Capital PPS transition period affects timing differences - prospective payment system

Healthcare Financial Management, Jan, 1992 by Martha Garner, Woodrin Grossman

For many hospitals, the Health Care Financing Administration's (HCFA's) new capital payment rules will affect their financial statements in areas other than contractual allowances. Under cost-based payment systems, expenses can be paid in a different year than that in which they are recognized for financial reporting purposes.

HCFA issued regulations implementing a new payment system to cover capital costs directly related to inpatient hospital care of Medicare beneficiaries on Aug. 30, 1991. The new system took effect Oct. 1, 1991.

Accelerations and lags in payment mean timing differences-deferred assets or liabilities-must be recorded on a hospital's books. Subsequent changes in payment programs may affect the degree to which deferred assets will result in cash inflows or deferred liabilities will result in a decrease of future program payments.

Many hospitals have significant deferred assets and liabilities on their balance sheets related to timing differences that arose from debt extinguishments such as bond defeasances.

As a result, the new

Medicare payment system for capital costs has implications for a healthcare organization's ability to recover and realize those deferred assets and liabilities.

In November 1991, HFMA's Principles and Practices (P&P) Board approved its Statement No. 13, Timing Differences Pertaining to Third-Party Payment," which describes in general how timing differences are affected by changes in third-party payment programs. The conclusions in the statement can be applied to the specific issue of how capital cost timing differences will be affected by the new Medicare capital payment regulations. (See the P&P Board statement on page 100.)

New system basics

Under the old payment system, hospitals were reimbursed for their Medicare inpatient capital costs on a reasonable-cost basis (reduced by across-the-board percentage reductions). The new system calls for a 10-year transition from the current system to a fully prospective payment system (PPS) in which all hospitals would be paid a standard rate (the "Federal rate") for each Medicare discharge. Beginning in FY2001, capital payments to all PPS hospitals will be based entirely on the Federal rate.

During the 10-year transition period, hospitals will be divided into two groups according to whether they are below or above the national average inpatient capital cost per case ("low-cost" or "high-cost" hospitals, respectively).

Low-cost facilities will be paid according to a blend of their own actual costs and the Federal rate. The portion based on their own costs declines gradually during the transition period.

High-cost hospitals will continue to receive cost-based payments for a portion of their "old capital." For purposes of the new rules, old capital is defined as all allowable capital-related costs for assets put into patient use (or contractually committed to) on or before Dec. 31, 1990. An exceptions policy will ensure that a hospital's aggregate capital payments do not fall below a certain level.

FACTS ASSUMED. An example can help clarify the idea. Sample Hospital averages 70 percent Medicare utilization annually, has a fiscal year ending Sept. 30, and is not a sole community provider. Sample Hospital defeased an old bond issue in 1986, and experienced a $1 million loss on the transaction. The call date on the defeased bonds is 1995.

Under the cost-based payment rules in effect in 1986, Medicare would reimburse Sample Hospital for the portion of the defeasance loss attributable to inpatient care of Medicare beneficiaries (the 70 percent Medicare utilization group). But Medicare requires the loss to be amortized over future years instead of reimbursed all at once. The amortization period generally is the period from the date of the defeasance (in this case, 1986) to the call date on the defeased bonds (1995).

Because Sample Hospital must amortize the loss to future years for Medicare cost reporting purposes, Sample Hospital's actual Medicare payments in future years (rather than just payments in the year of the defeasance) will increase. The estimated Medicare effect in each of the years of amortization and the total estimated reimbursement effect are shown in Exhibit 1. For the sake of simplicity, the effects of the current percentage reductions in Medicare capital payments have been excluded from the exhibit.

Generally accepted accounting principles require Sample Hospital to recognize the entire loss on the transaction ($1 million) in the year in which the defeasance occurred. For financial reporting purposes, Sample Hospital also must recognize the Medicare payment effect of the loss in the same year the loss occurred, so that the total economic impact of the defeasance transaction is measured in the income statement for the year in which the defeasance occurred.

As a result, in Sample Hospital's income statement for the year ending Sept. 30, 1986, the $700,000 of future Medicare payments attributable to the defeasance loss-the timing difference - would be netted against the $1 million extraordinary loss that generated it. To record these transactions, Sample Hospital would make the following entries at the time of the defeasance: