This morning I listened to a webcast of the Not-for-profit Advisory Committee (NAC) as they discussed the issue of valuation of donated pharmaceuticals. The NAC provides feedback to FASB about issues affecting the NPO community.
You can find an outline of the agenda, which includes an attachment for issues regarding donated meds here. Attached to the agenda are several articles from William
Bennett Barrett and Caroline Preston. (Oops! Sorry Mr. Barrett.)
You can find an on-line archived recording of the meeting here. It is the March 1, 2012 meeting that started at 10 AM.
I have just a few thoughts after having listened to the meeting.
The committee is working to get its arms around the issue. Some of the members are quite informed and others are just starting to tune in to the issue.
The core of the issue is pharmaceuticals, especially deworming medicine, especially mebendazole in the 500 mg dosage. That was the focus of the discussion today. (As an aside, I perceive that’s the primary issue. I think there are some other specific medicines that have a significant impact on the financial statements, but they way behind mebendazole in impact.)
It is worth noting that the comments in the meeting are discussions as the committee walks through the issue. There is a lot of personal opinion but no guidance presented.
Here are a few of the highlights from the meeting:
One nonprofit representative mentioned this is an issue that could start to undercut trust in nonprofits. Implication is this could start to affect donations. He perceives a speedy resolution is very important.
Later, another participant suggested that extensive disclosures would be a very good way to deal with this issue to retain trust. He suggested going overboard on disclosures this year. Not a bad idea. Maybe a really good idea.
One person who represents a state attorney general is, well, let’s just say the AG’s office is not amused.
Multiple participants perceive the issue is caused by the unique circumstances of this particular medicine and not an underlying problem with either FAS 136 or FAS 157. If my recollection and notes are correct, participants who hold to this position would include a representative of the Better Business Bureau, an audit partner in an accounting firm with several R&D clients, a representative of FASB (who was expressing his personal opinion), and another person who is with either FASB or AICPA (I didn’t recognize the voice and the person’s name making that particular point wasn’t mentioned).
Several participants indicated that their perception is that the Red Book developed as the “best practice” not because it is best or right but because it is consistent for all NPO’s and easy to apply. FAS 157 moves us from a place of easy and consistent to a place of difficult and diverse.
A FASB representative, expressing his personal opinion, suggested that not having a contractual right to sell a donated medicine in a particular country does not affect determination of fair value. At the same time, having a legal restriction on where you can distribute or use a medicine likely would affect determination of the principal market.
That is an extremely critical point, in my opinion. The implication of that point is that the values in the US are completely irrelevant for non-FDA-approved medicine.
Several representatives, obviously not NPO executives, indicated that nonprofit organizations have bias and motivation in terms of valuation. What are the biases? To increase total revenue. To meet matching requirements of US AID grants. To improve the program service portion of functional allocation.
Many participants suggested there is a need for additional guidance on how to apply the accounting rules for donated pharmaceuticals.
However, one participant, a representative of FASB, again voicing his personal opinion addressed that issue (you will now see why I repeated the personal-opinion comment). He asked who is the guidance for? He perceives there is a bias on the part of management of nonprofits. The job of the auditor is to watch for management’s biases and challenge management when their bias is visible. He suggested there may not be any particular problems with the guidance found in the authoritative literature.
A material estimate
In the 2009 financial statements for Feed the Children, donated mebendazole is about 45% of total revenue. See my discussion here and here. One med is almost half of revenue. I’m having a difficult time quantifying that relationship for other NPOs because there isn’t quite enough public data available.
I think the estimated fair value of that specific medicine is material.
Dealing with biases
Multiple participants in the NAC meeting mentioned bias.
Biases in other people are easy to see. Bias in your own mind is very difficult to detect. If one is interested in a place to start looking at that issue, consider Thinking, Fast and Slow, by Daniel Kahneman. I’m struggling with his ideas and discussing the journey in a series of posts that start here on my other blog.
Dealing with estimates
For auditors, here are a few extracts from the audit literature discussing estimates to remind us of our responsibility:
AU 342.04 – auditing accounting estimates
The auditor is responsible for evaluating the reasonableness of accounting estimates made by management in the context of the financial statements taken as a whole. As estimates are based on subjective as well as objective factors, it may be difficult for management to establish controls over them. Even when management’s estimation process involves competent personnel using relevant and reliable data, there is potential for bias in the subjective factors. Accordingly, when planning and performing procedures to evaluate accounting estimates, the auditor should consider, with an attitude of professional skepticism, both the subjective and objective factors.
AU 312.58 – audit risk and materiality in conducting an audit:
The auditor should also consider whether the difference between estimates best supported by the audit evidence and the estimates included in the financial statements, which are individually reasonable, indicate a possible bias on the part of the entity’s management. For example, if each accounting estimate included in the financial statements was individually reasonable, but the effect of the difference between each estimate and the estimate best supported by the audit evidence was to increase income, the auditor should reconsider the estimates taken as a whole. In these circumstances, the auditor should reconsider whether other recorded estimates reflect a similar bias and should perform additional audit procedures that address those estimates. …
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