OCTOBER TERM, 1994
Syllabus
SHALALA, SECRETARY OF HEALTH AND HUMAN SERVICES
v.
GUERNSEY MEMORIAL HOSPITAL
CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE SIXTH
CIRCUIT
No.93-1251. Argued October 31, 1994-Decided March 6,1995
After the refinancing of its bonded debt resulted in a
"defeasance" loss for accounting purposes, respondent health care
provider (hereinafter Hospital) determined that it was entitled to
Medicare reimbursement for part of that loss. Although the Hospital
contended that it should receive its full reimbursement in the year
of the refinancing, the fiscal intermediary agreed with petitioner
Secretary of Health and Human Services that the loss had to be
amortized over the life of the Hospital's old bonds in accord with
an informal Medicare reimbursement guideline, PRM § 233. The
District Court ultimately sustained the Secretary's position, but
the Court of Appeals reversed. Interpreting the Secretary's
Medicare regulations, 42 CFR pt. 413, to require reimbursement
according to generally accepted accounting principles (GAAP), the
latter court concluded that, because PRM § 233 departed from GAAP,
it effected a substantive change in the regulations and was void by
reason of the Secretary's failure to issue it in accordance with
the notice-andcomment provisions of the Administrative Procedure
Act (APA).
Held:
1. The Secretary is not required to adhere to GAAP in making
provider reimbursement determinations. Pp. 91-97.
(a) The Medicare regulations do not require reimbursement
according to GAAP. The Secretary's position that 42 CFR §
413.20(a)-which specifies,
inter alia, that "[tJhe
principles of cost reimbursement require that providers maintain
sufficient financial records ... for proper determination of
costs," and that "[sJtandardized definitions, accounting,
statistics, and reporting practices that are widely accepted in the
hospital and related fields are followed"-ensures the existence of
adequate provider records but does not dictate the Secretary's own
reimbursement determinations is supported by the regulation's text
and the overall structure of the regulations and is therefore
entitled to deference as a reasonable regulatory interpretation.
Moreover, § 413.24-which requires that a provider's cost data be
based on the accrual basis of accounting-does not mandate
reimbursement according to GAAP, since GAAP is not the only form of
accrual accounting. In fact, PRM § 233 reflects a different accrual
method. Pp. 92-95.
88
(b) The Secretary's reading of her regulations is consistent
with the Medicare statute, which does not require adherence to
GAAP, but merely instructs that, in establishing methods for
determining reimbursable costs, she should "consider, among other
things, the principles generally applied by national organizations
or established prepayment organizations (which have developed such
principles) ... ," 42 U. S. C. § 1395x(v)(1)(A). Nor is there any
basis for suggesting that the Secretary has a statutory duty to
promulgate regulations that address every conceivable question in
the process of determining equitable reimbursement. To the extent
that § 1395x(v)(1)(A)'s broad delegation of authority to her
imposes a rulemaking obligation, it is one she has without doubt
discharged by issuing comprehensive and intricate regulations that
address a wide range of reimbursement questions and by relying upon
an elaborate adjudicative structure to resolve particular details
not specifically addressed by regulation. The APA does not require
that all the specific applications of a rule evolve by further,
more precise rules rather than by adjudication, and the Secretary's
mode of determining benefits by both rulemaking and adjudication is
a proper exercise of her statutory mandate. pp. 95-97.
2. The Secretary's failure to follow the APA notice-and-comment
provisions in issuing PRM § 233 does not invalidate that guideline.
It was proper for the Secretary to issue a guideline or
interpretive rule in determining that defeasance losses should be
amortized. PRM § 233 is the Secretary's means of implementing the
statute's mandate that the Medicare program bear neither more nor
less than its fair share of reimbursement costs, 42 U. S. C. §
1395x(v)(1)(A)(i), and the regulatory requirement that only the
actual cost of services rendered to beneficiaries during a given
year be reimbursed, 42 CFR § 413.9. As such, PRM § 233 is a
prototypical example of an interpretive rule issued by an agency to
advise the public of its construction of the statutes and rules it
administers. Interpretive rules do not require notice and comment,
although they also do not have the force and effect of law and are
not accorded that weight in the adjudicatory process. APA
rulemaking would be required if PRM § 233 adopted a new position
inconsistent with any of the Secretary's existing regulations.
However, because the Secretary's regulations do not bind her to
make Medicare reimbursements in accordance with GAAP, her
determination in PRM § 233 to depart from GAAP by requiring bond
defeasance losses to be amortized does not amount to a substantive
change to the regulations. Pp.97-100.
3. An examination of the nature and objectives of GAAP
illustrates the unlikelihood that the Secretary would choose to
impose upon herself the duty to go through the time-consuming
rulemaking process when-
89
ever she disagreed with any anouncements or changes in GAAP and
wished to depart from them. Pp. 100-102.
(a) GAAP does not necessarily reflect economic reality, and its
conservative orientation in guiding judgments and estimates ill
serves Medicare reimbursement and its mandate to avoid
cross-subsidization. pp. 100-101.
(b) GAAP is not a lucid or encyclopedic set of pre-existing
rules.
It encompasses the conventions, rules, and procedures that
define accepted accounting practice at a particular point in time,
and changes over time. Even at anyone point, GAAP consists of
multiple sources, any number of which might present conflicting
treatments of a particular accounting question. pp. 101-102.
996 F.2d
830, reversed.
KENNEDY, J., delivered the opinion of the Court, in which
REHNQUIST, C. J., and STEVENS, GINSBURG, and BREYER, JJ., joined.
O'CONNOR, J., filed a dissenting opinion, in which SCALIA, SOUTER,
and THOMAS, JJ., joined,
post, p. 102.
Kent L. Jones argued the cause for petitioner. With him on the
briefs were Solicitor General Days, Assistant Attorney General
Hunger, Deputy Solicitor General Kneedler, Anthony
J.
Steinmeyer, and John P. Schnitker.
Scott W Taebel argued the cause for respondent. With him
on the brief was
Diane M. Signoracci. *
JUSTICE KENNEDY delivered the opinion of the Court.
In this case a health care provider challenges a Medicare
reimbursement determination by the Secretary of Health and Human
Services. What begins as a rather conventional accounting problem
raises significant questions respecting the interpretation of the
Secretary's regulations and her authority to resolve certain
reimbursement issues by adju-
*Briefs of
amici curiae urging affirmance were filed for
the American Hospital Association et al. by
Robert A. Klein
and
Charles W Bailey; for the hospitals participating in
St. John Hospital v.
Shalala by
William G.
Christopher, Chris Rossman, and
Kenneth R. Marcus;
and for the Mother Frances Hospital et al. by
Dan M.
Peterson.
90
dication and interpretive rules, rather than by regulations that
address all accounting questions in precise detail.
The particular dispute concerns whether the Medicare regulations
require reimbursement according to generally accepted accounting
principles (GAAP), and whether the reimbursement guideline the
Secretary relied upon is invalid because she did not follow the
notice-and-comment provisions of the Administrative Procedure Act
(APA) in issuing it. We hold that the Secretary's regulations do
not require reimbursement according to GAAP and that her guideline
is a valid interpretive rule.
I
Respondent Guernsey Memorial Hospital (hereinafter Hospital)
issued bonds in 1972 and 1982 to fund capital improvements. In
1985, the Hospital refinanced its bonded debt by issuing new bonds.
Although the refinancing will result in an estimated $12 million
saving in debt service costs, the transaction did result in an
accounting loss, sometimes referred to as an advance refunding or
defeasance loss, of $672,581. The Hospital determined that it was
entitled to Medicare reimbursement for about $314,000 of the loss.
The total allowable amount of the loss is not in issue, but its
timing is. The Hospital contends it is entitled to full
reimbursement in one year, the year of the refinancing; the
Secretary contends the loss must be amortized over the life of the
old bonds.
The Secretary's position is in accord with an informal Medicare
reimbursement guideline. See U. S. Dept. of Health and Human
Services, Medicare Provider Reimbursement Manual § 233 (Mar. 1993)
(PRM). PRM § 233 does not purport to be a regulation and has not
been adopted pursuant to the notice-and-comment procedures of the
Administrative Procedure Act. The fiscal intermediary relied on §
233 and determined that the loss had to be amortized. The Provider
Reimbursement Review Board disagreed, see App. to Pet. for Cert.
54a, but the Administrator of the Health Care
91
Financing Administration reversed the Board's decision, see
id., at 40a. In the District Court the Secretary's position
was sustained, see
Guernsey Memorial Hospital v.
Sullivan, 796 F. Supp. 283 (SD Ohio 1992), but the Court of
Appeals reversed, see
Guernsey Memorial Hospital v.
Secretary of Health and Human Services, 996 F.2d
830 (CA6 1993). In agreement with the Hospital, the court
interpreted the Secretary's own regulations to contain a "fiat
statement that generally accepted accounting principles 'are
followed'" in determining Medicare reimbursements.
Id., at
833 (quoting 42 CFR §413.20(a)). Although it was willing to accept
the argument that PRM § 233's treatment of advance refunding losses
"squares with economic reality," 996 F. 2d, at 834, the Court of
Appeals concluded that, because PRM § 233 departed from GAAP, it
"effects a substantive change in the regulations [and is] void by
reason of the agency's failure to comply with the Administrative
Procedure Act in adopting it."
Id., at 832. Once the court
ruled that GAAP controlled the timing of the accrual, it followed
that the Hospital, not the Secretary, was correct and that the
entire loss should be recognized in the year of refinancing.
We granted certiorari, 511 U. S. 1016 (1994), and now
reverse.
II
Under the Medicare reimbursement scheme at issue here,
participating hospitals furnish services to program beneficiaries
and are reimbursed by the Secretary through fiscal intermediaries.
See 42 U. S. C. §§ 1395g and 1395h (1988 and Supp. V). Hospitals
are reimbursed for "reasonable costs," defined by the statute as
"the cost actually incurred, excluding therefrom any part of
incurred cost found to be unnecessary in the efficient delivery of
needed health services." § 1395x(v)(1)(A). The Medicare Act, 79
Stat. 290, as amended, 42 U. S. C. § 1395
et seq.,
authorizes the Secretary to promulgate regulations "establishing
the method or methods to be used" for determining reasonable costs,
directing
92
her in the process to "consider, among other things, the
principles generally applied by national organizations or
established prepayment organizations (which have developed such
principles) in computing" reimbursement amounts. §
1395x(v)(1)(A).
The Secretary has promulgated, and updated on an annual basis,
regulations establishing the methods for determining reasonable
cost reimbursement. See
Good Samaritan Hospital v.
Shalala, 508
U. S. 402, 404-407 (1993). The relevant provisions can be found
within 42 CFR pt. 413 (1994). Respondent contends that two of these
regulations, §§ 413.20(a) and 413.24, mandate reimbursement
according to GAAP, and the Secretary counters that neither
does.
A
Section 413.20(a) provides as follows:
"The principles of cost reimbursement require that providers
maintain sufficient financial records and statistical data for
proper determination of costs payable under the program.
Standardized definitions, accounting, statistics, and reporting
practices that are widely accepted in the hospital and related
fields are followed. Changes in these practices and systems will
not be required in order to determine costs payable under the
principles of reimbursement. Essentially the methods of determining
costs payable under Medicare involve making use of data available
from the institution's basis accounts, as usually maintained, to
arrive at equitable and proper payment for services to
beneficiaries."
Assuming,
arguendo, that the "[s]tandardized definitions,
accounting, statistics, and reporting practices" referred to by the
regulation refer to GAAP, that nevertheless is just the beginning,
not the end, of the inquiry. The decisive question still remains:
Who is it that "follow[s]" GAAP, and for what purposes? The
Secretary's view is that § 413.20(a) ensures
93
the existence of adequate provider records but does not dictate
her own reimbursement determinations. We are persuaded that the
Secretary's reading is correct.
Section 413.20(a) sets forth its directives in an ordered
progression. The first sentence directs that providers must
maintain records that are sufficient for proper determination of
costs. It does not say the records are conclusive of the entire
reimbursement process. The second sentence makes it clear to
providers that standardized accounting practices are followed. The
third sentence reassures providers that changes in their
recordkeeping practices and systems are not required in order to
determine what costs the provider can recover when principles of
reimbursement are applied to the provider's raw cost data. That
sentence makes a distinction between recordkeeping practices and
systems on one hand and principles of reimbursement on the other.
The last sentence confirms the distinction, for it contemplates
that a provider's basic financial information is organized
according to GAAP as a beginning point from which the Secretary
"arrive[s] at equitable and proper payment for services." This is
far different from saying that GAAP is by definition an equitable
and proper measure of reimbursement.
The essential distinction between recordkeeping requirements and
reimbursement principles is confirmed by the organization of the
regulations in 42 CFR pt. 413 (1994). Subpart A sets forth
introductory principles. Subpart B, containing the regulation here
in question, is entitled "Accounting Records and Reports." The
logical conclusion is that the provisions in subpart B concern
recordkeeping requirements rather than reimbursement, and closer
inspection reveals this to be the case. Section 413.20 is the first
section in subpart B, and is entitled "Financial data and reports."
In addition to § 413.20(a), the other paragraphs in § 413.20 govern
the "[f]requency of cost reports," "[r]ecordkeeping requirements
for new providers," "[c]ontinuing provider recordkeeping
requirements," and "[s]uspension of program
94
payments to a provider ... [who] does not maintain. adequate
records." Not until the following subparts are cost reimbursement
matters considered. Subpart C is entitled "Limits on Cost
Reimbursement," subpart D "Apportionment [of Allowable Costs],"
subpart E "Payments to Providers," and subparts F through H address
reimbursement of particular cost categories. The logical sequence
of a regulation or a part of it can be significant in interpreting
its meaning.
It is true, as the Court of Appeals said, that § 413.20(a) "does
not exist in a vacuum" but rather is a part of the overall Medicare
reimbursement scheme. 996 F. 2d, at 835. But it does not follow
from the fact that a provider's cost accounting is the first step
toward reimbursement that it is the only step. It is hardly
surprising that the reimbursement process begins with certain
recordkeeping requirements.
The regulations' description of the fiscal intermediary's role
underscores this interpretation. The regulations direct the
intermediary to consult and assist providers in interpreting and
applying the principles of Medicare reimbursement to generate
claims for reimbursable costs, § 413.20(b), suggesting that a
provider's own determination of its claims involves more than
handing over its existing cost reports. The regulations permit
initial acceptance of reimbursable cost claims, unless there are
obvious errors or inconsistencies, in order to expedite payment. §
413.64(f)(2). When a subsequent, more thorough audit follows, it
may establish that adjustments are necessary.
Ibid.; see
also §§ 421.100(a), (c). This sequence as well is consistent with
the Secretary's view that a provider's cost accounting systems are
only the first step in the ultimate determination of reimbursable
costs.
The Secretary's position that § 413.20(a) does not bind her to
reimburse according to GAAP is supported by the regulation's text
and the overall structure of the regulations. It
95
is a reasonable regulatory interpretation, and we must defer to
it.
Thomas Jefferson Univ. v.
Shalala, 512 U. S. 504, 512
(1994); see also
Martin v.
Occupational Safety and Health
Review Comm'n, 499 U. S. 144, 151 (1991)
("Because applying an agency's regulation to complex or changing
circumstances calls upon the agency's unique expertise and
policymaking prerogatives, we presume that the power
authoritatively to interpret its own regulations is a component of
the agency's delegated lawmaking powers");
Lyng v.
Payne, 476 U.
S. 926, 939 (1986) ("agency's construction of its own
regulations is entitled to substantial deference").
Respondent argues that, even if § 413.20(a) does not mandate
reimbursement according to GAAP, § 413.24 does. This contention
need not detain us long. Section 413.24 requires that a provider's
cost data be based on the accrual basis of accounting, under which
"revenue is reported in the period when 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." §
413.24(b)(2). But GAAP is not the only form of accrual accounting;
in fact, both the GAAP approach and PRM § 233 reflect different
methods of accrual accounting. See Accounting Principles Board
(APB) Opinion No. 26, " 5-8, reprinted at App. 64-66 (describing
alternative accrual methods of recognizing advance refunding
losses, including the one adopted in PRM § 233). Section 413.24
does not, simply by its accrual accounting requirement, bind the
Secretary to make reimbursements according to GAAP.
B
The Secretary's reading of her regulations is consistent with
the Medicare statute. Rather than requiring adherence to GAAP, the
statute merely instructs the Secretary, in establishing the methods
for determining reimbursable costs, to "consider, among other
things, the principles generally applied by national organizations
or established prepay-
96
ment organizations (which have developed such principles) in
computing the amount of payment ... to providers of services." 42
U. S. C. § 1395x(v)(1)(A).
Nor is there any basis for suggesting that the Secretary has a
statutory duty to promulgate regulations that, either by default
rule or by specification, address every conceivable question in the
process of determining equitable reimbursement. To the extent the
Medicare statute's broad delegation of authority imposes a
rulemaking obligation, see
ibid., it is one the Secretary
has without doubt discharged. See
Good Samaritan Hospital v.
Shalala, 508 U. S., at 418, and n. 13, 419, n. 15. The
Secretary has issued regulations to address a wide range of
reimbursement questions. The regulations are comprehensive and
intricate in detail, addressing matters such as limits on cost
reimbursement, apportioning costs to Medicare services, and the
specific treatment of numerous particular costs. As of 1994, these
regulations consumed some 640 pages of the Code of Federal
Regulations.
As to particular reimbursement details not addressed by her
regulations, the Secretary relies upon an elaborate adjudicative
structure which includes the right to review by the Provider
Reimbursement Review Board, and, in some instances, the Secretary,
as well as judicial review in federal district court of final
agency action. 42 U. S. C. § 139500(f)(1); see
Bethesda Hospital
Assn. v.
Bowen, 485 U. S. 399, 400-401 (1988). That her
regulations do not resolve the specific timing question before us
in a conclusive way, or "could use a more exact mode of
calculating," does not, of course, render them invalid, for the
"methods for the estimation of reasonable costs" required by the
statute only need be "generalizations [that] necessarily will fail
to yield exact numbers."
Good Samaritan, supra, at 418. The
AP A does not require that all the specific applications of a rule
evolve by further, more precise rules rather than by adjudication.
See
NLRB v.
Bell Aerospace Co., 416 U. S. 267
97
(1974); SEC v.
Chenery Corp., 332 U. S. 194 (1947). The
Secretary's mode of determining benefits by both rulemaking and
adjudication is, in our view, a proper exercise of her statutory
mandate.
III
We also believe it was proper for the Secretary to issue a
guideline or interpretive rule in determining that defeasance
losses should be amortized. PRM § 233 is the means to ensure that
capital-related costs allowable under the regulations are
reimbursed in a manner consistent with the statute's mandate that
the program bear neither more nor less than its fair share of
costs. 42 U. S. C. § 1395x(v)(1)(A)(i) ("[T]he necessary costs of
efficiently delivering covered services to individuals covered by
[Medicare] will not be borne by individuals not so covered, and the
costs with respect to individuals not so covered will not be borne
by [Medicare]"). The Secretary has promulgated regulations
authorizing reimbursement of capital-related costs such as
respondent's that are "appropriate and helpful in ... maintaining
the operation of patient care facilities," 42 CFR § 413.9(b)(2)
(1994); see generally §§ 413.130-413.157, including "[n]ecessary
and proper interest" and other costs associated with capital
indebtedness, § 413.153(a)(1); see also §§ 413.130(a)(7) and (g).
The only question unaddressed by the otherwise comprehensive
regulations on this particular subject is whether the loss should
be recognized at once or spread over a period of years. It is at
this step that PRM § 233 directs amortization.
Although one-time recognition in the initial year might be the
better approach where the question is how best to portray a loss so
that investors can appreciate in full a company's financial
position, see APB Opinion 26, "4-5, reprinted at App. 64, the
Secretary has determined in PRM § 233 that amortization is
appropriate to ensure that Medicare only reimburse its fair share.
The Secretary must calculate how much of a provider's total
allowable costs are
98
attributable to Medicare services, see 42 CFR §§ 413.5(a),
413.9(a), and (c)(3) (1994), which entails calculating what
proportion of the provider's services were delivered to Medicare
patients, §§ 413.50 and 413.53. This ratio is referred to as the
provider's "Medicare utilization." App. to Pet. for Cert. 49a. In
allocating a provider's total allowable costs to Medicare, the
Secretary must guard against various contingencies. The percentage
of a hospital's patients covered by Medicare may change from year
to year; or the provider may drop from the Medicare program
altogether. Either will cause the hospital's Medicare utilization
to fluctuate. Given the undoubted fact that Medicare utilization
will not be an annual constant, the Secretary must strive to assure
that costs associated with patient services provided over time be
spread, to avoid distortions in reimbursement. As the provider's
yearly Medicare utilization becomes ascertainable, the Secretary is
able to allocate costs with accuracy and the program can bear its
proportionate share. Proper reimbursement requires proper timing.
Should the Secretary reimburse in one year costs in fact
attributable to a span of years, the reimbursement will be
determined by the provider's Medicare utilization for that one
year, not for later years. This leads to distortion. If the
provider's utilization rate changes or if the provider drops from
the program altogether the Secretary will have reimbursed up front
an amount other than that attributable to Medicare services. The
result would be cross-subsidization,
id., at 50a, which the
Act forbids. 42 U. S. C. § 1395x(v)(1)(A)(i).
That PRM § 233 implements the statutory ban on
crosssubsidization in a reasonable way is illustrated by the
Administrator's application of § 233 to the facts of this case. The
Administrator found that respondent's loss "did not relate
exclusively to patient care services rendered in the year of the
loss .... [but were] more closely related to [patient care services
in] the years over which the original bond term extended." App. to
Pet. for Cert. 49a. Because the loss
99
was associated with patient services over a period of time, the
Administrator concluded that amortization was required to avoid the
statutory ban on cross-subsidization:
"The statutory prohibition against cross-subsidization [citing
the provision codified at 42 U. S. C. § 1395x (v)(l)(A)], requires
that costs recognized in one year, but attributable to health
services rendered over a number of years, be amortized and
reimbursed during those years when Medicare beneficiaries use those
services." Id., at 50a (footnote omitted).
"By amortizing the loss to match it to Medicare utilization over
the years to which it relates, the program is protected from any
drop in Medicare utilization, and the provider is likewise assured
that it will be adequately reimbursed if Medicare utilization
increases. Further, the program is protected from making a payment
attributable to future years and then having the provider drop out
of the Program before services are rendered to Medicare
beneficiaries in those future years." Id., at 49a (footnote
omitted).
As an application of the statutory ban on crosssubsidization and
the regulatory requirement that only the actual cost of services
rendered to beneficiaries during a given year be reimbursed, 42 U.
S. C. § 1395x(v)(1)(A)(i); 42 CFR § 413.9 (1994), PRM § 233 is a
prototypical example of an interpretive rule" 'issued by an agency
to advise the public of the agency's construction of the statutes
and rules which it administers.'"
Chrysler Corp. v.
Brown, 441 U.
S. 281, 302, n. 31 (1979) (quoting Attorney General's Manual on
the Administrative Procedure Act 30, n. 3 (1947)). Interpretive
rules do not require notice and comment, although, as the Secretary
recognizes, see Foreword to PRM, they also do not have the force
and effect of law and are not accorded that weight in the
adjudicatory process,
ibid.
100
We can agree that APA rulemaking would still be required if PRM
§ 233 adopted a new position inconsistent with any of the
Secretary's existing regulations. As set forth in Part II, however,
her regulations do not require reimbursement according to GAAP. PRM
§ 233 does not, as the Court of Appeals concluded it does,
"effec[t] a substantive change in the regulations." 996 F. 2d, at
832.
IV
There is much irony in the suggestion, made in support of the
Hospital's interpretation of the statute and regulations, that the
Secretary has bound herself to delegate the determination of any
matter not specifically addressed by the regulations to the
conventions of financial accounting that comprise GAAP. The
Secretary in effect would be imposing upon herself a duty to go
through the time-consuming rulemaking process whenever she
disagrees with any announcements or changes in GAAP and wishes to
depart from them. Examining the nature and objectives of GAAP
illustrates the unlikelihood that the Secretary would choose that
course.
Contrary to the Secretary's mandate to match reimbursement with
Medicare services, which requires her to determine with some
certainty just when and on whose account costs are incurred, GAAP
"do[es] not necessarily parallel economic reality." R. Kay & D.
Searfoss, Handbook of Accounting and Auditing, ch. 5, p. 7 (2d ed.
1989). Financial accounting is not a science. It addresses many
questions as to which the answers are uncertain and is a "process
[that] involves continuous judgments and estimates."
Id.,
ch. 5, at 7-8. In guiding these judgments and estimates, "financial
accounting has as its foundation the principle of conservatism,
with its corollary that 'possible errors in measurement [should] be
in the direction of understatement rather than overstatement of net
income and net assets.'"
Thor Power Tool Co. v.
Commissioner, 439 U. S. 522, 542 (1979)
(citation omitted). This orientation may be consistent with the
ob-
101
jective of informing investors, but it ill serves the needs of
Medicare reimbursement and its mandate to avoid crosssubsidization.
Cf.
id., at 543 ("[T]he accountant's conservatism cannot
bind the Commissioner [of the IRS] in his efforts to collect
taxes").
GAAP is not the lucid or encyclopedic set of pre-existing rules
that the dissent might perceive it to be. Far from a single-source
accounting rulebook, GAAP "encompasses the conventions, rules, and
procedures that define accepted accounting practice at a particular
point in time." Kay & Searfoss, ch. 5, at 7 (1994 Update). GAAP
changes and, even at anyone point, is often indeterminate. "[T]he
determination that a particular accounting principle is generally
accepted may be difficult because no single source exists for all
principles."
Ibid. There are 19 different GAAP sources, any
number of which might present conflicting treatments of a
particular accounting question.
Id., ch. 5, at 6-7. When
such conflicts arise, the accountant is directed to consult an
elaborate hierarchy of GAAP sources to determine which treatment to
follow.
Ibid. We think it is a rather extraordinary
proposition that the Secretary has consigned herself to this
process in addressing the timing of Medicare reimbursement.
The framework followed in this case is a sensible structure for
the complex Medicare reimbursement process. The Secretary has
promulgated regulations setting forth the basic principles and
methods of reimbursement, and has issued interpretive rules such as
PRM § 233 that advise providers how she will apply the Medicare
statute and regulations in adjudicating particular reimbursement
claims. Because the Secretary's regulations do not bind her to make
Medicare reimbursements in accordance with GAAP, her determination
in PRM § 233 to depart from GAAP by requiring bond defeasance
losses to be amortized does not amount to a substantive change to
the regulations. It is a valid interpretive rule, and it was
reasonable for the Secretary to follow that
102
policy here to deny respondent's claim for full reimbursement of
its defeasance loss in 1985.
The judgment of the Court of Appeals is reversed.
It is so ordered.
JUSTICE O'CONNOR, with whom JUSTICE SCALIA, JUSTICE SOUTER, and
JUSTICE THOMAS join, dissenting.
Unlike the Court, I believe that general Medicare reporting and
reimbursement regulations require provider costs to be treated
according to "generally accepted accounting principles." As a
result, I would hold that contrary guidelines issued by the
Secretary of Health and Human Services in an informal policy manual
and applied to determine the timing of reimbursement in this case
are invalid for failure to comply with the notice and comment
procedures established by the Administrative Procedure Act, 5 U. S.
C. § 553. Because the Court holds to the contrary, I respectfully
dissent.
I
It is undisputed, as the Court notes,
ante, at 90, that
respondent, Guernsey Memorial Hospital (Hospital), is entitled to
reimbursement for the reasonable advance refunding costs it
incurred when it refinanced its capital improvement bonds in 1985.
The only issue here is one of timing: whether reimbursement is to
be made in a lump sum in the year of the refinancing, in accordance
with generally accepted accounting principles (known in the
accounting world as GAAP), or in a series of payments over the
remaining life of the original bonds, as the Secretary ultimately
concluded after applying § 233 of the Medicare Provider
Reimbursement Manual (PRM). The Hospital challenged the Secretary's
reimbursement decision under the Medicare Act, 42 U. S. C. §
139500(f), which incorporates the Administrative Procedure Act, 5
U. S. C. § 551
et seq. (1988 ed. and Supp. V), by reference.
Under the governing standard, reviewing courts are to "hold
103
unlawful and set aside" an agency action that is "arbitrary,
capricious, an abuse of discretion, or otherwise not in accordance
with law." 5 U. S. C. § 706(2)(A). We must give substantial
deference to an agency's interpretation of its own regulations,
Lyng v.
Payne, 476 U. S. 926, 939
(1986), but an agency's interpretation cannot be sustained if it is
"'plainly erroneous or inconsistent with the regulation.'"
Stinson v.
United States, 508 U. S. 36, 45 (1993)
(quoting
Bowles v.
Seminole Rock &
Sand
Co., 325 U. S.
410, 414 (1945)). In my view, that is the case here.
The Medicare Act requires that, for reimbursement purposes, the
actual reasonable costs incurred by a provider "shall be determined
in accordance with regulations establishing the method or methods
to be used ... in determining such costs." 42 U. S. C. §
1395x(v)(1)(A). The Secretary's regulations similarly provide that
the "[r]easonable 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." 42 CFR § 413.9(b)(1)
(1994). The Secretary is not bound to adopt GAAP for reimbursement
purposes; indeed, the statute only requires that, in promulgating
the necessary regulations, "the Secretary shall consider, among
other things, the principles generally applied by national
organizations or established prepayment organizations (which have
developed such principles) in computing the amount of payment ...
to providers of services .... " 42 U. S. C. § 1395x(v)(1)(A).
Neither the Hospital nor the Court of Appeals disputes that the
Secretary has broad and flexible authority to prescribe standards
for reimbursement. See
Good Samaritan Hospital v.
Shalala, 508
U. S. 402, 418,
Nevertheless, the statute clearly contemplates that the
Secretary will state the applicable reimbursement methods in
regulations-including default rules that cover a range of
situations unless and until specific regulations are promulgated to
supplant them with respect to a particular type of
104
cost. Indeed, despite the Court's suggestion to the contrary,
ante, at 96, only by employing such default rules can the
Secretary operate the sensible, comprehensive reimbursement scheme
that Congress envisioned. Otherwise, without such background
guidelines, providers would not have the benefit of regulations
establishing the accounting principles upon which reimbursement
decisions will be based, and administrators would be free to
select, without having to comply with notice and comment
procedures, whatever accounting rule may appear best in a
particular context (so long as it meets minimum standards of
rationality). In my view, the question becomes simply whether the
Secretary has in fact adopted GAAP as the default rule for cost
reimbursement accounting.
Like the Court, see
ante, at 95-96, I do not think that
42 CFR § 413.24(a) (1994), which provides that Medicare cost data
"must be based on ... the accrual basis of accounting," requires
the use of GAAP. As the regulation itself explains, "[u]nder the
accrual basis of accounting, revenue is reported in the period when
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." § 413.24(b)(2). This definition of "accrual
basis" simply incorporates the dictionary understanding of the
term, thereby distinguishing the method required of cost providers
from "cash basis" accounting (under which revenue is reported only
when it is actually received and expenses are reported only when
they are actually paid). GAAP employs the generally accepted form
of accrual basis accounting, but not the only possible form. In
fact, both the applicable GAAP rule, established by Early
Extinguishment of Debt, Accounting Principles Board Opinion No. 26
(1972), reprinted at App. 62, and PRM § 233 appear to reflect
accrual, as opposed to cash basis, accounting principles.
Although § 413.24 simply opens the door for the Secretary to
employ GAAP, § 413.20 makes clear that she has, in fact,
105
incorporated GAAP into the cost reimbursement process. That
section provides that "[s]tandardized definitions, accounting,
statistics, and reporting practices that are widely accepted in the
hospital and related fields are followed." § 413.20(a). As the
Court of Appeals noted, "[i]t is undisputed, in the case at bar,
that Guernsey Memorial Hospital keeps its books on the accrual
basis of accounting and in accordance with generally accepted
accounting principles."
Guernsey Memorial Hospital v.
Secretary of HHS, 996 F.2d
830, 834 (CA6 1993). Similarly, related entities in the health
care field employ GAAP as their standardized accounting practices.
See American Institute of Certified Public Accountants, Audits of
Providers of Health Care Services § 3.01, p. 11 (1993) ("Financial
statements of health care entities should be prepared in conformity
with generally accepted accounting principles"); Brief for American
Hospital Association et al. as
Amici Curiae 7-8 ("Generally
accepted accounting principles have always provided the standard
definitions and accounting practices applied by nongovernment
hospitals in maintaining their books and records"). Accordingly,
the Secretary concedes that, under § 413.20, the Hospital at the
very least was required to submit its request for Medicare
reimbursement in accordance with GAAP.
Guernsey Memorial
Hospital v.
Sullivan, 796 F. Supp. 283, 288-289 (SD Ohio
1992); Tr. of Oral Arg. 8.
The remainder of § 413.20 demonstrates, moreover, that the
accounting practices commonly used in the health care field
determine how costs will be reimbursed by Medicare, not just how
they are to be reported. The first sentence of § 413.20(a) begins
with a statement that the provision explains what "[t]he principles
of
cost reimbursement require." (Emphasis added.) And the
sentence emphasizing that standardized accounting and reporting
practices "are followed" is itself accompanied by the promise that
"[c]hanges in these practices and systems will not be required in
order to determine costs payable [that is, reimbursable] under
the
106
principles of reimbursement." The language of the regulation,
taken as a whole, indicates that the accounting system maintained
by the provider ordinarily forms the basis for determining how
Medicare costs will be reimbursed. I find it significant that the
Secretary, through the Administrator of the Health Care Finance
Administration, has changed her interpretation of this regulation,
having previously concluded that this provision generally requires
the costs of Medicare providers to be reimbursed according to GAAP
when that construction was to her benefit. See
Dr. David M.
Brotman Memorial Hospital v.
Blue Cross Assn./Blue Cross of
Southern California, HCFA Admin. Decision, CCH Medicare and
Medicaid Guide, 30,922, p. 9839 (1980) (holding that, "[u]nder 42
CFR 405.406 [now codified as § 413.20], the determination of costs
payable under the program should follow standardized accounting
practices" and applying the GAAP rule-that credit card costs should
be treated as expenses in the period incurred-and not the PRM's
contrary rule-that such costs should be considered reductions of
revenue).
Following the Secretary's current position, the Court concludes,
ante, at 92-93, that § 413.20 was intended to do no more
than reassure Medicare providers that they would not be required
fundamentally to alter their accounting practices for reporting
purposes. Indeed, the Court maintains, the regulation simply
ensures the existence of adequate provider financial records,
maintained according to widely accepted accounting practices, that
will enable the Secretary to calculate the costs payable under the
Medicare program using some other systemwide method of determining
costs, which method she does not, and need not, state in any
regulations. For several reasons, I find the Court's interpretation
of § 413.20 untenable.
Initially, the Court's view is belied by the text and structure
of the regulations. As the Court of Appeals noted, "the sentence in
[§ 413.20(a)] that says standardized reporting
107
practices 'are followed' does not exist in a vacuum." 996 F. 2d,
at 835. The Provider Reimbursement Review Board has explained:
"[T]he purpose of cost reporting is to enable a hospital's costs to
be known so that its reimbursement can be calculated. For that
reason, there must be some consistency between the fundamental
principles of cost reporting and those principles used for cost
reimbursement."
Fort Worth Osteopathic Medical Center v.
Blue Cross and Blue Shield Ass'nlBlue Cross and Blue Shield of
Texas, CCH Medicare and Medicaid Guide, 40,413, p. 31,848
(1991). The text of § 413.20 itself establishes this link between
cost reporting and cost reimbursement by explaining that a provider
hospital generally need not modify its accounting and reporting
practices in order to determine what costs Medicare will reimburse.
That is, "the methods of determining costs payable under Medicare
involve making use of data available from the institution's basis
accounts, as usually maintained, to arrive at equitable and proper
payment for services to beneficiaries." § 413.20(a). By linking the
reimbursement process to the provider's existing financial records,
the regulation contemplates that both the agency and the provider
will be able to determine what costs are reimbursable. It would
make little sense to tie cost reporting to cost reimbursement in
this manner while simultaneously mandating different accounting
systems for each.
In addition, as the Court aptly puts it, "[t]he logical sequence
of a regulation ... can be significant in interpreting its
meaning."
Ante, at 94. Consideration of how a provider's
claim for reimbursement is processed undermines the Court's
interpretation of § 413.20(a). The Court suggests that the fiscal
intermediaries who make the initial reimbursement decisions take a
hospital's cost report as raw data and apply a separate set of
accounting principles to determine the proper amount of
reimbursement. In certain situations, namely where the regulations
provide for specific departures from GAAP, this is undoubtedly the
case. But the
108
description of the intermediary's role in the regulations
contemplates reliance on the GAAP-based cost report
as
determining reimbursable costs in considering the ordinary
claim. See,
e. g., § 413.60(b) (providing that, "[a]t
the end of the [reporting] period, the actual apportionment,
based on the cost finding and apportionment methods selected by
the provider, determines the Medicare reimbursement for the
actual services provided to beneficiaries during the period"
(emphasis added)); §413.64(f)(2) ("In order to reimburse the
provider as quickly as possible, an initial retroactive adjustment
will be made as soon as the cost report is received. For this
purpose,
the costs will be accepted as reported, unless there
are obvious errors or inconsistencies, subject to later audit.
When an audit is made and the final liability of the program is
determined, a final adjustment will be made" (emphasis added)). The
fiscal intermediary, then, is essentially instructed to check the
hospital's cost report for accuracy, reasonableness, and presumably
compliance with the regulations. But that task seems to operate
within the framework of the hospital's normal accounting
procedure-i.
e., GAAPand not some alternative, uncodified
set of accounting principles employed by the Secretary. See
generally 42 CFR §§ 421.1-421.128 (1994).
I take seriously our obligation to defer to an agency's
reasonable interpretation of its own regulations, particularly
"when, as here, the regulation concerns 'a complex and highly
technical regulatory program,' in which the identification and
classification of relevant 'criteria necessarily require
significant expertise and entail the exercise of judgment grounded
in policy concerns.'"
Thomas Jefferson Univ. v.
Shalala, 512
U. S. 504, 512 (1994) (quoting
Pauley v.
BethEnergy
Mines, Inc., 501
U. S. 680, 697 (1991)). In this case, however, the Secretary
advances a view of the regulations that would force us to conclude
that she has not fulfilled her statutory duty to promulgate
regulations determining the methods by which reasonable Medicare
costs are to be
109
calculated. If § 413.20 does not incorporate GAAP as the basic
method for determining cost reimbursement in the absence of a more
specific regulation, then there is
no regulation that
specifies an overall methodology to be applied in the cost
determination process. Given that the regulatory scheme could not
operate without such a background method, and given that the
statute requires the Secretary to make reimbursement decisions "in
accordance with regulations establishing the method or methods to
be used," 42 U. S. C. § 1395x(v)(1)(A), I find the Secretary's
interpretation to be unreasonable and unworthy of deference.
Unlike the Court, therefore, I would hold that § 413.20 requires
the costs incurred by Medicare providers to be reimbursed according
to GAAP in the absence of a specific regulation providing
otherwise. The remainder of my decision flows from this conclusion.
PRM § 233, which departs from the GAAP rule concerning advance
refunding losses, does not have the force of a regulation because
it was promulgated without notice and comment as required by the
Administrative Procedure Act, 5 U. S. C. § 553. And, contrary to
the Secretary's argument, PRM § 233 cannot be a valid
"interpretation" of the Medicare regulations because it is clearly
at odds with the meaning of § 413.20 itself. Thus, I would conclude
that the Secretary's refusal, premised upon an application of PRM §
233, to reimburse the Hospital's bond defeasement costs in
accordance with GAAP was invalid.
II
The remaining arguments advanced by the Court in support of the
Secretary's position do not alter my view of the regulatory scheme.
The Court suggests that a contrary decision, by requiring the
Secretary to comply with the notice and comment provisions of the
Administrative Procedure Act in promulgating reimbursement
regulations, would impose an insurmountable burden on the
Secretary's administration of the Medicare program. I disagree.
Congress obviously
110
thought that the Secretary could manage that task when it
required that she act by regulation. Moreover, despite the Court's
suggestion,
ante, at 96, nothing in my position requires the
agency to adopt substantive rules addressing every detailed and
minute reimbursement issue that might arise. An agency certainly
cannot foresee every factual scenario with which it may be
presented in administering its programs; to fill in the gaps, it
must rely on adjudication of particular cases and other forms of
agency action, such as the promulgation of interpretive rules and
policy statements, that give effect to the statutory principles and
the background methods embodied in the regulations. Far from being
foreclosed from case-by-case adjudication, the Secretary is simply
obligated, in making those reimbursement decisions, to abide by
whatever ground rules she establishes by regulation. Under the
Court's reading of the regulations, the Secretary in this case did
not apply any accounting principle found in the regulations to the
specific facts at issue-and indeed could not have done so because
no such principles are stated outside the detailed provisions
governing particular reimbursement decisions. I believe that the
Medicare Act's command that reimbursement requests by providers be
evaluated "in accordance with regulations establishing the method
or methods to be used" precludes this result.
Moreover, I find it significant that the bond defeasement
situation at issue here
was foreseen. If the Secretary had
the opportunity to include a section on advance refunding costs in
the PRM, then she could have promulgated a regulation to that
effect in compliance with the Administrative Procedure Act, thereby
giving the public a valuable opportunity to comment on the
regulation's wisdom and those adversely affected the chance to
challenge the ultimate rule in court. An agency is bound by the
regulations it promulgates and may not attempt to circumvent the
amendment process through substantive changes recorded in an
informal policy
111
manual that are unsupported by the language of the regulation.
Here, Congress expressed a clear policy in the Medicare Act that
the reimbursement principles selected by the Secretary-whatever
they may be-must be adopted subject to the procedural protections
of the Administrative Procedure Act. I would require the Secretary
to comply with that statutory mandate.
The PRM, of course, remains an important part of the Medicare
reimbursement process, explaining in detail what the regulations
layout in general and providing those who must prepare and process
claims with the agency's statements of policy concerning how those
regulations should be applied in particular contexts. One role for
the manual, therefore, is to assist the Secretary in her daunting
task of overseeing the thousands of Medicare reimbursement
decisions made each year. As the foreword to the PRM explains,
"[t]he procedures and methods set forth in this manual have been
devised to accommodate program needs and the administrative needs
of providers and their intermediaries and will assure that the
reasonable cost regulations are uniformly applied nationally
without regard to where covered services are furnished." Indeed,
large portions of the PRM are devoted to detailed examples,
including step-bystep calculations, of how certain rules should be
applied to particular facts. The manual also provides a forum for
the promulgation of interpretive rules and general statements of
policy, types of agency action that describe what the agency
believes the statute and existing regulations require but that do
not alter the substantive obligations created thereby. Such
interpretive rules are exempt from the notice and comment
provisions of the Administrative Procedure Act, see 5 U. S. C. §
553(b)(A), but they must
explain existing law and not
contradict what the regulations require.
As a result, the policy considerations upon which the Court
focuses, see
ante, at 97-100, are largely beside the point.
Like the Court of Appeals, I do not doubt that the
112
amortization approach embodied in PRM § 233 "squares with
economic reality," 996 F. 2d, at 834, and would likely be upheld as
a rational regulation were it properly promulgated. Nor do I doubt
that amortization of advance refunding costs may have certain
advantages for Medicare reimbursement purposes. It is certainly
true that the Act prohibits the Medicare program from bearing more
or less than its proper share of hospital costs, 42 U. S. C. §
1395x(v)(1)(A)(i), but immediate recognition of advance refunding
losses does not violate this principle. While the Court, like the
Secretary, assumes that advance refunding costs are properly
attributed to health care services rendered over a number of years,
it does not point to any evidence in the record substantiating that
proposition. In fact, what testimony there is supports the view
that it is appropriate to recognize advance refunding losses in the
year of the transaction because the provider no longer carries the
costs of the refunded debt on its books thereafter; the losses in
question simply represent a onetime recognition of the difference
between the net carrying costs of the old bonds and the price
necessary to reacquire them. See,
e. g., App. 14-15,
22. While reasonable people may debate the merits of the two
options, the point is that both appear in the end to represent
economically reasonable and permissible methods of determining what
costs are properly reimbursable and when. Given that neither
approach is commanded by the statute, the cross-subsidization
argument should not alter our reading of § 413.20.
Finally, the Secretary argues that she was given a "broad and
flexible mandate" to prescribe standards for Medicare
reimbursement, and that, as a result, "it is exceedingly unlikely
that the Secretary would have intended, in general regulations
promulgated as part of the initial implementation of the Medicare
Act, to abdicate to the accounting profession (or to anyone else)
ultimate responsibility for making particular cost reimbursement
determinations." Brief for Petitioner 19. She points out that the
purpose of Medicare
113
reimbursement, to provide payment of the necessary costs of
efficient delivery of covered services to Medicare beneficiaries,
may not be identical to the objective of financial accounting,
which is "to provide useful information to management,
shareholders, creditors, and others properly interested" and "has
as its foundation the principle of [financial] conservatism."
Thor Power Tool Co. v.
Commissioner, 439 U. S. 522,
542 (1979) (rejecting taxpayer's assertion that an accounting
principle that conforms to GAAP must be presumed to be permissible
for tax purposes). The Court makes this argument as well. See
ante, at 100-101.
Reading the regulations to employ GAAP, even though it is
possible that the relevant reimbursement standard will change over
time as the position of the accounting profession evolves, does not
imply an abdication of statutory authority but a necessary
invocation of an established body of accounting principles to apply
where specific regulations have not provided otherwise. The
Secretary is, of course, not bound by GAAP in such a situation and,
indeed, has promulgated reimbursement
regulations that
depart from the GAAP default rule in specific situations. Compare,
e. g., § 413.134 (f)(2) (limited recognition of gain
or loss on involuntary conversion of depreciable asset) with R. Kay
& D. Searfoss, Handbook of Accounting and Auditing, ch. 15, p.
14 (2d ed. 1989 and 1994 Supp.) (gains or losses are recognized
under GAAP in the period of disposal of a depreciable asset, even
if reinvested in a similar asset). The Secretary would also be free
to devise a reimbursement scheme that does not involve GAAP as a
background principle at all if she believes, as the Court argues,
that use of GAAP binds her to a cost allocation methodology ill
suited to Medicare reimbursement, see
ante, at 101. Our task
is simply to review the regulations the Secretary has in fact
adopted, and I conclude that the Secretary has incorporated GAAP as
the reimbursement default rule.
114
III
Contrary to the Court's conclusion, I do not believe that the
Administrator's reimbursement decision can be defended as a
rational application of the statute and the existing regulations.
The Hospital sought reimbursement for its advance refunding costs
in accordance with GAAP and in compliance with the Secretary's
published regulations. The Administrator applied PRM § 233, which
calls for a departure from GAAP in this instance, to deny the
Hospital's request; that decision contradicted the agency's own
regulations and therefore resulted in a reimbursement decision that
was "not in accordance with law" within the meaning of the
Administrative Procedure Act, 5 U. S. C. § 706(2)(A). I agree with
the court below that "[t]he 'nexus' that exists in the regulations
between cost reporting and cost reimbursement is too strong ... to
be broken by a rule not adopted in accordance with the rulemaking
requirements of the Administrative Procedure Act." 996 F. 2d, at
836. Because the Court holds otherwise, I respectfully dissent.
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