Valuation of deworming meds illustrates the front-page-of-the-newspaper test – part 1

“How will this look on the front page of the newspaper?”

That is a helpful way to evaluate decisions.

When you are trying to figure out what’s the right thing to do, ponder for a moment how your decision will look if you read about it on the front page of your local newspaper.

If you are going to look really bad, then maybe, just maybe, you might be making a bad decision.  I mentioned this in a post some time ago.

We are seeing this illustrated live with the issue of valuing deworming medicines. Mebendazole is in the news!

Newspaper test in action

Here is one simple, recent illustration of how this looks in the newspaper.

I mentioned earlier a Pittsburgh Tribute-Review article by Mr. Bill Zlatos.  The article says Mr. Tony Sellars, a spokesman for Feed the Children provided the following information:

In 2009, Feed the Children valued its 60 million deworming pills at $9.07 each on its financial statements, Sellars said. The next year, the agency reduced its program to 30 million pills and valued them at 35 cents apiece. Its revenue for that drug alone plummeted from $544.2 million to $10.5 million.

The reason for the change in valuation is because Statement of Financial Accounting Standards #157 went into effect, which refined “fair value” to a more specific “exit price in the principal market”.

Because of that accounting rule, the valuation for one specific medicine went from $9.07 to $0.35. The new value dropped to 3.9% of its previous valuation because of an accounting rule.  Half a billion dollars disappeared from revenue because of a revised definition of fair value.

Nobody other than a CPA or someone working for a relief and development NPO has any clue what the previous two paragraphs mean.  If you are reading this post, you probably understand.

Pretend for a moment you don’t have enough knowledge to understand what I’m talking about. What would your reaction be to a story that explains that contributions dropped by half a billion because of a change in some silly accounting rule that doesn’t seem to be a change at all?

Most people are probably thinking, “Come on. Going from one fair value rule to a different fair value rule is a massive change? Doing this fair value thing dropped income half a billion dollars? Really?”

Going with a technical explanation of the transition, especially for a medicine which is illegal to distribute in the United States but was valued at an extrapolation from values inside the United States, just makes it look worse.

No matter how it is explained, the transition from $9.07 to $0.35 looks bad. Doesn’t matter if the top number was $16.25 or $10.64 or $9.07 and the bottom number was $0.35, $1.54, $2.00 or $0.05.  It is really, really hard to explain why that $9.07 or $10.64 was right last year but wrong this year.

Next – Part 2 on reputational risk, which media are following the story, and overlap of donor base to those media’s audience.

Here’s two questions for discussion. First, how do you think these stories look to people who don’t understand the accounting rules?

Second, would anyone like to write a detailed explanation of why the previous valuations were appropriate?  I’m willing to run an anonymous guest post with extremely light editing. Leave a comment, which I won’t publish, giving an email for contact.

8 Responses to Valuation of deworming meds illustrates the front-page-of-the-newspaper test – part 1

  1. In the case of Feed The Children, even a 35-cent-per-pill valuation for mebendazole is about 1,650% higher than what it can be purchased for on world markets (2 cents a pill or less). So Feed The Children is merely coming down from an even more absurd 45,250% overvaluation. In my view, even the previous accounting standards behind which many GIK charities are seeking cover from now-they-show-up regulators did not allow such markups, at least in the absence of evidence that the pills could not be purchased for less than that, or evidence that someone buying in bulk actually paid that sum (or more; values topping $16.00 a pill were used by some charities). I have yet to find a GIK charity with such evidence. Otherwise, the accounting industry is saying there was nothing wrong at all with acquiring a commodity item worth 2 cents and immediately declaring it was worth 800 times more. In other endeavors people have gone to jail for this.

    • Jim Ulvog says:

      Thanks for your post. Good background on the issue.

      My posts on bargain purchase, found at http://wp.me/p131q2-M2 and http://wp.me/p131q2-M4 describe the accounting rules that have been in place for a long time.

      Notice that under current and previous rules, the value of the contribution begins with fair value. Start with that concept, then go back to your comments on the world-wide market information showing the meds available for purchase in the range of pennies per dose.

      What is the fair value for a medicine illegal to distribute in the U.S.? $9.07 extrapolated from the Red Book? $.05 or $0.03 from list prices?

      Then you can calculate the contribution by subtracting the purchase price/fees paid/handling charge from the fair value.

      I have some more posts in mind.

  2. The Red Book in its introduction disclaims all responsibility for the accuracy of listed prices and even suggests the prices in its own publication may be wrong! I quoted the specific language at length in my Forbes article (http://onforb.es/sXZCf1). So I don’t see how reputable CPAs could use the Red Book as a basis for any extrapolation. I would welcome a citation to, and discussion of, the specific accounting principle that requires or even allows an immediate 81,250% markup from the 2 cent cost on the open market to $16.25 on financial statements. I’m sure the IRS task force in Seattle looking into the issue would be interested, too.

  3. Jim Ulvog says:

    If anyone is interested in explaining that accounting approach I’d be willing to provide a guest post platform for the discussion.

  4. My, what a rush by GIK nonprofit accountants to defend their efforts!

  5. […] other media sources are sounding the alarm as well. The number is […]

  6. […] front-page-of-the-newspaper test is showing regularly that the explanations are not believable for people who look at things […]

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