Guidance on valuing medical GIKs in the 2011 NPO Audit Risk Alert

The issue of determining fair value of donated pharmaceuticals has been quiet for a little while. I’ve not seen much discussion of mebendazole on the ‘net lately.  Perhaps it is safe to venture back into the waters.

I’d like to mention some of the accounting guidance that is around and provide a few comments.

The AICPA’s 2011 Not-for-Profit Entities Industry Developments Audit Risk Alert contains a two-page discussion of valuing gifts-in-kind (GIK).  SOme key paragraphs are quoted below along with my comments.

This is not an exhaustive discussion of the issue and is not a position paper.

This is intended to further the conversation on valuing GIKs, especially for people who don’t keep copies of the audit risk alerts on their nightstand for leisure reading. (You may now roll your eyes in pity for those of us who enjoy reading such things.)

This discussion appeared in the 2011 and 2010 NPO Audit Risk Alert. The comments were not present in the 2009 and 2008 editions.

Here we go.

 .126 Some NFPs receive a significant amount of gifts in kind (GIK) for use in carrying out their program activities. Examples might include thrift shop operators who receive donations of clothing and household items or international relief and development agencies that receive donations of pharmaceuticals or similar medical supplies. Because these transactions typically result in the NFP recording substantial amounts of revenue and a corresponding program service expense, particular attention should be paid to how fair value has been calculated.

This guidance has obviously been written with donated meds in mind.

.128 Other GIK donations are relatively difficult to measure at fair value because observable inputs are not readily available due to the unique characteristics of the donated assets. For example, an NFP may receive donations of certain pharmaceuticals that are not approved by the federal Food and Drug Administration (FDA) for sale in the United States or articles of clothing that are prohibited from being distributed to beneficiaries in the United States by the donor.

This discussion clearly applies to the issue of 500 mg mebendazole. It certainly looks like the authors were aware of complications created by medicine that cannot legally be distributed in the US.  Also looks like the authors were aware of the commotion on the World Vision t-shirt issue.

.129 It is important for an NFP to have a reasonable and reliable method for assessing the fair value of donated goods. Certain pricing services have been used by NFPs but such services may not provide supportable and verifiable values. The auditor’s assessment of the method used depends on the specific facts and circumstances and could include the following:

• The significance of GIK to the financial statements

• The nature and valuation complexity of the GIK (for example, non-FDA approved pharmaceuticals may be more difficult to value than FDA-approved pharmaceuticals)

• The nature and extent of management’s processes and related internal controls associated with valuation of GIK, including its experience with such transactions

• The nature and extent of information available to management to support its valuation process and valuation conclusions

It seems to me like this paragraph is pointing to the Red Book. Some people think that resource is quite problematic for valuing meds like mebendazole. Those who do not think so would need to address this paragraph in their internal files or audit work papers.

This paragraph should also caution auditors to put more attention on the valuation issue when the volume of medicine is an extreme distance above the point where it would have become material. If an NPO is generating 30% or 50% of its income from donated meds, this paragraph is suggesting there should be more time involved.  In addition there is a specific mention of medicines that cannot be distributed in the United States.

In my considered opinion, combining non-FDA approved medicines with extremely high volumes (like 30% or  50% of revenue from one drug) means there needs to be a lot of discussion in the audit work papers on that item. Seems like valuation of that drug would be rather high on the list of significant risks for the audit.

The next two paragraphs discuss the definition of fair value.

  .130 FASB ASC 820-10-20 defines fair value as “[t]he price that would be received to sell an asset … in an orderly transaction between market participants at the measurement date.”

.131 In applying the definition of fair value to GIK, NFPs should consider any restrictions on sale or use of the GIK by the NFP. To determine whether restrictions should affect the fair value measurement of the GIK, the NFP should determine whether the restrictions are asset specific or entity specific. FASB ASC 820-10 clarifies that asset-specific restrictions affect the fair value measurement, but entity-specific restrictions do not. FASB ASC 820-10 contains guidance to help NFPs distinguish between asset-specific or entity-specific restrictions for the GIK they are measuring at fair value.

The asset specific or entity specific distinction is very significant. The NFL T-shirts donated to World Vision have an entity specific restriction.  The NFL placed a restriction on World Vision. I know I am speaking in code words. If you’re interested in this issue and have read this far, you are already aware of the issue.

As a very obscure aside, there can be a vast difference between the accounting value of a GIK and the economic value.

It sure seems to me that donations of meds which cannot be legally distributed in the United States are an asset specific issue. The implication for valuing 500 mg mebendazole is that it would be inappropriate to use Red Book or any other methodology that involves what is happening inside the United States.  It would only be appropriate to use inputs from outside the United States.

 .132 In developing inputs for the fair value measurement, NFPs also should assume the highest and best use of the GIK by the market participants that is physically possible, legally permissible, and financially feasible, in other words, the use that would maximize the economic value of the GIK to the market participants. Generally, this results in looking to commercial markets for fair value inputs, rather than charitable use of the GIK.

There is a lot of discussion we could have from that paragraph.  We won’t do that now.

The last sentence means we will typically be looking to commercial prices for donated meds.

 .133 Fair value inputs should be based upon the attributes that market participants would use to value the GIK. For the purposes of fair value measurements, market participants are buyers in the principal (or most advantageous) market for the GIK that are independent of the reporting entity, knowledgeable, and able and willing to transact for the GIK. Beneficiaries to which the NFP may distribute the GIK often would not qualify as market participants for the fair value measurement because the beneficiaries often are not willing or able to transact (that is, pay money) for the GIK. For example, certain types of pharmaceuticals are distributed to beneficiaries in developing countries. The beneficiaries receiving those pharmaceuticals usually do not have the resources to transact for those pharmaceuticals, and accordingly, the NFP would not consider the beneficiaries market participants for determining fair value. Instead, the NFP would look to commercial markets for these pharmaceuticals. If no commercial market exists for the specific pharmaceuticals, then the NFP may need to consider a hypothetical market using inputs from commercial markets for similar pharmaceuticals.

This is where judgment comes into play and it gets really difficult.

Recipients of development aid typically would not be market participants.

Who then are the market participants for mebendazole in lot sizes of tens of thousands or millions of doses? If you can’t find any then you need to go to a hypothetical market.

I keep getting hung up at the question of who buys 100,000 deworming meds at a time.

This is where the divergence of professional judgment really kicks in. It seems to me that this is the place where the International Drug Price Indicator Guide comes into play. Others have different opinions.

If I am reading that document correctly and if it contains what I think it does, then we have a source for actual prices paid by actual purchasers of 500 mg mebendazole in volumes comparable to what are donated to NPOs. Seems to me, sitting in my little corner of the accounting world, we have a source for actual transactions from market participants operating at the place in the distribution stream where INGOs are also operating.  From my perspective, I can’t quite imagine a source for input data that would be a better conceptual match.

Who else is buying 100,000 mebendazole tablets at time?  Am I missing something?

Again, others have different opinions.

.135 Inputs to the valuation techniques should prioritize the use of observable inputs over unobservable inputs. NFPs should give highest priority to level 1 inputs (unadjusted quoted prices in active markets for identical assets) and lowest priority to level 3 inputs (management’s assumptions about the assumptions market participants would utilize). However, level 1 inputs often are not available for GIK. Level 2 inputs (inputs other than quoted prices included in level 1 that are observable for the asset) generally include quoted prices in active markets for assets similar to the donated GIK or quoted prices for identical or similar assets in markets that are not active. An example would be two buildings of similar size and condition within a downtown real estate market. An example of a level 3 input might include an estimated value provided by the donor. However, management has the responsibility to independently assess the reasonableness and accuracy of the value provided by the donor.

Here again is where professional judgment enters the discussion. It seems to me the International Drug Price Indicator Guide contains level 2 inputs. Maybe there are other sources of level 2 inputs as well.  Anyone have any ideas?

On the other hand, if I’m reading the Guide correctly and it contains actual prices from national agencies and INGOs, then are we actually looking at level 1 inputs? I’d appreciate help in processing through whether that would be level 1 or 2.

The Guide is obviously not a level 3 input.

.136 In developing methodologies for measuring fair value of GIK, NFPs should consider the guidance in FASB ASC 820-10, bearing in mind that the guidance is principles based and requires NFPs to use judgment in measuring fair value. Accordingly, it is possible that different NFPs can assign different fair values to the same type of GIK.

I recall a comment from a participant in the March 1, 2012 meeting of the Not-for profit Advisory Committee. That person’s comment, speaking personally and not representing his organization, was that there is sufficient guidance in the professional literature to address the issue of valuing pharmaceutical GIKs. Totally apart from what role the Guide plays, the above discussion goes a long way to illustrate why he made that comment.  Again, sitting here in my little firm, it seems to me there is plenty to work with here.

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