ment for depreciation of the asset is, in fact, a cost of the production of those services. Moreover, recognition of this cost is necessary to maintain productive capacity for the future. An incentive for funding of depreciation is provided in these principles by the provision that investment income on funded depreciation is not treated as a reduction of allowable interest expense under § 405.419(a) which follows.

[31 FR 14812, Nov. 22, 1966. Redesignated at 42 FR 52826, Sept. 30, 1977]

§ 405.419 Interest expense.

(a) Principle. Necessary and proper interest on both current and capital indebtedness is an allowable cost. However, interest cost incurred as a result of judicial review by a Federal court (as described in § 405.454(1) is not an allowable cost.

(b) Definitions—(1) Interest. Interest is the cost incurred for the use of borrowed funds. Interest on current indebtedness is the cost incurred for funds borrowed for a relatively short term. This is usually for such purposes as working capital for normal operaiing expenses. Interest on capital indebtedness is the cost incurred for funds borrowed for capital purposes, such as acquisition of facilities and equipment, and capital improvements. Generally, loans for capital purposes are long-term loans.

(2) Necessary. Necessary requires that the interest:

(i) Be incurred on a loan made to satisfy a financial need of the provider. Loans which result in excess funds or investments would not be considered necessary.

(ii) Be incurred on a loan made for a purpose reasonably related to patient

care.

(iii) Be reduced by investment income except where such income is from gifts and grants, whether restricted or unrestricted, and which are held separate and not commingled with other funds. Income from funded depreciation or provider's qualified pension fund is not used to reduce interest expense. Interest received as a result of judicial review by a Federal court (as described in § 405.454(1)) is not used to reduce interest expense.

(3) Proper. Proper requires that interest.

(i) Be incurred at a rate not in excess of what a prudent borrower would have had to pay in the money market existing at the time the loan was made.

(ii) Be paid to a lender not related through control or ownership, or personal relationship to the borrowing organization. However, interest is allowable if paid on loans from the provider's donor-restricted funds, the funded depreciation account, or provider's qualified pension fund.

(c) Borrower-lender relationship. (1) To be allowable, interest expense must be incurred on indebtedness established with lenders or lending organizations not related through control, ownership, or personal relationship to the borrower. Presence of any of these factors could affect the "bargaining” process this usually accompanies the making of a loan, and could thus be suggestive of an agreement on higher rates of interest or of unnecessary loans. Loans should be made under terms and conditions that a prudent borrower would make in armslength transactions with lending institutions. The intent of this provision is to assure that loans are legitimate and needed, and that the interest rate is reasonable. Thus, interest paid by the provider to partners, stockholders, or related organizations of the provider would not be allowable. Where the owner uses his own funds in a business, it is reasonable to treat the funds as invested funds or capital, rather than borrowed funds. Therefore, where interest on loans by partners, stockholders, or related organizations is disallowed as a cost solely because of the relationship factor, the principal of such loans shall be treated as invested funds in the computation of the provider's capital under § 405.429.

equity

(2) Exceptions to the general rule regarding interest on loans from controlled sources of funds are made in the following circumstances. Interest on loans to providers by partners, stockholders, or related organizations made prior to July 1, 1966, is allowable as cost, provided that the terms and conditions of payment of such loans

have been maintained in effect without modification subsequent to July 1, 1966. Where the general fund of a provider "borrows" from a donor-restricted fund and pays interest to the restricted fund, this interest expense is an allowable cost. The same treatment is accorded interest paid by the general fund on money "borrowed" from the funded depreciation account of the provider or from the provider's qualified pension fund. In addition, if a provider operated by members of a religious order borrows from the order, interest paid to the order is an allowable cost.

(3) Where funded depreciation is used for purposes other than improvement, replacement, or expansion of facilities or equipment related to patient care, allowable interest expense is reduced to adjust for offsets not made in prior years for earnings on funded depreciation. A similar treatment will be accorded deposits in the provider's qualified pension fund where such deposits are used for other than the purpose for which the fund was established.

(d) Loans not reasonably related to patient care. (1) The following types of loans are not considered to be for a purpose reasonably related to patient

care:

(i) For loans made to finance acquisition of a facility, that portion of the cost that exceeds:

(A) Historical cost as determined under § 405.415(b); or

(B) The cost basis determined under § 405.415(g); and

(ii) Loans made to finance capital stock acquisitions, mergers, or consolidations for which revaluation of assets is not allowed under § 405.415(1).

(2) In determining whether a loan was made for the purpose of acquiring a facility, we will apply any owner's investment or funds first to the tangible assets, then to the intangible assets other than goodwill and lastly to the goodwill. If the owner's investment or funds are not sufficient to cover the cost allowed for tangible assets, we will apply funds borrowed to finance the acquisition to the portion of the allowed cost of the tangible assets not covered by the owner's investment, then to the intangible assets other

than goodwill, and lastly to the goodwill

(e) Limitation on Federal participation for capital expenditures. See § 405.435, "Nonallowable costs related to certain capital expenditures" for situations where interest on borrowed funds is not an allowable cost.

[31 FR 14813, Nov. 22, 1966, as amended at 38 FR 14093, May 29, 1973; 40 FR 32743, Aug. 4, 1975; 41 FR 52050, Nov. 26, 1976. Redesignated at 42 FR 52826, Sept. 30, 1977, and further amended at 44 FR 6915, Feb. 5, 1979]

§ 405.420 Bad debts, charity, and courtesy allowances.

(a) Principle. Bad debts, charity, and courtesy allowances are deductions from revenue and are not to be included in allowable cost; however, bad debts attributable to the deductibles and coinsurance amounts are reimbursable under the program.

(b) Definitions—(1) Bad debts. Bad debts are amounts considered to be uncollectible from accounts and notes receivable which were created or acquired in providing services. "Accounts receivable" and "notes receivable" are designations for claims arising from the rendering of services, and are collectible in money in the relatively near future.

(2) Charity allowances. Charity allowances are reductions in charges made by the provider of services because of the indigence or medical indigence of the patient.

(3) Courtesy allowances. Courtesy allowances indicate a reduction in charges in the form of an allowance to physicians, clergy, members of religious orders, and others as approved by the governing body of the provider, for services received from the provider. Employee fringe benefits, such as hospitalization and personnel health programs, are not considered to be courtesy allowances.

(c) Normal accounting treatment: Reduction in revenue. Bad debts, charity, and courtesy allowances represent reductions in revenue. The failure to collect charges for services rendered does not add to the cost of providing the services. Such costs have already been incurred in the production of the services.

(d) Requirements for title XVIII. Under title XVIII of the Act, costs of covered services furnished beneficiaries are not to be borne by individuals not covered by the health insurance program, and conversely, costs of services provided for other than beneficiaries are not to be borne by the health insurance program. Uncollected revenue related to services rendered to beneficiaries of the program generally means the provider has not recovered the cost of services covered by that revenue. The failure of beneficiaries to pay the deductible and coinsurance amounts can result in the related costs of covered services being borne by other than beneficiaries of title XVIII. To assure that such covered service costs are not borne by others, the costs attributable to the deductible and coinsurance amounts which remain unpaid are added to the title XVIII share of allowable costs. Bad debts arising from other sources are not allowable costs.

(e) Criteria for allowable bad debt. A bad debt must meet the following criteria to be allowable:

(1) The debt must be related to Coered services and derived from deductible and coinsurance amounts.

(2) The provider must be able to establish that reasonable collection efforts were made.

(3) The debt was actually uncollectable when claimed as worthless.

(4) Sound business judgment established that there was no likelihood of recovery at any time in the future.

(f) Charging of bad debts and bad debt recoveries. The amounts uncollectible from specific beneficiaries are to be charged off as bad debts in the accounting period in which the accounts are deemed to be worthless. In some cases an amount previously written off as a bad debt and allocated to the program may be recovered in a subsequent accounting period; in such cases the income therefrom must be used to reduce the cost of beneficiary services for the period in which the collection is made.

(g) Charity allowances. Charity allowances have no relationship to beneficiaries of the health insurance program and are not allowable costs. The cost to the provider of employee

fringe-benefit programs is an allowable element of reimbursement.

[31 FR 14813, Nov. 22, 1966, as amended at 32 FR 5259, Mar. 27, 1967; 32 FR 7126. May 11, 1967. Redesignated at 42 FR 52826, Sept. 30, 1977]

§ 405.421 Cost of educational activities.

(a) A provider's allowable cost may include its net cost of approved educational activities, as calculated under paragraph (g) of this section.

(b) Definition-Approved educational activities. Approved educational activities means formally organized or planned programs of study usually engaged in by providers in order to enhance the quality of patient care in an institution. These activities must be licensed where required by State law. Where licensing is not required, the institution must receive approval from the recognized national professional organization for the particular activi

ty.

Many

(c) Educational activities. providers engage in educational activities including training programs for nurses, medical students, interns and residents, and various paramedical specialties. These programs contribute to the quality of patient care within an institution and are necessary to meet the community's needs for medical and paramedical personnel. It is recognized that the costs of such educational activities should be borne by the community. However, many communities have not assumed responsibility for financing these programs and it is necessary that support be provided by those purchasing health care. Until communities undertake to bear these costs, the program will participate appropriately in the support of these activities. Although the intent of the program is to share in the support of educational activities customarily or traditionally carried on by providers in conjunction with their operations, it is not intended that this program should participate in increased costs resulting from redistribution of costs from educational institutions or units to patient care institutions or units.

(d) "Crientation" and "on-the-job training". The costs of "orientation" and "on-the-job training" are not

(h) Reporting of costs and revenues. Effective for cost reporting periods beginning on or after January 1, 1978, if a provider has received a grant or donation that the donor has designated for an internship or residency program in family medicine, general internal medicine, or general pediatrics, the following requirements apply:

(1) For each program for which the provider received a grant or donation, the provider shall report to its Medicare intermediary, in the form required by HCFA, the following information:

(i) The total direct and indirect costs the provider incurred for the program, as determined under the Medicare cost-finding principles in § 405.453;

(ii) The total revenues the provider received for the program, including tuition, grants and donations designated for the program, and patient care revenues attributable to the program, as calculated under paragraph (h)(2) of this section;

(iii) The amount of the difference between program costs and program revenues; and

(iv) The name and address of the donor of each grant or donation designated for the program, and the amount given by each donor.

(2) For purposes of the report required under paragraph (h)(1) of this section, the provider shall determine the portion of patient care revenues for each department that is attributable to an internship or residency program based on the ratio of that program's costs allocated to the department under § 405.453 to total costs allocated to the department under § 405.453.

(3) The Medicare intermediary will notify HCFA of the amount of any surplus of program revenues over program costs that a provider reports under paragraph (h)(1) of this section, and of the name and address of each donor that supported the program.

(4) If a provider reports a surplus for a program under paragraph (h)(1) of this section that is equal to or less than the amount of the grant the provider received for the program from the Public Health Service, HCFA will notify the Public Health Service of the amount of the surplus. If the sur

plus exceeds the amount of the grant the provider received for the program from the Public Health Service, HCFA will notify the Public Health Service and other donors of the amount of the surplus. If the provider did not receive a Public Health Service grant for the program, HCFA will notify other donors of the amount of the surplus.

(Sections 1102 and 1871 of the Social Security Act (42 U.S.C. 1302 and 1395hh) Catalog of Federal Domestic Assistance Program No. 13.773, Medicare-Hospital Insurance) [31 FR 14814, Nov. 22, 1966, as amended at 39 FR 32328, Sept. 6, 1974. Redesignated at 42 FR 52826, Sept. 30, 1977, and further amended at 45 FR 5:786, Aug. 5, 1980; 45 FR 59153, Sept. 8, 1980]

(a) Principle. Costs incurred for research purposes, over and above usual patient care, are not includable as allowable costs.

(b) Application. (1) There are numerous sources of financing for health-related research activities. Funds for this purpose are provided under many Federal programs and by other tax-supported agencies. Also, many foundations, voluntary health agencies, and other private organizations, as well as individuals, sponsor or contribute to the support of medical and related research. Funds available from such sources are generally ample to meet basic medical and hospital research needs. A further consideration is that quality review should be assured as a condition of governmental support for research. Provisions for such review would introduce special difficulties in the health insurance programs.

(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 FR 14814, Nov. 22, 1966. Redesignated at 42 FR 52826 Sept. 30, 1977]