Update – Mark Hrywna (@mhrywna) tweeted on 6/17/19 the Senate Judiciary committee has scheduled a hearing on AB 1181 on 7/9/19.
After attending CalCPA’s Not-for-Profit Organization conference last week and talking to a small group of my CPA colleagues, I have two thoughts on regulatory attention currently focused on the valuation of donated medicine. Let me provided two questions which will focus my comments:
- What is the primary concern of the regulators?
- What is the specific, focused target of California AB 1181?
Previous post discussed the first question.
As I mentioned in that post, I have long wanted to develop an extensive discussion on the main accounting issues found in the California AG’s three cease and desist orders along with several accounting issues raised in their January 2019 settlement and May 2019 litigation.
That full discussion would have ended up somewhere around 3 or 5 times longer than these two posts. I won’t have time in the foreseeable future to write such an extended discussion. This pair of posts, at over 2,600 words, will have to do.
What is the specific, focused target of California AB 1181?
For this discussion I move to more inside-baseball details than usual, on the assumption anyone following along on a discussion of AICPA audit guides and the specific wording of legislation will be able to handle the details.
It is my perception that AB 1181 has a hyper-narrow, laser-like focus on one paragraph of the AICPA’s audit guide for nonprofits.
That would be paragraph 5.139 which provides FinREC’s opinion on the application of the entity restriction/ asset restriction issue to accounting for donated medicine when there is a geographic restriction by the donor.
It appears the ‘access to market’ issue was a major point of contention in the appeal hearing over the AG’s C&D order, but that major issue is moot in light of the wording of AB 1181.
So I perceive para 5.139 is the exquisitely narrow focus of the bill.
What does AB 1181 say?
I will quote the core of AB 1181 which uses red strikethrough to note deletions from current law and blue italics noting revisions made by the bill:
17510.5.
(a) The financial records of a soliciting organization shall 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 established by the Financial Accounting Standards Board.
(b) The disclosure requirement of paragraph (7) (4) of subdivision (a) of Section 17510.3 shall be based on the same accounting principles used to maintain the soliciting organization’s financial records.
(c) Notwithstanding subdivision (a), if a noncash contribution received by a charitable organization is restricted by the donor so that it cannot be used in the United States, the contribution shall be valued using the fair value of the end recipient market 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.
(d) For the purposes of this section:
(1) “End recipient market” means the market in the country where the noncash contribution is to be ultimately distributed.
(2) “Fair value” means the price that the receiving charitable organization would receive if it sold the noncash contribution.
The key sentence is:
…if a noncash contribution received by a charitable organization is restricted by the donor so that it cannot be used in the United States, the contribution shall be valued using the fair value of the end recipient market or a reasonable estimate thereof …
Paraphrased, and dropping out what are follow-on practical expedients, the bill says if a donor says a GIK may only be distributed overseas, the item must be valued at an international price, not the price in the U.S.
What does the audit guide say?
Compare that proposed requirement to what the AICPA’s Audit and Accounting Guide – Not-for-Profit Entities (Updated as of March 1, 2018) states, which I will quote under fair use so you can see the precise wording:
5.138 As discussed in paragraph 3.165 , FASB ASC 820-10-35-2B and FASB ASC 820-10-55-51 state that when measuring fair value, an NFP should take into account the characteristics of an asset (such as certain legal restrictions on sale or use) if market participants would take those characteristics into account when pricing the asset or liability at the measurement date. The effect on the measurement arising from a particular characteristic will differ depending on whether that restriction will transfer to market participants. Thus, a conservation easement, which is recorded like a deed and is binding upon future owners of the property, would be considered in pricing the asset if a donor places that restriction on use of the property.
5.139 In comparison, restrictions that are specific to the donee should be reflected in the classification of net assets, not in the measurement of fair value. FinREC believes that in implementing that guidance, limitations imposed by IRC Section 170(e)(3), prohibiting NFPs from selling the gifts in kind, as well as donor restrictions limiting the geographic locations area in which the gifts in kind may be distributed, are restrictions specific to the entity. Because those restrictions are not a characteristic of the asset, they would not transfer to market participants, and therefore should not be considered in pricing the asset.
The key sentence in 5.139 says:
FinREC believes that … donor restrictions limiting the geographic locations area in which the gifts in kind may be distributed, are restrictions specific to the entity.
That means the geographic restriction does not affect the valuation of the medicine which can then be valued based on U.S. prices, not international prices.
Hopefully you can now see how AB 1181 is focused on one paragraph of the audit guide. In fact, it is focused on the second of two conditions in the first sentence of 5.139.
By the way, I have not seen any of the donation documents, but would severely doubt they are written in such a way that a recipient could pass the meds on to another charity which could then distribute the meds inside the U.S. Allowing such a transfer to put the meds inside the U.S. would be a severe oversight by the manufacturer. I cannot fathom a donor allowing the meds to work their way back into the U.S. market. Thus the last comment of “would not transfer to market participants” seems illogical to me.
More background on the Audit Guide. Oh, who is this FinREC of whom we speak?
The preface to the Audit and Accounting Guide – Not-for-Profit Entities (Updated as of March 1, 2018) provides background on the status of an audit guide. The preface also gives context to the large volume of comments by FinREC contained in audit guides.
The preface explains this audit guide was developed by the AICPA’s Not-for-Profit Entity Expert Panel and the Guide Task Force. The preface explains that audit guides are interpretative publications of GAAS. They are not GAAS themselves, but interpretations.
AU-C 200 requires auditors to consider the audit guidance found in interpretive publications and document how GAAS requirements were complied with if the audit guide comments were not followed.
That means if auditors don’t follow guidance provided by the audit guide in terms of audit procedures, there needs to be some documentation in the file explaining the situation.
The authority of FinREC is described in the preface. Since it is so relevant, I will quote the paragraph:
The Financial Reporting Executive Committee (FinREC) is the designated senior committee of the AICPA authorized to speak for the AICPA in the areas of financial accounting and reporting. The financial accounting and reporting guidance contained in this guide was approved by the affirmative vote of at least two-thirds of the members of FinREC in November 2012. Conforming changes made to the financial accounting and reporting guidance after that vote are approved by the FinREC Chair (or his or her designee). Updates made to the financial accounting and reporting guidance in this guide exceeding that of conforming changes are approved by the affirmative vote of at least two-thirds of the members of FinREC.
So FinREC is a committee of the AICPA which addresses accounting application issues which are not addressed elsewhere. To make the point clear, FinREC addresses accounting issues which are not addressed in authoritative GAAP.
The preface describes a few things the audit guide accomplishes in terms of FinREC. Again, quoting the guide:
- Describes FinREC’s understanding of prevalent or sole industry practice concerning certain issues. In addition, this guide may indicate that FinREC expresses a preference for the prevalent or sole industry practice, or it may indicate that FinREC expresses a preference for another practice that is not the prevalent or sole industry practice; alternatively, FinREC may express no view on the matter.
- Identifies certain other, but not necessarily all, industry practices concerning certain accounting issues without expressing FinREC’s views on them.
- Provides guidance that has been supported by FinREC on the accounting, reporting, or disclosure treatment of transactions or events that are not set forth in FASB ASC.
The preface then disclaims that FinREC has any authority to define GAAP, stating only FASB does so and that is accomplished in the ASC. That means any comments from FinREC in an audit guide are “nonauthoritative accounting guidance.”
Let me rephrase that from the possible perspective of someone outside the CPA auditor world. The comments in paragraph 5.139 are from FinREC, a committee of the AICPA. That group does not have authority to set GAAP because only FASB may do so. The comments by FinREC are in a lower category called nonauthoritative guidance. Further, the comments from FinREC are their opinion, or more precisely, the opinion of at least two-thirds of the committee and that was back in 2012. That opinion was reached before a number of charities each started booking hundreds of millions or billions of revenue from GIK.
An outsider might then ponder that the valuation of many billions of dollars of donated medicine rests upon this opinion, which is nonauthoritative, from a small committee of the AICPA, which does not set accounting rules, but expects CPAs to follow the accounting rules it sets.
Recognition of multiple billions of revenue across the R&D sector is supported by the phrase “FinREC believes.”
Let me rephrase my perspective one more time: AB 1181 seeks to reverse one phrase, of one sentence, of one paragraph, in one audit guide.
I think this epic fight is over 16 words in para 5.139 of the NFP audit guide.
What do you think?
Your comments are welcome. Stay professional. Remember that all comments are moderated.
Keep in mind I have sole authority for determining what constitutes a professional comment.
Anyone interested in writing a guest post to extend this discussion? If so, drop a comment here and I will see it but not post it.