Some additional news reports on the California AG’s enforcement actions

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There are a few recent articles discussing enforcement action by the California Attorney General regarding the accounting for donated medicine used by three national charities. Looks like the issue is beginning to get a bit wider attention than this teeny tiny little ol’ blog.

Inflated Expectations / What’s going on with foreign affairs nonprofit Food for the Poor? from Slate on May 10, 2018, provides a non-technical description of the issues raised by the California AG.

Good explanation of medicine valuation, near-term expiry, joint cost allocation, principal market, access, and materiality issues without ever using those words. Even hints at daisy chain and SFAS 136 agency transactions.

Let me suggest a couple of exercises for accountants in the audience.

First, read through the article another time identifying all the accounting issues touched upon. Think about that as an illustration of how to describe technical accounting issues without being technical. (Yeah, I know, what a crazy idea – explaining stuff so people will understand.)

Second exercise is to read through the article thinking about how non-accountants would respond to each of those ideas if it was the first time they had heard about it.

How many of those GAAP accounting treatments would actually make sense?

How many would seem flat-out silly to people who haven’t spent years working with accounting rules?

Description of one shipment

The article focuses on the two specific shipments mentioned in the AG’s cease-and-desist order which the AG says illustrates the transactions which are of concern. I will quote the C&DO and then quote the Slate article, under fair use.

In paragraph 12 the AG describes one transaction as follows:

Food for the Poor 2012 shipment to Nicaragua: Food for the Poor valued the pharmaceutical Simvastatin at $924,671 (total) using U.S. prices; using appropriate international prices, the total value was less than $5,000;

Two of the three sentences describing this transaction in the article are:

The charity valued the pills, which were nearing their expiration date, at $924,671. At the same time, a charitable soul inclined to purchase the products in Nicaragua and give them away could have bought the exact same pills, nowhere near their expiry date, for less than $5,000.

Consider that as an example of explaining an accounting issue in non-technical terms.

The Slate comment links two ideas:  paragraph 12 which describes two specific shipments and paragraph 4 which asserts that “many” of the donated medicines are “close to expiration.”

This particular transaction, according to the AG’s calculation, is overstated by approximately 99.5% of the recorded donation, or a ratio of booked amount to AG claimed amount of more than 185:1.  Think back to the days when many reporters were discussing mebendazole and you will recall there was a vastly higher ratio in play back then for that particular med.

Without knowing the exact quantity, dosage, expiration date, and reference source for overseas valuation, none of us can recalculate the AG’s numbers.

As an aside of some significance, when valuation of donated medicine has been an issue in the past there were lots and lots of documents floating around showing actual transactions. I read quite a few of them.  In the past that allowed recalculating some numbers. I’m not aware of any documents being passed around this time to show specifics. None of the few articles in print have hints the reporters have seen any live documents. If anyone happens to know of any shipping documents that are in circulation, I’m sure that any reporter who has reported on GIK issues in the past would be quite happy to take a look at the documents.

Deductions for pharma companies

The Slate article closes with a hint that the pharmaceutical companies are taking a deduction for the market value of donations. While there is a qualification of “if it’s taking place”, there is a hint this is motivation for the donations which provides a rich payoff.

I did some checking and found out there actually is an enhanced deduction for donated inventory. I am advised that regulation section 1.170A-4A allows a deduction for donated inventory equal to cost (basis) plus one-half the difference between cost and sales price. That means that deduction is equal to cost to manufacture the inventory plus one half of the markup. There is a further restriction that the deduction is limited to twice the basis.

Since there is a quite dramatic markup on pharmaceuticals in order to recover the astronomical cost of development I would guess at that second limit of two times basis would be the deduction for any donated medicine (i.e. deduction is double the cost to manufacture).

Therefore if my understanding is correct there would be relatively small deductions for pharmaceutical companies donating medicine to charities.

Other articles

Nonprofit Quarterly gives an overview on May 11, 2018 by Ruth McCambridge:  One Attorney General’s Response to “Creative” Nonprofit Accounting. Article refers back to previous times the valuation issue has surfaced.

Article confuses the near-expiry issue and the overseas pricing issue in the third paragraph, saying that the meds were prohibited from distribution because of the near term expiration.

Those are actually two different issues.

A near-expiry med has reduced value since it must be used quickly. That is separate from a restriction that a med must not be distributed in the U.S.  A discount for near-expiry would be a significant percent of the value. However, if the proper pricing is overseas markets instead of U.S. markets, the AG’s examples suggest the impact on pricing is a discount in the range of 90% or more.

Both issues may be in play but near expiration is a minor issue in the C&DO. The core issue is overseas pricing or U.S. pricing. That is where the fight will be.

The South Florida Sun Sentinel posted an article on May 11, 2008, by Tonya Alanez:  Food for the Poor’s charity status under siege over drug donations. Article provides a high-level overview of the C&DO.

A casual one paragraph summary describes the AG’s claim. I will paraphrase the reporter’s comment: a combination of accepting donations near expiration and the medicine having a restriction from being distributed in the US means the overseas price must be used instead of the higher US market prices.

Not bad, although the comment does combine the main issue of overseas restrictions with the minor issue of near-term expiry.

In Florida the state agency that regulates charities is the Department of Agriculture and Consumer Services. The department did not provide any comment by deadline. The state AG provided a comment that they are looking at the matter under the state’s Deceptive and Unfair Trade Practices Act.

The South Florida Sun Sentinel has a same-day update on May 11:  Florida agency gave Food for the Poor all-clear after investigation. The state regulator said that after an investigation, they did not find any violation of state law. Article contains no hint of how long the regulators were looking at the issue.

 

For Purpose Law Group posted an article on May 3, 2018, CA Issues Cease-and-Desist Orders to Out-of-State Charities. Article provides brief background on the cases, but is a bit out of date since it does not make any mention of the three appeals that were timely filed.

Only other article I’ve seen discussing the C&DOs is one I previously mentioned on April 30:  Charities Get Cease And Desist From California AG by Mark Hrywna writing at The Nonprofit Times.

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