Regulators have serious problems with how the nonprofit community is accounting for donated medicine.

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There is a serious problem in the nonprofit community in terms of accounting for donated medicine. Three major enforcement actions by various regulators tell us that the regulators have serious reservations about how charities are dealing with gifts-in-kind.

Those of us working in the charity world need to ponder what could be making so many regulators so concerned.

50 Attorneys General

The rumors in the wind mentioned in my next post were discussed in 2012.  That turned into a major enforcement action by the Federal Trade Commission and all 50 state Attorneys General against 4 cancer charities. (See my posts under the tag FTC.) That was in 2015.

I’m not aware of any followup by that group and I’ll guess the reason is the complexity of coordinating a 50+ member committee.

For the FTC and all 50 Attorneys General to all be on the same page on an issue should serve as a warning they believe there is a serious problem.

IRS

There was a major effort from the IRS challenging the valuation of meds at Food for the Hungry (see tag for posts). That was in the news from 2012 through about 2014. That issue was resolved at great cost to the charity and faded away, in my opinion, only as a collateral consequence of the massive IRS 501(c)(4) fiasco.

I’m not aware of any other enforcement action the IRS has taken on valuation of medicine since the FFH issue. From the regulators’ perspective that may be considered an additional consequence of the (c)(4) mess. From the perspective of the R&D community that is a reprieve from enforcement – there was more time to address the issues.

Were it not for the IRS shooting itself in the left foot (and then the right foot, and then both feet again for good measure), I’ll guess there would have been enforcement efforts against other charities.

California AG

And now, in 2018, the California Attorney General has filed cease and desist orders against three large, high visibility charities for alleged overvaluation of medicine (see tag California A.G.).

I’m not sure how the appeals process works for actions taken by the AG. I’ll assume there is an internal process for hearings and further assume there is an option to move into the state court system after the internal appeals. (Anyone care to enlighten me with more detail?)

If my assumption on the process is correct, and if the AG’s actions are successful upon internal appeal, and if their actions are sustained by courts, then the implications for the charitable community (especially the relief and development community) could be substantial.

Financial statement assertions

Three major enforcement efforts over donated medicine accounting issues is a warning sign that something is wrong.

For accountants, it seems to me that each aspect of the accounting for donated medicine has been challenged at some point.

For auditors, think about financial statement assertions. Ponder the issues raised in the enforcement efforts and the extensive publicity regarding mebendazole in terms of those assertions. Issues raised involve the following assertions:

  • Class of transactions (i.e. statement of activity): occurrence, accuracy, classification
  • Balances (i.e. statement of financial position): existence, rights & obligations, valuation
  • Presentation and disclosure: occurrence, classification & understandability, accuracy & valuation

From my observations, it seems only the completeness and cutoff assertions for donated medicine are not involved.  I hope so much that the audit workpapers contain extensive documentation regarding the above 9 assertions.

In terms of materiality, those assertions are in play for the largest item on the statement of financial position, the largest item in revenue, the largest item in expenses, the largest item in the functional expense allocation, and the most significant item in disclosures. For the charities in this sector, the amounts involved are a vast long distance above any materiality cutoff.

From an accounting perspective there are substantial challenges to the accounting and from an audit perspective there are substantive challenges to financial statement assertions.

The nonprofit community (which I proudly consider myself to be a part of) really, really needs to address and resolve the GIK issues raised by regulators. If one of these regulatory enforcement efforts actually takes hold, we will not like the result.

Next post: the town fire alarm is sounding.

2 Responses to Regulators have serious problems with how the nonprofit community is accounting for donated medicine.

  1. And to throw another log on the fire, there’s also the possibility that for a number of charities, donated gift-in-kind medicine isn’t a received charitable contribution at all, but simply a purchase covered up by calling the purchase price shipping or handling.

    • Jim Ulvog says:

      Hello William:

      That particular log has been on the fire for quite sometime. If memory serves correctly, I think you had something to do with pointing it out. A long tie ago.

      In any event, that log is still burning brightly yet does not appear to be an explicit issue with the California A.G.

      For those just tuning in, the issue involves a shipment with valuation based on US market prices but for which there is a shipping or handling fee that vaguely corresponds to the list prices for those meds which are posted by wholesalers in Europe or Asia. The difference between value in US markets and the shipping cost is recognized as contribution income based on the accounting concept of a bargain purchase.

      For non-auditors reading along at home, this particular issue would involve the occurrence and accuracy assertions for class of transaction and the existence, rights & obligations, and valuation assertions for the statement of financial position. Dollar amounts of this issue might easily be well over the materiality threshold.

      For auditors wanting to think up an unexpected audit test for the next audit (for non-auditors, unexpected tests are a requirement for each audit), you might think about looking for payments to overseas manufacturers or extending out a few invoices at posted international prices and comparing that to the shipping costs. One possible way to find items to test would be to look for a drop shipment from Europe, say from a wholesaler on the continent. Might need to add time to the budget for pondering how to address any odd results.

      Thanks for taking time to remind us of that issue,
      Jim

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