A hospital or skilled nursing facility that treats Medicare patients does not close its revenue story at year end. Interim payments flow all year, but the final amount owed is set months or years later when the cost report is filed, audited and settled. Until then, the financial statements carry an estimate: a receivable from Medicare or a payable back to it. That estimate is among the most judgmental numbers in a healthcare audit file.
This guide covers where the number comes from, what the regulations say about it, and how to test it.
Where the settlement comes from
Medicare-certified institutional providers are required to submit an annual cost report to a Medicare Administrative Contractor (MAC). CMS stores the data in the Healthcare Provider Cost Reporting Information System. Hospitals file on form CMS-2552-10 and skilled nursing facilities on CMS-2540-10. A cost report holds facility characteristics, utilization, costs and charges by cost center, Medicare settlement data and financial statement data.
Under 42 CFR 413.24, cost reports generally cover a consecutive 12-month period and are due by the last day of the fifth month after the period closes. Costs are reported on the accrual basis, except for governmental institutions that operate on a cash basis. The underlying records must be capable of verification by qualified auditors. For a paragraph-by-paragraph read of 413.24, including cost-finding methods, certification and acceptable submission, see Medicare cost report audit considerations.
The cost report compares allowable reimbursable cost to the interim payments received. The difference is the settlement. A positive number is due to the provider, and a negative number is an overpayment the provider owes back.
How the estimate is recorded
Settlements under cost reimbursement agreements are estimated and recorded in the period the related services are rendered. They are adjusted in later periods as final settlements are determined. Final amounts under Medicare and Medicaid arrive in subsequent years because of program audits and appeal rights. Management estimates the amount for each payor from the applicable regulations and contract terms. This is an accounting estimate, so AU-C 540 governs the audit approach, including the risk of management bias. See AU-C 540 and point estimates, ranges and management bias.
The settlement timeline
Knowing the status of each open year drives the whole test plan.
- As submitted. The provider has filed. Nothing is final.
- Settled without audit or settled with audit. The MAC has issued a notice of program reimbursement under 42 CFR 405.1803. The notice explains how reimbursement was calculated against the amount claimed. The provider has 180 days after receipt to request a hearing.
- Reopened or amended. Under 42 CFR 405.1885 a determination may be reopened on the contractor's own motion or at the provider's request within 3 years of the determination, and the period runs separately for each specific finding. A determination procured by fraud or similar fault may be reopened at any time.
A reopening can change a year that looks closed.
Risk areas
Bad debts. Bad debts are generally revenue deductions, but unpaid Medicare deductible and coinsurance on covered services can be reimbursed. Under 42 CFR 413.89 the debt must relate to covered services, reasonable collection efforts must have been made, the debt must actually have been uncollectible when claimed as worthless, and there must be no likelihood of future recovery. For non-indigent patients, collection effort must resemble the effort made on comparable non-Medicare patients. For cost reporting periods beginning on or after October 1, 2020, the bill must go out no later than 120 days after the latest relevant remittance advice, and collection continues at least 120 days after that. Indigence needs a documented review of income and assets convertible to cash, and a patient's declaration of inability to pay is not sole proof.
A 2022 HHS Office of Inspector General report sampled 67 cost reports and 148 bad debts. Of those, 86 related to patients deemed indigent. Of the remaining 62, 18 failed federal requirements, and four more were claimed at amounts that did not reflect what beneficiaries owed. The 22 items produced $29,787 in unallowable reimbursement. OIG attributed the result to contractors not focusing on bad debts during audits.
Cost finding and allocation. Overhead cannot be improperly allocated, and costs of services furnished to free-standing entities must come out of the provider's allowable costs.
Protested items. To be reimbursed, an item must be claimed in full or self-disallowed as a protested amount with supporting worksheets. An item that was neither claimed nor protested has no appeal path.
Prior year true-ups. Gains from final settlements that land in the current year belong to prior service periods. Disclose the change in estimate when material.
Typical audit procedures
- Build a schedule of every open cost reporting year with status, filing date, NPR date, appeal status, reopening activity and the recorded receivable or payable.
- Obtain filed cost reports and the worksheets that produce the settlement. Reconcile reported costs to the general ledger and the audited trial balance.
- Obtain NPRs and MAC correspondence. Compare each settled year's final amount to the amount previously recorded and analyze the pattern of true-ups. Consistent favorable true-ups point to a conservative estimate. Consistent unfavorable ones point to an aggressive one.
- Test the bad debt claim by sampling accounts. Inspect billing dates, collection letters and calls, agency placement and return, and indigence files. Confirm recoveries after write-off reduced the claim.
- Evaluate the allocation statistics that drive cost finding, such as square footage, patient days and FTEs, and confirm the step-down method matches the filed report.
- Read subsequent events through the report date for notices, audit adjustments and appeals.
Worked example
This is an illustrative example. A hospital recorded interim Medicare payments of $48.0 million for the year. Its filed cost report computes reimbursable cost and PPS amounts of $48.9 million, so management recorded a $900,000 settlement receivable.
In testing, the auditor samples bad debt accounts. Several fail the collection-effort criteria and several indigence files rest only on patient statements. Projecting the exceptions across the claimed population indicates $250,000 of the bad debt claim would not survive MAC audit. The adjusted settlement is $650,000. The auditor proposes a $250,000 reduction in the receivable and revenue. The prior two settled years show final results below the amounts recorded, which supports the conclusion that the original estimate was biased upward.
PBC items
Add these to the standard PBC list:
- Filed cost reports for each open year, with the electronic submission confirmation
- NPRs, audit adjustment reports and MAC correspondence
- Appeal filings and reopening requests
- Bad debt listings with billing and collection documentation and indigence determinations
- Allocation statistics and the step-down worksheets
- Reconciliation of cost report costs to the trial balance
- Management's settlement receivable and payable schedule by payor and year
- Legal letter responses covering reimbursement disputes
Red flags
- Recorded settlements that exceed the filed cost report amount
- Open years with no audit activity and no estimate review
- Bad debt claims that jump without a volume explanation
- Cost reports filed late or amended repeatedly
- Estimates that never change after settlement notices arrive
Sources
- 42 CFR 413.20, Financial data and reports, Cornell Legal Information Institute (law.cornell.edu/cfr/text/42/413.20)
- 42 CFR 413.24, Adequate cost data and cost finding, Cornell Legal Information Institute (law.cornell.edu/cfr/text/42/413.24)
- 42 CFR 413.89, Bad debts, charity, and courtesy allowances, Cornell Legal Information Institute (law.cornell.edu/cfr/text/42/413.89)
- 42 CFR 405.1803, Contractor determination and notice of amount of Medicare reimbursement, Cornell Legal Information Institute (law.cornell.edu/cfr/text/42/405.1803)
- 42 CFR 405.1885, Reopening a determination or decision, Cornell Legal Information Institute (law.cornell.edu/cfr/text/42/405.1885)
- CMS, Cost Reports (form CMS-2552-10 for hospitals, CMS-2540-10 for skilled nursing facilities, and HCRIS): https://www.cms.gov/data-research/statistics-trends-and-reports/cost-reports
- HHS Office of Inspector General, Providers Did Not Always Comply With Federal Requirements When Claiming Medicare Bad Debts (2022): https://oig.hhs.gov/reports/all/2022/providers-did-not-always-comply-with-federal-requirements-when-claiming-medicare-bad-debts/
- AICPA, AU-C Section 540, Auditing Accounting Estimates and Related Disclosures
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