceable agreement to 
remunerate an organization of nonpaid workers be discharged no later 
than the end of the provider's cost reporting period following the 
period in which the services were furnished.
     In a new Sec. 413.24(c)(3)(vi), we proposed that the 
employer's share of FICA and other payroll taxes that the provider 
becomes obligated to remit to governmental agencies may be included in 
allowable costs only during the cost reporting period in which payment, 
upon which the tax is based, is actually made to the employee. For 
example, no legal obligation exists for the provider-employer to pay 
FICA taxes until such time as the employee is paid and the specific 
amount of payroll liability is known.
     In a new Sec. 413.24(c)(3)(vii), we proposed that accrued 
liabilities related to contributions to a funded deferred compensation 
plan must be liquidated in accordance with the policy stated above in 
Sec. 413.24(c)(3)(i) for a short-term liability. However, if the plan 
is not funded, reasonable provider payments made to employees under 
deferred compensation plans would be considered an allowable cost only 
during the cost reporting period in which actual payment is made to the 
participating employee.
     In a new Sec. 413.24(c)(3)(viii), we proposed that accrued 
liability related to contributions under a self-insurance program that 
are systematically made to a funding agency, and that cover malpractice 
and comprehensive general liability, unemployment compensation, 
workers' compensation insurance losses, or employee health benefits, 
must be liquidated within 75 days after the close of the cost reporting 
period.

III. Discussion of Public Comments

    In response to the October 9, 1991 proposed rule, we received 17 
timely items of correspondence. The comments were submitted by eight 
providers or provider associations, two trade associations, five 
consultants or accounting firms, one State, and one law firm. Our 
responses are presented below:

A. General

    Comment: Several commenters raised questions regarding the 
relationship between Medicare payment policy and generally accepted 
accounting principles (GAAP). Some commenters believe that the proposed 
rule conflicts with GAAP and that HCFA is bound to use GAAP.
    Response: The regulations at Sec. 413.24(a) establish the general 
principle that cost data be based on the accrual basis of accounting, a 
concept also integral to GAAP. However, regarding application of the 
accrual basis of accounting, Medicare payment policy does not always 
follow GAAP exactly because Medicare payment policy and GAAP have 
different objectives. Medicare's objective for cost payment purposes is 
to pay providers appropriately for the reasonable and proper cost of 
furnishing services to Medicare beneficiaries in a specific fiscal 
period. On the other hand, the primary goal of GAAP is the full and 
proper presentation of accounting data through statements and reports. 
[[Page 33128]] 
    Medicare's longstanding position on the relationship between 
Medicare payment policy and GAAP is that GAAP will be followed only in 
cost situations not covered by the Medicare statute, regulations, 
rulings, manual provisions, or program policy (American Medical Int'l 
v. Secretary of Health, Educ., and Welfare, 466 F. Supp. 605, 624 n.21 
(D.D.C. 1979), aff'd 677 F.2d 118 (D.C. Cir. 1981)). This position has 
long been stated in the Foreword to the Provider Reimbursement Manual 
and elsewhere (41 Fed. Reg. 46, 291-2 (Oct. 20, 1976)) and is 
consistent with the Medicare statute.
    Section 1861(v)(1)(A) requires the Secretary, in defining 
reasonable cost, to ``consider, among other things, the principles 
generally applied by national organizations or established prepayment 
organizations (which have developed such principles).* * *'' At most, 
the statute requires the Secretary to consider certain principles. 
Moreover, the principles that must be considered are not generally 
accepted accounting principles, but are payment principles developed by 
national insurance or prepayment organizations in the health services 
sector. Therefore, we disagree with the commenter's belief that HCFA is 
bound to use GAAP in determining what costs are allowable. Instead, 
GAAP, which includes accrual accounting, is used by providers in 
maintaining their records and reporting their costs. When reporting 
their costs, providers register their trial balance in accordance with 
their records and subsequently make reclassification and adjustments to 
the trial balance in certain situations (for example, when Medicare 
payment policies depart from GAAP). (See section 2407 of the Provider 
Reimbursement Manual, Part II.)
    The Supreme Court recently upheld Medicare's longstanding position 
on the relationship between Medicare Payment Policy and GAAP in Shalala 
v. Guernsey Memorial Hosp., 115 S. Ct. 1232 (1995). The Court agreed 
that neither the Medicare statute nor the regulations (42 C.F.R. 
Secs. 413.20 and 413.24) mandate Medicare payment according to GAAP. 
The Court also accepted the Secretary's position that the regulations 
require only that providers use GAAP for recordkeeping.
    Because of the apparent confusion regarding the relationship 
between Medicare payment policy and GAAP, we have decided to move the 
provisions beginning with Sec. 413.24(b)(3) of the proposed rule into a 
new Sec. 413.100, Special Treatment of Certain Accrued Costs, in 42 CFR 
Subpart F, Specific Categories of Costs. We believe that leaving these 
payment provisions in Sec. 413.24 of Subpart B, Accounting Records and 
Reports, which does not address allowable Medicare costs, would 
continue to create confusion about the role of GAAP in determining 
whether a cost is allowable under the Medicare program. Leaving the 
provisions in Sec. 413.24 would fail to recognize the distinction 
between the role of GAAP in recordkeeping and reporting, where 
providers adhere to GAAP (including accrual accounting), and the role 
of GAAP in determining allowable costs, where GAAP applies only if 
there is no Medicare policy covering the cost situation. (See section 
IV of this preamble for a crosswalk between the regulation text 
citations for provisions of the proposed rule and the corresponding 
provisions of the final rule.)
    Comment: Some commenters objected to the establishment of time 
limits for the liquidation of an accrued liability since such time 
limits are not required under GAAP. One commenter asserted that it was 
inefficient to require hospitals to follow Medicare's unique accrual 
policies when all other users of hospital financial statements accept 
GAAP.
    Response: The fact that Medicare payment policies may at times 
differ from GAAP is neither unusual nor unintentional. This rule is a 
case in point. We recognize that the accrual basis of accounting, as 
defined in Sec. 413.24(b)(2), is essential for the proper reporting of 
costs. However, as the commenters pointed out, GAAP does not impose 
time limits for liquidating accrued liabilities. Time limits for 
liquidating accrued liabilities are essential to ensure that Medicare 
recognizes only costs associated with a liability that is liquidated 
timely through an actual expenditure of funds. Medicare policy does not 
prevent a provider from maintaining its books and records in accordance 
with GAAP. Rather, for Medicare purposes, payment for a claimed accrual 
must be recovered if the accrual is not timely liquidated.
    Comment: Some commenters stated that they opposed the proposal 
because it adds to the burden and cost to providers without any 
demonstrated need to do so, while providing relatively small benefit to 
HCFA.
    Response: This rule should not add to the burden and costs to 
providers. It merely conforms regulations to present policies and 
longstanding practices regarding the circumstances under which Medicare 
recognizes, for purposes of program payment, a provider's claim for 
costs for which the provider has not actually expended funds during the 
current cost reporting period. It does not require changes in reporting 
or recordkeeping.
    We do not agree that this rule provides a relatively small benefit 
to HCFA. Incorporation in the regulations of our longstanding policies 
will clarify that Medicare does not make payment for provider expenses 
for which the associated liabilities are not liquidated timely.
    Comment: Several commenters stated that the proposed rule 
constituted a policy change, rather than just a codification of 
existing policy. They believe that the proposed changes to the 
regulations improperly deny payment for substantial costs incurred in 
furnishing services to Medicare beneficiaries. They opposed any changes 
to the existing definition of the accrual basis of accounting in 
regulations at Sec. 413.24(b)(2). In addition, some commenters stated 
that we do not have authority to implement changes in Medicare 
regulations retroactively. They believe that this new provision may not 
be applied to services provided before the effective date of this final 
rule.
    Response: This final rule does not implement a change in Medicare 
policy. Rather, it incorporates into the regulations our longstanding 
policy on the timely liquidation of liabilities, as contained in 
sections 704.3, 704.5, 906.4, 2140, 2144.8, 2144.9, 2146, 2162.9, and 
2305 of the Provider Reimbursement Manual. Accordingly, this final rule 
does not represent a retroactive change in Medicare payment policy. 
Program manuals contain HCFA's guidelines for implementing the statute 
and regulations, that is, on how we interpret the statute and 
regulations. Our policy guidelines on the timely liquidation of 
liabilities have been included in the Provider Reimbursement Manual for 
many years. These guidelines are now being incorporated into the Code 
of Federal Regulations, as of the prospective effective date of this 
final rule.
    Comment: One commenter believes the proposed rule places 
intermediaries in the role of ``policemen'' to determine whether a 
provider is a ``going concern''.
    Response: Under this rule, providers simply would be required to 
liquidate liabilities timely in accordance with our longstanding 
policies, in order for them to be allowable costs for Medicare payment 
purposes. The rule adds no new requirements regarding whether a 
provider is a going concern. As always, intermediaries will monitor a 
provider's furnishing of patient care services. If a provider goes out 
of business, it is still necessary for the provider to timely 
[[Page 33129]] liquidate liability for expenses paid by the Medicare 
program.
    Comment: According to one commenter, when HCFA implemented the 
prospective payment system for hospitals in 1983, we stated that after 
capital and outpatient cost reimbursement were folded into the 
prospective payment system, the hospital cost reports would become 
obsolete and could be phased out. In light of this statement, the 
commenter believes that the cost reporting burden on providers should 
not be expanded, and objects to HCFA's proposal to expand the burden of 
cost reporting by no longer allowing GAAP.
    Response: Section 1886(f) of the Act requires the Secretary to 
maintain a system of cost reporting for hospitals receiving payments 
under the prospective payment system. Thus, the submission of cost 
reports continues to be a statutory requirement. Moreover, even if cost 
reporting were not necessary for prospective payment purposes, cost 
reporting continues to be required to determine Medicare payment for 
outpatient services in prospective payment hospitals and for services 
in other types of providers.
    We are not expanding the burden of cost reporting. Providers have 
always been required to maintain sufficient financial records and 
statistical data of costs payable under the program (Sec. 413.20(a)). 
This rule simply codifies in the regulations Medicare's longstanding 
policy regarding the timing of payment for accrued costs by requiring 
timely liquidation of liabilities in order to receive Medicare payment. 
This policy is intended to prevent the outlay of Federal trust funds 
before they are needed to pay the costs of providers' actual 
expenditures. It does not require changes in reporting or recordkeeping 
and, therefore, does not expand the burden of cost reporting.
    Comment: One commenter stated that the proposed rule conflicts with 
the requirements of the Medicare law and regulations, and noted that 
HCFA has recognized that the Medicare law requires it to determine 
payment in accordance with standardized accounting practices widely 
accepted in the hospital and related fields. Furthermore, the commenter 
pointed out that, in National Medical Enterprises v. Bowen, 851 F. 2d 
291, 294 (9th Cir. 1988), the United States Court of Appeals for the 
Ninth Circuit concluded that the accounting standards used by hospitals 
to calculate and record costs are integral parts of Medicare 
regulations regarding what is a reasonable cost under Medicare.
    Response: The rule implements already existing policy. We believe 
it does not conflict with the authority in the law or the regulations 
that implement the law. On the contrary, section 1861(v)(1)(A) of the 
Act defines reasonable cost as cost actually incurred, and states that 
reasonable costs shall be determined in accordance with regulations. 
Thus, the Secretary has broad discretion to define reasonable cost by 
regulation.
    We are aware of the court's decision in National Medical 
Enterprises regarding the applicability of accepted accounting 
standards (such as GAAP) in determining reasonable cost under Medicare. 
However, National Medical Enterprises does not hold that generally 
accepted accounting principles supersede explicit Medicare instructions 
stated in the regulations. GAAP is important to a provider in 
maintaining its books and records and is relevant to the determination 
of Medicare payment when there is no Medicare policy on point. However, 
as discussed in our response to an earlier comment, GAAP and Medicare 
payment policy have different purposes. Unlike GAAP, which is intended 
to be used to present the financial position of an organization, 
Medicare policy specifically deals with paying providers for costs 
incurred in furnishing care to Medicare beneficiaries. For payment 
purposes, the Medicare Trust Funds should not be required to pay a 
provider for costs associated with liabilities that are not liquidated 
timely. Thus, we do not believe that Medicare policy must fully 
incorporate GAAP. To the extent that the National Medical Enterprises 
case differs with our policy on GAAP, we believe that case is 
inconsistent with the decision of the Supreme Court in Shalala v. 
Guernsey Memorial Hosp., 115 S. Ct. 1232 (1995). (We note that we are 
developing a notice of proposed rulemaking to clarify the general 
applicability of GAAP to Medicare payment policy.)
    Comment: One commenter asserted that HCFA's purpose in proposing 
the rule change is solely financial. The commenter stated further that 
courts have held that HCFA may not create an interpretation of the 
Medicare statute or regulations simply as a means of saving money 
(Villa View Community Hospital, Inc. v. Heckler, 720 F. 2d 1086, 1094 
(9th Cir. 1983)).
    Response: The primary purpose of the rule is to codify in 
regulations longstanding policy precluding Medicare payment for 
otherwise allowable costs in cases in which a provider has not 
liquidated timely the liability associated with the expense. For HCFA 
not to recover its payment for a cost accrued by a provider when the 
provider fails to make an expenditure to liquidate timely its liability 
on an obligation is not appropriate. In effect, the provider would be 
paid by Medicare for an expense for which it has had no outlay of 
funds, which is not consistent with the law. Thus, this rule does not 
constitute an interpretation of Medicare statute or regulations simply 
designed to save money, and, therefore, it is not in conflict with the 
reasoning of Villa View Community Hospital.
    Comment: Several commenters stated that the proposal violates 
principles of accrual accounting and would force an already over-
regulated industry to maintain two sets of books. They also alleged 
that provider costs would escalate dramatically as a result of 
providers being forced to spend untold hours converting to cash basis 
accounting.
    Response: This change does not violate the principles of accrual 
accounting; rather, it provides time limitations by which liabilities 
must be liquidated in order to receive Medicare payment for the year of 
accrual. Providers initially record their costs in their books and 
records in accordance with GAAP and, subsequently, make necessary 
reclassifications and adjustments in their Medicare cost reports to 
conform with Medicare policy. The incorporation into regulations of 
already-functioning time limitations related to accrued costs would not 
change providers' established accounting systems or their preparation 
of Medicare cost reports. Therefore, a provider would not have to 
maintain two sets of books to comply with this regulation, nor would 
the regulations require conversion to cash basis accounting.
    Comment: One commenter stated that the proposed change will prove 
to be detrimental to providers due to the wide variety of possible 
interpretations by fiscal intermediaries.
    Response: We believe that the commenter's contention that this rule 
raises the possibility of a wide variety of interpretations by fiscal 
intermediaries is unfounded. The purpose of the rule is to avoid this 
possibility by explicitly setting forth in regulations longstanding 
policy that mandates specific time frames for liquidation of 
liabilities.
    Comment: One commenter suggested that we include in the final rule 
examples of workers' compensation plans structured to lend themselves 
to unwarranted payment of Federal funds, for example, (1) situations in 
which a provider's workers' compensation [[Page 33130]] insurance 
premium payments are funneled back to a reinsurer related to the 
provider, or (2) situations in which a provider may have the option of 
paying less than the insurance premium billed to it (that is, claim an 
accrual for the billed premium but eventually pay the insurer a smaller 
amount). The commenter felt the regulations should be clear that a 
provider's costs are payable only to the extent that the provider has 
actually paid a premium.
    Response: We have chosen not to incorporate the commenter's 
examples in the regulations. However, we agree that Medicare cannot 
properly pay a provider unless the provider has actually incurred a 
cost. In the first example, the provider's intermediary must examine 
the situation of an insurer reinsuring with a party related to the 
provider. To the extent the intermediary determines the provider's 
premiums are unnecessarily or improperly funneled back to a party 
related to the provider, the premiums would be unallowable. In the 
second example, to the extent that a provider does not fully liquidate 
its accrual, that portion of the accrual would be unallowable.
    Comment: One commenter took exception to the proposal's claim that 
no additional information collection requirements would be imposed as a 
result of the proposed changes to the regulations. The commenter stated 
that the requirement that unfunded deferred compensation (for example) 
be an allowable cost only during the period in which actual payment was 
made to the employee would necessitate additional recordkeeping by 
providers who must convert their financial reporting systems.
    Response: Medicare policy for unfunded deferred compensation plans 
remains unchanged. If deferred compensation is unfunded, Section 2140.2 
of the Provider Reimbursement Manual has long indicated that the 
provider does not claim an expense until actual payment is made to the 
employee (or accrued and liquidated timely). Any necessary 
recordkeeping should already be in place to comply with existing 
policy. No new or additional recordkeeping would be required under this 
rule.
    Comment: One commenter believes the proposal addressed a concern 
with over-accrual of costs but failed to provide for under-accrual of 
costs. The commenter indicated that if payment subsequent to filing the 
cost report exceeds the accrual, there is no ready mechanism to correct 
the under-accrued costs and to obtain proper payment. Similarly, the 
rule should be clarified to allow the provider to increase its interest 
expense in a situation in which accrued investment income is offset 
against interest costs but payment is not subsequently received.
    Response: If the amount actually expended is greater than the 
accrual, the excess amount may be treated as paid on a cash basis. 
Similarly, if the amount of investment income actually realized is less 
than the amount of the accrual, the amount received serves as the basis 
for making an appropriate adjustment (that is, to allow additional 
interest expense).
    Comment: One commenter stated that if this rule were adopted, 
providers would incur costs in treating Medicare patients that would 
not be paid by Medicare, thus forcing providers to shift incurred costs 
to other patients. The commenter noted that such cost shifting is 
prohibited by section 1861(v)(1)(A) of the Act.
    Response: In accordance with our policy involving the accrual basis 
of accounting, Medicare has always paid a provider for incurred costs 
for which the related liability has been properly accrued, even though 
the provider has not transferred actual assets to satisfy its 
obligation. That is, Medicare, through interim payments and eventually 
through the cost report settlement process, has paid its share of the 
cost even though the provider in some cases has not yet expended any 
funds. To the extent that Medicare pays before the provider expends 
funds, Medicare has made an advance payment for the cost. The purpose 
of this rule is to recover Medicare's payment after permitting the 
provider a reasonable period of time in which to liquidate its 
obligation, if liquidation has not occurred within the required time 
period. To recover Medicare payments for costs for which the provider 
has not timely liquidated its obligation does not shift incurred costs 
to non-Medicare patients.
    Comment: One commenter stated that the rule should be clarified to 
reflect that providers are entitled to be paid for the current period's 
amortized portion of costs that are not liquidated within 1 year, such 
as bond discount or bond issue costs.
    Response: We do not agree that clarification is necessary. The 
regulation addresses costs for which liabilities are incurred and must 
be liquidated timely in order to receive Medicare payment for the year 
of accrual. It is not intended to apply to the current year's amortized 
portion of costs, which do not require current liquidation.
    Comment: One commenter believed that the savings to the program 
cited in the proposed rule are suspect because in the vast majority of 
cases for the items in question, payment to the provider merely will be 
deferred to a later period. Therefore, a savings to the government 
would not be permanent.
    Response: We did not identify any ``savings'' in the proposed rule. 
Rather, we stated that the lack of clarification in the regulations 
involving the accrual basis of accounting forced the Medicare program 
to settle cases involving accrued sick leave, FICA taxes, deferred 
compensation, and unpaid mortgage interest. We indicated our belief 
that without a change to the regulations, the Medicare program could be 
forced to pay additional amounts of accrued liabilities even though 
providers may not liquidate the liabilities on a current (that is, 
timely) basis.
    This rule will result in a clearer statement in the regulations of 
our policy precluding Medicare payment for expenses in a cost reporting 
period for which the associated liability is not liquidated timely. If 
the liability is not liquidated timely, Medicare will recover payment 
it made for the year of accrual. (Generally, recovery is applicable to 
the actual year of accrual, although it could apply to a later period 
in some cases, such as for vacation pay.) Should the liability 
thereafter be liquidated and our policy provides for Medicare payment 
in that subsequent period, there will be a Medicare outlay for that 
period. In cases in which the liability is never liquidated, Medicare 
does not share in the cost, in the current period or a later period.

B. Self-Insurance

    Comment: Some commenters noted that under the proposal, self-
insurance program costs would have to be paid within 75 days after the 
close of the cost reporting period. They suggested that we modify the 
proposed change to allow program payment in the cost reporting period 
in which the provider incurs the cost, provided that payment by the 
provider is made within the timeframes specified in the provider's 
self-insurance funding plan.
    Response: The commenter suggests that the program should recognize 
a provider's own established time frames in liquidating liabilities for 
contributions to a self-insurance fund. This would defeat the purpose 
of the rule, which requires a consistent time frame to be used by all 
providers, in accordance with longstanding program policy.
    Comment: One commenter stated that the proposed rule was not clear 
as to Medicare's policy in cases in which a self-insurer provides 
advance funding under State law, and the account is 
[[Page 33131]] maintained and administered by the provider.
    Response: By definition, self-insurance is a means whereby a 
provider undertakes the risk of protecting itself against anticipated 
liabilities by providing equivalent funds to liquidate those 
liabilities. In order for the contributions to a self-insurance fund to 
be recognized under Medicare, the self-insurance fund must be 
established with an independent fiduciary such as a bank, a trust 
company, or a private benefit administrator. In the case of a State or 
local governmental provider or pool, the State in which the provider or 
pool is located may act as a fiduciary. In either case, section 2162.7 
of the Provider Reimbursement Manual sets forth stringent criteria that 
must be met in order to gain program recognition as a self-insurance 
fund. These criteria are designed to ensure the soundness and 
independent integrity of the fund. The situation alluded to, in which 
the account is maintained and administered by the provider, would not 
qualify.

C. All-Inclusive Paid Days Off

    Comment: One commenter suggested that we modify the proposal to 
allow for differences in benefit plans across entities within a 
company. In some of the provider's facilities, according to the 
commenter, the benefit plan permits employees to accrue leave or 
payment in lieu of leave for any combination of types of leave, with 
some employees accruing leave over an extended period of time. The 
commenter believes that the proposal creates discrimination among 
employees even when the different plans do not, and that the proposed 
change may cause companies to remove the flexibility and control that 
employees currently have over their benefit plans.
    Response: Our intent is not to remove the flexibility a provider's 
employees may have over their benefit plans. If a provider's vacation 
policy or its all-inclusive paid days off policy is consistent among 
all employees, liquidation of the liability is not limited by the 
proposal. The accrued costs of benefits in the period earned remain 
costs of that period provided that liquidation of the benefits is made 
within the period provided for by the provider's policy. Consistent 
application under a policy may provide for increased benefits based on 
years of service, provided it applies in the same manner to all 
employees.
    We believe that consistent application of the provider's policy 
ensures that an employee actually takes the vacation or all-inclusive 
paid days off benefits for the costs that are claimed.

D. Short-Term Liability
    Comment: One commenter believes that if consistency and assurance 
of payment for actual costs are the goals, it is inappropriate to allow 
a 3-year extension for ``good cause'' for payment of short-term 
liabilities. The commenter views such a determination as being highly 
subjective and largely dependent upon the good will of the fiscal 
intermediary. Instead, the commenter suggested that we allow 
liquidation of liabilities consistent with GAAP and in conformity with 
existing provider agreements and policies regardless of whether those 
policies cover accrued benefits, self-insurance, or deferred 
compensation payments.
    Response: We do not agree with the commenter's suggestion to allow 
liquidation of liabilities in accordance with GAAP and in conformity 
with existing provider agreements and policies. The purpose of the 
regulation is to assure that Medicare recognizes only costs associated 
with a liability that is timely liquidated through an actual 
expenditure of funds. GAAP does not offer this assurance for Medicare.
    Although the end of the year following the year of accrual permits 
adequate time for timely liquidation of liabilities in the vast 
majority of cases, we believe that an extension of up to 2 additional 
years is appropriate if a provider can support its need for additional 
time in accordance with instructions in the Provider Reimbursement 
Manual. We do not believe the granting of an extension is subjective or 
dependent on the goodwill of the intermediary.
    Comment: One commenter suggested that we clarify that if short-term 
liabilities are the subject of dispute or litigation, they need not be 
discharged within 1 or even 3 years.
    Response: Even in disputed cases or cases that are in litigation, 
our policy on the timely liquidation of liabilities still applies. The 
policy does not disadvantage a provider even if the liability is not 
discharged within 1 year, or up to 3 years in the case of an extension 
granted by the intermediary for cause. While the cost cannot be paid by 
Medicare in the year of accrual in the absence of timely liquidation of 
the liability, the cost can be claimed in the cost reporting period 
when the liquidation of the liability occurs, that is, when an actual 
expenditure takes place, as currently described in section 2305 of the 
Provider Reimbursement Manual.
    Comment: One commenter suggested that we permit providers 
terminated from Medicare to obtain payment for all properly accrued 
costs incurred during their final cost reporting period (together with 
costs incurred after termination authorized under section 2176 of the 
Provider Reimbursement Manual).
    Response: All properly accrued allowable costs are recognized for a 
provider that is terminating from the Medicare program. However, the 
rules for liquidation of liabilities contained in the proposed 
regulation continue to apply. That is, although a provider is 
terminating, the intermediary must still assure that the liability is 
timely liquidated.
    Comment: One commenter suggested that the final rule should 
explicitly provide that the regulations are intended to address only 
short-term liabilities, that is, amounts normally paid within 1 year of 
the date the cost report is filed, and not the discharge of long-term 
liabilities.
    Response: In this final rule, we have revised Sec. 413.24(c)(3)(i) 
of the proposed rule (now Sec. 413.100(c)(2)(i)) to provide that short-
term liabilities include the current portion of long-term liabilities, 
such as the mortgage interest due to be paid in the current year. That 
is, the portion of a long-term liability due in the current year is a 
short-term liability for the year. Section 413.100(c)(2)(i) of this 
rule does not apply to portions of long-term liabilities due in future 
periods.

E. Compensation of Owners

    Comment: One commenter stated that the proposed rule appears to 
indicate that the liability must be liquidated in the form of cash 
within 75 days after the close of the cost reporting period. The 
commenter noted that section 906.4 of the Provider Reimbursement Manual 
recognizes a promissory note as liquidation and recommended that the 
language in the regulations should be consistent with that in the 
Provider Reimbursement Manual. Another commenter stated that if we 
intend to propose more restrictive requirements on compensation of 
owners, we should also specifically provide in regulations that the 
issuance of an enforceable note to the owner for the amount of 
compensation should constitute liquidation of the accrued liability.
    Response: The proposed rule stated simply that liquidation of an 
owner's compensation accrual must occur within 75 days after the close 
of the cost reporting period in which the liability occurs. We do not 
plan to specify in the regulations the manner of liquidation, 
[[Page 33132]] but rather have chosen to continue to address those 
specifics in the Provider Reimbursement Manual. Therefore, the proposed 
regulation did not provide a more restrictive liquidation policy than 
existing policy in the Provider Reimbursement Manual.
    However, we intend to revise section 906.4 of the Provider 
Reimbursement Manual to deny recognition of the liquidation of 
liabilities by use of a promissory note without the actual transfer of 
assets within 75 days of the close of the cost reporting period. 
Revised section 906.4 then will be consistent with instructions in 
section 2305 of the Provider Reimbursement Manual concerning 
requirements for liquidating liabilities. Those instructions (albeit 
with different time limitations) require that a liability actually be 
liquidated by the end of the appropriate time period, rather than being 
extended by way of another liability, for example, a promissory note.

F. FICA and Other Payroll Taxes

    Comment: One commenter asserted that accrual of employer-related 
FICA liabilities is clearly appropriate under GAAP as well as under 
Sec. 413.24(b)(2), and that HCFA should continue to allow recognition 
of these costs especially as they relate to the accrual of year-end 
wages.
    Response: We believe that employer-related FICA taxes should be 
accrued and claimed for Medicare payment only in the period in which 
actual payment to the employee is made. It is not until that point that 
the liability for the employer-related FICA tax is incurred.
    Comments: One commenter pointed out that the preamble language in 
the proposed rule stated that FICA and other payroll taxes related to 
vacation pay and nonpaid workers would be paid only in the period in 
which payment is actually made to the employee. Yet, the language of 
proposed Sec. 413.24(c)(3)(vi) indicated that all FICA and payroll 
taxes would be handled in the same way. The commenter suggested that we 
clarify the discrepancy in the final rule.
    Response: Even though the preamble language for the proposed rule 
specifically addressed only payroll taxes related to vacation pay and 
nonpaid workers, our intent was to prohibit the accrual and claim for 
Medicare payment of such taxes for all types of payments until the 
period in which payment (on which the tax is based) is actually made to 
the employee. Thus, as the commenter suggests, and as the regulations 
text has always specified, this policy applies to all FICA and payroll 
taxes.
    Comment: Some commenters stated that the applicable FICA and other 
payroll taxes should be accrued during the same period that the 
employee benefits are earned and accrued. One commenter stated that 
FICA and other payroll accruals apply equally to accrued vacation, 
holiday, and sick pay benefits. Another commenter suggested that if 
such payments are not made to employees in subsequent years, Medicare 
may recover the excess cost in subsequent years.
    Response: We continue to believe that such taxes should not be 
accrued and claimed for Medicare payment until the period in which 
actual payment to the employees is made. It is at that point that the 
liability for the related payroll taxes is incurred.

G. Sick Pay

    Comment: Regarding the sick leave example in the proposed rule (56 
FR 50835), one commenter believes that providers would not typically 
accrue for forfeitable sick leave. Even if providers do so, the 
commenter believes that Medicare could avoid payment by requiring 
forfeitures to be offset against subsequent sick pay costs.
    Response: We agree with the commenter that providers should not 
accrue forfeitable sick leave. However, we disagree that where 
forfeitable sick leave is accrued and claimed for Medicare payment, 
Medicare would avoid payment by requiring forfeitures to be offset 
against sick pay costs incurred during the period in which the 
forfeitures occur. Handling forfeitable sick leave in this manner would 
result in Medicare recognizing and paying for excessive sick leave 
costs up until the point of forfeiture.
    As a result of this comment, we have made two revisions to this 
final rule. First, we have clarified under Sec. 413.100(c)(2)(iii)(A) 
that if sick leave is funded in a deferred compensation plan, the 
contributions to the fund must take into account forfeitures. Second, 
if an employee has the right to demand cash payment at the end of the 
year, we believe that forfeitures are not an issue because the employee 
has earned a nonforfeitable right. Accordingly, we also have specified 
under Sec. 413.100(c)(2)(iii)(B) that if a provider's sick leave plan 
grants employees the nonforfeitable right to demand cash payment for 
unused sick leave at the end of each year, sick pay is includable in 
allowable costs, without funding, in the cost reporting period in which 
it is earned.
    Comment: One commenter asserted that providers should not be 
financially disadvantaged by disallowance of accrued benefits that are 
vested but subject to forfeiture clauses. The commenter stated that 
such clauses are financially prudent and result in lower Medicare 
program costs.
    Response: We believe the commenter is concerned that if forfeitures 
are possible, Medicare would not recognize any accrual of sick leave. 
On the contrary, as discussed in the response to the preceding comment, 
if sick leave is funded in a deferred compensation plan, the 
contributions to the fund must take into account forfeitures. That is, 
the accrual of the contributions to the deferred compensation fund 
reflects anticipated forfeitures. However, the issue of forfeitable 
sick leave occurs only in the context of contributions to a deferred 
compensation fund. In a situation in which an employee has the right to 
demand cash at the end of the year for unused sick leave, the employee 
has earned a nonforfeitable right. In all other situations, sick pay 
can be claimed for Medicare payment only on a cash basis for the year 
in which the benefits are paid; therefore, the issue of accrual of 
forfeitable sick leave does not arise.
    In proposing to incorporate Medicare's policy on sick leave costs 
(contained in section 2144.8 of the Provider Reimbursement Manual) into 
the regulations, we believe it was understood that sick pay costs can 
be claimed for payment only in the cost reporting period in which paid, 
unless the sick leave is funded in a deferred compensation plan or 
unless an employee has the nonforfeitable right to demand cash at the 
end of the year for unused sick leave. This policy has been included in 
section 2144.8 for many years. Nevertheless, we have revised the 
regulations by specifying under Sec. 413.100(c)(2)(iii)(C) that sick 
pay costs can be claimed only on a cash basis if paid on any bases 
other than those in Sec. 413.100(c)(2)(iii) (A) or (B) (that is, 
through a funded deferred compensation plan, or in situations in which 
the sick leave plan grants employees the nonforfeitable right to demand 
cash payment for unused sick leave at the end of each year).
    Comment: One commenter stated that although timing differences will 
occur in any accrual method of accounting, in total, the program is not 
overpaying since any overestimate of expenses in one year is offset by 
reduction in accrued expenses in a subsequent period when the sick 
leave, vacation, and other types of leave are determined to be 
overaccrued.
    Response: The purpose of the longstanding policy on liquidation of 
liabilities, which we proposed to incorporate in the regulations, is to 
[[Page 33133]] assure that a provider properly claims costs during each 
cost reporting period. Costs claimed during a period for which the 
related liability may never be liquidated result in overpayment of the 
costs in the year the costs are claimed. Reduction in accrued expenses 
in a subsequent period when sick leave is determined to be overaccrued 
results in Medicare's recognizing and paying for excessive costs up 
until the point when accrued expenses are reduced in the subsequent 
period.
    However, in the case of vacation benefits, we are incorporating 
into the regulations the policy that is currently included in the 
Provider Reimbursement Manual regarding liquidation of the vacation 
accrual. In proposing to incorporate the requirements of section 2146, 
Medicare's policy on vacation costs, into the regulations, we believe 
it was understood that if payment is not made within the required time 
period or if benefits are forfeited by the employee, the adjustment to 
disallow the cost is made in the current period (that is, the latest 
year in which payment should have been made or the year in which the 
benefits are forfeited) rather than in the period in which the cost was 
accrued and claimed for Medicare payment. (However, an intermediary may 
choose to require adjustment in the period in which the cost was 
accrued and claimed for Medicare payment if the cost report for that 
period is open or can be reopened, and if the intermediary believes the 
adjustment is more appropriate in that period.) This policy has been 
included in section 2146.2 for many years. The new 
Sec. 413.100(c)(2)(ii)(C) codifies this longstanding policy.
    Comment: One commenter asserted that administrative costs 
associated with a funded deferred compensation plan (required when sick 
pay is not payable at year end) would prohibit the implementation of 
such plans in numerous facilities--effectively eliminating this form of 
``short-term disability insurance.''
    Response: If a provider is unable to afford the administrative 
costs associated with establishing a deferred compensation plan, the 
provider could simply claim its sick pay costs at the time when payment 
is made to the employee, in accordance with Sec. 413.100(c)(2)(iii)(C). 
Of course, under this arrangement, the provider would not be permitted 
to claim accrued sick pay costs. However, under 
Sec. 413.100(c)(2)(iii)(B), if a provider's sick leave plan grants 
employees the nonforfeitable right to demand cash payment for unused 
sick leave at the end of each year, sick pay is includable in allowable 
costs, without funding, in the cost reporting period in which it is 
earned.

H. Vacation Pay

    Comment: One commenter stated that the consistency requirement for 
vacations is unclear and has no relationship to the probability or 
timing of payment, and requested that the term ``consistent'' be 
limited to the time frame for liquidation of the vacation liability and 
not be extended to the rate of accrual. The commenter believes that as 
vacation pay benefits are vested, the accrual should be recognized--
consistency between classes of employees is irrelevant.
    Response: This rule codifies long-standing Medicare policy (section 
2146 of the Provider Reimbursement Manual) regarding payment for 
vacation benefits. This policy recognizes the accrual of vacation 
benefits, and permits payment for the accrual in the cost reporting 
period in which the benefit is earned, if the provider's vacation 
policy regarding when the vacation must be taken--or when payment is 
made in lieu of the vacation--is consistent for all employees. If the 
policy regarding when vacation must be taken is not consistent among 
all employees, vacation must be taken or payment in lieu of vacation 
must be made within 2 years after the close of the cost reporting 
period in which the vacation was accrued in order for the accrual to be 
allowed in the year in which the vacation is earned.
    We agree with the commenter that, for purposes of this Medicare 
vacation policy, a provider's vacation policy that is ``consistent 
among all employees'' addresses the provider's policy regarding the 
time frame in which vacation benefits must be used. The provider's 
policy may provide for different amounts of vacation accrual depending 
upon such factors as an employee's length of service, or whether the 
employee is managerial or nonmanagerial. We now believe our statement 
in the proposed rule that a provider's consistent policy is one in 
which no provision of the policy provides for different amounts of 
vacation benefits for certain positions and types of employees was an 
overextension of the language ``consistent among all employees''.
    Medicare's vacation policy is intended to assure that a provider 
actually liquidates its accrued costs for vacation benefits. We believe 
the policy is clear and permits a high degree of flexibility for a 
provider. In situations in which a provider's vacation policy is not 
consistent for all employees regarding when vacation must be taken, 
Medicare's policy permits a reasonable time frame--2 years after the 
close of the cost reporting period in which the vacation was accrued--
for liquidating vacation accruals in order for the accruals to be 
allowed in the year when the vacation is earned.

I. Deferred Compensation

    Comment: One commenter expressed concern that the proposal would 
require hospitals to devote staff to track the payment of deferred 
compensation for 10, 20, or possibly more years in order to obtain 
payment.
    Response: The proposed regulation did not change our current policy 
on deferred compensation, which has been in section 2140 of the 
Provider Reimbursement Manual for many years. If a provider's deferred 
compensation plan is funded in accordance with that policy, program 
payment has long been based on the current period contributions to the 
fund, provided liabilities related to the contributions are timely 
liquidated (usually within 1 year after the close of the current cost 
reporting period). Benefit payments from the deferred compensation 
fund, which can occur many years later, are part of the operation of 
the fund and do not affect program payments in the later periods when 
payments are actually made from the fund.
    If a provider's deferred compensation is not funded in accordance 
with requirements in section 2140 of the Provider Reimbursement Manual, 
the manual instructions have long permitted program payment only during 
the period in which actual payment is made.
    Therefore, these regulations require no more staff time to track 
deferred compensation payments than is used by providers under our 
current, longstanding policy.
    Comment: One commenter asked that we add the word ``Plans'' to the 
title of Sec. 413.24(c)(3)(vii) of the proposed rule, to read 
``Deferred Compensation Plans'' and that we add a new paragraph 
(vii)(C), to read ``Deferred compensation plans under this section do 
not include accrued salaries and/or accrued bonuses that are allowable 
in the year earned, provided they are liquidated no later than the end 
of the provider's cost reporting period following the period in which 
the salary and bonuses were earned.''
    Response: We believe it is clear that the salaries and bonuses 
referred to in the comment, which are earned currently and which are 
liquidated timely under this rule with no attempt to defer payment, are 
not treated as [[Page 33134]] deferred compensation. Therefore, we have 
not adopted the commenter's suggestion to address salaries and bonuses 
in the text of the regulation.

IV. Provisions of the Final Rule

    This final rule generally confirms the provisions of the proposed 
rule, with the clarifying changes discussed above in the responses to 
comments. In addition, upon further consideration of the regulations 
text set forth in the proposed rule, we believe that one additional 
policy clarification is necessary.
    Section 413.24(c)(2) of the proposed rule consisted of an example 
that indicated that the accrual of postretirement health benefits under 
Medicare cannot be recognized unless the liability for the benefits is 
liquidated timely. That example referred to Statement of Financial 
Accounting Standards (SFAS) No. 106 (December 1990), Employers' 
Accounting for Postretirement Benefits Other Than Pensions, without 
explicitly citing SFAS No. 106. SFAS No. 106, generally effective for 
fiscal years beginning after December 15, 1992, requires an employer to 
accrue the expected cost of providing postretirement benefits to 
employees (and the employees' beneficiaries and covered dependents) 
during the years the employees provide the necessary services. However, 
it does not provide for timely liquidation of the accruals in 
accordance with Medicare policy. Accordingly, the example clarified, 
consistent with Medicare policy, that the accrual of postretirement 
benefits (addressed in SFAS No. 106) cannot be recognized in allowable 
costs in the year of the accrual without timely liquidation of the 
related liability.
    We now believe that the original example is unnecessary in the 
final rule. Because payment for postretirement benefits is deferred, 
the benefits are deferred compensation. Therefore, Medicare policy on 
deferred compensation, funded and unfunded, applies to postretirement 
benefit deferred compensation plans as well as to other types of 
deferred compensation plans. The deferred compensation policy is found 
in section 2140 of the Provider Reimbursement Manual and also, with 
regard to liquidation of liabilities related to accrued deferred 
compensation costs, in Sec. 413.100(c)(2)(vii) of this final rule. The 
deferred compensation policy sets forth the requirements to be met, 
including timely liquidation of liabilities, in order to receive 
Medicare payment for deferred compensation.
    Under SFAS No. 106, a provider may have postretirement benefit 
obligations applicable to more than one year, for example, prior 
service costs, or a transition obligation (which, under SFAS No. 106, 
the provider may elect to accrue immediately or on a delayed basis). 
For purposes of Medicare payment, the deferred compensation policy 
provides, in Provider Reimbursement Manual section 2140.3.B.1 (by 
reference to section 2142.5, Pension Costs for Past and Current 
Service), that past service costs applicable to more than one cost 
reporting year must be amortized over a minimum of 10 years, even if 
the related liability for the accrual has been liquidated timely.
    Therefore, in lieu of the example in proposed Sec. 413.24(c)(2), we 
have clarified in Sec. 413.100(c)(2)(vii)(C) of this final rule that 
postretirement benefit plans addressed in SFAS No. 106 are deferred 
compensation arrangements to which all the provisions of Medicare's 
deferred compensation policy apply.
    We believe it should have been clear to readers of the proposed 
rule that Medicare's deferred compensation policy applies to all 
deferred compensation arrangements, including postretirement benefit 
plans. However, although the proposed rule addressed postretirement 
health benefits, clarifying that the accrual of such benefits cannot be 
recognized for Medicare payment in the year of the accrual without 
timely liquidation of the liability for the benefits, it did not 
emphasize the applicability of the deferred compensation policy in all 
respects to postretirement benefit plans.
    Therefore, there could be situations in which a provider that has 
elected to accrue postretirement benefit past service costs over more 
than 10 years for accounting and reporting purposes (that is, for non-
Medicare purposes) in conformity with SFAS No. 106, mistakenly believed 
it needed to use the same period for amortizing the costs for Medicare 
purposes. If, for Medicare purposes, the provider now wants to amortize 
the costs over fewer years, but not fewer than 10 years, it may request 
its intermediary, subject to the requirements in the regulations at 
Sec. 405.1885, to make the change to applicable cost reporting periods 
in accordance with the longstanding policy in section 2140.3.B.1 of the 
Provider Reimbursement Manual. In all cases, Medicare payment is 
subject to the policy in this final rule and in Provider Reimbursement 
Manual section 2140.4 regarding timely liquidation of the associated 
accruals for the deferred compensation.
    Correspondingly, if a provider has amortized the costs over fewer 
than 10 years for Medicare purposes without the express permission of 
its intermediary, the intermediary is required, subject to 
Sec. 405.1885, to make necessary adjustments to conform the 
amortization to the policy in section 2140.3.B.1. of the Provider 
Reimbursement Manual. (We note that if a provider has been permitted by 
its intermediary to amortize such costs for Medicare purposes over 
fewer than 10 years, assuming timely liquidation of the associated 
accruals, the intermediary will not now make adjustments to reflect 
amortization over at least 10 years, nor is the provider required to 
make such a change.)
    The other clarifying changes to the proposed rule that are set 
forth in this final rule, as discussed in our responses to public 
comments in Section IV of this final rule, are as follows:
     In Sec. 413.100(c)(2)(i) of this rule, we have clarified 
that short-term liabilities also include the current portion of long-
term liabilities, such as the mortgage interest due to be paid in the 
current year.
     We have added new Sec. 413.100(c)(2)(ii)(C) to address 
necessary adjustment to a provider's cost report if accruals for 
vacation pay and all-inclusive paid days off are not properly 
liquidated. The new material incorporates policy currently in section 
2146.2 of the Provider Reimbursement Manual, which provides that the 
adjustment to disallow accrued cost generally is made in the current 
period if payment for the vacation or all-inclusive paid days off is 
not made in the required time period or if benefits are forfeited by 
the employee.
     In Sec. 413.100(c)(2)(iii)(A) concerning sick pay, we have 
clarified that contributions to the deferred compensation plan must be 
reduced to reflect estimated forfeitures.
     In Sec. 413.100(c)(2)(iii)(B), we have clarified that only 
if an employee has a nonforfeitable right to demand cash for unused 
sick leave at the end of each year can the sick pay be includable in 
allowable costs, without funding, in the cost reporting period in which 
it is earned. We believe that, typically, an employee's right to demand 
cash for unused sick leave is nonforfeitable. However, in a situation 
in which an employee has a right to demand cash but, later, for any 
reason may not be entitled to receive the cash (that is, the amount is 
forfeitable under certain conditions), a provider cannot accrue the 
sick leave benefit and make a current year claim for Medicare payment 
under Sec. 413.100(c)(2)(iii)(B) [[Page 33135]] because that section 
applies only to situations in which an employee's right to demand cash 
is nonforfeitable. Rather, the provider can claim the cost only in the 
year when paid to the employee, unless it meets the provisions of 
Sec. 413.100(c)(2)(iii)(A).
     We have added new Sec. 413.100(c)(2)(iii)(C) to clarify in 
the regulations Medicare's policy in section 2144.8 of the Provider 
Reimbursement Manual, that sick pay paid can be claimed for Medicare 
payment only on a cash basis if paid on any basis other than those in 
Sec. 413.100(c)(2)(iii) (A) or (B) (that is, through a funded deferred 
compensation plan, or in situations in which the sick leave plan grants 
employees the nonforfeitable right to demand cash payment for unused 
sick leave at the end of each year).
     In Sec. 413.100(c)(2)(viii), we have removed the language 
included in the proposed rule that addressed the allowability in 
subsequent periods of self-insurance accruals liquidated after the time 
limit provided in that section. We did not address that issue for any 
of the other types of accrued costs addressed in the proposed rule and 
thus we do not believe it would be consistent to address that issue 
here. This issue is already addressed in implementing manual 
instructions.
     We have revised the wording of Secs. 413.100(c)(2)(i), 
(c)(2)(iii), and (c)(2)(vii)) of this rule to clarify that a request 
for extension to the 1-year time limit for liquidating a liability must 
be made within the 1-year time period. We believe it was clear that a 
provider could not reasonably request an extension after having failed 
to liquidate within the 1-year period. The regulation now specifically 
addresses this point.
    In the same sections of the rule, we have removed the language 
included in the proposed rule describing ``good cause'' for an 
extension. Such description is already covered in section 2305 of the 
Provider Reimbursement Manual.
    Finally, as explained in section III of this final rule, we are 
moving the proposed provisions of Sec. 413.24(b)(3) and (4), and 
Sec. 413.24(c) into a new Sec. 413.100, Special Treatment of Certain 
Accrued Costs. For the convenience of the reader, presented below is a 
crosswalk that shows the regulatory citations for the provisions of the 
proposed rule and for the corresponding provisions of this final rule.

------------------------------------------------------------------------
           Proposed                               Final                 
------------------------------------------------------------------------
Sec.  413.24(b)(2)............  Sec.  413.24(b)(2)                      
                                Sec.  413.100(a)                        
Sec.  413.24(b)(3)............  Sec.  413.100(b)(1)                     
Sec.  413.24(b)(4)............  Sec.  413.100(b)(2)                     
Sec.  413.24(c)...............  Sec.  413.100(c)                        
Sec.  413.24(c)(1)............  Sec.  413.100(c)(1)                     
Sec.  413.24(c)(2)............  delete                                  
Sec.  413.24(c)(3)............  Sec.  413.100(c)(2)                     
Sec.  413.24(c)(3)(i)(A)(B)...  Sec.  413.100(c)(2)(i)(A)(B)            
Sec.  413.24(c)(3)(ii)(A)(B)(C  Sec.  413.100(c)(2)(ii)(A)(B)(C)        
 ).                                                                     
Sec.  413.24(c)(3)(iii)(A)(B)(  Sec.  413.100(c)(2)(iii)(A)(B)(C)       
 C).                                                                    
Sec.  413.24(c)(3)(iv)........  Sec.  413.100(c)(2)(iv)                 
Sec.  413.24(c)(3)(v).........  Sec.  413.100(c)(2)(v)                  
Sec.  413.24(c)(3)(vi)........  Sec.  413.100(c)(2)(vi)                 
Sec.  413.24(c)(3)(vii)(A)(B).  Sec.  413.100(c)(2)(vii)(A)(B)(C)       
Sec.  413.24(c)(3)(viii)......  Sec.  413.100(c)(2)(viii)               
------------------------------------------------------------------------

V. Impact Statement

    Unless we certify that a final rule will not have a significant 
economic impact on a substantial number of small entities, we generally 
prepare a regulatory flexibility analysis that is consistent with the 
Regulatory Flexibility Act (RFA) (5 U.S.C. 601 through 612). For 
purposes of the RFA, we consider all hospitals, long-term care 
facilities, and other providers to be small entities.
    Also, section 1102(b) of the Act requires us to prepare a 
regulatory impact statement if a final rule may have a significant 
economic impact on the operations of a substantial number of small 
rural hospitals. Such an analysis must conform to the provisions of 
section 603 of the RFA. With the exception of hospitals located in 
certain rural counties adjacent to urban areas, for purposes of section 
1102(b) of the Act, we define a small rural hospital as a hospital with 
fewer than 50 beds.
    Our intention in this rule is not to signify a change in policy 
but, rather, to incorporate in regulations our longstanding policy 
regarding the circumstances under which Medicare accepts a provider's 
claim for costs for which it has not actually expended funds during the 
current cost reporting period. Because this rule merely conforms 
regulations to present policies and practices, we have determined, and 
certified, that this rule will not have a significant effect on the 
operations of a substantial number of small entities or small rural 
hospitals. Therefore, we have not prepared a regulatory flexibility 
analysis or an analysis of the impact of this rule on small rural 
hospitals.
    In accordance with the provisions of Executive Order 12866, this 
regulation was not reviewed by the Office of Management and Budget.

VI. Collection of Information Requirements

    This document does not impose information collection and 
recordkeeping requirements. Consequently, it need not be reviewed by 
the Office of Management and Budget under the authority of the 
Paperwork Reduction Act of 1980 (44 U.S.C. 3501 et seq.).

List of Subjects in 42 CFR Part 413

    Health facilities, Kidney diseases, Medicare, Puerto Rico, 
Reporting and recordkeeping requirements.
    42 CFR part 413 is amended as follows:

PART 413--PRINCIPLES OF REASONABLE COST REIMBURSEMENT; PAYMENT FOR 
END-STAGE RENAL DISEASE SERVICES

    1. The authority citation for part 413 is revised to read as 
follows:

    Authority: Secs. 1102, 1861(v)(1)(A), and 1871 of the Social 
Security Act (42 U.S.C. 1302, 1395x(v)(1)(A), and 1395hh).

    2. In Sec. 413.1, the following changes are made:
    a. The heading of paragraph (a) is revised to read as set forth 
below. [[Page 33136]] 
    b. Paragraph (a)(2) is redesignated as paragraph (a)(3).
    c. Paragraph (a)(1) is redesignated as paragraph (a)(2), and the 
heading ``General summary.'' is removed and the heading ``Scope.'' is 
added in its place.
    d. A new paragraph (a)(1) is added to read as follows:


Sec. 413.1  Introduction.

    (a) Basis, scope, and applicability--(1) Statutory basis. (i) Basic 
provisions. Section 1815 of the Act requires that the Secretary make 
interim payments to providers and periodically determine the amount 
that should be paid under Part A of the Medicare program to each 
provider of services for services it furnished. Section 1814(b) of the 
Act (for Part A) and section 1833(a) of the Act (for Part B) provide 
for payment on the basis of the lesser of a provider's reasonable costs 
or customary charges. Section 1861(v) of the Act defines ``reasonable 
cost.''
    (ii) Additional provisions. Section 1814(j) of the Act provides for 
exceptions to the ``lower of cost or charges'' provisions. Section 1833 
(a)(4) and (i)(3) of the Act provide for payment of a blended amount 
for certain surgical services furnished in a hospital's outpatient 
department. Section 1833(n) of the Act provides for payment of a 
blended amount for outpatient hospital diagnostic procedures such as 
radiology. Section 1834(c)(1)(C) of the Act establishes the method for 
determining Medicare payment for screening mammograms performed by 
hospitals. Section 1881 of the Act authorizes payment for services 
furnished to ESRD patients. Section 1883 of the Act provides for 
payment for post-hospital SNF care furnished by rural hospitals having 
swing-bed approval. Section 1886(h) of the Act provides for payment to 
a hospital for the services of interns and residents in approved 
teaching programs on the basis of a ``per resident amount.''
* * * * *

Subpart B--Accounting Records and Reports

    3. Section 413.24 is amended by revising paragraph (b)(2) to read 
as follows:


Sec. 413.24  Adequate cost data and cost finding.

* * * * *
    (b) Definitions--
* * * * *
    (2) Accrual basis of accounting. As used in this part, the term 
accrual basis of accounting means that revenue is reported in the 
period in which it is earned, regardless of when it is collected; and 
an expense is reported in the period in which it is incurred, 
regardless of when it is paid. (See Sec. 413.100 regarding limitations 
on allowable accrued costs in situations in which the related 
liabilities are not liquidated timely.)
* * * * *

Subpart F--Specific Categories of Costs

    4. Section 413.100 is added to read as follows:


Sec. 413.100  Special treatment of certain accrued costs.

    (a) Principle. As described in Sec. 413.24(b)(2), under the accrual 
basis of accounting, revenue is reported in the period in which it is 
earned and expenses are reported in the period in which they are 
incurred. In the case of accrued costs described in this section, for 
Medicare payment purposes the costs are allowable in the year in which 
the costs are accrued and claimed for Medicare payment only under the 
conditions set forth in paragraph (c) of this section.
    (b) Definitions. (1) All-inclusive paid days off benefit. An all-
inclusive paid days off benefit replaces other vacation and sick pay 
plans. It is a formal plan under which, based on actual hours worked, 
all employees accrue vested leave or payment in lieu of vested leave 
for any combination of types of leave, such as illness, medical 
appointments, holidays, and vacations.
    (2) Self-insurance. Self-insurance is a means by which a provider 
independently or as part of a group undertakes the risk of protecting 
itself against anticipated liabilities by providing funds in an amount 
equal to anticipated liabilities, rather than by purchasing insurance 
coverage.
    (c) Recognition of accrued costs.--(1) General. Although Medicare 
recognizes, in the year of accrual, the accrual of costs for which a 
provider has not actually expended funds during the current cost 
reporting period, for purposes of payment Medicare does not recognize 
the accrual of costs unless the related liabilities are liquidated 
timely.
    (2) Requirements for liquidation of liabilities. For accrued costs 
to be recognized for Medicare payment in the year of the accrual, the 
requirements set forth below must be met with respect to the 
liquidation of related liabilities. If liquidation does not meet these 
requirements, the cost is disallowed, generally in the year of accrual, 
except as specified in paragraph (c)(2)(ii) of this section.
    (i) A short-term liability.
    (A) Except as provided in paragraph (c)(2)(i)(B) of this section, a 
short-term liability, including the current portion of a long-term 
liability (for example, mortgage interest payments due to be paid in 
the current year), must be liquidated within 1 year after the end of 
the cost reporting period in which the liability is incurred.
    (B) If, within the 1-year time limit, the provider furnishes to the 
intermediary sufficient written justification (based upon documented 
evidence) for nonpayment of the liability , the intermediary may grant 
an extension for good cause. The extension may not exceed 3 years 
beyond the end of the cost reporting year in which the liability was 
incurred.
    (ii) Vacation pay and all-inclusive paid days off.
    (A) If the provider's vacation policy, or its policy for all-
inclusive paid days off, is consistent for all employees, liquidation 
of the liability must be made within the period provided for by that 
policy.
    (B) If the provider's vacation policy, or its policy for all-
inclusive paid days off, is not consistent for all employees, 
liquidation of the liability must be made within 2 years after the 
close of the cost reporting period in which the liability is accrued.
    (C) If payment is not made within the required time period or if 
benefits are forfeited by the employee, an adjustment to disallow the 
accrued cost is made in the current period (that is, the latest year in 
which payment should have been made or the year in which the benefits 
are forfeited) rather than in the period in which the cost was accrued 
and claimed for Medicare payment. However, an intermediary may choose 
to require the adjustment in the period in which the cost was accrued 
and claimed for Medicare payment if the cost report for that period is 
open or can be reopened as provided in Sec. 405.1885 of this chapter, 
and if the intermediary believes the adjustment is more appropriate in 
that period.
    (iii) Sick pay.
    (A) If sick leave is vested and funded in a deferred compensation 
plan, liabilities related to the contributions to the fund must be 
liquidated, generally within 1 year after the end of the cost reporting 
period in which the liability is incurred. If, within the 1-year time 
limit, the provider furnishes to the intermediary sufficient written 
justification (based upon documented evidence) for nonpayment of the 
liability, the intermediary may grant an extension for good cause. The 
extension may not exceed 3 years beyond the end [[Page 33137]] of the 
cost reporting year in which the liability was incurred. Contributions 
to the deferred compensation plan must be reduced to reflect estimated 
forfeitures. Actual forfeitures above or below estimated forfeitures 
must be used to adjust annual contributions to the fund.
    (B) If the sick leave plan grants employees the nonforfeitable 
right to demand cash payment for unused sick leave at the end of each 
year, sick pay is includable in allowable costs, without funding, in 
the cost reporting period in which it is earned.
    (C) Sick pay paid on any basis other than that specified in 
paragraphs (c)(2)(iii) (A) or (B) of this section can be claimed for 
Medicare payment only on a cash basis for the year in which the 
benefits are paid.
    (iv) Compensation of owners. Accrued liability related to 
compensation of owners other than sole proprietors and partners must be 
liquidated within 75 days after the close of the cost reporting period 
in which the liability occurs.
    (v) Nonpaid workers. Obligations incurred under a legally-
enforceable agreement to remunerate an organization of nonpaid workers 
must be discharged no later than the end of the provider's cost 
reporting period following the period in which the services were 
furnished.
    (vi) FICA and other payroll taxes. The provider's share of FICA and 
other payroll taxes that the provider becomes obligated to remit to 
governmental agencies is included in allowable costs only during the 
cost reporting period in which payment (upon which the tax is based) is 
actually made to the employee. For example, no legal obligation exists 
for a provider-employer to pay FICA taxes until the employee is paid 
and the specific amount of liability known.
    (vii) Deferred compensation. 
    (A) Reasonable provider payments made under unfunded deferred 
compensation plans are included in allowable costs only during the cost 
reporting period in which actual payment is made to the participating 
employee.
    (B) Accrued liability related to contributions to a funded deferred 
compensation plan must be liquidated within 1 year after the end of the 
cost reporting period in which the liability is incurred. An extension, 
not to exceed 3 years beyond the end of the cost reporting year in 
which the liability was incurred, may be granted by the intermediary 
for good cause if the provider, within the 1-year time limit, furnishes 
to the intermediary sufficient written justification for non-payment of 
the liability.
    (C) Postretirement benefit plans (including those addressed in 
Statement of Financial Accounting Standards No. 106 (December 1990)) 
are deferred compensation arrangements and thus are subject to the 
provisions of this section regarding deferred compensation and to 
applicable program instructions for determining Medicare payment for 
deferred compensation.
    (viii) Self-insurance. Accrued liability related to contributions 
to a self-insurance program that are systematically made to a funding 
agency and that cover malpractice and comprehensive general liability, 
unemployment compensation, workers' compensation insurance losses, or 
employee health benefits, must be liquidated within 75 days after the 
close of the cost reporting period.

(Catalog of Federal Domestic Assistance Program No. 93.773, 
Medicare--Hospital Insurance)

    Dated: April 20, 1995.
Bruce C. Vladeck,
Administrator, Health Care Financing Administration.
[FR Doc. 95-15341 Filed 6-26-95; 8:45 am]
BILLING CODE 4120-01-P