Charity Navigator’s raises idea to revise prior year reports for changes in GIK valuation – A brief discussion of the rules for restating financial statements

Caroline Preston, from The Chronicle of Philanthropy, reports in Watchdogs Zero In on Charity Drug Valuations, that Charity Navigator is floating the idea of asking some charities to restate the last four years of financial statements.

Many NPOs that applied SFAS #157 saw their revenue drop dramatically because of using lower valuation for medicine, especially deworming meds, most specifically mebendazole. (I know, I know, it’s actually ASC 820-10, but my brain still thinks in terms of SFAS numbers when it comes to pre-ASC rules.)

The rating methodology used by Charity Navigator, according to Ms. Preston’s article, penalizes NPOs whose income drops. That means a lot of relief & development NPOs will take a big hit on their ratings.

I don’t have any information beyond the article, so I don’t know what reaction they are getting.

It’s just my guess, but I think they will not get a very good response to their idea.  I don’t think NPOs will be at all amused to take this approach.

Let me walk through the circumstances when previously issued financial statements can be changed.

My discussion here will casual instead of technical. If it becomes necessary to split hairs very fine and use precise technical language, I can do that.  For this post however, I’ll try to translate the accountantese into English.

(I realize I’ve already failed on that goal – SFAS means Statement on Financial Accounting Standards, the name for accounting rules until a few years ago.  ASC means Accounting Standards Codification, the huge on-line document that contains all accounting rules for non-government organizations, including NPOs.)

You can find the discussion of these issues in ASC 250-10-45, if you want to check it out yourself.

In that section, there are several approaches to restating financial statements. They are:

Change in accounting principle (-45-1) – this can happen for one of two reasons. First, there is a new accounting rule that requires a change. Second, there are several equally acceptable alternative principles and an organization concludes that a different principle is preferable (45-2). 

If there is a change from one principle to another the prior years are restated. If the change was made because of a new accounting rule, then you look at the rule to find out what the treatment is.

Let’s look at SFAS #157, which is the accounting rule that created the change in valuation of pharmaceutical GIKs.  FAS 157 is required to be applied after the effective date. What’s important is that FAS 157 does not give permission to apply retroactively.  This means the new requirements cannot be applied to previous periods.  Paragraph 37, available here, says:

This Statement shall be applied prospectively as of the beginning of the fiscal year in which this Statement is initially applied, except as follows.

The exceptions mentioned are certain financial instruments that are not relevant to this discussion.

My read of the authoritative literature indicates an organization is not allowed to restate fair market values in prior years. Any CPAs out there see something I missed?

Change in accounting estimate (-45-17) – this would be something like a change in remaining useful life of depreciable assets. The impact of a change in accounting estimate is made on a go-forward basis. This concept does not apply to the med valuation issue.

Change in reporting entity (-45-21)– obviously does not apply to this discussion.

Correction of an error in previously issued financial statements (-45-22) – an error here is defined as:

An error in recognition, measurement, presentation, or disclosure in financial statements resulting from mathematical mistakes, mistakes in the application of generally accepted accounting principles, or oversight or misuse of facts that existed at the time the financial statements were prepared. (250–10–20)

Occasionally there are errors in financial statements.  NPOs sometimes gain more insight on the nature of temporary or permanent restrictions which changes the amounts of net assets.  Sometimes there is a revised understanding of what the expectations have been for those restrictions.

Sometimes there are just flat-out errors in complex calculations.  For example, deferred giving calculations are very complicated and could have errors creep in.  Sometimes organizations realize that complex spreadsheets used to calculate certain amounts have had an error for several years. 

In those situations, the prior year financial statements are revised.

There’s a particular implication of a restatement for CPAs in California.  All restatements for NPOs that file a state tax return must be self-reported to the California Board of Accountancy.  That’s not a letter that CPAs like to send.

What then is the accounting rationale for restating prior year financial statements due to the valuations of medical GIKs?

Change in accounting principle doesn’t work because FAS 157 doesn’t allow retrospective application.

Change in accounting estimate and change in reporting entity don’t apply.

That would leave correction of errors.  That would be the conceptual justification for complying with the Charity Navigator request.  Taking this approach would require admitting that the valuations of the past were wrong and the valuation currently in use should have been used all these years.

Again, it’s just my guess, but I seriously doubt many NPOs, or their auditors, are going to agree with that idea.

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