The dispute in this case concerns the timing of Medicare reimbursement payments for costs incurred by provider hospitals under the Medicare Program. The particular costs at issue herein stem from an "advance refunding" transaction conducted by Mother Frances Hospital of Tyler, Texas (the "Hospital") in 1987. In that transaction, the Hospital incurred "defeasance" costs when it refunded an old series of bonds ahead of schedule in order to obtain new financing. All parties agree that these costs are reimbursable. The only issue that is contested is when and how this reimbursement is to be made. The Hospital maintains that such a loss is reimbursable immediately in a lump sum. By contrast, the Secretary of Health and Human Services (the "Secretary") contends that reimbursement should be amortized over the life of the old bonds. The district court ruled in favor of the Secretary. We REVERSE.

In 1987, the Hospital borrowed money by issuing a new series of bonds. Most of the proceeds of this 1987 bond issue were used in an "advance refunding" transaction to refinance an earlier, 1983 bond issue. In this transaction, the Hospital placed the funds from the new bond issue into an irrevocable trust account under the direction of an independent trustee. The trustee invested this money in U.S. Treasury obligations at an interest rate sufficient to pay the principal and interest of the old bonds as they came due. By means of this transaction, the Hospital was able to transfer its legal liability for the 1983 bonds to the trustee. Thus, the Hospital's liability for the bonds was "defeased."

As a result of this transaction, the Hospital incurred a loss.1 This loss occurred because in order to create a sufficient fund in the trust to service the old bonds, the Hospital had to borrow a greater principal amount in the new bond issue.2 Thus, after the 1987 transaction, the Hospital had a greater debt.3

Acting in accordance with Generally Accepted Accounting Principles (GAAP)4, as is required by 42 C.F.R. Sec. 413.20, the Hospital sought reimbursement for this entire loss in 1987. This request was denied, though, by the "fiscal intermediary"5 to which such requests are initially routed. Instead, the intermediary allowed only a portion of this loss in 1987 and sought to space out the remaining reimbursement by amortizing it over the life of the old bonds. The Hospital appealed this decision to the Provider Reimbursement Review Board, a body established by the Secretary pursuant to 42 U.S.C. Sec. 1395oo to hear these appeals. Finding that the regulations implementing the Medicare program provided for the use of GAAP in the absence of specific regulations to the contrary, the Board reversed the decision of the intermediary and issued a decision calling for full reimbursement in 1987.

The Board's decision was, in turn, reviewed by the Administrator of the Health Care Finance Administration. In making his decision, the Administrator relied on a policy announced in section 233 of the agency's Provider Reimbursement Manual (PRM) calling for amortization of advance refunding costs. Accordingly, the Administrator reversed the decision of the Board. Under 42 C.F.R. Sec. 405.1875, this decision represented the final decision of the Secretary.

From this decision, the Hospital appealed to the district court where arguments were heard before a magistrate judge. The magistrate judge issued a Report and Recommendation in favor of the Hospital finding that section 233 was no more than a manual provision without the force and effect of law and thus was ineffective to change the meaning of the governing regulations, 42 C.F.R. Sec. 413.20(a) and 413.24(a) and (b)(2), which call for the use of GAAP. This recommendation was rejected by the district judge, however, who found that section 233 was merely interpretive of the regulations and was therefore valid. Hence, the district court granted summary judgment for the Secretary, 818 F. Supp. 990. The Hospital timely appeals from this decision.

Under the Medicare statute, the Secretary must reimburse provider hospitals for the reasonable costs of services rendered to eligible Medicare beneficiaries. The calculation of these reasonable costs "shall be determined in accordance with regulations establishing the method or methods to be used...." 42 U.S.C. Sec. 1395x(v). Moreover, "[i]n prescribing the regulations, the Secretary shall consider, among other things, the principles generally applied by national organizations...." Id. These "national organizations" utilize GAAP.

This statute only states that the Secretary must "consider" GAAP in making regulations. It does not say that she must pass regulations adopting GAAP. However, under 42 C.F.R. Sec. 413 et seq., entitled "Principles of Reasonable Cost Reimbursement," she appears to have done so. Under section 413.20(a), the regulations state that

[t]he 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 (emphasis added).

Moreover, section 413.24(a) states that "[t]he cost data must be based on an approved method of cost finding and on the accrual basis of accounting." Lastly, section 413.24(b)(2) instructs that

[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 (emphasis added).

In light of GAAP, the manifest conclusion from reading these regulations is that the Hospital was entitled to full reimbursement for this advance refunding loss in 1987.

Nevertheless, the Secretary seeks to avoid this result. She argues that the regulations merely provide for GAAP with respect to a hospital's reporting of its costs and do not compel a result with respect to the timing of cost reimbursement. Instead, she maintains that the timing of cost reimbursement in advance refunding transactions should be governed by PRM Sec. 233. This provision speaks directly to advance refunding transactions and, contrary to GAAP, clearly provides for amortization of the loss.6

This argument by the Secretary has not fared well in the federal courts. Aside from the decision by the district court herein, every district court to have addressed the issue of the timing of reimbursement for an advance refunding loss has held, consistent with GAAP and contrary to the Secretary's argument, that this loss is immediately reimbursable.7 Further, this issue was thoroughly discussed and the Secretary's arguments were rejected by the Sixth Circuit in Guernsey Memorial Hosp. v. Secretary of Health and Human Services8, 996 F.2d 830 (6th Cir.1993).

In Guernsey, a case on all fours with the case sub judice, the Sixth Circuit determined that the language and structure of the Medicare regulations unambiguously provide that reimbursement will be made on the basis indicated by GAAP. Id. at 835. Specifically, the court found that

[w]ere it not for Sec. 233 of the Provider Reimbursement Manual, any fair minded person reading the regulations in the light of generally accepted accounting principles would have to conclude that [the hospital] was entitled to reimbursement for its advance refunding costs in the year in which, under GAAP, the costs were deemed to have been incurred.

Id. at 834.

As to section 233, the Guernsey court concluded that it was invalid. Id. at 835. This is because issuance of the Provider Reimbursement Manual was not preceded by the formal rulemaking requirements of 5 U.S.C. Sec. 5539 and thus it does not carry the force and effect of law or regulation. National Medical Enterprises v. Bowen, 851 F.2d 291, 293 (9th Cir.1988). Lacking these formal requisites, section 233 could only be valid if it were an "interpretive" rule as opposed to a "substantive" rule.10 See 5 U.S.C. Sec. 553(b)(A).

Accordingly, the Secretary argued in Guernsey, as she argues herein, that section 233 merely interprets the regulations. The Guernsey court, however, disagreed. It found that as opposed to merely interpreting existing regulations, section 233 impermissibly changed the meaning of the properly promulgated regulations. Id. at 835; See also Graham, 832 F. Supp. at 1243. Hence, the Guernsey court found that section 233 worked a substantive change in the regulations and was thus an invalid attempt to make a substantive rule without the formalities of the Administrative Procedures Act.11 Guernsey, 996 F.2d at 832.

We agree with the reasoning of Guernsey and adopt its holding that the Medicare regulations provide for the use of GAAP in determining the timing of Medicare reimbursement in advance refunding transactions and that section 233, which provides to the contrary, is an invalid attempt to promulgate a substantive rule without complying with the rulemaking formalities. Moreover, we see nothing contrary to this holding in our decision in Sun Towers, Inc. v. Heckler, 725 F.2d 315 (5th Cir.), cert. denied, 469 U.S. 823, 105 S. Ct. 100, 83 L. Ed. 2d 45 (1984).

In Sun Towers, this Court was called on to decide whether certain costs were allowable under the Medicare program. Among these costs were "stock maintenance costs."12 Id. at 326. The Secretary disallowed reimbursement for these costs finding that they were only tangentially related to the care of Medicare beneficiaries.13 The district court, however, reversed the Secretary's determination.

Among the arguments the district court presented to support its decision in Sun Towers was an argument based on GAAP. Id. at 328. Under GAAP, stock maintenance costs are recognized as general and administrative expenses. Thus, the district court argued that these costs were allowable because 42 C.F.R. Sec. 405.40614 required GAAP to be applied in determining reasonable costs. Id.

We rejected this argument holding that GAAP was not necessarily to be used in determining if a particular cost was allowable. Id. at 328-29. In particular, we found that section 405.406 was not designed to determine the "costs allowable under the Medicare Act. The regulation is directed at the type of financial data and reports required of providers; it is not a regulation affecting the substantive provisions of the program as to what constitutes reimbursable costs." Id. at 329 (quoting American Medical International, Inc. v. Secretary of Health, Education and Welfare, 466 F. Supp. 605, 623 (D.D.C.1979), aff'd 677 F.2d 118 (D.C.Cir.1981) (emphasis added). Hence, we reversed the decision of the district court and held that the Secretary's determination was neither arbitrary nor capricious. Sun Towers, 725 F.2d at 330.

In Sun Towers, the issue was whether a particular cost was allowable at all. In the case at bar, as it was in the Guernsey case, the issue is when a cost that was clearly allowable should have been reimbursed. These are different questions and we do not believe that Sun Towers speaks to the issue of when reimbursement is to be made.

Accordingly, we adhere to our decision in Sun Towers as to whether a particular cost is allowable. However, we follow Guernsey as to when advance refunding costs are to be reimbursed.

For the reasons stated above, we hold that, under the applicable Medicare regulations, the Hospital was entitled to reimbursement for the full amount of its advance refunding loss in 1987 plus interest. Therefore, we REVERSE the decision of the district court and REMAND this case for a determination of the exact amount of the advance refunding loss and the amount reimburseable under Medicare plus interest from 1987.15