Currently, there is no statutory or regulatory authority governing allowability of administrative costs included in the adjusted community rate (ACR) process for determining Medicare capitation rates under risk-based contracts with managed care organizations (MCO). At a Region V risk-based MCO we identified $1.2 million in administrative costs that would be considered inappropriate and unallowable if considered in light of the Medicare program's general principle of paying only reasonable costs. Examples of the inappropriate costs included bad debt expenses, monies paid to a trade association, and monies used for public relations, donations, contributions, gifts, entertainment, and social functions for customers and employees. The methodology which allows MCOs to apportion administrative costs to Medicare is flawed and results in Medicare covering a disproportionate amount of the MCO's administrative costs. Additional reviews of the ACR process, currently ongoing, disclose similar problems at other MCOs. The results of these reviews are being shared with the Health Care Health Financing Administration so that appropriate legislative changes can be considered.