OBJECTIVE: The Centers for Medicare and Medicaid Services (CMS) computes clinical staff incident-to services in physician offices under a zero work hour alternative method. This study compares the results of CMS alternative method payment computations for indirect overhead costs with the actual resource-based level of effort for office-based drug management costs as incurred in U.S. physicians' offices. METHODS: Phase I: CMS methods used for zero work hour practice expense rate-setting were identified. Underlying assumptions were examined and formal methodology evaluations were collected. Phase II: On-site activity analyses were performed in over 70 physicians' offices located in 27 states. An activity database was created from study data obtained through direct observation and on-site interviews. Analyses employing descriptive statistics identified activities, tasks, and staff type involved in specific tasks, including drug management. The activity analysis findings were compared to the CMS reimbursement assumptions about these activities. RESULTS: A database of CMS methodology explanations, visuals, and evaluations was created. Activity analysis identified costs of labor and space to order, track, receive, store and pay for the drug; drug inventory carrying costs; net receivables carrying costs and average bad debt cost. Study analyses illustrate that current CMS practice expense payments do not adequately recognize drug management costs in physicians' offices. Study results revealed a statistically significant differential between actual and assumed use of administrative labor for indirect overhead zero work pool tasks, including those of drug management. CONCLUSIONS: CMS zero work hour methodology to compute payments for office-based practice expense is deficient as to drug management costs. Payment for this component does not align with actual practice occurring within the physicians' offices. These findings will be of use to economists, cost accountants, and policy makers interested in arriving at an equitable resource-based payment for drug management.