The annual costs of hospital care under the medicare program exceed $20 billion per year. In the medicare legislation, Congress mandated that reimbursement to hospitals be limited to the costs of treating medicare patients. Ideally, neither nonmedicare patients nor hospitals would bear the costs of medicare patients nor would the government bear costs of nonmedicare patients. Given the large sums involved, it is not surprising that cost reimbursement specialists, computer programs, publications, and other products and services have arisen to provide hospital administrators with the assistance needed to obtain an appropriate reimbursement for medicare patient services.

Hospital departments may be divided into two categories: (1) revenue-producing departments and (2) nonrevenue-producing departments. This classification is simple but useful. The traditional accounting concepts associated with "service department cost allocation," while appropriate to this context, lead to a great deal of confusion in terminology since all of the hospital's departments are considered to be rendering services.

Costs of revenue-producing departments are charged to medicare and nonmedicare patients on the basis of actual use of the departments. These costs are relatively simple to apportion. Costs of nonrevenue-producing departments are somewhat more difficult to apportion. The approach to finding the appropriate distribution of these costs begins with the establishment of a reasonable basis for allocating nonrevenue-producing department costs to revenue-producing departments.

Statistical measures of the relationships between departments must be ascertained.

The cost allocation bases listed in Exhibit A were established as acceptable for cost reimbursement purposes. The regulated order of allocation must be used for medicare reimbursement.

A hospital may then use either the reciprocal method to the cost allocation problem, or they may use the step method. If the step method is used, the order of departments for allocation is the same order as that by which the departments are listed in Exhibit A. Thus, Depreciation—Buildings is allocated before Depreciation—

Movable Equipment. Cost centers must be established for each of these nonrevenue-producing costs that are relevant to a particular hospital's operations.