Gamesmanship in GIK valuations? Part 3

Two previous posts discussed the issues raised by an article in Forbes about the valuation used by some nonprofits in their financial statements for recording donations of deworming medicine.

I’d planned to look at the impact on some specific financial statements next, but think it would be better to look at what the accounting rules have to say before doing some number crunching.  This will be a really long post, so please bear with me.

The Forbes article by William P. Barrett is Donated Pills Make Some Charities Look Too Good on Paper.

On to the accounting

Nonprofits should use fair value to record GIK.  This rolls forward from the old NPO Audit Guide. The requirement can now be found in the discussion of non-profit issues in topic 958 of the Accounting Standards Codification.  ASC 958-605-30-11 applies:

Gifts in kind that can be used or sold shall be measured at fair value. In determining fair value, entities should consider the quality and quantity of the gifts, as well as any applicable discounts that would have been received by the entity, including discounts based on that quantity if the assets had been acquired in exchange transactions.

That fair value reference points us to FAS 157, which is now at ASC Topic 820.  In terms of quantity, receiving 500,000 doses is not valued the same as receiving one case.  In terms of quality, if the expiration date is approaching, that affects value.  Meds that can not be imported into the U.S. because the manufacturer has not jumped through the hoops to get FDA approval is another quality issue that needs to be considered.

So, off we go to fair value world.

I think the key paragraph is here:

820-10-30-3 In many cases, the transaction price will equal the exit price and, therefore, represent the fair value of the asset or liability at initial recognition. In determining whether a transaction price represents the fair value of the asset or liability at initial recognition, the reporting entity shall consider factors specific to the transaction and the asset or liability. For example, a transaction price might not represent the fair value of an asset or liability at initial recognition if any of the following conditions exist:

d. The market in which the transaction occurs is different from the market in which the reporting entity would sell the asset or transfer the liability, that is, the principal market or most advantageous market. For example, those markets might be different if the reporting entity is a securities dealer that transacts in different markets, depending on whether the counterparty is a retail customer (retail market) or another securities dealer (interdealer market).

We can discuss another day the impact on ‘exit price’ from the shipping costs to move resources overseas. The sidetrip we do need to make is to the definition of  principal market and most advantageous market.

Two key definitions

We need to go to the ASC’s glossary, which says:

Principal Market

The principal market is the market in which the reporting entity would sell the asset or transfer the liability with the greatest volume and level of activity for the asset or liability. The principal market (and thus, market participants) should be considered from the perspective of the reporting entity, thereby allowing for differences between and among entities with different activities.

Note: The following definition is Pending Content; see Transition Guidance in 820-10-65-8.

The market with the greatest volume and level of activity for the asset or liability.

and

Most Advantageous Market

The most advantageous market is the market in which the reporting entity would sell an asset or transfer a liability with the price that maximizes the amount that would be received for the asset or minimizes the amount that would be paid to transfer the liability, considering transaction costs in the respective market(s). The most advantageous market (and thus, market participants) should be considered from the perspective of the reporting entity, thereby allowing for differences between and among entities with different activities.

Those are the accounting rules. Where do we go from there?

What is the appropriate accounting approach?

Obviously deworming pills distributed to needy people are not going to be ‘sold.’  The definition of principal market and paragraph 30-3 d  means you would then value a deworming pill in the market where you’re going to distribute it to the recipient.  The quality and quantity reference in 958-605-30-11 means we should be looking to price for large volumes, which means the wholesale value in those locations.

Therefore, it sure seems to me like the appropriate accounting treatment is to use the market value in the location where the deworming pills will be distributed.  That means we have to use the wholesale value in Africa or Asia. Not Los Angeles or Manhattan. 

Even if one argues that the most advantageous market is England or Holland, there will be a dramatically different price than in the U.S.

So here is my main point to expand on the articles written by Mr. Barrett and others:

Even if the “ain’t what’s paid” prices in the Red Book were accurate, those would then have to be adjusted from one wholesale carton to freight car volume, then adjusted from just–manufactured to soon-to-expire shelf life if needed, and then finally adjusted from U.S. pricing to developing-world pricing. The biggest transition is from U.S. to overseas pricing.

There may be some room for a bunch of CPAs to argue (put 20 CPAs in a room and we can argue about anything), but it sure seems to me that it would be exquisitely hard to defend the valuation of Mebendazole deworming medicine at $10 or $16 per dose under U.S. GAAP after FAS 157 went into effect if you can buy it for $0.04 or $0.02 on the world market. 

Seems to me it would be hard to defend $2.00, $1.00, or even $0.35 considering the definition of principal market and most advantageous market.

Effective date

This always requires translation from the accounting standards, which only CPAs will understand, into something that other people can grasp.

FAS 157, which you can get to here, gives the following transition dates:

36. Except as provided in subparagraphs 36(a) and 36(b) below, this Statement shall be effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years…

a. Delayed application of this Statement is permitted for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until fiscal years beginning after November 15, 2008, and interim periods within those fiscal years.

Here’s the translation: FAS 157 goes into effect for fiscal years beginning after 11-15-08, which means years ending 12-31-09. For NPOs with a year-end other than 12-31, this means FAS 157 would first apply in their next year, say 3-31-10 or 6-30-10.  In other words, 2009 calendar years and fiscal years ending in 2010.

Practical implication is that changes in valuation, if there are any made by an organization, will probably appear in 12-31-09 or fiscal 2010 audited financial statements.

Full disclosure: As mentioned in the first post of this series, I am CPA providing audit and review services to the religious non-profit community.  None of the current or past clients of Ulvog CPA are involved in receiving medical or other GIKs and shipping them overseas. 

Therefore, my comments are not based on any inside or confidential information.  The flip side of that idea is that I don’t know what is in the workpapers of the auditors who examined the financial statements of the organizations discussed in the Forbes article.  I also am not familiar with the considered reasoning of the NPOs discussed in the article.

Maybe I’m missing the boat.  But I don’t think so.

3 Responses to Gamesmanship in GIK valuations? Part 3

  1. […] 12-21-11 – I’ve changed the sequence of planned posts.  Next post introduces the GAAP accounting rules. LD_AddCustomAttr("AdOpt", "1"); LD_AddCustomAttr("Origin", […]

  2. […] A major component of this discussion is new accounting rules that change the definition of how to value GIKs. Those changes are discussed here. […]

  3. […] The accounting rules for fair value recently changed. This is now having an impact on the financial statements of a number of nonprofit organizations that get a lot of GIK. I discussed that here. […]

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