Check out this set of financial statements to see a live example of the pharmaceutical GIK issues – part 2

This series of posts looks at the issues surrounding valuation of GIK medication in the nonprofit community that have been getting attention lately.  The 2011 financial statements for Blessings International illustrate these issues.  This series show how those issues appear in one set of financial statements. 

See the first post in this series for suggestions on how to download a copy of the full 990 and audited financial statements.

Statement of activity

The statement of activity is presented on the “pancake” method, which means that all of the unrestricted activity is listed first followed by the temporarily restricted items. To find out the amount of total revenue requires doing some math. Total revenue for 2011 is $61.25M (calculated as $3.36 plus $57.82 plus $0.07). Total revenue for 2010 is $39.0.

Donated meds are $57.8 in 2011, which is 94.4% of total revenue.

In 2010, the $35.6 of GIK is 91.3% of total revenue.

The net handling charge revenue on the statement of activity is $3.16m and $3.15m (again, the first amount is for 2011 and the second is 2010). On the statement of cash flow, cash received from net handling charges is $3.30m and $3.32m. The differences between those amounts in each year are due to changes in receivables, which is typical.

The statement of activity shows other pharmaceutical costs of $2.1m and $1.7m. The 2011 amount corresponds very closely to the amounts on the 990 (see page 10) for pharmaceutical purchases of $1.85m and postage & shipping of $0.15m.  The supplemental schedule on page 22 of the financial statements describes the $1.85m as pharmaceutical purchases. If the miscellaneous distribution costs on line 24c are included, that suggests the visible costs on the 990 for buying and shipping meds is $2.05m.

Based on the line item names on the tax return, the description on the statement of activity, and the cover letter, those amounts would appear to be what was paid as a part of acquiring the medicine. Remember again there were no donated meds in 2011 – all was acquired by bargain purchase. That interpretation is consistent with this paragraph from note 1:

The Ministry is supported primarily through “handling charges” (service fees) charged to its Christian mission clientele to cover the costs of overseas shipment, warehouse and other overhead costs, as well as the costs of purchased pharmaceuticals. To a much lesser extent, the Ministry is supported by donor contributions, including federal and state government campaign pledges.

Notes to the financial statements

Note 1 on page 11 has a great description of the organization’s programs of providing low-cost medicine to needy or indigent people.

The first paragraph of note 1 says:

…The ministry primarily obtains its pharmaceuticals by purchasing them from both U.S. and overseas sources. In recent years, the Ministry has increasingly relied on bulk purchases of generic drugs from two overseas suppliers through its “Import for Export” program. In prior years, the Ministry has obtained significant pharmaceuticals from donations solicited from major pharmaceutical firms; however, no donations have been received since February 2009.

There are two primary vendors.

The most recent donated medicines were in February 2009. That means for the remaining six months of fiscal year 2010 and for all of fiscal year 2011 all of the medicines were acquired by bargain purchase.

I do not know why note 1 says the last donated medicines were received in February 2009 while note 3 says all medicines acquired in fiscal 2010 were by bargain purchase. That does not matter for my purposes because I will focus on the 2011 financial statements for additional analysis.

Why is this important? That means 100% of the medicines in 2011 are affected by the bargain purchase concept, which is the core of the issue in discussion.

I will quote note 2 (e) for inventories in its entirety, so the context is clear:

(e) Inventories

Inventories of pharmaceuticals, consisting of medicines, drugs, and medical supplies, whether purchased or donated, are recorded at their estimated current average wholesale value at date of donation or purchase and are tracked by a specific identification method.

For specific pharmaceuticals purchased or donated from U.S. pharmaceutical companies, the inventory received is identified by manufacturer, item number and lot size (NDC code), and lot number and expiration date. These pharmaceuticals are recorded at their current “Average Wholesale Price” (“AWP”) per the Thomson Reuters Red Book for their specific NDC code, or an estimated average wholesale value based on the AWP for a similar product of equivalent lot size and potency.

However, the majority of the value of the pharmaceutical inventory consists of generic products purchased in bulk quantities from U.S. or overseas (“Import for Export”) sources. For these products, Ministry warehouse personnel sort and repackage the products under Blessings International NDC codes. The average wholesale values of such products at the time of manufacture are conservatively estimated based on the current AWP’s of similar equivalent products in the latest Thomson Reuters Red Book, adjusted for differences in lot size and potency, as applicable.

That last sentence is key for 500mg mebendazole. Continuing with note 2(e):

At the end of each fiscal year, the AWP’s of the major items in the pharmaceutical inventory are reviewed and adjusted, if necessary, if significant changes in the estimated average wholesale values have occurred since the date of purchase or donation.

Here we have the core of the debate over valuing GIK.

Kudos to Blessings International for the clear explanation of their approach.

The meds are valued at Red Book.  For meds that are not listed, an AWP is estimated based on the potency of a comparable medicine. Cutting to the chase, this means that since a 500 mg dose of mebendazole is not listed in the Red Book, its value is estimated based on a relationship to the valuation for a 100 mg dose of mebendazole. Also, the valuation is adjusted for the volume of medicine.

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