Guest post – GIK Valuation: The issues not being discussed

The following is a guest post submitted to me from a reader. As I read the article, it became obvious that the author is familiar with the issues of the relief and development organizations.  Whether the author is an outside auditor, accountant inside an NPO, or even a medical vendor does not matter. Obviously the comments reflect the author’s opinion and not those of his/her employer.  This also does not reflect my opinion.

Agree or disagree as you wish, here are ideas deserving your careful consideration:

GIK Valuation:  The issues not being discussed

While there are many, if not dozens, of misconceptions and false information floating around pharmaceutical values, GIK values, and NPOs supposed conspiracy to inflate revenues to improve their Charity Navigator rating, I thought I would point out a few things to try to bring the conversation around to the big picture rather than focusing on the quite narrow discussion around non-FDA approved, 500mg mebendazole.

500mg mebendazole is a red herring

Yes, 500mg Mebendazole is red herring.  The Chronicle of Philanthropy, Forbes, etc. have focused entirely on this one drug because they don’t understand the industry.  As with all media-hyped issues, it is easier to find a scapegoat and blame everything on them, than to research the real issue (take the recent IRS scandal, everything was the fault of two low-level employees, riiiight…).

For this issue, mebendazole has become the scapegoat.  It’s easiest to blame everything on one drug than to actually research the issue.  First, mebendazole is only one deworming drug out of several the NPOs use.  Second, deworming drugs are only one kind of drug used by NPOs.  There are cancer drugs, HIV/AIDS drugs, anti-malarials, vitamins, and the list goes on.  Mebendazole is only a small fraction of the drugs used in the nonprofit community, both domestically and internationally.  The recent IRS audit findings letter that has circulated went into several accounting issues unrelated to the value of mebendazole.  By focusing on only this one drug, all other issues are largely ignored and organizations that receive donations of other drugs are able to skirt by without scrutiny.  Charities are more than happy to help keep the conversation focused on just mebendazole, and cater to the ignorant media.

It’s likely, and perhaps understandable, that some groups, organizations, and media outlets want to see someone punished, want to see someone made an example of so that they can pat themselves on the back and feel like justice has been served.  Taking the sawdust out of someone else’s eye while ignoring the plank in their own, so to speak. 

This is also likely the reason that change is slow in coming. By focusing on one small issue and ignoring the greater issue, the problem, if there is one, doesn’t get solved. In order for there to be real progress in the valuation of pharmaceuticals, scrutiny needs to be given to the valuation of all gifts-in-kind: clothing, shoes, books, equipment, cars, medical equipment, etc.; and to all the accounting issues surrounding GIK, not just the one that makes headlines.  All GIK can be overvalued and misused.  Some focus should be given to the overall picture of valuation.

Hiding behind FDA approval

The discussion around the valuation of pharmaceuticals has focused on one particular issue:  the valuation of drugs that are not FDA-approved, particularly dewormers.  It has become commonly accepted since the issuance of FAS 157/ASC 820 that without FDA-approval, US price sources (CMS-FUL, WAC, SMAC, etc) are not acceptable valuation sources for non-FDA approved drugs because the drugs are not legally permissible to be sold in the US.  Therefore, for the last few years you have seen organizations drop their values of these drugs.

The number of organizations working with non-FDA approved drugs is pretty small in comparison to the total number of relief and development organizations, and especially in comparison to the total number of charities in the US taking pharmaceutical donations.  So while the controversy over those organizations values has been boiling, it has allowed the other organizations to hide behind the FDA approval of their donations.

The basis of the controversy is that organizations are “inflating” their drug values by using US-based pricing sources (like AWP) which are well known to be inaccurate or overpriced.  With the inclusion of the “legally permissible” language in ASC 820, this led organizations to look only at non-FDA approved drugs which were not legally permissible to the sold in the US.  Organizations subsequently looked for alternative pricing sources and lowered their values to values that were in accordance with markets that were legally permissible for the donations received.

All the while, organizations dealing in FDA approved drugs were ignored by the controversy and continued to value their donations using the U.S. pricing sources.  The same pricing sources that are considered inflated and led to changes in the valuation of some drugs continue to be used for other drugs.

What many organizations have done is “changed” their valuation without really changing.  Most commonly, organizations have begun using Wholesale Acquisition Cost (WAC).  Our favorite villain, AWP, is actually directly related to WAC in that WAC equals 80% of AWP.  So organizations can say, “Look! We lowered our valuation!” and most observers would note it and move one, or even applaud them for being forthcoming.  This ignores the potential that WAC is still overinflated.  AWP is considered to be overinflated by perhaps 80%, meaning that a price somewhere in the range of 20%-50% of AWP is most appropriate for the valuation of FDA-approved pharma, not the 80% that WAC lands at.

Because these drugs are FDA approved, organizations have been able to hide behind this characteristic and continue to use inflated US pricing sources.  As mentioned before on this blogsite, FMV is the value that would be received if the asset was sold.  In the volumes and types of drugs that organizations are using, a WAC price or other US based price is unlikely to be received by the organization in a hypothetical sale regardless of FDA approval.

The issue gets even more comical when you apply some common sense (not that accounting rules necessarily follow common sense).  Say you have two drugs:  FDA-anti-malarial and non-FDA-anti-malarial.  Nearly all drugs are manufactured in India and China regardless of pharmacopeia standard (FDA approval does not mean manufactured in the US, few pharmaceuticals, if any, are actually manufactured in the US).  So our two anti-malarials are manufactured in the same factory in India, on the same assembly line.  Both are made using the same materials, both produce the same results when used in medical treatments.  However, when it comes to GIK valuation, FDA-anti-malarial gets an FUL-based GIK value of $1.00 a pill and the media says nothing or even applauds the org for using a non-AWP value, while non-FDA-anti-malarial gets an internationally-based GIK value of $0.20 a pill and the media and bloggers are in an outrage.  This makes no sense, but orgs are secure hiding behind the FDA approval because this is all perfectly acceptable and in accordance with GAAP.

Pass-throughs are the bigger issue

What is really being ignored in all of this is the passing through of gifts from one organization to another, something that has been referred to as “daisy-chains” and may represent the largest issue in GIK accounting.  The scenario can work a number of ways ranging from quite simple to fairly complicated, for example:

1. Organization A works with the same donors every year, receiving the same kinds of donations, and giving those donations to Organization B every year.  Rather than have Org-B work with the donor directly, Org-A remains involved and booking revenue year after year under the justification that they are the one-stop contact for the donor, or are providing sorting and packaging services.
2. Organization C has some GIK to be shipped internationally.  They can’t afford the shipping so Organization D pays the shipping costs.  Both record revenue for the full value of the GIK, even though Org-D did nothing except make a donation for freight.
3. Organization-Brazil secures a GIK donation from a US corporation.  The US corporation can’t get a tax write-off for donating to a foreign entity, so Organization-Brazil works out a deal with Organization-US wherein Org-US “accepts” the donation from US-Corp and receipts them, then the donation ships direct from US-Corp to Org-Brazil.  Org-US records the full amount of the GIK as a donation even though they did nothing but write a donation receipt.

Some of these can be found easily but some would take a little digging.  In regards to example 1, some organizations year after year give 70% or more of their income to the same unrelated organization.  At some point, wouldn’t it be easier for the donor to work directly with the end organization?  Examples 2 & 3 are just straight dishonest, if not fraud.  There should be more emphasis and pressure put on organizations to work directly between the donor and end user whenever possible, or even forego recording revenue when and organization knows it is just passing it along.

All this to say… it is really just arguing accounting points.  And, while I enjoying arguing accounting minutia, on the grand scale, I couldn’t give 2 cents about accounting.  The only thing that should really matter is the effectiveness of the programs.  All kinds of cash, grant and GIK donations can be misused and can do unintentional harm.  Equally, all kinds of cash, grant and GIK donations can be used in quality programs, resulting in long-term, sustainable development.  Funny business in accounting will continue as long as the only thing people are able to look at when rating charities is overhead rates.  I think there is momentum in the industry to look more at the effectiveness of organizations rather than the faux-holy-grail of overhead rates.  Even Charity Navigator has introduced their 3.0 concept to begin looking at effectiveness.  Hopefully the momentum in the industry continues.

Comments from Jim:

Many thanks to the author for taking the time to write the above post. For those wanting to keep score at home, this post is well over 1,500 words long. I know how much effort goes into preparing a well-crafted article of that length. Thanks.

So…Your thoughts?

Anyone else want to expand the discussion? Let’s keep it professional and I’ll put up all posts and approve all comments.