A moment of background, which I know is the completely wrong way to start a blog post – The Journal of Accountancy is one of the major publications in the accounting world. It is the lead magazine of the American Institute of Certified Public Accountants, the largest trade association for CPAs. The AICPA also has significant self-regulatory authority for large parts of the CPA profession.
You might want to get a fresh cup of coffee – this will be a long post.
In its August 2013 edition, the JofA published a major article on valuing donated goods: Gifts-in-kind: What are they worth? How to avoid pitfalls of GIK valuation. The article is by Jennifer Brenner,
…an associate director for financial accounting and operations for World Vision, a relief, development, and advocacy organization that works to fight poverty.
She blogs here. She is speaking on her own behalf, not as a representative of her employer.
General comments
I have two general comments before I get into discussing specific ideas mentioned in the article.
First, the article is superb. It provides a very good description of the accounting rules regarding GIK valuation. It uses precise, technical wording while providing a great explanation. If you want to understand the rules for valuing GIK, please study the article.
Second, the article addresses most of the issues that are getting attention in the NPO community. If you want to learn the accounting words you can use to criticize the valuations currently in use, you would do well to study the article. The ironic thing is this article provides a superb path to frame up criticisms of the valuations used today and in the past.
The biggest issue the article doesn’t address is variance authority, colloquially referred to as SFAS 136 or pejoratively referred to as ‘daisy chains.’
On to the article.
Fair value is required
Are NPOs required to use fair value in getting an amount for recording GIKs? The article correctly explains the answer is ‘yes’. See ASC section 820.
Ms. Brenner summarizes the definition of fair value and then says:
That definition leads charities to use fair value, not the most conservative value, or an aggressive value.
That is exactly correct. If you want a simple explanation of the conceptual issue, check out the article.
Principal market
The article discusses principal market, which is a difficult concept to apply in practice. Not impossible, just difficult.
Legal restrictions
Here is a major issue for the largest medicine in the GIK valuation area. The article has a good explanation.
Ms. Brenner says:
…an NFP needs to identify any legal restrictions on the GIK. Based upon those data, the NFP should determine which exit markets, whether inside or outside the United States, are applicable to its circumstances and then seek pricing inputs in those markets.
For more detail on the impact of that comment, consider this:
If the medical supplies would be sold in the United States at the greatest volume, and there are no other asset restrictions to consider, then the United States may be considered the principal market for valuation purposes.
In accounting language, when there is an asset restriction on the use of a GIK that would prevent the distribution of the item in the U.S. then the U.S. would not be a principal market and thus pricing in the U.S. would not be indicative of an exit price.
Let me use non-accountant language with a specific application: 500 mg mebendazole is not licensed for sale in the United States. As a result there is a legal restriction on every dose of that medicine. Therefore, any reference to pricing in the U.S. is invalid for determining the donated value of 500 mg mebendazole.
So that you know why I emphasize 500 mg mebendazole in my conversation, please realize that from my observations over the last year or so, the majority of the dollar amount of GIK revenue in the R&D sector of the NPO community is from that dose of that medicine.
What fair value is not
Putting all that together, we can say that under GAAP GIK must be valued at fair value considering the asset-based restrictions on the donated items.
Valuing GIK at zero is not GAAP.
Valuing them at a very low, cautious number is not GAAP.
Valuing them at some amount that has no correlation to any actual transactions is not GAAP. Yes, I’m thinking of AWP.
Valuing medicine restricted from sale in the U.S. based on any indication of pricing in the U.S. is not GAAP.
Valuing them at some fantastical number supported by a complex, sophisticated, multi-page rationalization that is a humongous multiple of actual transactions is not GAAP. Yes, I’m thinking about 500 milligram mebendazole. (If you really need more detail on that point please read anything written by Mr. William Barrett at Forbes or the staff of the Chronicle of Philanthropy on the issue.)
The numbers $10.65 $10.64 and $16.25 come to mind when I think of fantastical numbers. And yes, I realize that is pejorative language. Yet that is the actual valuation used by most NPOs prior to SFAS 157 and still in use by some today. The numbers $2.00 and even $1.50 come to mind.
Here is some very deep, inside-baseball code language that only a very few people will possibly understand: As you thought, when I use the word rationalization, I’m thinking of the way we use that in talking about triangles. If you think I’m completely out of line, you might consider calling a certain assistant A.G. to ask for her thoughts.
Volume of medicine
The number of doses has an impact on the donated value. The article correctly points out that the manufacturer or wholesaler may or may not represent the principal market for an NPO. On the other hand, it might.
This provides a way to analyze the transaction. Who is handling medicine in the volumes that are donated? Who uses those meds in pallet size volumes? That points towards valuations earlier in distribution system rather than later.
There are different FMVs for donation of a bottle, or a case, or a pallet of meds.
Contribution or purchase?
This is an issue that has not received enough attention from the media.
What to do when a payment was made for a pallet of medicine?
The concept is described in accounting language this way:
One challenging situation for NFPs to evaluate is a bargain purchase or inherent contribution.
The article explains this well using accounting language.
It also provides the following superb illustration:
For example, a corporation provides a parcel of land to an NFP with a fair value of $100,000, but it requests the NFP provide $10,000 in exchange for the land.
If the land actually has a fair value of $100,000, then there is a $90,000 contribution.
There is a major accounting issue here that I’ve not yet been able to document in blog posts. Let’s pretend the example in the article was a GIK of meds received by a charity in the news. If that were the case, some of them (many? most?) would have recorded a donation of $100,000 and recorded the $10,000 payment as shipping or some other type of program expense.
That would overstate both revenue and the program service costs. That would in turn overstate the apparent size of the organization and understate the overhead ratio.
I’ve seen that accounting in many financial statements and haven’t seen it discussed in public anywhere. Like I said, I’ve not had time to write a series of blog posts on this specific issue.
Here’s where it gets worse. What if there was an appraisal supporting that $100k price but other transactions for comparable land in the area were for $8K or $15K. What do you think the contribution would be? I’ll leave that for you to consider.
Let’s convert that to donated meds, oh, say of mebendazole. If the written documentation says the meds are worth $200,000 and a payment of $5,000 was made to acquire the meds, what is the contribution amount? The typical charity would record a $200K contribution with $5K shipping costs.
What would you say if there is public information suggesting several national level health agencies purchased the same med in the same dose and paid something in the rough range of $4,000 or $6,000 for what would be the same volume? What if there are multiple price lists from wholesalers suggesting that they could deliver that med for a pricing of that volume that would be something in the range of $5,000 with some vendors at $3,000 and some at $8,000? Would that call into question whether the transaction was a donation or purchase?
Ms. Brenner has a dramatic recommendation:
A best practice for an NFP may be to have a policy with a rebuttable presumption that such exchange transactions are reciprocal transactions or “purchases.” Any indication of a bargain purchase or an inherent contribution when a fee is exchanged should be examined, and the NFP should document any exceptions that overcome the purchase presumption.
Sounds like a good idea to me.
Do you actually need the meds in your programs?
Another issue seldom discussed in published reports:
GIKs should be accepted if they can be used in the NPOs programs. Ms. Brenner suggests:
An NFP should have a policy for assessing a GIK prior to accepting it and also needs to exercise discretion regarding what goods to accept based on a programmatic needs assessment.
Let me take a too-close-to-real-to-be-a-hypothetical example. Let’s say your charity provides direct support to people fighting a particular disease, oh, let’s say cancer. You provide toys, health items, cash support, books, booklets, education, or encouragement to people across the U.S. battling that illness in hospitals or clinics.
What is the programmatic need for a pallet of assorted medicine most useful in a general medical clinic that you shipped to a medical facility overseas?
If that is question that gathers your interest, check out the article.
Resolving every one of these issues is the responsibility of management
The article concludes:
An NFP is responsible for the information contained in its financial statements. Issues such as the applicable principal markets and the effect of nominal fees associated with a GIK require NFPs to scrutinize their GIK practices to ensure the proper application of U.S. GAAP.
Management should be able to provide a clear answer to how they addressed every one of these issues for each shipment of GIK. The volume of answers in the public realm leaves something to be desired.
Conclusion
I encourage you to read the article in the JofA. It is very good.
If you’ve read this far, you have probably also read my other blog posts. The time is running short. Let those who have ears to hear the fire alarms listen carefully.
Update: Something missing from the Journal of Accountancy article on GIK discusses some disclosure that Mr. William Barrett thinks should have been made. Probably would have been a good idea.