(2) Where research is conducted in conjunction with and as a part of the care of patients, the costs of usual patient care are allowable to the extent that such costs are not met by funds provided for the research. Under this principle, however, studies, analyses, surveys, and related activities to serve the provider's administrative and program needs, are not excluded as allowable costs in the determination of reimbursement under title XVIII of the Act. [31 F.R. 14814, Nov. 22, 1966]

§ 405.423 Grants, gifts, and income from endowments.

(a) Principle. Unrestricted grants, gifts, and income from endowments should not be deducted from operating costs in computing reimbursable cost. Grants, gifts, or endowment income designated by a donor for paying specific operating costs should be deducted from the particular operating cost or group of costs.

grants, gifts, income from endowment. Unrestricted grants, gifts, and income from endowments are funds, cash or otherwise, given to a provider without restriction by the donor as to their use.

(2) Designated or restricted grants, gifts, and income from endowments. Designated or restricted grants, gifts, and income from endowments are funds, cash or otherwise, which must be used only for the specific purpose designated by the donor. This does not refer to unrestricted grants, gifts, or income from endowments which have been restricted for a specific purpose by the provider.

(c) Application. (1) Unrestricted funds, cash or otherwise, are generally the property of the provider to be used in any manner its management deems appropriate and should not be deducted from operating costs. It would be inequitable to require providers to use the unrestricted funds to reduce the payments for care. The use of these funds is generally a means of recovering costs which are not otherwise recoverable.

(2) Donor-restricted funds which are designated for paying certain hospital operating expenses should apply and serve to reduce these costs or group of costs and benefit all patients who use services covered by the donation. If such costs are not reduced, the provider would secure reimbursement for the same expense twice; it would be reimbursed through the donor-restricted contribu

(a) Principle. The value of services in positions customarily held by fulltime employees performed on a regular, scheduled basis by individuals as nonpaid members of organizations under arrangements between such organizations and a provider for the performance of such services without direct remuneration from the provider to such individuals is allowable as an operating expense for the determination of allowable cost subject to the limitation contained in paragraph (b) of this section. The amounts allowed are not to exceed those paid others for similar work. Such amounts must be identifiable in the records of the institutions as a legal obligation for operating expenses.

(b) Limitations; services of nonpaid workers. The services must be performed on a regular, scheduled basis in positions customarily held by full-time employees and necessary to enable the provider to carry out the functions of normal patient care and operation of the institution. The value of services of a type for which providers generally do not remunerate individuals performing such services is not allowable as a reimbursable cost under the title XVIII health insurance program. For example, donated services of individuals in distributing books and magazines to patients, or in serving in a provider canteen or cafeteria or in a provider gift shop, would not be reimbursable.

(c) Application. The following illustrates how a provider would determine an amount to be allowed under this principle: The prevailing salary for a lay nurse working in Hospital A is $5,000 for the year. The lay nurse receives no maintenance or special perquisites. A sister working as a nurse engaged in the same activities in the same hospital receives maintenance and special perquisites which cost the hospital $2,000 and are included in the hospital's allowable operating costs. The hospital would then include in its records an additional $3,000 to bring the value of the services rendered to $5,000. The amount of $3,000 would be allowable where the provider assumes obligation for the expense under a written agreement with the sis

erhood or other religious order covering ayment by the provider for the services. 31 F.R. 14815, Nov. 22, 1966]

405.425 Purchase discounts and allowances, and refunds of expenses.

(a) Principle. Discounts and allownces received on purchases of goods or ervices are reductions of the costs to hich they relate. Similarly, refunds previous expense payments are reducons of the related expense.

(b) Definitions (1) Discounts. Dis›unts, in general, are reductions ranted for the settlement of debts.

(2) Allowances. Allowances are deictions granted for damage, delay, ortage, imperfection, or other causes, :cluding discounts and returns.

(3) Refunds. Refunds are amounts id back or a credit allowed on account an overcollection.

(c) Normal accounting

treatment:

eduction of costs. All discounts, alwances, and refunds of expenses are ductions in the cost of goods or serves purchased and are not income. hen they are received in the same acunting period in which the purchases ere made or expenses were incurred, ey will reduce the purchases or exenses of that period. However, when ey are received in a later accounting riod, they will reduce the comparable rchases or expenses in the period in ich they are received.

(d) Application. (1) Purchase disunts have been classified as cash, ade, or quantity discounts. Cash disunts are reductions granted for the ttlement of debts before they are due. ade discounts are reductions from list ices granted to a class of customers fore consideration of credit terms. antity discounts are reductions from prices granted because of the size individual or aggregate purchase ansactions. Whatever the classifican of purchase discounts, like treatent in reducing allowable costs is reired. In the past, purchase discounts re considered as financial manageent income. However, modern acunting theory holds that income is not rived from a purchase but rather from ale or an exchange and that purchase counts are reductions in the cost of atever was purchased. The true cost the goods or services is the net amount ually paid for them. Treating purase discounts as income would result

in an overstatement of costs to the extent of the discount.

(2) As with discounts, allowances, and rebates received from purchases of goods or services and refunds of previous expense payments are clearly reductions in costs and must be reflected in the determination of allowable costs. This treatment is equitable and is in accord with that generally followed by other governmental programs and third-party payment organizations paying on the basis of cost.

[31 F.R. 14815, Nov. 22, 1966]

§ 405.426 Compensation of owners.

(a) Principle. A reasonable allowance of compensation for services of owners is an allowable cost, provided the services are actually performed in a necessary function.

(b) Definitions—(1) Compensation. Compensation means the total benefit received by the owner for the services he renders to the institution. It includes:

(1) Salary amounts paid for managerial, administrative, professional, and other services.

(ii) Amounts paid by the institution for the personal benefit of the proprietor.

(iii) The cost of assets and services which the proprietor receives from the institution.

(iv) Deferred compensation.

(2) Reasonableness. Reasonableness requires that the compensation allow

ance:

(1) Be such an amount as would ordinarily be paid for comparable services by comparable institutions.

(ii) Depend upon the facts and circumstances of each case.

(3) Necessary. Necessary requires that the function:

(i) Be such that had the owner not rendered the services, the institution would have had to employ another person to perform the services.

(ii) Be pertinent to the operation and sound conduct of the institution.

(c) Application. (1) Owners of provider organizations often render services as managers, administrators, or in other capacities. In such cases, it is equitable that reasonable compensation for the services rendered be an allowable cost. To do otherwise would disadvantage such owners in comparison with corporate providers or providers employing persons to perform similar services.

(2) Ordinarily, compensation paid to proprietors is a distribution of profits. However, where a proprietor renders necessary services for the institution, the institution is in effect employing his services, and a reasonable compensation for these services is an allowable cost. In corporate providers, the salaries of owners who are also employees are subject to the same requirements of reasonableness. Where the services are rendered on less than a full-time basis, the allowable compensation should reflect an amount proportionate to a full-time basis. Reasonableness of compensation may be determined by reference to, or in comparison with, compensation paid for comparable services and responsibilities in comparable institutions; or it may be determined by other appropriate

means.

[31 F.R. 14815, Nov. 22, 1966]

§ 405.427

Cost to related organizations.

(a) Principle. Costs applicable to services, facilities, and supplies furnished to the provider by organizations related to the provider by common ownership or control are includable in the allowable cost of the provider at the cost to the related organization. However, such cost must not exceed the price of comparable services, facilities, or supplies that could be purchased elsewhere.

(b) Definitions-(1) Related to provider.

Related to the provider means that the provider to a significant extent is associated or affiliated with or has control of or is controlled by the organization furnishing the services, facilities, or supplies.

Common

(2) Common ownership. ownership exists when an individual or individuals possess significant ownership or equity in the provider and the institution or organization serving the provider.

(3) Control. Control exists where an individual or an organization has the power, directly or indirectly, significantly to influence or direct the actions or policies of an organization or institution.

(c) Application. (1) Individuals and organizations associate with others for various reasons and by various means. Some deem it appropriate to do so to assure a steady flow of supplies or services, to reduce competition, to gain a tax advantage, to extend influence, and for other reasons. These goals may be accomplished by means of ownership or

control, by financial assistance, by management assistance, and other ways.

(2) Where the provider obtains items of services, facilities, or supplies from an organization, even though it is a separate legal entity, and the organization is owned or controlled by the owner(s) of the provider, in effect the items are obtained from itself. An example would be a corporation building a hospital or a nursing home and then leasing it to another corporation controlled by the owner. Therefore, reimbursable cost should include the costs for these items at the cost to the supplying organization. However, if the price in the open market for comparable services, facilities, or supplies is lower than the cost to the supplier, the allowable cost to the provider shall not exceed the market price.

(d) Exception. An exception is provided to this general principle if the provider demonstrates by convincing evidence to the satisfaction of the fiscal intermediary (or, where the provider has not nominated a fiscal intermediary, the Social Security Administration), that the supplying organization is a bona fide separate organization; that a substantial part of its business activity of the type carried on with the provider is transacted with others than the provider and organizations related to the supplier by common ownership or control and there is an open, competitive market for the type of services, facilities, or supplies furnished by the organization; that the services, facilities, or supplies are those which commonly are obtained by institutions such as the provider from other organizations and are not a basic element of patient care ordinarily furnished directly to patients by such institutions; and that the charge to the provider is in line with the charge for such services, facilities, or supplies in the open market and no more than the charge made under comparable circumstances to others by the organization for such services, facilities, or supplies. In such cases, the charge by the supplier to the provider for such services, facilities, or supplies shall be allowable as cost. [31 F.R. 14815, Nov. 22, 1966]

§ 405.428 Allowance in lieu of specific recognition of other costs.

(a) Cost reporting period ending before July 1, 1969. With respect to any cost reporting period ending before July 1, 1969, there shall be included as

element of reasonable cost of services allowance in lieu of specific recogtion of other costs in providing and proving services amounting to 2 pernt of allowable costs (with the excepn of interest expense and the allowce of this principle) except that for oprietary providers the allowance shall 11⁄2 percent of allowable costs (with e exception of interest expense, the owance under this principle and the urn allowed on equity capital). (b) Cost reporting period beginning er June 30, 1969. With respect to any t reporting period beginning after ne 30, 1969, there shall not be inded as an element of reasonable costs y allowance in lieu of specific recnition of other costs.

2) Cost reporting period beginning bee July 1, 1969, and ending after ne 30, 1969. With respect to any cost orting period beginning before July 1, 9, and ending after June 30, 1969, an >wance in lieu of specific recognition >ther costs in providing and improving vices shall be calculated in accorde with the provisions of paragraph of this section: Provided, That, there 11 be included as an element of reaable costs of services only that part such allowance in lieu of specific ognition of other costs which is aptioned to that part of the cost reportperiod falling before July 1, 1969. The Ount to be apportioned to the period ore July 1, 1969, is computed by applyto the amount computed in accorde with paragraph (a) of this section, action whose numerator is the numof months before July 1969, and ominator the total number of months he cost reporting period. (Where a reporting period ends on a day other n the last day of the month, the days me reporting period before July 1969, 1 be included in the numerator, and total days in the reporting period 1 be included in the denominator.) .R. 9927, June 27, 1969]

5.429 Return on equity capital of proprietary providers.

> Principle. An allowance of a reable return on equity capital invested used in the provision of patient care lowable as an element of the reable cost of covered services furnished eneficiaries by proprietary providers. amount allowable on an annual basis termined by applying to the providequity capital a percentage equal to

one and one-half times the average of the rates of interest on special issues of public debt obligations issued to the Federal Hospital Insurance Trust Fund for each of the months during the provider's reporting period or portion thereof covered under the program.

(b) Application. Proprietary providers generally do not receive public contributions and assistance of Federal and other governmental programs such as Hill-Burton in financing capital expenditures. Proprietary institutions historically have financed capital expenditures through funds invested by owners in the expectation of earning a return. A return on investment, therefore, is needed to avoid withdrawal of capital and to attract additional capital needed for expansion. For purposes of computing the allowable return, the provider's equity capital means: (1) The provider's investment in plant, property, and equipment related to patient care (net of depreciation) and funds deposited by a provider who leases plant, property, or equipment related to patient care and is required by the terms of the lease to deposit such funds (net of noncurrent debt related to such investment or deposited funds), and (2) net working capital maintained for necessary and proper operation of patient care activities (excluding the amount of any current payment made pursuant to § 405.454(g) (1)). However, debt representing loans from partners, stockholders, or related organizations on which interest payments would be allowed as costs but for the provisions of § 405.419 (b) (3) (ii), is not subtracted in computing the amount of (1) and (2), in order that the proceeds from such loans be treated as a part of the provider's equity capital. In computing the amount of equity capital upon which a return is allowable, investment in facilities is recognized on the basis of the historical cost, or other basis, used for depreciation and other purposes under the health insurance program. For purposes of computing the allowable return the amount of equity capital is the average investment during the reporting period. The rate of return allowed, as derived from time to time based upon interest rates in accordance with this principle, is determined by the Social Security Administration and communicated through intermediaries. Return on investment as an element of allowable costs is subject to apportionment in the same manner as other elements of al

lowable costs. For the purposes of this regulation, the term "proprietary providers" is intended to distinguish providers, whether sole proprietorships, partnerships, or corporations, that are organized and operated with the expectation of earning profit for the owners, from other providers that are organized and operated on a nonprofit basis. [31 F.R. 14816, Nov. 22, 1966]

§ 405.451 Cost related to patient care.

(a) Principle. All payments to providers of services must be based on the "reasonable cost" of services covered under title XVIII of the Act and related to the care of beneficiaries. Reasonable cost includes all necessary and proper costs incurred in rendering the services, subject to principles relating to specific items of revenue and cost.

(b) Definitions-(1) Reasonable Cost. Reasonable cost of any services must be determined in accordance with regulations establishing the method or methods to be used, and the items to be included. The regulations in this subpart take into account both direct and indirect costs of providers of services. The objective is that under the methods of determining costs, the costs with respect to individuals covered by the program will not be borne by individuals not so covered, and the costs with respect to individuals not so covered will not be borne by the program. These regulations also provide for the making of suitable retroactive adjustments after the provider has submitted fiscal and statistical reports. The retroactive adjustment will represent the difference between the amount received by the provider during the year for covered services from both title XVIII and the beneficiaries and the amount determined in accordance with an accepted method of cost apportionment to be the actual cost of services rendered to beneficiaries during the year.

(2) Necessary and proper costs. Necessary and proper costs are costs which are appropriate and helpful in developing and maintaining the operation of patient care facilities and activities. They are usually costs which are common and accepted occurrences in the field of the provider's activity.

(c) Application. (1) It is the intent of title XVIII of the Act that payments

to providers of services should be fair to the providers, to the contributors to the health-insurance trust funds, and to other patients.

(2) The costs of providers' services vary from one provider to another and the variations generally reflect differences in scope of services and intensity of care. The provision in title XVIII of the Act for payment of reasonable cost of services is intended to meet the actual costs, however widely they may vary from one institution to another. This is subject to a limitation where a particular institution's costs are found to be substantially out of line with other institutions in the same area which are similar in size, scope of services, utilization, and other relevant factors.

It

(3) The determination of reasonable cost of services must be based on cost related to the care of beneficiaries of title XVIII of the Act. Reasonable cost includes all necessary and proper expenses incurred in rendering services, such as administrative costs, maintenance costs, and premium payments for employee health and pension plans. includes both direct and indirect costs and normal standby costs. However, where the provider's operating costs include amounts not related to patient care, or specifically not reimbursable under the program, such amounts will not be allowable. The reasonable cost basis of reimbursement contemplates that the providers of services would be reimbursed the actual costs of providing quality care however widely the actual costs may vary from provider to provider and from time to time for the same provider.

[31 F.R. 14816, Nov. 22, 1966]

§ 405.452

Determination of cost of services to beneficiaries.

(a) Principle. Total allowable costs of a provider shall be apportioned between program beneficiaries and other patients so that the share borne by the program is based upon actual services received by program beneficiaries. To accomplish this apportionment, the provider shall have the option of either of the two following methods:

(1) Departmental method. The ratio of beneficiary charges to total patient charges for the services of each department is applied to the cost of the department.