Committee analysis of California AB 1181

Image courtesy of Adobe Stock.

Update: The Senate rules committee assigned the bill to the Judiciary committee a few days ago, 5/22/19.

The Assembly Committee on Privacy and Consumer Protection prepared a seven page analysis of AB 1181. The proposed bill, which has since passed the Assembly, would change accounting for GIK when the donor says the donated materials may only be distributed overseas.

Financial reports filed with the California Attorney General and solicitations to citizens of California would have to comply with the new accounting.

The following will be a loooong read, but the analysis by the committee is helpful for understanding the bill. There is good background in the discussion.

I will quote the analysis and provide some comments along the way. I quote the material without permission because it is a public document.

Highlights include the AG describing a successful enforcement action in which a charity turned a $225,000 purchase of meds into a $34,900,000 donation. Also, a representative of the California Society of CPAs makes an invalid argument against the bill.

From the committee analysis:

2) Author’s statement: According to the author, “AB 1181 addresses reported practices by some charities that grossly inflate the value of their publicly reported revenue and program expense, especially with respect to in-kind donations of pharmaceutical drugs. Overvaluation of the gifts-in-kind leads to an inflated total revenue for the charity which makes the charity appear more successful and efficient to the public and potential donors. An inflated revenue, in turn, can serve as a basis to hide excessive fundraising and administrative costs because these expenses would now appear smaller in comparison to the inflated total revenue. Inflated reports may also increase the charity’s ranking by charity watchdogs. This type of accounting practice is manipulative, misleading, and inconsistent with state law that safeguards transparency, fair reporting, and ensure a level playing field for honest charities that report accurate data to the Attorney General’s Registry of Charitable Trusts.”

At an overall level, the statement above provides a survey of the regulator’s and author’s concern regarding overvaluation of GIKs.

In particular, notice the last comment saying charities without large volumes of donated materials are at a disadvantage when appealing for donations from consumers.

Back to the analysis:

3) Addresses longstanding concerns with overvaluation of gift-in-kind donations: Under California law, the AG oversees registered charities to ensure that funds received are properly managed and devoted to charitable programs. The office derives its authority from the Charitable Purposes Act, which was originally enacted in 1959. This law generally requires every person or entity that holds or solicits property for charitable purposes in California to file specified documents and information, including annual financial statements, with the AG. These reports are in turn used by the AG to investigate and litigate cases of charity fraud and mismanagement by trustees and directors of charities. This bill seeks to address longstanding concerns with charities overvaluing gift-in-kind donations, a type of charitable donation where goods and services are given instead of cash to buy needed goods or services.

As far back as 2012, Forbes reported on a multi-state effort to crack down on nonprofits who greatly exaggerate the value of donated goods to make themselves look more successful than they actually are.

“In theory, there’s nothing wrong with gift-in-kind itself. A donation to a worthy charity is a donation to a worthy charity. The problem comes largely with the valuation. Cash is easily valued at, well, the amount of cash. But freed of the precision that cash provides, some charities value donated goods at many times the market price. The overvaluation makes a charity seem larger and more popular than it is, and also increases–artificially–financial efficiency ratios that many donors look at.” (Barrett, Charity Regulators (Finally) Eye Overvaluation Of Donated Goods, Forbes (Nov. 8, 2012).)

Mr. Barrett has been writing about overvaluation of GIK since at least 2012. I think he was writing on the issue a few years even before that.

This issue has been getting attention for at least seven years, yet the issue is still alive.

In 2018, drug, tech, and financial services companies topped the list of corporate donors. (O’Leary et al, Drug, Tech, and Financial-Services Companies Top List of Corporate Donors, Chronicle of Philanthropy, (Sept. 5, 2018).) Many pharmaceutical companies make product donations a common feature of their corporate social responsibility efforts. In response to the crisis in Syria, for example, several major multinational pharmaceutical companies have donated medicines and cash to emergency relief organizations, including the International Committee of the Red Cross, International Health Partners and Project Hope. (Gray et al, Pharmaceutical companies donating medicines in crisis situations, Devex (Feb. 29, 2016).) The AG, sponsor of this bill, writes:

“Pharmaceutical donations to charities are particularly susceptible to overvaluation abuse because their value on the international market can be pennies on the dollar compared to their market value in the United States (U.S.). Thus, charities benefit from reporting pharmaceutical gift-in-kind donations at the higher U.S. market value even when such drugs will not be used for charitable programs in the U.S. Reporting the inflated value of the drugs through the use of U.S. prices is especially misleading when drug companies make the donations with the restriction that the donated drugs not be used in the U.S. Because of their intent to prohibit the use of the drugs in the U.S., the drug companies typically make donations of drugs to charities that provide international assistance, with the expectation that the donated drugs will be distributed to end recipient individuals or charitable groups located in other countries. In those circumstances, the charity should not be valuing their pharmaceutical gifts-in-kind using U.S. prices.

“In a recent case investigated by [the California] [Department of Justice] DOJ, for example, a charitable organization created two subsidiary companies that purchased pharmaceutical drugs from a European wholesaler for less than $225,000. These subsidiaries then donated the drugs to the parent charity. The parent charity reported the total value of these pharmaceutical donations as being over $34.9 million using U.S. drug prices, rather than the actual purchase price paid by its subsidiaries. The parent charity also inaccurately claimed, in its financial reporting and on its website, that 99 [%] of all contributions it received provided direct aid. [Our] investigation found the parent charity’s representation was the result of deceptive reporting of gift-in-kind donations, and that the charity had engaged in a misleading reporting scheme to purposefully increase the amount of its gift-in-kind donations to mislead the public. Ultimately, due to DOJ’s investigation, this charity agreed to pay a large settlement and to stop its misleading representations.”

Wow.

I’ll research this case later, but consider the fact pattern asserted by the AG:

Charity forms a sub. The sub buys meds for $225K on the international market. Sub donates meds to parent. Parent, using US values, books revenue of $34.9M from the GIK.

The AG is asserting the cost of the medicine on the international market for that charity is 0.64% of the US price.

To generate $1.00 of GIK revenue, the sub spent $0.006, about half a penny for each dollar of revenue.

Put another way, a $1 purchase on the international market converts to $155 on the audited, published, filed-with-the-AG financial statements when using domestic pricing.

A multiplier of 155x is not as good as mebendazole used to be, but is still a high ratio.

If you might still be wondering why the IRS and the FTC and every one of the AGs a few years ago and now the California AG get so worked up about GIK valuations, consider that they see fact patterns like a 155x multiplier of converting purchases into donations.

Continuing with the committee analysis:

By prohibiting charitable organizations from reporting gift-in-kind donations in a way that is misleading or likely to cause confusion, and requiring gift-in-kind donations conditioned on distribution outside the U.S. to reflect the fair market value in the market where the recipient charity is located, AB 1181 should arguably increase transparency for Californians, who often look to the value of a charity’s donations when deciding the charity to which they wish to contribute. These requirements are also consistent with existing law which already prohibits using any unfair or deceptive practices or engaging in any fraudulent conduct that creates a likelihood of confusion or misunderstanding. The Act also expressly prohibits a person from knowingly filing a report or financial statement with the AG that contains information or an omission that is false or misleading. This bill would merely clarify that these same standards apply to in-kind donations.

4) Generally accepted accounting principles: The Charitable Purposes Act currently requires the financial records of a soliciting organization to be maintained on the basis of generally accepted accounting principles as defined by the American Institute of Certified Public Accountants, the Governmental Accounting Standards Board, or the Financial Accounting Standards Board. This bill would instead require financial records to be maintained only according to principles established by the Financial Accounting Standards Board.

As I mentioned in a previous post, FASB has defined GAAP to consist of the Accounting Standards Codification.

The California Society of CPAs (CalCPA), representing the Certified Public Accountant profession, opposes this bill unless amended. CalCPA shares the goal of safeguarding Californians by ensuring charitable organizations do not mislead donors, and also recognizes that there are charitable organizations overstating the valuations of noncash contributions to inflate the efficiency in the use of donor funds in their programs. CalCPA argues, however, that:

“The language of AB 1181 would undermine uniform national accounting and valuation standards by essentially allowing California to set its own accounting standards and procedures that significantly deviate from those that are accepted and universally utilized throughout the United States. […] Charities would need to maintain two separate financial and accounting records: one that is non-GAAP [generally accepted accounting principles] for California purposes and one that complies with GAAP for federal and other state’s purposes. Two sets of financial and accounting records would create consumer confusion and significantly increase the complexity and cost of preparing and maintaining records for charitable organizations. […]

“GAAP refers to a uniform set of accounting principles, standards, and procedures that determine how businesses, governments, and nonprofits present financial information. […] GAAP is not a single standard, rather it is a combination of authoritative standards and the accepted guidance in applying those standards to record and report accounting information. […]

“A CPA that prepares a charitable organization’s financial statement in accordance with GAAP would need to look to more than just FASB standards. By removing the reference to the [American Institute of Certified Public Accountants] AICPA and [Governmental Accounting Standards Board] GASB in Section 17510.5 (a) of the Business and Professions Code, AB 1181 undermines GAAP by expressly removing the reference to two entities that are core to the formation and application of GAAP. This makes it unclear as to whether AICPA guidance and GASB can be used when preparing a financial statement for a charitable organization. In effect, this would prevent charitable organizations from across the country from being able to present financial statements in accordance with GAAP.”

It used to be there were four levels of GAAP, starting with level “A”, which were Statements of Financial Accounting Standards from the FASB. All the way down at level “D” were published articles, accounting text books, and industry practice.  If an issue wasn’t addressed in level A, one would work through lower levels to find appropriate guidance. If guidance at different levels diverged, then the ‘higher’ level prevailed.

That changed starting with client financial years ending after July 1, 2009. Since 2009, in other words for the last decade, GAAP consists only of those items included in the ASC. Everything else is non-authoritative. Some items, like AICPA pronouncements, carry a lot of weight, but they are still not GAAP.

So, when CalCPA argues that AICPA pronouncements are GAAP, the society is incorrect.

When they argue that CPAs won’t be able to look at AICPA audit guides or risk alerts for guidance, they are incorrect.

CalCPA, therefore requests that the author either: (1) allow for the completion of a process being undertaken by the Financial Accounting Standards Board (FASB), whereby they are reviewing how GAAP can be adjusted to address for concerns related to the valuation of gift-in-kind donations; or, (2) require a charity who has received a noncash contribution that is restricted to delivery outside the U.S. to indicate that condition on the organization’s annual renewal form and disclose it on its website, as well as on all forms of solicitations for financial support.

The author and sponsor, who have been working with CalCPA to address their concerns, respond that GAAP, according to DOJ experts, is actually not defined by AICPA, GASB, or FASB, and that arguing such is a “misstatement of the way things really are today—that, in fact, FASB establishes the codification (the authority) and AICPA helps the accounting community understand and apply the codifications. In other words, AICPA provides guidance interpreting FASB ASCs (Accounting Standards Codification) but it is not a coequal source of “defining” GAAP. DOJ believes that this is a technical amendment to correct an outdated statute, and that this bill does not hamper AICPA from continuing to play an important role in providing guidance to the nonprofit sector.”

The Attorney General and Honorable Assemblymember are correct.

Accordingly, to address CalCPA’s concerns regarding overseas valuation of gifts-in-kind, the author offers the following amendment, which would allow more flexibility for charities in valuating noncash contributions distributed abroad, where the donation’s value in the recipient market is unknown.

Author’s amendment:

Page 2, line 12, strike “If” and insert: “Notwithstanding subdivision (a),

Page 2, line 15, after “recipient market” insert: “or a reasonable estimate thereof if the end recipient market value cannot be ascertained following a reasonable inquiry. If the end recipient market is unknown when the noncash contribution is received, the charitable organization shall value the contribution using only those markets in which the contribution is reasonably likely to be distributed or used, taking all facts and circumstances into consideration, and which are consistent with any restrictions, including donor restrictions, and with its mission and charitable purpose”

Page 3, line 3, strike “receiving charitable organization is located” and insert “noncash contribution is to be ultimately distributed”

Staff notes that this bill does not seemingly address gifts-in-kind that end up being distributed abroad, despite not having that condition assigned to them. As this bill moves through the legislative process, the author and sponsor may also want to consider if requiring valuation based on end recipient markets should be required for all gifts-in-kind.

Uh, oh.

The staff member drafting the analysis is suggesting that the bill could be expanded to cover all GIK that is distributed overseas, not just those items for which the donor has indicated the item must be distributed overseas.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.

%d bloggers like this: