New York State Department of Social Services, DAB No. 1394 (1993)

Department of Health and Human Services

DEPARTMENTAL APPEALS BOARD

Appellate Division

SUBJECT:  New York State Department of Social Services

DATE:  March 5, 1993
Docket No. A-92-35
Decision No. 1394

                        DECISION

The New York State Department of Social Services (NYSDSS) appealed a
disallowance of $4,493,585 in federal financial participation (FFP)
claimed under Title XIX (Medicaid) of the Social Security Act (Act).
(NYSDSS originally appealed $5,024,406, but conceded that $530,821 of
the disallowance was correct, leaving the above amount in dispute.)
This disallowance arose from a review of per diem rates charged for
intermediate care facilities for the mentally retarded (ICF/MRs) by the
New York State Office of Mental Retardation and Developmental
Disabilities (OMRDD).  The review was performed by Urbach, Kahn and
Werlin, P.C. (UKW) under contract with the Health Care Financing
Administration (HCFA) and covered costs included in the base year ending
March 31, 1987 for use in reimbursement rates for fiscal year (FY)
1988-89. Based on the results of the review, HCFA determined that NYSDSS
had overstated the base year costs by improperly including general State
interest costs, claiming depreciation costs for assets whose existence
and use could not be verified due to inadequate documentation,
incorrectly treating certain assets as abandoned, omitting salvage
values from depreciation calculations, incorrectly amortizing certain
design costs, including design costs which already had been fully
amortized, and making certain mathematical errors in calculation.

For the reasons discussed below, we uphold the disallowance in part,
reverse it in part, and remand part of the disallowance for further
development, as explained in detail in the conclusion section at the end
of this decision.

Background

In order to be eligible for FFP under the Act, state claims for the
costs of medical assistance services must be in accordance with an
approved Medicaid state plan.  Section 1903(a) of the Act.  ICF/MR
services are included in the definition of "medical assistance" eligible
for reimbursement based on rates determined by methods and standards in
the plan.  Sections 1902(a)(13)(A) and 1905(a) of the Act.  The state
must find and make assurances to the Secretary that the rates are
reasonable and adequate to meet the costs of efficiently and
economically operated facilities meeting applicable regulatory
requirements.  Section 1902(a)(13)(A) of the Act ("Boren Amendment"); 42
C.F.R. Part 447, Subpart C.

New York's approved state plan (State plan) provides for payment of
services in public ICF/MRs based on a per diem rate determined by
methods set out in the plan.  See NYSDSS Exhibit (Ex.) 7 (relevant
excerpts of New York State plan).  The rate for the facilities at issue
here (developmental centers with more than 30 beds) is determined by
reference to the statewide average rate based on cost reports from
developmental centers for a base period, in this case the fiscal year
ending March 31, 1987.  Certain costs, such as overhead and personal
services costs, are adjusted by a trend factor for later periods, while
capital costs are not trended.  The interest and depreciation costs at
issue here were not trended.

The State plan provides guidance as to which costs are allowable in
calculating the base period costs, and further provides that, except
where specific rules are stated in the plan, the Medicare Provider
Reimbursement Manual (PRM) will be used as the "major determining factor
in deciding on the allowability of costs."  NYSDSS Ex. 7, at 22.  The
plan sets out an overall requirement that, "to be considered allowable,
costs must be properly chargeable to necessary client care . . . ."  Id.
Where both the plan and the PRM are silent, allowability is to be "based
on reasonableness and relationship to client care and generally accepted
accounting principles."  Id. at 23.

The UKW review gauged the allowability of depreciation costs included in
base period rates for ICF/MR facilities against the standards provided
in the State plan. 1/  The costs which HCFA determined to be unallowable
based on the UKW review were as follows: 2/

       (1)  Interest costs on general State borrowing ($4,457,741).

     (2)  Depreciation on assets which were not adequately documented or
     were not in use for Medicaid purposes ($2,401,398), based on a
random statistical sample and examination of OMRDD depreciable assets.

       (3)  Abandonment loss on a facility transferred without cost for
       use as a public college campus ($1,088,402).

       (4)  Excess depreciation because of the failure to assign any
       salvage value for depreciated assets ($1,883,997).

       (5)  Design costs amortized over too short a period ($529,357).

       (6)  Design costs which were already fully depreciated by the
       base year ($8,389).

       (7)  Mathematical errors in the calculation of depreciation on
       some assets ($4,881).

The total was reduced by items which HCFA found had been understated in
NYSDSS' claims amounting to $325,352, and then adjusted to reflect the
State's 50 percent medical assistance rate for FFP, resulting in the
original disallowance amount of $5,024,406.

Analysis

1.  Allowability of interest on general State borrowing

       A.  Background and arguments

Each year, New York State issues tax and revenue anticipation notes
(TRANs, also known as "spring borrowing") for short-term borrowing to
cover disbursements scheduled to be made during the spring quarter,
before sufficient tax revenues are collected. NYSDSS Br. at 9.  The
proceeds of the TRANs go to New York State's General Fund, from which
they are dispensed for payments to local governments and school
districts and day-to-day State operations.  Id. at 9-10, and exhibits
cited therein.  A portion of OMRDD's funding in the spring quarter was
attributed to proceeds from TRANs. OMRDD included a share of the
interest costs for the TRANs, net of the interest income derived by the
State on the TRANs proceeds, as part of OMRDD's net capital costs.
NYSDSS Ex. 1 (UKW final report at internal ex. H).  The proportion of
net interest costs allocated to OMRDD was based on the ratio of OMRDD's
operational budget to the total State budget for local assistance and
State purposes, 3.3496 percent.  NYSDSS Br. at 10.

NYSDSS argued that these interest costs were properly included as
indirect operating expenses under the State plan as interest on working
capital indebtedness.  NYSDSS argued that resort to the PRM was
unnecessary in determining the allowability of the interest costs, since
this explicit provision applies.  Even if Medicare standards were to
apply, NYSDSS argued, the Medicare regulations and PRM requirements
would allow these interest costs.  HCFA contended that TRANs costs are
incurred to manage the State's general cash flow and are unrelated to
the operating expenses of particular OMRDD facilities.  Further, HCFA
argued that interest on TRANs is expressly prohibited under the PRM and
cannot be properly allocated to OMRDD through a cost allocation plan
(CAP).

We conclude that the interest costs were not properly included in the
calculation of the reimbursement rates.

       B.  Discussion

             1.  The State plan does not specifically address these
             interest costs.

The State plan allows "[i]nterest on working capital indebtedness,"
subject to certain standards.  NYSDSS Ex. 7, at 29.  The State plan does
not define interest on working capital indebtedness, so we look to the
PRM for assistance in determining the scope of that phrase.  The PRM
defines "working capital borrowing" as short term borrowing for "normal
operating expenses."  PRM, . 202.1 (February 1991). 3/  NYSDSS did not
persuade us that the "normal operating expenses" of public facilities
could be read to include interest costs related to operation of State
government generally, rather than borrowing designated for or tied to
any particular facility. 4/  Moreover, the discussion of interest in the
State plan occurs in a section addressing costs of individual
facilities, such as rentals, depreciation, and moveable equipment costs.
5/  By contrast, the indebtedness involved here is remote from the
operation of any particular facility, being based on state-wide
operations.  Thus, we find that the State plan did not expressly address
the costs at issue here, since its provision on working capital
indebtedness on its face does not include costs of general government
borrowing.

NYSDSS also argued that we should look to its consistent administrative
practice, under which it allegedly included TRANs interest in OMRDD
rates for five years before the period at issue, for evidence of the
correct interpretation of "working capital indebtedness."  NYSDSS Reply
Br. at 15.  NYSDSS argued that HCFA acquiesced in this practice because
a prior HCFA review did not identify these costs as unallowable, even
though items of less monetary value were questioned.  Id. at 15-16;
NYSDSS Supp.  Resp. Br. at 4-8; NYSDSS Exs. 42 and 43.  HCFA responded
that the earlier review dealt with other major problems and simply did
not address the allowability of the TRANs interest, even though it
appeared in listings of OMRDD cost components. HCFA Supp. Br. at 4-6;
Dunstan Affidavit at 3.

Administrative practice is relevant to determining whether the state
actually had an interpretation of its state plan which it was applying
or merely developed one after-the-fact to justify non-compliance with
the state plan.  However, a "state's interpretation cannot prevail
unless it is reasonable in light of the purpose of the provision and
program requirements."  South Dakota Dept. of Social Services, DAB No.
934, at 4 (1988).  We do not find the interpretation proposed by NYSDSS
to be reasonable, because the context in the State plan weighs against
such a broad interpretation of "working capital indebtedness" and
because the Medicaid program is aimed at providing federal funding for
the costs of medical services to recipients, not for State cash flow
management.  Nor do we find HCFA's failure to disallow a cost in an
earlier review to be evidence that the cost is allowable under the State
plan.

In addition, the State plan requires that costs be chargeable to
necessary client care. NYSDSS Ex. 7, at 22.  NYSDSS failed to
demonstrate a necessary connection between the provision of client care
in its facilities and the selection of a state-wide cash flow management
device.  Basically, the "necessity" of incurring the interest costs was
unrelated to OMRDD's operations, but rather depended on the State's
choice as to the source of its funding to OMRDD.  The State is
essentially trying to shift some of the costs of raising the revenue to
cover its own share of Medicaid funding for these facilities to the
federal government.

             2.  The PRM expressly disallows these interest costs.

Since the State plan does not specifically deal with the treatment of
these costs, the plan requires us to look to the PRM for guidance. 6/
"Tax anticipation warrants," such as the TRANs at issue here, are
expressly named in the PRM as unallowable central service costs.  Id. at
. 2156.1.  In addition, the PRM prohibits the inclusion of the costs of
financing general government functions in the costs used to determine
public facilities' reimbursement rates.  PRM, Part 2156 (May 1976).

Since the State plan is structured to rely on the PRM, except when
specifically providing otherwise, the plan's silence on a subject
expressly addressed in the PRM can only be interpreted as acceptance of
the PRM rule.  We therefore conclude that the interest costs related to
TRANs could not properly be included in the reimbursement rate
calculations using the standards of the PRM as incorporated in the State
plan. 7/

Moreover, we note that the PRM excludes the costs of tax anticipation
warrants and general government bonds (even if the proceeds are used to
acquire public facilities), despite allowing "[n]ecessary and proper
interest on both current and capital indebtedness," including "working
capital for normal operating expenses."  PRM, .. 200 and 202.1 (February
1991).  This reinforces our conclusion in the prior section that it
would be unreasonable to read the State plan allowance of "interest on
working capital indebtedness" of a facility as referring to the costs of
indebtedness incurred for general government purposes, even if some part
of the proceeds eventually benefits a public facility.

             3.  These interest costs are not allowable as either
             state-wide costs or indirect facility costs.

Furthermore, the State plan requires state-wide costs, such as the
interest costs at issue here, to be included in the reimbursement rate
only by allocation through a state-wide CAP.  NYSDSS Ex. 7, at 20.  The
interest costs here were not, and could not be, included in a state-wide
CAP because they are not allowable under Office of Management and Budget
(OMB) Circular A-87, Attachment B, section D.7, which makes unallowable
"[i]nterest on borrowings (however represented)."

NYSDSS argued that OMB Circular A-87 is inapplicable to this case
because prior Board decisions have held that reimbursement rates are
determined by methods and cost principles in each state plan rather than
by the principles of OMB Circular A-87. NYSDSS Br. at 11, citing
Missouri Dept. of Social Services, DAB No. 630 (1985), and North
Carolina Dept. of Human Resources, DAB No. 1133 (1990).  In Missouri,
the state included in the costs on which reimbursement rates for its
publicly-owned ICF/MRs were based certain central services costs which
were covered by an approved state-wide CAP.  It was undisputed that the
state calculated the reimbursement rates in accordance with its approved
state Medicaid plan.  HCFA argued that the costs were unallowable in
determining the rates because the department operating the ICF/MRs did
not have an approved CAP to distribute the indirect costs to the
particular ICF/MRs as allegedly required by OMB Circular A-87.  The
Board held that a public ICF/MR is not bound to follow the requirements
of OMB Circular A-87 in determining reimbursement rates because its
terms exempt "publicly-owned . . . providers of medical care."  OMB
Circular A-87, Attachment A, section A.3; Missouri, DAB No. 630, at 6.
In North Carolina, the Board reviewed the use of accrual accounting
methods for recording vacation leave for employees of publicly-owned
ICF/MRs which, according to HCFA, violated OMB Circular A-87 principles
even though they were required by an approved state plan amendment.  The
Board held that OMB Circular A-87 "cannot be used to override principles
made directly applicable for determining rates under the State plan."
North Carolina, DAB No. 1133, at 9.

We agree that OMB Circular A-87 does not apply directly to the
calculation of reimbursement rates for public facilities.  The State
plan here, however, provides that central services costs may be included
in the reimbursement rates only as they are allocated under the
state-wide CAP.  OMB Circular A-87 does apply to what costs may be
included in the CAP.  45 C.F.R. . 95.507(a)(2).  Furthermore, unlike in
the situations in Missouri and North Carolina, the problem here is that
the reimbursement rates were not calculated in accordance with the
requirements of the State plan.

The State plan allows inclusion of overhead 8/ in only two ways:  (1)
state-wide costs allocated through the state-wide CAP, and (2) other
indirect costs of the facilities if the costs are "eligible for
reimbursement pursuant to [OMB Circular A-87], provided that other
indirect costs may be included pursuant to guidelines specified herein
by the commissioner."  State Ex. 7, at 20.  As discussed above, these
costs were not allocated through the state-wide CAP and were not
eligible for reimbursement pursuant to OMB Circular A-87.  NYSDSS did
not point to any specific guidelines allowing inclusion of TRANs
interest as an indirect cost, except the mention of "working capital
indebtedness," which we have already found to be inapplicable.  OMB
Circular A-87 is therefore not being used in this case to "override"
State plan provisions, as in North Carolina, but rather to comply with
them.  Thus, TRANs interest does not meet either the State plan
requirements as an overhead cost or the PRM requirements for interest
costs.

NYSDSS also asserted that even if OMB Circular A-87 were applicable, the
prohibition on interest on borrowings should not be applied or should be
interpreted very narrowly based on its history.  NYSDSS Br. at 15, n.9.
In this regard, NYSDSS incorporated a brief from another case before the
Board, Docket No. A-92-52.  NYSDSS's challenges to the interest
prohibition were rejected in the decision in that case and are no more
persuasive now. New York State Dept. of Social Services, DAB No. 1360
(1992).  We also note that NYSDSS in prior challenges to OMB Circular
A-87's interest prohibition asserted that the prohibition was intended
to be limited to "interest relating to equity capital of contractors, or
the analogous `spring borrowing' to raise State funds to cover
operations before revenue is realized."  New York State Dept. of Social
Services, DAB No. 1336, at 20 (1992) (citation omitted).  Thus, NYSDSS
then asserted that interest on "spring borrowing," the very interest
which it now seeks to include as an allowable cost, was within the scope
of the interest prohibition.

             4.  The Boren Amendment does not make these costsallowable.

NYSDSS also pointed to the Boren Amendment as intended to vest broad
flexibility in the states to develop reimbursement rates without
excessive federal oversight, so long as the rates are set in accordance
with "the methods and standards in its Medicaid state plan" and the
required assurances are made.  NYSDSS Br. at 11-12, and cases cited
therein.  NYSDSS argued that including these interest costs in its
approved state plan was within its discretion under the Boren Amendment
and that the Boren Amendment requires us to defer to its reasonable
interpretation of the State plan and conclude that interest on the TRANs
borrowing is allowable as working capital indebtedness. NYSDSS Br. at
14-15.

While the Boren Amendment contemplates considerable discretion for the
states to decide what methods to include in a state plan, it does not
require us to defer to the state interpretation of a plan provision
where that interpretation is not reasonably supported by the language of
the plan provision or by the context and purpose of the provision.
South Dakota Dept. of Social Services, DAB No. 934, at 4 (1988).  Here,
we have already found that working capital indebtedness on its face does
not refer to government-wide borrowing for general purpose funds and
that the context relates to costs at the facility level, not the state
level.

Moreover, the issue here is not whether these costs could have been
included by the State plan in the reimbursement rates, but whether the
plan did in fact include them, i.e., whether their inclusion was in
accordance with the State plan.  Again, the State plan requires reliance
on the PRM, "except where specific rules concerning allowability of
costs are stated" in the plan itself. NYSDSS Ex. 7, at 22.  As we
discussed above, the PRM expressly disallows tax anticipation interest
costs, and no specific rule in the plan allows them.

Even under the Boren Amendment, the Board has subjected rate-setting for
public, as opposed to private, facilities to "closer scrutiny."  South
Dakota Dept. of Social Services, DAB No. 934, at 5 (1988).  The reason
for this concern is that increases in reimbursement rates for
state-owned facilities do not raise the cost to the state of operating
them, but rather benefit the state by increasing revenue from federal
funds. Therefore, the state may be less motivated to scrutinize public
facility rates carefully (or may interpret its plan more liberally in
regard to public facilities) than to control private facility rates
which impact state and federal funding sources similarly.  See
Massachusetts Dept. of Public Welfare, DAB No. 867, at 9 (1987);
Massachusetts Dept. of Public Welfare, DAB No. 730, at 5-6 (1986).

These concerns are triggered particularly where, as here, the costs at
issue are costs of general government operations which the State is
attempting to include in the reimbursement rates of state-owned
facilities but not private facilities.  In such situations, the Board
has upheld (even under the Boren Amendment) disallowance of costs
"required to carry out the overall responsibilities of State . . .
governments." Arkansas Dept. of Human Services, DAB No. 998, at 4 (1988)
(cost of housing state prison inmates who provided services at nursing
homes), interpreting OMB Circular A-87, Attachment A, section C.1.a.
Absent a specific state plan provision to the contrary, the Board
applied this provision to prohibit reimbursement for costs which the
State government would have incurred for its general operations, even if
the Medicaid program obtained a benefit from them.  Id.  NYSDSS argued
that the TRANs interest is unlike the costs at issue in Arkansas which
"otherwise would be borne generally by the state in the absence of the
Medicaid . . . program."  NYSDSS Reply Br. at 20, quoting Arkansas, DAB
No. 998, at 4.  By contrast, NYSDSS argued, OMRDD would not need to draw
on the TRANs proceeds but for the Medicaid program.  This distinction
has no validity.  The nursing homes in Arkansas would not have needed
the services provided by the inmates but for their Medicaid operations.
Nevertheless, the state could not take a cost of operating the prison
system and transfer it to a federally-funded program.  The Boren
Amendment vests considerable flexibility in the states in developing
rate-setting mechanisms in their state plans, but in no way authorizes a
state to ignore its state plan. Therefore, we conclude that, absent
clear authority in the approved State plan, NYSDSS here cannot transfer
the costs of general State cash flow management to the Medicaid program
through the reimbursement rates set for public facilities, simply on the
basis that OMRDD draws its State funding through the State General Fund.

             5.  The interest costs were added on to the  reimbursement
             rates in violation of State planmethods.

HCFA argued that NYSDSS's method for including these interest costs in
facility reimbursement rates was inconsistent with the overall method
described in the plan for calculating the base year costs, and amounted
to an improper add-on.  HCFA Br. at 28-36.  Simply summarized, the plan
method calls for calculating a statewide average rate for the base
period based on total reimbursable costs to be drawn from cost reports
submitted by the facilities (or budget reports for developmental centers
operating less than two years), subjected to various specified
adjustments (not relevant here), and divided by client days.  Overhead
costs to be included in the rate are the sum of the state-wide CAP costs
and the indirect costs under OMB Circular A-87 or specified in the
guidelines.  NYSDSS Ex. 7, at 16-20. TRANs interest costs were not on
any facilities' cost reports (because they were not allocated down to
the facilities' level), nor were they included in the overhead costs in
the CAP or facilities' indirect costs (for the reasons discussed above).
The State plan did not provide for adding on any other costs. NYSDSS
responded that requiring inclusion of the interest costs in the cost
reports of the individual facilities would force an allocation process
that would be "purely formalistic."  NYSDSS Reply Br. at 30.

We do not find it an unduly technical requirement of the State plan that
costs be derived only from the facilities' cost reports or allowable
sources of overhead specified in the plan.  Rather, this method prevents
the adding on of unallowable costs and is consistent with the intent of
the State plan to include costs of particular facilities rather than of
the State government as a whole (except as particularly provided
regarding CAP costs).

Based on the analysis above, we conclude that the State plan does not
permit the costs of interest on general state borrowing to be included
in calculating the reimbursement rates for ICF/MRs.  Therefore, we
uphold the portion of the disallowance relating to the interest costs at
issue.

2.  Depreciation costs on assets the present existence and use of which
cannot be fully documented are unallowable.

       A.  Background and arguments

This portion of the disallowance was based on a random statistical
sample of OMRDD's depreciable assets performed as part of the UKW
review.  The sample was drawn from OMRDD's Asset Depreciation Report
(ADR) for the fiscal year (FY) ending March 31, 1987.  The ADR is a list
of line items, each of which represents an asset or (more often) group
of assets with the associated historical cost and annual depreciation
amount.  Identifying the specific assets included in a line item
requires resort to "detail listings," which are computer printouts of
purchase transactions showing purchase price, date, facility location
and voucher numbers for each asset.  With this information, the original
vouchers can be used to locate the asset at a facility.  Detail listings
are not available for transactions prior to FY 1982-83.  As a result,
the assets cannot be traced to the original vouchers (although NYSDSS
asserted that the original vouchers are still on file) and often cannot
be physically located.  Thus, NYSDSS admitted that "for multiple-asset
line items preceding FY 1982-83, it is normally not possible to obtain
the specific information regarding individual assets included within
each line item that would permit the location and inspection of the
assets."  NYSDSS Br. at 55.

The ADR included six categories of assets which UKW reviewed.
Categories 1, 2 and 3 were land improvements, buildings, and other fixed
assets, respectively, which were inventoried in 1971-72 by Joseph Blake
& Sons, CPA and are therefore collectively referred to as "Blake Report
Assets."  Categories 4 and 5 had already been fully depreciated and did
not appear in the ADR for the year reviewed.  Category 6 included
buildings and renovations purchased by the Facilities Development
Corporation (FDC), a public benefit corporation responsible for
financing new and improved State facilities. Category 7 included
equipment assets purchased by the facilities but charged to FDC.
Category 8 was equipment purchased directly by the facilities.

UKW drew its sample of 417 items from the six categories using a method
called cumulative monetary amount sampling, which made the likelihood of
selection of a particular item depend on its dollar value.  UKW then
sought to check documentation on acquisition cost, review the assigned
useful life, and physically examine the assets to verify their existence
and their use for patient care purposes. 9/  The results fell into two
groups:

       (a) For categories 1, 2, 3 and 6 (Blake report assets and other
       fixed assets purchased by FDC), UKW successfully located all 321
line items in the sample, but found that 19 were transferred to other
agencies or replaced or were otherwise not in use for patient purposes.
NYSDSS Ex. 1 (UKW Report at internal exhibit L, sections D.2, D.5, D.6,
and D.7).

       (b) For categories 7 and 8 (equipment assets), UKW was unable to
       identify the assets covered by 63 of the 96 line items sampled
because of lack of documentation, and was able to identify two others
that were found not to be in use.  Id. at sections D.1 and D.4. 10/

Based on a projection of these results to the universe of depreciable
assets, UKW concluded (with 95% confidence) that depreciation costs were
overstated by at least $2,401,398. 11/  Id. at internal ex. C.

NYSDSS admitted that "some overstatement of depreciation costs"
occurred, but asserted that UKW had "greatly exaggerated" the amount,
based on the conclusions of a statistical analysis performed for NYSDSS
by Analysis and Inference, Inc. (A&I). NYSDSS Br. at 57.  A&I challenged
the factual bases for finding that 13 of the 19 items disallowed in
group (a) were not in use.  Id. at 57-58. NYSDSS also challenged the
disallowance of the assets in group (b) that could not be located,
because it characterized the disallowance as a penalty for recordkeeping
violations imposed despite the "virtual certainty" that the assets were
properly purchased and used.  Id. at 58 (emphasis in original).  NYSDSS
argued that UKW violated government audit standards by assuming that
assets that could not be documented or examined did not exist without
making further efforts to account for them.  A&I performed an analysis
to develop its own assessment of the overstated depreciation, by
evaluating how often the assets which could be traced turned out to be
in use for program purposes.  This analysis rested on the assumption
that the assets without documentation sufficient to locate them (most of
which were from before FY 1982-83) were as likely to be in use as the
assets for which documentation was available.  A&I then projected the
rate of errors in the examinable assets (as revised by A&I's other
calculations) and applied it to those without documentation, arriving at
a lower amount of overstated depreciation ($152,605, or $76,303 in FFP)
than that found by UKW.

We conclude that HCFA properly disallowed the items for which
documentation sufficient to permit identification and examination of the
assets was not available, as well as the items which NYSDSS admitted
were transferred by the relevant FY.  However, we remand to HCFA, as
explained further below, the portion of the disallowance relating to
seven items which NYSDSS alleged were still in use during the relevant
FY and one which was replaced.

       B.  Discussion

             1.  HCFA's findings that certain group (a) assets were
             transferred, replaced or not in use were accurate as to 11
items but require reassessment as to eight.

NYSDSS acknowledged that UKW's findings regarding six of the disallowed
items in group (a) were correct, but challenged the factual bases for
UKW's findings regarding the other thirteen.  NYSDSS Br. at 57-58.
NYSDSS' arguments fell into two main categories:  (1) as to five items,
12/ NYSDSS admitted that the assets had been transferred but claimed
that its depreciation claims were correspondingly reduced by means of a
square foot adjustment; (2) as to seven items, 13/ NYSDSS asserted that
the assets were associated with buildings that were not transferred
until after the end of the base year or were still in use during the
base year; and (3) as to one item that was admittedly replaced, NYSDSS
claimed that its depreciation claim was proper.  NYSDSS Br., at Appendix
(App.).

                    a.  NYSDSS's adjustments did not correct for
                    improper depreciation claims on transferred assets.

NYSDSS asserted that the assets which were admittedly transferred were
not included in the depreciation costs used to calculate the
reimbursement rates, even though they continued to appear in the ADR.
NYSDSS acknowledged that the State plan required that adjustments be
made to reflect any disposition of assets resulting in "substantial
material changes" in the reimbursement rate.  See NYSDSS Ex. 2, at 15.
NYSDSS asserted that OMRDD sought to correct the depreciation amounts
taken from the ADR to reflect recent disposition of assets, i.e.
"material changes," and also made "a reasonable attempt" to delete
assets associated with transferred buildings from the ADR. NYSDSS Br.,
App. at 2-3.  However, NYSDSS admitted that transferred assets may
remain on the ADR, particularly "in connection with older buildings and
multi-building contracts," because they are not identified by building
number.  Id. at 3.  Nevertheless, NYSDSS asserted that an adjustment was
made to account for these transferred assets by reducing the
reimbursement rate "on a square-footage basis, to reflect any
substantial, material transfer of building space." Id.

HCFA agreed that a square footage adjustment was taken in the
reimbursement rate, but asserted that the adjustment accounted for
inactive space and not for the transferred assets remaining erroneously
on the ADR.  The inactive space adjustment, which OMRDD determined by a
survey of the square footage not in use in each facility as a percentage
of total square footage, was taken into account in UKW's findings by
applying the aggregate percentage to the total amount of overstated
depreciation. HCFA Br. at 85.  However, HCFA argued that this process
did not adequately substitute for actually deleting assets from the ADR.
According to HCFA, the square footage adjustment does not reflect the
nature of the unused portion of the facility (e.g., a wood frame garage
or a concrete and steel building) or identify such associated assets as
improvements or components, so that the depreciation still included in
the capital rate may be well in excess of actual depreciation costs on
non-transferred assets at the facility.

In its reply, NYSDSS asserted that the square footage adjustment which
it made to the per diem rate to account for demolished or transferred
buildings was separate from and in addition to the inactive space
adjustment.  NYSDSS  Reply Br. at 94.  However, NYSDSS offered no
explanation of how such an additional reduction was calculated apart
from the calculation of active/inactive space by facility or how it
could accurately account for assets which in several cases could not
even be identified or located by building.  NYSDSS provided, as an
example, a worksheet showing an adjustment for square feet in use at
Craig before and after a September 1982 transfer of some of its
buildings.  NYSDSS Ex. 2, App. C.  This worksheet did not demonstrate
that the reduction of the square foot space in use at Craig was
accurately related to the value and depreciation cost of the particular
assets transferred in relation to those remaining in use.  Nor did
NYSDSS point to anything in the State plan that would permit use of
square footage as a rough estimate of the amount of change caused by
disposition of these assets.

NYSDSS itself asserted that OMRDD made efforts to remove assets related
to transferred or demolished buildings from the ADR whenever it could
identify them, so clearly OMRDD did not treat any square footage
adjustment which it made to be an adequate substitute for the deletion
of transferred assets.  Essentially, OMRDD deleted assets associated
with transferred or demolished buildings when it was able to identify
them.  In the case of the items at issue, OMRDD failed to identify and
delete them because it lacked records adequate to do so.  NYSDSS did not
demonstrate that any adjustments it made resulted in removing the actual
depreciation costs related to those assets that remained erroneously on
the ADR from inclusion in the reimbursement rate. Had UKW simply
excluded depreciation for all the transferred assets, the disallowance
might have duplicated part of the square footage adjustments.  However,
since UKW accounted for this duplication by reducing the overstated
depreciation amount by the inactive space adjustment, no risk of
duplication appears.  Therefore, we uphold the remaining disallowance
for those assets which NYSDSS admitted were transferred out of OMRDD's
use by the fiscal year in question.

                     b.  The depreciation costs for transferred
                     buildings should be based on the correct dates of
transfer.

NYSDSS asserted that particular assets were associated with buildings
that were not transferred until after the fiscal year in question, and
therefore depreciation related to those assets was properly included in
the rate calculations.  HCFA's response was that "any inaccuracies
regarding the dates of transfer of buildings . . . must be attributed to
OMRDD" because UKW got the dates from contact people at each facility
who were designated by OMRDD.  HCFA Br. at 81-82.  NYSDSS did not
explain how the dates which it alleged to be inaccurate were provided to
or obtained by UKW.  See NYSDSS Reply Br. at 93, n.52.  On the other
hand, HCFA provided no support for the factual accuracy of these dates
apart from its assertion that OMRDD was responsible for any errors.

The dates of transfer for those assets which can be identified by
building should be readily verifiable, however.  Therefore, we remand to
HCFA the portion of the disallowance relating to those assets identified
with buildings which NYSDSS asserted were transferred only after the
fiscal year in question, in order to permit NYSDSS another opportunity
to provide documentation of the correct dates of transfer.

                    c.  Depreciation costs on a replaced item must be
                    recalculated.

As to the one remaining item (3000001), a fire protection system with
associated annual depreciation costs of $5,473, NYSDSS admitted it had
been replaced but asserted that OMRDD was entitled to claim the
undepreciated basis of the replaced equipment over its useful life.
NYSDSS argued that this method was an acceptable alternative to the
procedure which HCFA pointed to in the PRM, i.e., adding the
undepreciated basis to the cost of the replacement equipment.  PRM,
.104.11 (November 1985).  See HCFA Br. at 85-86.

The PRM provision cited by HCFA relates only to determining the basis of
assets acquired in whole or part in trade for an asset previously used
in the program.  In such circumstances, the historical cost of the new
asset is determined by adding the undepreciated basis of the old asset
to any "boot," such as cash, paid in addition to the trade-in.  The
parties have not alleged that the fire system was part of such an
exchange. The provisions on disposal of assets are at .. 130-132 of the
PRM, which allow, under certain conditions, the claiming of loss upon
disposal up to the undepreciated basis.  The proper procedures under
those provisions depend on the method of disposal, i.e., whether the old
fire system was scrapped, traded-in on the new system, sold for salvage
value, etc.

Since neither party has presented sufficient factual information
concerning this asset to determine the method of disposal, we remand
this portion of the disallowance to HCFA to allow NYSDSS to provide
documentation regarding the method of disposal on which a determination
of the proper depreciation adjustment can be made.

              3.  Depreciation costs for those items in group (b)
              lacking documentation adequate to permit physical
examination are unallowable.

             a.  UKW's review complied with applicable auditing
             standards.

In regard to the disallowed items in group (b), NYSDSS argued that,
faced with the difficulty in identifying and locating the assets from
before FY 1982-83, UKW was obliged to devise a means of estimating how
many of those assets were still in use.  In support of this argument,
NYSDSS cited an auditing standard stating that "if considering those
unexamined items to be misstated would lead to a conclusion that the
balance or class contains material misstatement, the auditor should
consider alternative procedures that would provide him with sufficient
evidence to form a conclusion."  American Inst. of Certified Pub.
Accountants, Codification of Statements on Auditing Standards, . 350.25
(1991). However, the standard does not specify what alternative
procedures might be advisable, and certainly does not suggest relying on
the error rate of those items which were examinable, as A&I did. 14/

HCFA detailed efforts by UKW staff to retrieve data from FDC and OMRDD
files to try to locate descriptions of assets lacking detail listings,
pointed out that UKW was instructed to accept computer records without
original supporting documents so long as the printouts enabled UKW to
physically examine the items, and noted that UKW accepted additional
documentation found by OMRDD and performed a second site visit even
after its draft report was issued.  HCFA Br. at 68-71; NYSDSS Ex. 1 (at
internal ex. K) (noting reduction of overstated amount in light of
documentation produced after the exit conference).  (As HCFA pointed
out, UKW did not question the depreciation costs of six assets totaling
$6,892,286 which lacked original supporting documentation, but which UKW
was able to physically observe and to connect to a specific sampled line
item in the ADR.)  We find that these procedures were more than adequate
and that UKW was not obliged to perform additional procedures in order
to form an opinion that the items which could not be identified or
located were not adequately documented as in use for Medicaid purposes.

                    b.  A&I's alternative estimate of the overstated
                    depreciation is unacceptable.

NYSDSS employed A&I to undertake a statistical analysis to substitute
for the documentation required to actually locate the missing assets.
In support of this methodology, NYSDSS cited several Board cases for the
proposition that a claim for FFP can be based on statistical
projections.  In particular, NYSDSS relied on New York State Dept. of
Social Services, DAB No. 1134 (1990), in which we reviewed a claim for
FFP in payments on behalf of Medicaid-eligible individuals which had
erroneously been charged to state medical assistance only.  See NYSDSS
Br. at 62.  The sample cases were assumed for purposes of the decision
to be scientifically selected, to have documentation establishing
Medicaid eligibility, and to be the basis of a valid projection to a
"homogenous, defined universe."  DAB No. 1134, at 9. The Board
determined that such a projection could be relied on to determine the
amount of a claim as "an auditable determination of what amounts were
actually expended for a particular purpose."  Id. at 7, n.6.  This
distinguished DAB No. 1134 from an earlier case, New York State Dept. of
Social Services, DAB No. 1012 (1989), where statistical sampling
"circumvented specific requirements for documenting Medicaid claims
based on disability."  New York State Dept. of Social Services, DAB No.
1134, at 3.  The Board precedent thus permits statistical sampling to
test and validate the documentation of a claim where individual review
of the underlying records would be impractical due to volume and cost,
but does not permit statistical sampling to replace required
documentation that proves non-existent.

In the present case, A&I's effort to estimate depreciation costs based
on whichever assets could be located is unacceptable precisely because
its methods circumvent specific requirements that the assets being
depreciated must be documented.  We turn first to the State plan to
determine the requirements for claiming depreciation costs.  The State
plan allows depreciation costs for buildings, fixtures and capital
improvements "when based upon factors of historical costs and useful
lives," and requires that an appraisal based on comparable costs at the
time of acquisition be performed whenever historical costs cannot be
adequately determined.  NYSDSS Ex. 7, at 26.  In regard to moveable
equipment, furniture, and fixtures, the plan allows depreciation based
only on historical cost and useful life, and does not provide an
appraisal option.  Id. at 28.  The State plan thus does not permit
inclusion of depreciation costs for equipment assets to which no
historical costs can be assigned because OMRDD cannot identify the
particular assets involved in order to document their historical cost.
15/

The State plan is silent as to what records must be maintained to
support these requirements, so we are required by the plan to turn in
that regard to the PRM, which states:

     The depreciation allowance, to be acceptable, must be adequately
     supported by the provider's accounting records. . . . Appropriate
recording of depreciation requires the identification of the depreciable
assets in use, the assets' historical costs . . . , the assets' dates of
acquisition, the methods of depreciation, estimated useful lives, and
the assets' accumulated depreciation.

PRM, . 104.9 (November 1985) (emphasis added).  The PRM also requires
either tagging of major equipment or "alternative records . . . to
satisfy audit verification of the existence and location of assets."
Id. at . 134.8.  Thus, we conclude that the State plan, incorporating
the PRM, clearly required specific documentation of each depreciated
asset sufficient to identify and examine it.  NYSDSS, therefore, could
not meet this specific documentation requirement by statistical
projections showing that other assets which were documented and
examinable did exist.

Furthermore, the universe which A&I sought to use was not a homogeneous
group, but rather included only those assets for which adequate
documentation had been found, which were properly depreciated (since A&I
excluded items which should not have been depreciated from the universe
rather than counting them as errors), and which were disproportionately
recent in acquisition.  A&I recognized that the validity of this
universe depended on the assumption that unexamined assets would have
the same "error rate" as those that were available for examination
despite the difference in their age.  NYSDSS Ex. 30, at 9.  Therefore,
A&I performed an additional analysis which allegedly found no higher
error rate over time (no trend).  Id.; NYSDSS Reply Br. at 81-83.  A&I's
conclusion that errors were not more likely over time is based on two
findings:  (1) the three errors recognized by A&I among the Category 7
or 8 assets that could be examined showed no trend over time (but
admittedly they all dated from the same year), and (2) a random sample
of a later (FY 1988-89) ADR, using a survey of the facilities to
determine whether the assets in the ADR were in use, found only one
"error," an asset not found in use in an ICF/MR.

We find no support in these findings for A&I's conclusion that errors
were stable over time.  The existence of three errors from one year
obviously says nothing about the error rate over time.  The "random"
sample was not in fact random, since it excluded all line items relating
to assets predating FY 1982-83, all those for which vouchers could not
be located, those for which responses were not received from the
facilities, and those not within the scope of the federal audit.  Such a
sample tells nothing about whether older assets (particularly those
dating from the pre-FY 1982-83 time frame that were excluded from the
sample) are more likely to be out of service, for one reason or another,
than later-acquired assets.  Among the reasons that the assumption that
pre-FY 1982-83 assets were as likely to be in use as later-acquired
assets is faulty are (1) NYSDSS did not explain how these assets would
ever be removed from the ADR before being fully depreciated even if they
were destroyed, transferred, or disposed of, since none of the
individual asset's fates could be tracked, and (2) NYSDSS asserted (in
relation to salvage value) that OMRDD's moveable assets are subject to
"extraordinary wear and tear" and are usually "trashed or junked" when
beyond repair.  NYSDSS Br. at 28-29. Under such conditions, we see no
basis for assuming that the great majority of equipment acquired before
FY 1982-83 would still be in use if located.

A&I's approach to the question of error rates over time also
demonstrates the essential fallacy in A&I's methods: the restrictive
definition employed by A&I in counting an "error."  A&I counted as
errors only those assets with sufficient documentation to identify and
locate them, but found on examination not to be in use for patient
purposes.  A&I simply removed from the analysis, rather than treating as
error, any asset which was not documented or located or not properly
depreciated.  In effect, A&I created a universe of assets that were
properly defined as depreciable with vouchers that could be located,
excluding all other assets from the universe, rather than counting them
as errors.  See NYSDSS Ex. 30, at 5-8.  This approach stands the State
plan on its head. Under the plan, a provider must show its entitlement
to claim depreciation costs on an asset by documenting its present use,
identity, location, historical cost, etc.  Where OMRDD could not make
such a showing after repeated opportunities, UKW properly treated the
costs as errors.  Nothing in A&I's analysis, which simply showed that
documented assets were usually found to be in use upon examination,
provides a basis for finding that the costs at issue were correctly
claimed. 16/  We therefore uphold the disallowance of depreciation costs
on assets which lacked documentation sufficient to permit their
examination.

Contrary to NYSDSS's assertion, the disallowance here is not a penalty
for its recordkeeping deficiencies.  Cf. NYSDSS Br. at 59.  Rather, in
accordance with the State plan, HCFA is reasonably declining to
participate in the cost of depreciation on undocumented assets that, as
far as can be determined, exist only in a computer listing.  17/  While
some of the assets for which documentation permitting identification is
unavailable may nevertheless still be in use and properly depreciated,
NYSDSS' claim that this is a virtual certainty for the great majority of
them is utterly without objective support.

We conclude that depreciation costs for assets which cannot be
documented or located should have been excluded from the reimbursement
rates, and we therefore uphold the portion of the disallowance relating
to those costs.

3.  A facility transferred without cost for use as a public college
campus was not abandoned.

       A.  Background and arguments

The Staten Island Developmental Center (SIDC) closed on September 17,
1987, and OMRDD filed a Declaration of Abandonment under which most of
the facility, including 35 of 50 buildings on the grounds, was surplused
to the New York State Office of General Services (OGS).  On the same
date, OGS leased the surplused portion of the facility to the New York
State Dormitory Authority (a public benefit corporation created by the
State legislature) for use by the City University of New York (CUNY).  A
little over a year later, the same property was deeded to the Dormitory
Authority, as had been contemplated in the lease terms, once legal
authority was obtained to do so.  Id. at 32 and 36-37.  The remaining
portion of the facility was retained by OMRDD for use for administrative
purposes.  In addition, OMRDD continued to use some space in five of the
35 leased buildings, vacating them in stages through 1990.  See
generally NYSDSS Br. at 32-38 (and sources cited therein). 18/

The disallowed costs relating to SIDC consisted of three categories:

     (1)  $387,505 of unrealized depreciation claimed on the buildings
     transferred to the Dormitory Authority on the basis that they were
abandoned,

     (2)  $229,049 of unrealized depreciation claimed on renovations to
     those buildings which were made in order to comply with Medicaid
requirements but were of no value after the transfer, and

     (3)  $471,849 of unrealized depreciation claimed on similar
     renovations to the buildings retained by OMRDD but no longer used
for patient purposes, so that the renovations no longer served any
purpose.

NYSDSS Br. at 33; NYSDSS Ex. 17.  NYSDSS conceded that the third
category was properly disallowed and that some amount of the remaining
costs (which it estimated at $84,283) should have been excluded from the
reimbursement rate to reflect OMRDD's continued use of some of the
transferred buildings during the FY at issue.  NYSDSS Br.  at 44-46.
HCFA argued that the buildings were not abandoned, and consequently none
of the unrealized depreciation could properly be included in the
reimbursement rate calculations under the PRM. 19/  First, HCFA argued,
the facility remained throughout under the control of organizations
related in one way or another to the State of New York, which had not
therefore relinquished all claim to and use of the facility. Second,
according to HCFA, a cost-free transfer between governmental entities
under these circumstances is treated under the PRM as a donation for
which no gain or loss is realized.  In any case, HCFA asserted that no
loss could be claimed on an abandonment, even if this transfer could be
so characterized, because HCFA did not approve the abandonment in
advance as required by the PRM.

For the reasons explained below, we conclude that the loss claimed on
these assets is not allowable.

       B.  Discussion

             1.  SIDC cannot be treated as abandoned while State-related
             entities retain title or control.

Losses resulting from the abandonment or demolition of an asset may be
included in determining allowable cost up to the undepreciated basis of
the asset.  PRM, .. 130, 132 (June 1981). 20/  In order to be considered
"abandoned" under the PRM, an asset must be permanently retired from all
use, and the provider must have relinquished "all rights, title, claim,
and possession."  PRM, . 104.21 (November 1985).  HCFA suggested that
the requirement of relinquishment was not met here because the Dormitory
Authority was a quasi-state agency, and therefore a related organization
to the provider, since OMRDD is a part of the State.  HCFA Br. at 55,
n.24.  Under the PRM, costs of related organizations are attributed to
the provider, as discussed below.

The Board previously considered an analogous relationship between the
State and the Urban Development Corporation (UDC), a quasi-public
corporation created by State law for the purpose of financing government
construction projects, in New York State Dept. of Social Services, DAB
No. 1336 (1992).  In that case, UDC held title to a building which it
leased to OGS for use as NYSDSS headquarters in Albany for 40 years at
the end of which title would pass to New York State.  Id. at 2.  The
Board held that the State owned the building to which UDC held title,
because UDC was "a component of the State, created by State law, and
funded by State bond offerings."  Id. at 5.  The Dormitory Authority is
also created by State law, with a board consisting of public officials
and members appointed by the governor, and the power to acquire property
in the name of the State.  Public Auth. Law, Title 4, . 1677-1691
(1992).  While the Dormitory Authority is not "a mere arm of the State,"
and therefore is free of some of the restraints on direct state
contracts in its financing of construction projects, it is nevertheless
a public benefit corporation "with governmental functions delegated to
it by the State." Thompson Construction Corp. v. Dormitory Auth., 264
N.Y.S.2d. 842, at 845 (Sup.Ct. Albany Cty. 1965) (holding Dormitory
Authority is not required by statute to award contracts to lowest
bidder).  Thus, the Dormitory Authority, like the UDC, is a
quasi-governmental entity identified with the State.  For that reason,
just as the payment of "rent" from one State entity to another did not
create a "cost" in which the federal government should be required to
participate in DAB No. 1336, a transfer of assets from one part of the
State to another does not create an abandonment loss for purposes of
federal Medicaid reimbursement.

The PRM attributes costs of related organizations to providers, in order
to prevent the payment of excess profit resulting from less than arm's
length bargaining.  The same danger arises from treating an asset
transferred to a related organization as abandoned. Consequently, such
assets are treated as if they were still in the hands of the transferor.
Johnson-Mathers Health Care, Inc. v. Blue Cross and Blue Shield, PRRB
Dec. No.  83-D49, CCH Medicare and Medicaid Guide, New Developments .
32,869 (1983) (holding that a hospital which left a property it had
leased from a related party could not claim abandonment unless related
party also relinquished all rights); see also Highland View Hosp. v.
Blue Cross and Blue Shield, Inc./Blue Cross of Northeast Ohio, PRRB Dec.
No. 83-D17, CCH Medicare and Medicaid Guide, New Developments . 32,364
(1982) (holding that when county hospital board relocated its
activities, its former building was not abandoned because the county
still owned and used it).  In effect, the State as a whole has not
suffered a loss by the transfers between the entities related to it and
has not engaged in arm's-length bargaining over the value of the
transferred assets.

Furthermore, the PRM does not require that the Dormitory Authority be an
integrated component of the State in order to be considered a related
organization. 21/  The PRM provides that an organization is "related"
when the provider "to a significant extent is associated or affiliated
with, or has control of, or is controlled by" the other entity. PRM, .
1002.1 (December 1982).  Control is the power to "directly or
indirectly, significantly influence or direct the actions or policies of
an organization" and is decided by "the reality of the control . . . not
its form or the mode of its exercise."  PRM, . 1002.3 and 1004.3.  The
State clearly retains control over the activities of the Dormitory
Authority and benefits from the use of its assets for State purposes,
such as public educational institutions. 22/  We therefore conclude that
the Dormitory Authority is sufficiently related to the State that
property transferred to the Dormitory Authority by another State agency
(such as OMRDD, via OGS) has not been relinquished for all purposes and
cannot be claimed as abandoned. 23/  We discuss in a later section
whether OMRDD could claim a loss based on the demolition and gutting of
the buildings.

             2.  The transfer constituted a donation rather than an
             abandonment.

HCFA also argued that SIDC could not be treated as abandoned because the
transfer really amounted to a donation for the benefit of the Dormitory
Authority, for which no gain or loss may be realized under the PRM.  We
agree.

The PRM treats intergovernmental transfers as "donations" if a
"governmental entity acquires the asset without assuming the functions
for which the transferor used the asset or without making any payment
for it."  PRM, . 114.1.B (December 1974); 42 C.F.R.  . 413.134(h)(2).
While this provision relates to determining the basis of assets received
by donation, a later provision on disposal of assets also states that
losses from the "donation . . . of depreciable assets are not included
in the determination of allowable cost."  PRM, .132.A.2 (June 1981).

NYSDSS admitted that the transfer was without payment and that OMRDD
functions were not assumed, but asserted that the intergovernmental
transfer provisions were inapplicable to the Dormitory Authority.
Specifically, NYSDSS denied that the Dormitory Authority was a
governmental entity for purposes of PRM, . 114.1, because it is not
"part of the State government."  NYSDSS Br. at 42, n.28.  However, we
have already rejected this argument above and concluded that, while not
an arm of the State, the Dormitory Authority is a governmental entity
related to the State.  NYSDSS pointed to no authority limiting the term
"intergovernmental" to immediate components of the State government, and
cases have treated transfers between a county-owned hospital and a state
university, for example, as intergovernmental.  Univ. of Calif. Irvine
Med. Center v. Blue Cross and Blue Shield Assn./Blue Cross of Calif.,
HCFA Dep.  Adm. Dec., CCH Medicare and Medicaid Guide, New Developments,
. 34,527 (1984).

Moreover, factors present here, such as the absence of any arm's length
bargaining, the retention of reversionary rights, and restrictions on
the transferee's use of the property, have all been found to support the
interpretation of a transfer as a donation.  See, e.g., PRRB Dec. No.
75-D2, CCH Medicare and Medicaid Guide, New Developments, . 27,423
(1975) (finding transfer of a hospital from federal government to city
to be a donation, even though done in form of sale with a minimal price,
in view of surrounding circumstances).  We conclude that a transfer of
real estate from a state agency to a public benefit corporation with
governmental functions for use as a public university is
intergovernmental in nature and that the circumstances here constitute a
donation.

NYSDSS also argued that these assets had no value and therefore could
not be "donations."  NYSDSS Br. at 42.  NYSDSS' assertion that the
assets involved were worthless was based on the fact that most of the
buildings involved were either demolished or gutted and heavily
renovated by CUNY.  However, it was undisputed that the property was
never offered to alternative buyers who might have been able to retain
more of the original buildings for uses more closely related to their
original design, e.g., to use the Medicaid-related improvements for
patient care instead of gutting the buildings to redesign them as
classrooms or dormitories.  The actual market value here was not
established by any other means, such as an appraisal based on comparable
facilities.  The lack of evidence concerning the actual market value
distinguishes this case from those relied on by NYSDSS, where providers
made substantial unsuccessful efforts to sell deteriorated assets before
claiming abandonment.  See, e.g., Sisters of St. Francis Health
Services, Inc. v. Schweiker, 514 F. Supp. 607, 612-13 (D.D.C. 1981)
(finding abandonment of vacant building, despite facility remaining on
market, after almost three years without an offer).  The ultimate fate
of the buildings under the Dormitory Authority only establishes that
those assets were not of significant value to the State for other uses.
Further, the facility had some value even for CUNY since significant
portions of the structures were retained for use.

Furthermore, NYSDSS's argument that a donation cannot occur where the
gift has no value to the recipient is inconsistent with the HCFA
Administrator's treatment of a boarded-up hospital transferred to the
Salvation Army without cost.  HCFA Ad. Dec., CCH Medicare and Medicaid
Guide, New Developments . 28,661 (1977).  The Administrator found a
donation despite the Salvation Army's inability to put the deteriorated
building to any use.  The Administrator found that a donation is a
"contribution to a community effort in which Medicare will not
participate by way of reimbursement of claimed losses on depreciated
assets," because Medicare is a "program to finance health care costs for
Medicare beneficiaries, not costs associated with donations to charity."
Id. at 10,317.  Similarly, in the present case, Medicaid will not
participate in costs that benefit State higher education efforts rather
than health care for recipients.

We therefore conclude that SIDC was not abandoned, both because the
State or a related organization retained a claim to the property and
because the transfer constituted a donation.  We therefore uphold the
portion of the disallowance related to the claim of abandonment of SIDC.

             3.  OMRDD could not claim a loss based on the demolition,
             as opposed to abandonment, of the SIDC assets.

CUNY ultimately demolished many of the buildings and gutted others,
destroying the related renovations.  The term "demolition" is defined in
the PRM as the "deliberate destruction of a building or other asset
resulting in complete loss of economic value (other than scrap value) of
the asset."  PRM, . 104.22 (November 1985). 24/  No loss can be allowed
as a result of a demolition unless (1) the asset is replaced (which
indisputably did not occur here) or (2) the demolition was approved by
HCFA.  42 C.F.R. . 413.134(f)(5)(iv); PRM, . 132.A.3.a(3) (June 1981).

NYSDSS did not directly assert that the demolition was approved, but
argued that HCFA's approval for the abandonment could "be considered to
have been obtained" because HCFA was aware of and approved of the
closing of SIDC.  NYSDSS Br. at 39, n.27; NYSDSS Exs. 22-25.  The
documents on which NYSDSS relied establish that HCFA was informed of
OMRDD's intent to close SIDC as part of a plan of correction of
deficiencies there and an overall plan to move clients into community
facilities. NYSDSS Exs. 22-24.  HCFA officials expressed approval of
community living arrangements as "moving in the right direction."
NYSDSS Ex. 25 (Letter from HCFA Administrator William L. Roper, M.D.,
dated March 2, 1987).  None of the documents submitted suggests that
HCFA was informed of the plans to transfer SIDC to the Dormitory
Authority or CUNY's plans to demolish or gut most of the buildings, even
though NYSDSS stated that these plans were developed long before the
closure.  See NYSDSS Br. at 35.  Furthermore, none of the documents in
any way suggests that OMRDD planned to dispose of the assets involved by
abandonment or demolition, as opposed to seeking to realize whatever
economic value they might retain through sales or other means.  We
conclude that, since NYSDSS did not obtain HCFA's approval before the
demolition of the assets here and did not replace them, the resulting
loss is not allowable. 25/

NYSDSS did not request that HCFA consider retroactive approval of the
demolition of these assets.  Since the issue was not presented by the
parties, we do not here decide whether HCFA would have authority to
grant retroactive approval.  We are not aware of any provision in the
State plan or the PRM which would prevent HCFA from granting such
approval within its discretion.  In grant programs generally,
retroactive approval may be granted if "the transaction would have been
approved had the organization requested approval in advance."
Department of Health and Human Services Grants Administration Manual,
chapter 1-105-60, B.1; see Iowa Dept. of Human Services, DAB No. 1340,
at 5 (1992).

We therefore conclude that the losses relating to buildings that were
demolished were properly excluded from the calculation of reimbursement
rates.  We uphold the portion of the disallowance relating to these
loss, subject to HCFA's discretion to consider a request for retroactive
approval of the demolitions should NYSDSS make such a request.

              4.  The status of compliance-related renovations depends
              on the status of the related buildings.

NYSDSS acknowledged that an abandonment loss cannot be claimed where "a
provider merely has ceased to use an asset for patient-care purposes;
the asset must be permanently retired for any future purpose."  Id. at
39, citing 42 C.F.R. . 413.134(f)(5)(i) and PRM, . 104.21. However,
NYSDSS argued that renovations made to improve the facilities in order
to maintain certification and meet Medicaid requirements served no
function for CUNY, in light of CUNY's plan to either demolish or totally
renovate the buildings for its purposes.  NYSDSS argued that once a
building is not used "for program purposes, improvements that were
previously made . . . to satisfy certification requirements and that can
be of no further use are also deemed abandoned."  NYSDSS Br. at 41.  In
support, NYSDSS relied on two Provider Reimbursement Review Board (PRRB)
decisions.

In Monongalia Gen. Hosp. v. Blue Cross and Blue Shield Assn./West
Virginia Hosp.  Services, PRRB Dec. No. 83-D12, CCH Medicare and
Medicaid Guide, New Developments, . 32,361 (1983), a provider leased a
facility and made substantial leasehold improvements of which it lost
possession when it moved out of the building and the lease terminated.
In finding abandonment of the leasehold improvements, the PRRB
emphasized that the provider never had title to the building and had
lost all rights to the improvements and that the lessor to which the
building reverted was not a related party.  The situation in the present
case is precisely the reverse, since the State or a related party held
title continuously to the buildings and the improvements. Nothing in the
Monongalia case supports the idea that a provider can retain a claim to
a building and still take an abandonment loss on improvements to it,
simply because the building is no longer used for patient care purposes.
HCFA argued, and we agree, that the proper treatment of the
compliance-related improvements is the same as the assets to which they
are related.  The State retains a claim on the improvements as on the
buildings through its relationship with the Dormitory Authority, the
transfer of the improvements to the Dormitory Authority amounted to a
donation (regardless of whether the Dormitory Authority found the
improvements useful), and OMRDD did not obtain approval to abandon or
demolish the improvements and did not establish that they were without
value.  Therefore, we conclude that the loss claimed on the
compliance-related improvements was not allowable.

3. Salvage values must be assigned to the depreciated assets at issue.

       A.  Background and arguments

UKW determined that NYSDSS assigned no salvage value to any of its
depreciable assets.  Since salvage value is subtracted from the cost of
an asset before depreciation is calculated, the failure to assign a
salvage value increases the depreciation expenses attributed to that
asset.  UKW calculated that depreciation costs were overstated by
$1,883,997 based on its conclusion that a minimum ten percent salvage
value was appropriate under the PRM.

NYSDSS argued that the PRM did not specify a particular salvage value.
Further, NYSDSS argued that no salvage value could reasonably be
expected from OMRDD assets, because (1) they suffer so much abuse from
severely mentally retarded clients and (2) OMRDD procedures for
surplusing equipment and buildings rarely result in any sales.  NYSDSS
supported these assertions by a survey of facilities which concluded
that revenue from sales of surplused equipment was negligible.  In
addition, NYSDSS argued that it had never assigned salvage value to its
assets, rejecting HCFA's assertion that the Blake Report assigned a five
percent salvage value to the assets inventoried there.

As explained below, we conclude that it was reasonable to require some
salvage value for all assets (absent individual contrary
determinations).  We further conclude that ten percent was a reasonable
minimum salvage value to assign to buildings and fixed assets, and we
therefore uphold that portion of the disallowance.  However, we conclude
that NYSDSS demonstrated that moveable assets were expected to have a
lower salvage value, so that five percent would be a reasonable salvage
value to assign to the moveable assets, and we remand that portion of
the disallowance to HCFA to calculate a corresponding adjustment.

       B.  Discussion

             1.  Some salvage value should be assigned to virtually all
             depreciable assets.

The PRM provides as follows:

     Salvage value is the estimated amount expected to be realized upon
     the sale or other disposition of the depreciable asset when it is
no longer useful to the provider. . . . [I]f a provider disposes of its
assets when they are in good operating condition, the salvage value
would be higher than it might be if the provider used the assets until
their inherent life had been substantially exhausted.  Virtually all
assets have a salvage value substantial enough to be included in
calculating depreciation, and only in the rare instance will salvage
value be so negligible that it may be ignored.

PRM, . 104.19 (November 1985). 26/  The salvage value is an estimate at
the time of acquisition.  Id.  An adjustment to net depreciation claimed
is made at the time of disposal for any gain or loss based on the actual
useful life and salvage value realized. 42 C.F.R. . 413.134(f); PRM, .
132.

              2.  Fixed assets should have been assigned a salvage value
              of ten percent.

                     a.  Cost-free transfers of assets do not justify
                     assigning zero salvage value.

NYSDSS argued that it expected to realize no salvage value upon disposal
of its fixed assets because they were never sold but only transferred to
other agencies.  In this regard, it is important to remember, as
discussed above in relation to SIDC, that the PRM does not permit
realizing any gain or loss on assets disposed of as donations through
cost-free intergovernmental transfers. To allow NYSDSS to ignore salvage
value on its assets because it plans to dispose of them by donations
would be to destroy the meaning of this provision by allowing NYSDSS to
realize in advance the losses which the PRM forbids it to realize on
disposal.  In effect, NYSDSS seeks to shift costs to the federal
government by a policy of transferring all assets away from the
Medicaid-funded agencies to State-run programs rather than seeking to
recoup their residual value through bona fide sales.

As an example, compare two identical assets bought on the same date for
$10,000 with a useful life of ten years each.  Asset A is expected to be
sold for salvage value of $1,000 at the end of its useful life.  Asset B
is expected to be transferred to another State agency at no cost.  The
depreciation on Asset A in which Medicaid would participate would be
$10,000 - $1,000 divided over ten years, or $900 a year for 10 years.
However, under NYSDSS's approach, the depreciation on Asset B would be
$10,000 divided over ten years, or $1,000 a year for ten years. 27/  Not
only would the State have received a larger amount of federal funding
for depreciation over the years, but the State would receive a cost-free
donation of an asset worth a residual value of $1,000 which was
partially purchased with federal funds.  We agree with HCFA that nothing
in the PRM supports NYSDSS' position that the disposal of assets by
inter-agency donation evidences that the assets were expected to have no
salvage value.  Therefore, we reject NYSDSS's arguments that it expects
no salvage value on OMRDD's buildings because the only disposals of
buildings (Craig, Rome, and SIDC) have been cost-free "inter-agency
transfers." 28/ NYSDSS Br. at 30-31.

We therefore conclude that salvage values should have been assigned to
buildings and fixed assets regardless of OMRDD's use of cost-free
transfers in disposing of these assets.

                    b.  Ten percent is a reasonable salvage value to
                    assign to the buildings and fixed assets.

HCFA derived a ten percent figure from a survey performed by the
Inspector General of 30 hospitals, which NYSDSS asserted was
inapplicable to public facilities for the mentally retarded. 29/
However, NYSDSS did not present any other basis for determining the
appropriate amount of salvage value for its buildings and fixed assets,
because it relied on the theory that they had no salvage value since
they would be transferred rather than sold.

The survey on which the Inspector General's recommendation was based
showed that most of the sales were made at a gain, while those which did
show a loss resulted in salvage values between 24 and 51 percent of
historical cost.  NYSDSS Ex. 10, internal attachment 7, at 2-3.  The ten
percent figure was selected as minimal since it was less than the value
realized in any of the hospital sales.  Id.  Consequently, while the
survey sales may well not be representative of the value realizable were
the ICF/MR facilities here offered for sale, we conclude that the
minimal ten percent figure is a reasonable expectation for buildings to
account at least for the residual value of building shells and
components even where the facilities are deteriorated.

              3.  The moveable assets should have been assigned a lower
              salvage value of five percent.

                    a.  OMRDD's survey of surplused equipment
                    demonstrates a lower salvage value than for fixed
assets.

NYSDSS described OMRDD's written procedures for surplusing moveable
assets as beginning with a notice of availability to other OMRDD
facilities.  If no other facility wants the item, OGS is notified and
may arrange a cost-free inter-agency transfer (rarely done for
equipment), sell the item at public auction, or authorize a direct sale
by the facility.  Proceeds of any sale go to the State's general fund.
30/  If the item's condition is considered too bad or it cannot be sold,
it is hauled away as trash.  NYSDSS Br. at 27-28

NYSDSS asserted that the equipment surplused by OMRDD facilities
generally had no residual value.  First, the residents subject the
equipment to extraordinary abuse (throwing furniture, ripping
upholstery, battering equipment, etc.).  Second, because of budget
constraints, the facilities use the equipment so long as it can be
repaired or even used for parts, so that assets are not replaced until
they are beyond the point of being saleable even as salvage.  To verify
this assertion, OMRDD surveyed each of facilities to obtain lists of all
items surplused during FY 1986-87 and the total revenue through direct
sales of surplus property by the facility.  The survey concluded that,
for at least 1,797 depreciable moveable assets surplused by OMRDD
facilities, the total revenue obtained was $5,307.43, averaging less
than three dollars per asset.  NYSDSS Br. at 29-30; NYSDSS Ex. 13.  On
this basis, NYSDSS maintained that OMRDD's depreciable equipment
constituted the "rare instance" in which salvage value was so negligible
as to be ignored.  NYSDSS Br. at 31.

HCFA argued that the survey included only items that no OMRDD facility
or other State agency wanted, while transferred items may have had
residual value.  We rejected above the claim that cost-free transfers of
fixed assets to other State agencies demonstrated that OMRDD reasonably
expected no salvage value on those assets. However, NYSDSS asserted, and
HCFA did not deny, that such transfers were infrequent in the case of
moveable equipment. 31/  The assets accepted by other OMRDD facilities
(as well as any that were transferred to other State agencies) should
not have been considered as disposed of, since they were still in use by
a related party. HCFA did not deny that the other transactions reported
by the facilities represented bona fide sale or scrapping of the assets.
Therefore, these transactions would be the proper source for an
assessment of fair market value of these assets at disposal, rather than
those instances in which less-than-arm's length transfers occurred.  Cf.
HCFA Br. at 45-46; 42 C.F.R. . 413.134b2. 32/  The total amount of
revenue derived obviously was still relatively small, although the
average amount would be higher than the three dollar figure which was
based on dividing the revenue among all surplused equipment, including
inter-facility transfers.

We conclude that NYSDSS has demonstrated that moveable equipment used in
the ICF/MR facilities can be expected to have relatively low salvage
values.  We recognize that the PRM provides that the salvage value
assigned a particular asset may differ based on how intensively the
provider expects to use the asset.  We further recognize that the PRM
does not prohibit a zero salvage value in all cases, since it says
"virtually all," rather than "absolutely all" assets will have some
salvage value.  A zero salvage value might be justifiable in particular
instances where the provider so documented for an individual asset.
However, we are not persuaded that the PRM contemplated the "rare
instance" of zero salvage value being applied in blanket fashion to the
wide number and range of moveable assets held by OMRDD. 33/

We realize that the administrative effort and costs involved in making
individual assessments of salvage value as to each of the items of
equipment used in an OMRDD facility would likely be prohibitive, 34/ so
that some uniform figure is preferable.  HCFA treated the moveable
assets in the same way as the fixed assets discussed above and applied a
single ten percent figure.  We do not see a reasonable basis for this
conclusion, since NYSDSS provided significant evidence that the moveable
assets are likely to retain significantly less salvage value.  In
considering a reasonable uniform figure for moveable assets, we turn to
the Blake report below.

             b.  The Blake report assigned a five percent salvage value
             to moveable assets.

HCFA asserted that its contention that OMRDD assets did have salvage
value was supported by the Blake report, which considered appropriate
salvage values as part of the inventory and appraisal process.  HCFA
provided an excerpt from the Blake report which substantiated its claim
that the assets listed there for SIDC (then called the Letchworth
Village) were assigned a salvage value of five per cent (except for
carpets and drapes which were assigned zero salvage value).  HCFA Br. at
43-44; HCFA Exs. 4 and 5.  NYSDSS argued that the assets which were
assigned a five per cent salvage value were moveable assets that were
fully depreciated before the base year. NYSDSS speculated that the Blake
appraisers were not aware of the unusual mistreatment suffered by these
assets in OMRDD facilities.  NYSDSS Reply Br. at 45.  Further, NYSDSS
argued that the Blake report did not assign salvage value to the
buildings and fixed assets included in categories 1, 2 and 3 of the
depreciable assets at issue.  NYSDSS Br. at 21-22; NYSDSS Reply Br. at
45-46; NYSDSS Ex. 8. 35/

Neither the State plan nor the PRM prescribe specific amounts or methods
for estimating salvage values for moveable assets.  Where the State plan
and the PRM are both silent, the State plan requires us to weigh the
reasonableness of a cost, in relationship to client care and generally
accepted accounting principles.  NYSDSS Ex. 7, at 23.  Therefore, it is
appropriate to look at the Blake report figures in weighing
reasonableness.  We do not find any basis for NYSDSS's speculation that
the five percent salvage value assigned to moveable assets in the Blake
report resulted from the auditors' ignorance of the abuse of such assets
in the facilities.  The cover sheets indicate that each item was rated
for its condition and the excerpt listing moveable assets shows
condition ratings for each asset (most of them as having few if any
deficiencies).  HCFA Ex. 4, at 16-17; HCFA Ex. 5.  It is correct that
the particular moveable assets inventoried there are not at issue here,
having been fully depreciated.  However, NYSDSS did not demonstrate that
they differed in any significant way from the later-acquired moveable
assets that are at issue.  In light of NYSDSS's inability to assess the
individual salvage values of the large number of assets involved, the
moveable assets inventoried in the Blake report provide a reasonable
basis for assigning salvage value to OMRDD's moveable assets.

HCFA sought to assign a ten percent salvage value to all assets across
the board. However, HCFA relied on the Blake report in other respects
and, in fact, stated that the "Blake appraisers obviously conducted
their appraisal in accordance with PRM principles" in assigning salvage
values to the inventoried assets.  HCFA Br. at 44. HCFA never offered
any reason for its rejection of the five percent salvage value assigned
by the Blake appraisers to most of the moveable assets.

We conclude that OMRDD's moveable assets should have been assigned a
salvage value of five percent.  We remand to HCFA the portion of the
disallowance relating to the failure to assign salvage values to
moveable assets to recalculate using a five percent salvage value in
place of ten percent.

5.  Design costs on building renovations should be linked to the useful
lives of the buildings as extended by the renovations.

       A. Background and arguments

Design services, such as architectural and drafting services, for
existing OMRDD facilities are provided in-house by OGS and charged
annually to OMRDD.  (New building construction design is contracted out
and is not involved here.)  OMRDD included these charges in its base
year costs by amortizing them over a ten-year period. UKW found that the
design costs should have been included in the historical costs of the
related assets and amortized over the useful lives of the assets.
NYSDSS conceded that the PRM required amortization of design costs over
the useful lives of the related assets, but denied that the 40-year
useful life which UKW applied as typical was appropriate for renovations
and improvements to existing buildings.  See generally NYSDSS Br. at
46-47.  NYSDSS proposed a 20-year useful life as appropriate, thereby
reducing the contested portion of the questioned costs for design cost
amortization from $529,357 to $352,904. HCFA insisted that the 40-year
period was appropriate.

As explained below, we conclude that the design costs issue should be
remanded.  We also urge the parties to work out a reasonable estimate of
the remaining useful life of the buildings to which the renovations
relate.

       B.  Discussion

The State plan provides that the useful life of an asset over which its
historical cost (which both parties agreed included design costs) should
be amortized "shall be the higher of the reported useful life or those
from the `Estimated Useful Lives of Depreciable Hospital Assets' (1983
Edition) [AHA Guide, NYSDSS Ex. 26]."  State Ex.  7, at 26.  NYSDSS
argued that, because of its method of recording buildings as multiple
assets with different useful lives and because of the large number of
design projects affecting multiple buildings, it would be unworkable to
tie design costs to specific reported useful lives.  NYSDSS Reply Br. at
68-71.  NYSDSS acknowledged that the AHA Guide does not list useful
lives for capital improvements, but turned to the listings for
componentized parts of buildings and building services equipment which
showed useful lives ranging from 10 to 20 years.  Id. at 67.  HCFA
pointed instead to the listings for concrete and steel buildings which
showed useful lives ranging from 25-40 years, and suggested that the
maximum figure is appropriate in "the absence of proof to the contrary."
HCFA Br. at 62.  HCFA also asserted that the PRM provided that
improvements that extended the life of an asset are to be capitalized
over the remaining useful life of the asset as extended.  PRM, . 108.2
(February 1982).  Therefore, HCFA reasoned, the design costs for
projects to renovate buildings would be tied to the useful lives of the
buildings, not to particular systems or components of buildings which
are unlikely to require design improvements.  HCFA Br. at 60-62.

We agree with HCFA that the underlying assets for which the design costs
are incurred are more likely to be improvements to buildings than to
particular components.  (NYSDSS described the services as "design
functions for building renovation and rehabilitation projects."  NYSDSS
Br. at 47.)  Thus, while improvements such as new floor finishes, air
conditioning systems, or toilet partitions may well be installed as part
of a renovation project, the design costs at issue are described by
NYSDSS itself as on a scale involving one or more buildings, rather than
the design of, for example, a particular partition or air conditioner.
Cf. NYSDSS Reply Br. at 70.  Therefore, under the PRM, the costs should
be spread over the useful lives of the buildings affected. Since NYSDSS
argued that identifying the reported useful lives of the buildings
involved in any particular design project was impractical, HCFA
reasonably turned to the AHA Guide figures for the useful lives of
buildings.

On the other hand, we disagree with HCFA's use of the highest of the
range of figures for the useful lives of new buildings as the
appropriate period to amortize design costs on renovations, since the
relevant period is the remaining useful life of the asset as extended by
the improvements.  As NYSDSS pointed out, an asset's remaining useful
life "by the time renovation becomes necessary (even when that useful
life is extended by the renovation) obviously will be no greater than,
and likely less than, its initial useful life."  NYSDSS Reply Br. at
71-72.

Since we find that neither party has provided evidence adequate to
justify its proposed amortization schedule, we are remanding this issue.
NYSDSS will have the opportunity to provide evidence to HCFA regarding
the useful lives of renovated buildings.  If HCFA rejects NYSDSS'
proposed amortization period, HCFA should provide a better justification
than it has here for the application of a higher figure than NYSDSS
proposes in the case of these renovations.  Also, we urge the parties to
review their positions to determine whether they might be able to agree
upon a reasonable estimate for the amortization period.

6.  Design costs from FY 1976-77 were properly included.

       A.  Background and arguments

UKW found that the base year costs for FY 1986-87 included an amortized
portion of in-house design costs from FY 1976-77.  NYSDSS Ex. 1, at
internal exhibit H, . A.5. Since, as discussed above, NYSDSS amortized
these costs over ten years, UKW concluded that the costs should have
been fully amortized already and that their inclusion in the base year
costs overstated costs by $8,389. 36/  NYSDSS responded that its
reporting system for asset depreciation, as it functioned prior to FY
1983-84 because of the number and complexity of the assets and the
limitations of the older data processing system, caused a lag of one
year in claiming depreciation on most assets. 37/ In other words,
depreciation claims would not be made until the fiscal year after the
one in which an asset was acquired and consequently would end a year
later than the normal amortization period (i.e., had that period begun
to run on acquisition).  NYSDSS Br. at 49-50; NYSDSS Ex. 2, at 13
(Carusone Affidavit).  Thus, in the case of the design costs incurred on
assets constructed in FY 1976-77, NYSDSS contended that an amortized
portion was not included in depreciation costs until FY 1977-78, so that
FY 1986-87 was the tenth and final year of amortization.  Id.

HCFA responded that NYSDSS presented, and UKW's review disclosed, no
evidence of the existence of the alleged lag, and that NYSDSS bore the
burden of documenting its claim.  Therefore, HCFA argued that, in
absence of adequate documentation of the lag, the costs should be
treated as erroneously included in FY 1986-87.

For the reasons given below, we conclude that the base year was the
final year of amortization for these design costs and therefore reverse
this part of the disallowance.

       B.  Discussion

It was not disputed that the costs at issue were properly included in FY
1986-87 (with adjustments for the corrected amortization period), if in
fact they had not already been fully amortized.  HCFA argued instead
that NYSDSS did not document that the alleged lag in reporting existed.
The evidence which NYSDSS offered regarding the lag consisted of its
response to a draft of the UKW report (NYSDSS Ex. 40) and two affidavits
from Leonard Carusone (NYSDSS Exs. 2 and 34).  Mr. Carusone has been the
Principal Health Care Fiscal Analyst for OMRDD since 1981.  NYSDSS Ex.
2, at 1.  His job includes gathering the data for and supervising the
calculation of OMRDD reimbursement rates.  Mr. Carusone described the
asset depreciation system before FY 1983-84 and the resulting lag in
claiming depreciation, as summarized above.  Id., at 11-13.  No
documentary evidence was provided to demonstrate the effect of the lag.
We already have discussed the unavailability of documentation
identifying particular assets in the ADR prior to FY 1983-84.

While it would certainly be preferable if OMRDD were able to document
the assets to which these design costs were attributed and trace their
depreciation costs, HCFA did not challenge the existence or allowability
of these costs except on the limited basis that the time lag for
beginning their depreciation was not documented.  We note that the PRM
permits a time lag of up to one year after the year of acquisition in
which to begin claiming depreciation.  In such cases, "[i]n the year of
disposal a full year's depreciation is taken."  PRM, .118.A.2 (November
1985).  The PRM also allows a provider a one-time opportunity to change
its method of determining depreciation in the year of acquisition for
assets acquired after the change.  PRM, . 118.  The time at which to
begin claiming depreciation on a provider's assets is thus intended to
be set by policy and to apply across the board to all assets unless
changed for all subsequently-acquired assets.  Mr. Carusone's affidavit
provides credible information from a knowledgeable source regarding the
time lag policy and its change in FY 1983-84.  HCFA did not provide any
reason to disregard Mr. Carusone's explanation of how OMRDD handled
first-year depreciation costs, especially since the methods described
appear to be in compliance with the PRM.  Furthermore, we note that the
Blake report, dated January 3, 1972, described the depreciation policy
as employing the one-year-time-lag method from the PRM, and therefore
charging depreciation beginning in the fiscal year after acquisition.
HCFA Ex. 4, at 3.  This description corroborates Mr. Carusone's
affidavit.

Therefore, we conclude that the disallowance relating to these costs
should be reversed.

7.  NYSDSS did not show that discrepancies in depreciation amounts were
due to changes in historical cost.

       A. Background and arguments

UKW found that the amounts claimed for depreciation for 151 assets were
incorrect, for a total overstatement of $4,881.  NYSDSS Ex. 1, at
internal exhibit H, . A.6.  NYSDSS asserted that the discrepancies
between the amounts calculated by OMRDD and by UKW were not the result
of mathematical errors, as found by UKW, but resulted from OMRDD's
system for accounting for changes in project costs.  NYSDSS alleged that
depreciation begins once physical construction of an asset is complete,
but that the historical cost for the asset may change after that date,
due to contract renegotiation, litigation, etc.  If the historical cost
rises, the amount claimed for depreciation for any FYs before that
change would have been too small.  In such cases, not only is a higher
amount calculated for subsequent years, but the amount by which any
prior year's depreciation was understated (based on the new historical
cost) is added as a one-time increase. 38/

HCFA described this explanation as "appealing," but asserted that NYSDSS
had failed to provide any documentation to substantiate its assertions
that these discrepancies actually relate to later price adjustments.
NYSDSS asserted that the adjustments were automatically made by a
computer program called the "Project Management System Update" (PMS),
and that this process is reflected in the description of the
depreciation programs in OMRDD's computer program handbook by a
reference to "lump-sum adjustments."  NYSDSS Reply Br. at 90.  NYSDSS
also submitted Mr. Carusone's affidavits describing the adjustment
process and suggested that further verification could have been obtained
by UKW from the officials who designed and operated OMRDD's computer
system.  NYSDSS Reply Br. at 91; NYSDSS Exs. 2, 34.  However, NYSDSS
argued that requiring production of ADR printouts, detail listings or
original contracts dealing with these 151 assets would be unreasonable.
We conclude that, absent documentation, the overstated depreciation as
to these assets was unallowable.

       B.  Discussion

The difficulties described above in connecting ADR listings from before
FY 1983-84 to specific assets might account for NYSDSS' inability to
document the occurrence of later adjustments to historical cost in
regard to specific older assets.  However, NYSDSS did not provide
documentation evidencing such an adjustment for even one of the 151
assets at issue (nor did NYSDSS allege that all of these assets dated
from before FY 1983-84). In any case, as we discussed earlier in
relation to the assets in the survey which could not be located, NYSDSS
has the responsibility to maintain adequate documentation to support its
depreciation expenses.  It is simply not sufficient to say that a
computer is taking care of the calculations automatically, without being
able to provide the data which is being provided to the computer or to
identify the particular assets and the basis for their historical costs.
39/  While it may well be true that some discrepancies resulted from
recalculations performed by computer rather than from mathematical
error, we conclude that NYSDSS has failed to meet its burden to
demonstrate that that was so with regard to these 151 assets.

Conclusion

For the reasons explained above, we uphold the disallowance to the
extent that it relates to the following costs:

       --    Interest costs on general State borrowing.

       --    Depreciation relating to assets which NYSDSS admitted had
       been transferred away from OMRDD's use.

       --    Depreciation relating to assets for which documentation
       adequate to permit identification and examination was not
available.

       --    Abandonment loss on SIDC, transferred without cost for use
       as a public college campus, subject to HCFA's discretion to
consider a request for retroactive approval.

       --    Excess depreciation because of the failure to assign a ten
       percent salvage value to fixed assets.

       --    Mathematical errors in the calculation of depreciation on
       some assets.

We reverse the disallowance to the extent that it relates to the
following costs:

       --    Design costs arising in FY 1976-77 but not yet fully
       amortized in FY 1986-87 due to a one year time lag in effect for
claiming depreciation on assets acquired at that time.

We remand the following portions of the disallowance:

       --     Depreciation costs relating to seven assets for which the
       date of transfer was not determined, so that NYSDSS may provide
additional documentation and HCFA may make a determination as to the
correct dates of transfer.

       --    Depreciation costs relating to one asset which was
       replaced, so that NYSDSS may provide additional documentation and
HCFA may make a determination as to the method of disposal of this asset
and the consequent depreciation adjustment.

       --    Excess depreciation because of the failure to assign any
       salvage value to moveable assets, so that HCFA can recalculate
the amount of the disallowance using an assigned salvage value of five
percent for these assets.

       --    Design costs amortized over too short a period, so that
       NYSDSS may provide evidence regarding the useful lives of
renovated buildings and may seek agreement with HCFA on a reasonable
estimate for the amortization period.

In regard to those portions of the disallowance remanded to HCFA, NYSDSS
should submit any additional documentation (where appropriate) to HCFA
within 30 days of this decision, or such additional time as HCFA may
permit.  NYSDSS may appeal to the Board on the remanded items only
within 30 days of receiving HCFA's written determination.

                                              ___________________________
                                              Cecilia Sparks Ford

                                              ___________________________
                                              Norval D. (John) Settle

                                              ___________________________
                                              M. Terry Johnson Presiding
                                              Board Member

1.  NYSDSS contended that UKW's findings regarding interest costs were
unauthorized, because UKW's contract with HCFA only called for a review
of depreciation costs. NYSDSS Br. at 9, n.7.  However, NYSDSS did not
explain why the allowability of the interest costs would be affected
even if UKW's review of costs extended beyond its contractual
responsibility.  Therefore, we make no determination as to the scope of
UKW's contract with HCFA.

2.  The amounts of the overstated costs reflect adjustments by UKW to
allow for OMRDD's inactive space adjustment and a stepdown calculation
for capital cost rates, which are discussed in this decision only when
relevant to disputed issues.  See generally NYSDSS Ex. 1, at internal
exhibit E.

3.  In citing the PRM, we give the date of the most recent version of
each provision. The parties pointed to no instance in which the version
in effect at the period in question differed in any material way.

4.  The context of this provision in the PRM makes it even more unlikely
that normal operating expenses could have been intended to encompass
state-wide governmental costs.  The PRM generally requires that interest
costs be supported by loan contracts. Where supporting records are
maintained physically away from the facility (such as with a county
treasurer for bond records) and the interest is otherwise allowable, the
PRM permits the records to be deemed to be those of the facility where
the bond issues "have been specifically designated for the construction
and acquisition of your facilities." PRM, . 202.1.  NYSDSS acknowledged
that the interest costs here failed to meet the requirement that
interest be identifiable in the facilities' records.  NYSDSS Br. at 19.
NYSDSS contended TRANs interest was, in this regard, "no different from
other indirect costs that are allocated to OMRDD and are reimbursable
under" the state-wide CAP. However, as we discuss below, TRANs interest
was not and could not be included in the state-wide CAP.  We therefore
find that the record-keeping restriction in the PRM on interest cost
documentation supports our interpretation that the PRM did not intend
borrowing for "normal operating expenses" to be read so expansively as
to reach state-wide operations remote from specific facilities.

5.  NYSDSS noted that the State plan limits interest on working capital
indebtedness for certain facilities (those with less than 30 beds).
NYSDSS Reply Br. at 9.  NYSDSS contended that this limitation evidenced
that the State plan would also have expressly excluded "indebtedness
incurred by other agencies of the State on behalf of OMRDD" if such an
exclusion were intended.  Id.  If anything, this limitation on
facilities which can claim interest on working capital indebtedness
demonstrates further that this cost element was envisioned as related to
particular facilities and not as a pass-through of state-wide costs.

6.  NYSDSS argued that State plans are not required to make detailed
distinctions such as the relation of working capital indebtedness to
State tax anticipation indebtedness, relying on our decision in South
Dakota Dept. of Social Services, DAB No. 934, at 9 (1988).  State Reply
Br. at 10, n.3.  The point here, though, is not that the State plan was
flawed in its failure to specifically address tax anticipation
indebtedness, but rather that the plan chose to refer to the PRM for all
issues not specifically addressed in the plan itself.  To refuse to turn
to the PRM on this point would be to ignore the directive of the State
plan.

7.  The PRM has an analogous treatment of bonds to finance construction
or acquisition of publicly-owned facilities, making a distinction
between bonds directly issued to benefit a facility and the use of
general government funds, even if obtained through issuance of bonds.
PRM, Part 216 (January 1983).  Where the funds to finance a public
facility are obtained from general purpose government funds, even if "a
portion of such fund is raised through bond issues, no part of the
interest payable on the bonds is allowable as a cost of the provider."
Id. at . 216.2.

8.  NYSDSS described the interest costs in various ways and later denied
that they were indirect or overhead costs, subject to the plan
limitations on such costs.  NYSDSS Reply Br. at 17-19.  NYSDSS did not
explain how interest on borrowing by the State could be a direct cost of
an ICF/MR, but argued that the allowance of interest on capital
indebtedness, including working capital indebtedness, meant that "all
interest, including interest on spring borrowing, is includible . . .
even though it does not fall within the Plan's definition of `overhead
cost,' and regardless of whether it is a direct or indirect cost."  Id.
at 18-19.  Nothing in the plan supports this sweeping inclusion of the
interest costs of every level of state government for any purpose
whatever as costs of ICF/Mrs under the State plan.

9.  NYSDSS did not object to the sampling methods used by UKW, and in
fact asserted that its own statistical analysis duplicated UKW's
methodology.  NYSDSS's essential objection, which we address in the
text, was that UKW treated all items which could not be located and
examined as errors.

10.  NYSDSS made no separate argument in regard to the two items in
group (b) that were found not to be in use upon examination and
therefore we affirm that portion of the disallowance without further
discussion.

11.  The amount of the overstated depreciation calculated by UKW was
reduced to avoid duplication with the disallowance amount calculated for
failure to assign salvage value.

12.  The line items involved are as follows:  Two line items listed by
UKW as both lacking proper documentation and transferred (600037 and
600030), and challenged by NYSDSS, related to improvements to specific
buildings at the Craig Developmental Center (Craig) which were
transferred in 1984.  A third line item (600020) was also not properly
documented and was related to Craig, but could not be identified by
building. NYSDSS Br., App. at 3-4.  Another line item (600202) was found
to be partially documented and located at Craig but not identified with
a specific building.  (Line items 600020 and 600202 are included here
but since Craig was not completely closed until 1988, they could also
have fallen under the category of items treated as still in use in the
fiscal year had the buildings involved been identifiable.)  Another line
item (600183) was found adequately documented and identified with nine
buildings at Craig which were transferred to other agencies between 1982
and 1984.

13.  The line items involved are as follows: One line item (600041) was
found to lack documentation but was identified with a building at Rome
Developmental Center (Rome) which was transferred to another state
agency in October 1987 and was therefore allegedly in use during the
fiscal year in question.  Another line item (600064) was found to have
partial documentation and was identified with two buildings at Rome that
were not transferred until October 1989.  Id. at 5.  Two line items
(200277 and 600072) were adequately documented and related to specific
facilities at Rome which NYSDSS asserted were not transferred until
October 1987. Another line item (200556) was adequately documented and
identified with a building at Rome which NYSDSS alleged was in use until
1989.  Two line items (200082 and 300022) were found to be adequately
documented and identified with a building at the Long Island Development
Center (LIDC) which NYSDSS alleged was still in use in the fiscal year
in question.

14.  In fact, the standard also advises the auditor to consider whether
the reasons that the items cannot be examined have implications for the
auditor's "degree of reliance on management representations."  Id.  This
advice militates against reliance on unsupported claims by management
that items lacking documentation and not available for inspection are
nevertheless properly in use.

15.  Furthermore, the State plan does not allow the inclusion of any
expenses "that are not reasonably related to the efficient and
economical provision of care."  NYSDSS Ex.  7, at 23.  It is difficult
to see how the relation of these expenses to the efficient and
economical provision of care could be verified when the assets involved
cannot be identified, located or examined.

16.  HCFA attacked the validity of A&I's methodology on several other
grounds as well. See HCFA Br. at 72-77; HCFA Supplemental Br. at 7-11.
However, in light of our conclusion that statistical sampling could not
be used for the purposes attempted by A&I here, it is not necessary for
us to discuss further these disputes as to the validity of A&I's
methodology.

17.  NYSDSS claimed that HCFA was wrong to characterize this
depreciation as "not documented at all," since the assets were "at least
reflected in the ADR."  NYSDSS Reply Br. at 73, n.34; see HCFA Br. at
71, n.30.  It is academic whether the depreciation is characterized as
insufficiently documented or wholly undocumented.  The point is that
NYSDSS could not establish from its records what the assets listed in
the ADR were, where they were located, or whether they were being used
for proper purposes.  No statistical methods can remedy this omission.

18.  The parties agreed that the relevant year for this element of the
disallowance was FY 1988-1989, since the unrealized depreciation costs
were claimed as a material change from the base year costs based on the
transfer.

19.  Both parties agreed that Medicare principles apply to the issue
because no State plan provision was on point.  See NYSDSS Br. at 34,
n.22.

20.  The method of including the loss depends on the size of the
aggregate loss and the degree to which the asset was depreciated.  See
PRM, . 132.A.3.

21.  It is therefore not decisive that the Dormitory Authority has been
found to have "separateness and juridical distinction" from the State
for purposes of tort claims.  Braun v. State, 117 N.Y.S.2d 601, 602
(N.Y.Ct.Cl. 1952).  Nor is it significant that the Dormitory Authority
may not be "identical" with the State for purposes of enforcing a
contractual arbitration clause.  Dormitory Auth. v. Span Electric Corp.,
218 N.E.2d 693, 695 (N.Y.Ct.App. 1966).

22.  HCFA conceded that actual title to the facility passed from the
State of New York to the Dormitory Authority (which unlike OMRDD could
hold title in its own name). HCFA Br. at 54.  However, even after title
passed, HCFA argued that the State itself did not relinquish all claim
on the property since it retained a reversionary claim if the property
ever ceased to be used for college purposes, as well as a utility
easement.  Id.  at 54-55; NYSDSS Ex. 16, at 3-4.  NYSDSS argued that
these claims were irrelevant since the depreciable assets were the
buildings, not the land through which the easement ran, and the
reversionary claim was meaningless at least since so many of the assets
involved were buildings which were demolished or renovations which were
torn out.  NYSDSS Reply Br. at 57-59.  Since we have found that the
State continued to exercise control through the Dormitory Authority as a
related organization, the passing of title is not decisive.  The
reversionary claim simply demonstrates further that the State retained
rights to control the use of the property.  We discuss the effect of the
demolition of the assets below.

23.  In light of our conclusion that the Dormitory Authority is related
to the State for these purposes, we need not distinguish between the
period when SIDC was leased to it by OGS and the period after the deed
was executed.  Cf. NYSDSS Reply Br. at 55, 57, n.25.

24.  Therefore, the discussion in this section would not apply to
buildings or renovations which were not demolished or which continued to
be used for any purpose.  No loss can be claimed on these assets, since
they are neither demolished nor abandoned for the reasons discussed
above.

25.  NYSDSS also argued that, even if approval was not obtained, the PRM
provisions should not be read to apply strictly, since the State plan
merely adopts the PRM as the "major determining factor" rather requiring
absolute compliance with it.  NYSDSS Reply Br. at 64, n.31.  NYSDSS
based its argument on language in the PRM provision requiring the
approval request to be submitted to HCFA's Regional Office through the
"intermediary," a role that exists in Medicare but not Medicaid.  We
conclude that the reasonable interpretation of the State plan's adoption
of the PRM in the area of demolition is that the approval requirement
applies but can be met by submission to HCFA directly.

26.  Both parties agreed that the PRM applied to this issue because the
State plan contained no provision regarding salvage value.  See NYSDSS
Br. at 22, n.13; HCFA Br.  at 38, n.19.

27.  By contrast, under HCFA's approach, Asset B would be treated in the
same way as Asset A, since its anticipated value upon donation would be
the same, even though the provider chose to avoid actually realizing
that value by donating the asset rather than selling it.

28.  NYSDSS did not explain why it included the transfer of SIDC to OGS
and then to the Dormitory Authority as an inter-agency transfer here,
while denying that it constituted an intergovernmental transfer in
regard to OMRDD's claim of abandonment. Cf. NYSDSS Br. at 50, n.21.
Furthermore, the fact that CUNY demolished or gutted most of the
buildings at SIDC does not demonstrate that they were not expected to
have any salvage value at the end of their useful lives.  As also
discussed in relation to the abandonment issue, these assets were never
offered for sale in arm's-length transactions to parties who might have
been able to put them to use in a way which CUNY was not. Further, it
strains credulity to assert that, even as building shells or components,
these assets could not have been expected to generate some salvage
value.

29.  HCFA also suggested that the appropriate salvage value would be the
fair market value of the assets upon disposal or transfer, which could
be ascertained by independent appraisers.  HCFA Br. at 45-46.  NYSDSS
rejected this alternative approach, arguing that OMRDD does not expect
to realize revenue upon transfer of the buildings or to sell them for
fair market value.  NYSDSS Reply Br. at 48.

30.  NYSDSS also claimed that this fact meant that OMRDD itself did not
receive any revenue from the sales.  However, any income which the State
received from sale of assets acquired through operation of facilities
with Medicaid funding would be attributable to determining whether the
facilities overstated the depreciation of those assets in setting their
reimbursement rates, regardless of the account in which the State
deposited the revenues.

31.  HCFA also argued that the survey was flawed in covering only assets
disposed of in one year and only a small portion of OMRDD's total
depreciable assets.  We fail to see the relevance of these points since
the actual salvage value of assets is determinable only upon disposal,
not during use, and the base year would seem to be a reasonable time
frame in which to examine this.

32.  Thus, while an independent appraisal might be necessary, as HCFA
suggested, to determine the salvage value of transferred assets, no such
approach is needed where a bona fide sale or scrapping has occurred.
See generally PRM, . 132.

33.  Under the PRM provisions, however, depreciation is adjusted upon
disposal to reflect the actual value realized (gain or loss), if the
asset is disposed of by the methods permitted by the PRM.  Therefore,
assets which are disposed of by bona fide sale, scrapping (for personal
property), demolition or abandonment (if replaced or approved as
required), or involuntary conversion for less than the assigned salvage
value would be recalculated at the time of disposal.  No gain or loss
may be  realized on donations, trade-ins or exchanges.  See PRM, . 132;
HCFA Br. at 39-41.  Therefore, NYSDSS would recover any loss resulting
from too high an estimate of salvage value upon a bona fide disposal,
but would not be entitled to assume in advance a zero value
across-the-board.

34.  Neither party suggested undertaking such an effort as an
alternative.

35.  NYSDSS admitted in its reply that moveable assets were assigned
salvage values in the Blake report, but insisted that no salvage value
was assigned for category 1, 2 and 3 fixed assets.  NYSDSS Reply Br. at
45.  The Blake report excerpts in the record for Letchworth Village
(SIDC) fixed assets do not show any figure for salvage value.  Cf.
NYSDSS Ex. 8.  HCFA did not submit any other excerpt showing any salvage
value entry for category 1, 2 and 3 fixed assets, although HCFA did
provide cover sheets from the Blake report which state that the
appraisal program included determining a salvage value for each asset.
Cf.  HCFA Ex. 4, at 2, 10.  HCFA also provided excerpts relating to
moveable assets which do show salvage value figures.  HCFA Ex. 5.  We
therefore refer to the Blake report in relation to moveable assets but
not fixed assets.

36.  As discussed in the preceding section, NYSDSS conceded that the
design costs should have been amortized over a longer period and
therefore did not dispute $352,904 of the overstated design costs.
NYSDSS asserted that this adjustment also reflected adjusting the design
costs from FY 1977-78 to the 20-year amortization schedule suggested by
NYSDSS.  NYSDSS Br. at 48, 50.  UKW, on the other hand, reduced the
amount which it included as overstated under this element to avoid
duplication with its recommendation that all design cost claims be
amortized over 40 years.  Since we accept neither parties' figure, it
will be necessary to adjust the figures to reflect the amortization
period determined after remand.

37.  NYSDSS asserted that, beginning in FY 1983-84, the lag was
eliminated for category 6 assets (major fixed assets purchased by the
FDC) and was reduced to six months for category 7 and 8 assets
(equipment purchases charged to FDC or directly to facilities). NYSDSS
Br. at 49.

38.  NYSDSS described a hypothetical example of an asset entered into
the system with an initial price of $10,000 and a useful life of 20
years, resulting in an annual straight-line depreciation expense of
$500.  After the first year of depreciation is claimed, the price was
adjusted to $11,000 after litigation, raising the annual depreciation
expense to $550.  The first year's depreciation was too low by $50.
Therefore, the depreciation expense for the second year would be
included as $600, while the depreciation expense for the third and
following years would be $550.  NYSDSS argued that adjustments of this
kind caused the discrepancies which UKW attributed to mathematical
error.  NYSDSS Br. at 51-52.

39.  This element differs from the time lag discussed above, in that the
time lag for depreciating newly-acquired assets was applied
across-the-board to all assets, so that individual documentation was
less important.  The assertion that particular discrepancies may have
resulted from changes in historical cost due to contract renegotiations
or litigation, by contrast, would require substantiation that such
events had occurred and had had the purported effect on the depreciation
costs of individual