SC Administrative Law Court Decisions

This matter is before the Administrative Law Judge Division (Division) pursuant to a challenge by the Petitioner, Piedmont Medical Center (Piedmont) to a Certificate of Need (CON) non-applicability determination by the Respondent, South Carolina Department of Health and Environmental Control (DHEC). DHEC issued the non-applicability determination to the Respondent, AMICO, LLC, d/b/a Old Pointe Diagnostic Center (Old Pointe or AMICO) for an MRI project in Rock Hill, South Carolina.

A hearing on the merits of this case was held on March 6-8, 2001, at the offices of the Division in Columbia, South Carolina.

FINDINGS OF FACT

Having observed the witnesses and exhibits presented at the hearing and closely passed upon their credibility, and considering the burden of persuasion by the parties, I make the following Findings of Fact by a preponderance of the evidence:

General Findings

• The State Certification of Need and Health Facility Licensure Act, S.C. Code Ann. §§ 44-7-110, et seq. (Supp. 2001) requires that a Certificate of Need (CON) be obtained prior to the expenditure in excess of $600,000 for the acquisition of medical equipment which is to be used for diagnosis or treatment. S.C. Code Ann. § 44-7-160 (Supp. 2000) and 25A S.C. Code Ann. Regs. 61-15, Section 102.1(f) (Supp. 2000).
• The South Carolina Department of Health and Environmental Control (DHEC or the Department) is the agency of the State of South Carolina charged, inter alia, with the administration and implementation of the CON review procedure.
• The regulatory procedure by which a potential CON applicant can request a formal determination from DHEC as to whether the CON Act is applicable to its proposed health care project is set forth in 25A S.C. Code Ann. Regs. 61-15, Section 102.3 (Supp. 2000).
• On February 10, 2000, AMICO, LLC, d/b/a Old Pointe Diagnostic Center (Old Pointe), requested a determination from DHEC that its MRI project in Rock Hill, South Carolina was exempt from CON review because the total project costs were under $600,000. (DHEC Exh. No. 1, pp. 1-59). AMICO, LLC is a Tennessee limited liability company authorized to do business in South Carolina. At the time of the hearing, it owned two facilities providing MRI services: the Rock Hill facility at issue in this case and another facility in Orange City, Florida, which opened in October of 1999.
• Pursuant to requests from DHEC, Old Pointe sent additional information to DHEC on February 22, 2000, March 13, 2000, and March 16, 2000. Old Pointe's application for a non-applicability determination addressed all applicable standards and requirements as set forth in the regulations governing non-applicability determinations. (DHEC Exh. No. 1, pp. 60-89; 91-94).
• On March 16, 2000, DHEC issued a non-applicability determination that the proposed project did not require CON review. The approval letter stated that the determination was valid for six months from the date of the letter. Further, the Department requested that, once the project was fully implemented, Old Pointe provide DHEC with (a) an audited report to show all expenditures on the approved project; (b) the contractor's signed statement of final construction costs; (c) an equipment listing and inventory for the project; (d) a program and/or service narrative describing the final project configuration; and (e) a signed statement from the applicant that the project was implemented as outlined in the exemption request. (DHEC Exh. No. 1, pp. 95-96).
• Petitioner Piedmont Medical Center (Piedmont or Petitioner) is a for-profit hospital owned by Tenet, located in Rock Hill, South Carolina. It appealed the decision of the Department to issue the non-applicability determination, contending that the total project cost exceeded $600,000. (DHEC Exh. No. 1, 98-105; 108-112).

• Shortly after Piedmont appealed DHEC's decision, Old Pointe informed DHEC that construction of the facility would begin on May 17, 2000. Piedmont moved for a stay. This Court denied the motion for a stay but granted a temporary restraining order upon Old Pointe for the pendency of the case, requiring a bond to be posted by Piedmont in the amount of $200,000. (DHEC Exh. No. 1, pp. 113-121).
• Piedmont did not post the bond, and acknowledged to this Court and the parties that Old Pointe could commence construction. Old Pointe received its temporary certificate of occupancy on September 11, 2000, and began seeing patients on September 12, 2000.
• On September 18, 2000, in response to questions from Old Pointe concerning the form and content of the audited cost report and completion report, DHEC informed Old Pointe that implementation did not require that the project be completed within six months. Further, DHEC stated that no specific form was required for a completion report. DHEC subsequently sent, as guidance, to Old Pointe's CPA firm copies of two completion reports from previous determinations. DHEC reminded Old Pointe that the audited cost report should include the total capital costs of the project in accordance with generally accepted accounting principles (GAAP). DHEC referred Old Pointe to 25A S.C. Code Ann. Regs. 61-15, Section 103.25 for explanation of the accounting procedures for leased buildings and equipment. Finally, DHEC also requested that the audited cost report document costs, to include all contracts, invoices, and assumptions for any allocations of costs (if applicable). (DHEC Exh. No. 1, pp. 133-137; Old Pointe Exh. No. 2).
• Old Pointe's expert testified that he used the examples provided by DHEC as a format for Old Pointe's audited cost report. (Transcript, Day 2, pp. 126-127).
• I find that the format used by Old Pointe's accountant was consistent with DHEC's requirements and consistent with other audited cost reports submitted to DHEC pursuant to 25A S.C. Code Ann. Regs. 61-15, Section 103.25.
• The audited cost report was submitted to DHEC on January 18, 2001. It was prepared by Old Pointe's CPA firm, the Horne Group, using generally accepted auditing standards in conformity with GAAP. (DHEC Exh. No. 1, pp. 141-143). Old Pointe submitted a listing of the equipment and inventory, a final project configuration narrative and a statement of implementation on February 8, 2001. On February 9, 2001, the contractor submitted his total construction costs for the MRI project. (DHEC Exh. No. 1, pp. 141-145; 166-169).

Total Project Costs

• The acquisition of medical equipment used for diagnosis or treatment is exempt from the requirement for a CON if the total project costs are less than $600,000.
• Section 103.25 of Regulation 61-15 is used by DHEC to determine the total project costs. It defines "total project cost" as follows:

"Total project cost is the estimated total capital cost of a project including land cost, construction, fixed and moveable equipment, architect's fee, financing cost, and other capital costs properly charged under generally accepted accounting principals [sic] as a capital cost. The determination of project costs involving leased equipment or buildings will be calculated based on the total value (purchase price) of the equipment or building being leased."

• It is not uncommon for budgets of projects which request an exemption from CON review to change from the time of the proposal to the time of the final audited cost report. (Transcript, Day 3, pg. 29).
• DHEC does not withdraw a non-applicability determination due to changes in furniture purchases or additional purchases so long as the total project costs do not exceed $600,000 and the diagnosis or treatment projected by the exempted project can still be adequately accomplished. (Transcript, Day 3, pp. 29-30).
• As required by DHEC, the Old Pointe audited cost report contains both the total costs and the total project costs. The total project cost (TPC) itemized in the cost report was $582,050.00. At the hearing, Old Pointe submitted the supporting documentation for these amounts. (Old Pointe Exhibit No. 3 and 13).
• Piedmont does not dispute the costs which were included in the Old Pointe cost report, totaling $582,050.00. However, Piedmont asserts that certain of the costs in the categories included in the cost report were not accurately capitalized and were improperly excluded from the total project cost, and that other costs were improperly excluded from the cost report.
• Piedmont's Exhibits 9 and 11 set forth which costs Piedmont contends should be capitalized and how those costs differ from those capitalized costs offered by the accountants for Old Pointe, the Horne Group.
• These costs, alleged by Petitioner to increase Old Pointe's total project costs over the $600,000 limit, include additional closing costs, accounting fees, management services, a new roof for the MRI unit, MRI equipment costs, telephone costs, salaries, supplies, inventories, miscellaneous project costs, and travel costs. Piedmont's calculations showed capitalized costs of $677,129.41 for the Old Pointe project. (Piedmont Exh. Nos. 9 and 11).

Application of GAAP

• Generally accepted accounting principles (GAAP) guide accountants and others in determining how costs are allocated. Often the determination is based on the type of project or activity involved.
• GAAP has differing levels of hierarchy which accountants use to interpret when costs should be capitalized or expensed. (Old Pointe Exh. No. 4). There are five levels of hierarchy when applying GAAP guidelines, with a Level I principle being the most authoritative and a Level V being the least authoritative. Financial Accounting Standards Board statements (FASB) and APB Opinions are Level I pronouncements and Statements of Position (SOP) by the American Institute of Certified Public Accountants (AICPA) are Level II. A higher level GAAP principle, if applicable to the fact situation, outranks and supersedes a lower level principle. If there is no Level I standard applicable to a situation, a Level II standard is applied to the audit.
• Piedmont presented two experts, Gary A. Luoma (Luoma--expert in GAAP as it relates to financial accounting) and Robert J. Taylor, IV, (Taylor--expert in accounting, GAAP and the capitalization of health care projects) who contend that the total project cost of the Old Pointe Facility is in excess of $600,000.
• Luoma testified that, in performing an engagement like preparing a Cost Report for submittal to DHEC, the most important thing is to understand the regulations governing the matter. (Transcript, Day 1, p. 39). In preparing for his testimony, Luoma only read 25A S.C. Code Regs. 61-15, §§ 102(f) and 103.25. Luoma also acknowledged that the GAAP hierarchy includes historical practices that have evolved and gained acceptance with time and experience. However, Luoma did not speak with anyone at DHEC concerning their application of the regulations, nor did he obtain any prior history of the Department's application of the regulations. (Transcript, Day 1, pp. 39-40, 95-96; Day 3, pp. 180-181).
• Luoma based his opinion on his contention that the costs associated with the development and startup of the Old Pointe Facility should be accounted for under the standards set forth in FASB 7, "Accounting and Reporting by Development Stage Enterprises," adopted in 1990 (Piedmont Ex. 3). (Transcript, Day 1, p. 52). Luoma contended that the Old Pointe project was a "developmental stage" project as described in FASB 7. As such, he argued that the disputed costs were capital costs of the enterprise. (Transcript, Day 1, pp.52-55; Transcript, Day 3, pp. 173-175).
• Taylor testified that he characterized the costs he felt were associated with the Old Pointe Facility as either capital or expense costs based upon his experience. (Transcript, Day 1, pp. 185-187). ⁽¹⁾ The standard approach he uses to organize costs as either capital or expense are based upon the cost categories used in Georgia and Florida as the format under which the costs are organized for submittal for Certificates of Need in those states. (Transcript, Day 1, pp. 192-193). Taylor has not worked previously with a CON project in South Carolina.
• FASB 7 is applicable "to any separate financial statements of a development stage subsidiary or other investee of an established operating enterprise …." Piedmont Exh. 3, p. 63, ¶ 4. FASB 7 was not intended to and did not change the application of GAAP to established operating enterprises. (Transcript, Day 3, pp. 174-176).
• Luoma testified that while AMICO itself is not a development stage enterprise (DSE), the Old Pointe Facility is a subdivision or subsidiary or operating unit of AMICO and is a DSE. Tr. March 6, p. 53, ll. 1-16. On cross examination Luoma testified that the Old Pointe Facility is a development stage investee pursuant to paragraph 4 of FASB 7 and the calculation of total project cost is thus subject to FASB 7 guidelines. (Tr., March 6, p. 53, ll. 10 through 16; pp. 105, l. 5 through 108, l. 7). Luoma defined "investee" as "an entity in which someone else has made an investment." Tr. March 6, p. 106, ll. 3-6.
• Footnote 4 to paragraph 4 of FASB 7 provides that "[t]he terms subsidiary and investee are defined in paragraph 3 of APB Opinion No. 18, "The Equity Method of Accounting for Investment in Common Stock." Piedmont Exh. 3, p. 63. APB Opinion No. 18 is Level 1 in the GAAP Hierarchy. "Investee" is defined as "a corporation that issued voting stock held by an investor" and "subsidiary" refers "to a corporation which is controlled, directly or indirectly, by another corporation." Old Pointe Exh. 11, pp. 2-3, paragraph 3(b)(c).
• Arvil Stanford, AMICO's expert, testified that in his opinion, FASB 7 was not applicable to determine the total project cost in this matter because the Old Pointe Facility is not an investee as used in paragraph 4 of FASB 7 and defined in APB Opinion No. 18, paragraph 3. (Transcript, Day 2, pp. 130-132).
• Having reviewed both FASB 7 and SOP 98-5, the testimony of the Piedmont and AMICO experts, and the definition of "investee" contained in APB Opinion No. 18, and based upon the uncontradicted evidence: (1) that the Old Pointe Facility is a wholly owned facility of AMICO doing business as Old Pointe Diagnostic Center; and (2) the Old Pointe Facility does not issue stock, I find that the Old Pointe Facility is not an investee as defined in FASB 7. I further find that, based upon the uncontradicted evidence, the Old Pointe Facility is a wholly owned facility of AMICO and is not a separate corporation. The Old Pointe Facility is not a subsidiary of AMICO.
• Mr. Arvil Stanford (Stanford) testified on behalf of AMICO as an expert in the application of GAAP in the auditing process. Tr. March 7, p. 123, ll. 1-7. Mr. Stanford has been a CPA practicing in the private sector since 1983 and is the director of the Horne Group's audit and accounting services.
• The Horne Group and Stanford familiarized themselves with Regs. 61-15 §§ 102.2(f), 102.3 and 103.25 by reviewing the regulations, talking with DHEC staff concerning the Department's expectations regarding the Cost Report, and finding out what other CPA firms were presenting to the Department as Cost Reports for non-applicability determinations. (Transcript, Day 2, pp. 124-128). The Department provided Stanford with examples of non-applicability Cost Reports provided to DHEC by other CPA firms. Old Pointe Exh. 2.
• In determining whether to capitalize or expense Old Pointe's costs, including salaries and benefits, telephone and utilities, travel expenses, supplies, taxes and licenses, repairs and maintenance, legal and professional fees and other, associated with the activities necessary to open the Old Pointe facility in Rock Hill, the Horne Group relied upon SOP 98-5, "Reporting on the Costs of Start-Up Activities." (Transcript, Day 2, pp. 8, 141).
• "Start-up costs" are broadly defined as "those one-time activities related to opening a new facility, …." Old Pointe Exh. 5, p. 100, ¶ 5. Various terms such as preopening costs, preoperating costs, organization costs and start-up costs are used in practice to refer to start-up costs, and for purposes of SOP 98-5 are all referred to as start-up costs. Old Pointe Exh. 5, p. 100, ¶ 6.
• Start-up costs associated with activities related to the opening of the Old Pointe Facility are costs which are not specifically identifiable, have indeterminate lives or are inherent in a continuing business and related to an enterprise as a whole. Old Pointe Exh. 5, p. 102, ¶ 38.
• Luoma and Stanford both agreed that the start-up costs identified by Horne were inherent in a continuing business and I so find.
• Luoma testified that an asset is an embodiment of future benefits to an organization (Transcript, Day 1, p. 67) and that all costs incurred in order to put the Old Pointe Facility into use should be capital costs because they provide a future benefit and the project itself is the asset or collection of assets. (Transcript, Day 3, pp. 205-206).
• Luoma also testified that the project itself was the identifiable asset or collection of assets for purposes of his determination that SOP 98-5 was not applicable, and that such costs as travel, lodging, meals, etc. should be capitalized because they relate to the creation of the Old Pointe Facility and not to the opening of the Facility. Luoma testified that "opening of a new facility" means the day the facility opens its doors and not the creation or development of a new facility. (Transcript, Day 3, p. 219). Thus, Luoma opined that SOP 98-5 was not applicable.
• Based upon SOP 98-5's inclusion of the phrases "preopening costs," "preoperating costs," and "organization costs" as interchangeable with "start-up costs," I find that "start-up costs" include the cost of activities involved with developing a new facility and not just those associated with the day of opening the facility.
• Luoma further testified that "indeterminate life" means a cost incurred for which there can be no determination as to its future benefit. (Transcript, Day 1, p. 68). I find that as associated with the start-up activities of the Old Pointe Facility, AMICO's and American Diagnostic's staff salaries, travel, meals, lodging, recruiting costs, utility costs and meal costs are costs for which there can be no determination as to its future benefit.
• The application of SOP 98-5, that all start-up costs should be expensed rather than capitalized, applies to established operating enterprises as well as to development stage enterprises. (Transcript, Day 2, pp. 145-146; Old Pointe Exh. 5, p. 101, ¶ .33; and Piedmont Exh. 3, pp. 64, ¶ 10). An established operating enterprise is a business that has begun doing what it was created to do. (Transcript, Day 3, p. 178). Based upon the evidence in the record, I find that AMICO is an established operating enterprise.
• Established operating enterprises incur costs with varying degrees of uncertainty about future benefits in expanding their businesses and FASB 7 was not intended to specify criteria or guidelines for when such costs should be expensed or capitalized. (Transcript, Day 3, pp. 179-180).



• Based upon the credible evidence in the record, I find that AMICO was expanding its existing business when it undertook the activities associated with starting up the Old Pointe Facility. I find that if the Old Pointe Facility project constitutes a future benefit for AMICO and is the asset for purposes of determining what is a capital cost under GAAP, then every cost incurred by AMICO should be capitalized, which is not the intent of 25A S.C. Code Ann. Regs. 61-15 § 103.25.
• Having reviewed both FASB 7 and SOP 98-5, and having considered the testimony of the experts and the historical treatment by DHEC of these costs, I find that neither AMICO nor the Old Pointe Facility meets the definition of either a development stage subsidiary or investee as defined in paragraph 3 of APB Opinion No. 18 and adopted by FASB 7. FASB 7 is not applicable to the Old Pointe Facility. I find that SOP 98-5 is applicable and that any costs incurred with the activities associated with opening the Old Pointe Facility are start-up costs which were properly expensed in the Cost Report.

Closing Costs

• Initially, I find that there is insufficient evidence from the testimony of one of Piedmont's expert witnesses, Robert J. Taylor, that an amount of $9,571.00 should be added to the closing costs. Mr. Taylor's assumption that this item is a capital cost derives from information in a letter from Ken McNeese (the lessor) to a bank officer. Upon cross-examination, Mr. Taylor admitted that he had no evidence of this additional cost other than the vague references in the letter. Having reviewed the letter and the HUD-1 closing costs report submitted by Old Pointe, I find the HUD-1 report to be more credible as to the closing costs incurred in the purchase of the land on which the MRI project is located. Accordingly, the amount of $9,571.00 was correctly omitted by Old Pointe as an additional capital closing cost. (Piedmont Exh. No. 11, pg. 94; Old Pointe Exh. No. 3, pp. 12-13).

Accounting Fees, Management Services, and Travel Costs

• DHEC's expert witnesses, Ms. Cantwell and Mr. Frishman, testified that accounting fees, management services, and travel costs have never been included as a part of the total project cost for purposes of non-applicability determinations, either by DHEC or in Cost Reports submitted by outside accountants. This testimony was undisputed.

• Old Pointe's expert, Stanford, categorized the management services and travel costs as operating expenses pursuant to the guidelines of Statement of Position 98-05 (SOP 98-5), since these were "start-up" costs of the new facility. (Old Pointe Exhibit 5; Transcript, Day 2, pp. 148-150). He testified that he would not consider the accounting fees or travel costs suggested by Piedmont for capitalization as capital costs, because they were not costs which should be capitalized according to GAAP. (Transcript, Day 2, pp. 148-150; 170-172).
• Having reviewed both FASB 7 and SOP 98-5, and having considered the testimony of the experts and the historical treatment by DHEC of these costs, I find that the management services and travel costs, totaling $40,825.37, were "start-up" costs of Old Pointe and were properly treated as operating expenses by Old Pointe's accountants pursuant to SOP 98-5.
• I find that the accounting fees paid by AMICO to the Horne Group, in the amount of $9,700.00, are not capital costs, based upon a review of FASB 7, SOP 98-5, the testimony of the experts, and the testimony of the DHEC witnesses. I further find that to capitalize accounting costs would unfairly penalize those projects where the TPC is over $500,000 or where an appeal is filed, since only in those situations would the applicant be faced with including the accounting fees as part of the TPC. In fact, if an applicant had a TPC close to $600,000, a competitor could cause the TPC to exceed the threshold simply by filing a request for a contested case hearing and causing the applicant to incur accounting expenses.

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