Answer: You should assign observation codes with a place of service of 22 (Outpatient Hospital), not 23 (Emergency Room - Hospital).
Reason: The patient's status - not his physical location - determines the POS. Even though the patient is physically in an emergency department, when the pediatrician registers him to observation status the patient is considered a hospital outpatient. The physician can perform observation anywhere: in a room, a clinic or a hallway.
Watch out: Double-check your observation code. You should use 99235 (Observation or inpatient hospital care, for the evaluation and management of a patient including admission and discharge on the same date ...) if the pediatrician admits and discharges the patient on the same date. But if the 12-hour observation occurs on different dates, you should instead report the admission with 99218-99220 (Initial observation care, per day, for the evaluation and management of a patient ...) and the discharge with 99217 (Observation care discharge day management ...).
Variation: Some insurers may want you to use 99218-99220 for same-day observation admits and discharges. These payers follow Medicare's interpretation that the initial observation care code represents a full day of care.