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Accounting Proposal Targets Drug-Pricing by Bad-Actor Charities

Feb. 10, 2020, 9:29 PM

Charities would have to reveal more details about donor contributions of drugs, canned goods, and household supplies under a proposal Monday from U.S. accounting rulemakers.

The proposed rules represent an effort to illuminate the sources of charities’ money after regulator and watchdog criticism that unscrupulous groups bend accounting rules to inflate the value of the physical donations they receive.

It isn’t cans of soup that are causing heartburn; rather, big-dollar pharmaceuticals and high-profile crackdowns on shady charities have led the Financial Accounting Standards Board to issue the proposal.

The proposal, however, doesn’t change the way groups recognize and measure non-cash donations. Instead, the plan would make groups separately list in-kind gifts in a special line-item in their financial statements. They would have to break down details about the types of gifts, and how they value them, in the footnotes.

“The proposal is definitely a step in the right direction, although it doesn’t address the core issue of the potential for inflated valuation,” said Yael Fuchs, president of the National Association of State Charity Officials.

Padding Balance Sheets

Plenty of well-known charities rely on donations of drugs that they in turn distribute to needy communities overseas. But organizations receiving such donations can pad their balance sheets through complex accounting maneuvers, regulators say. Big pharmaceutical values boost an organization’s bottom line, which can make a group look large and legitimate—and make overhead and executive pay expenses look small in comparison.

Under U.S. accounting rules, nonprofit groups are required to recognize gifts in kind at fair value—the price to buy or sell an asset or transfer a liability in an orderly transaction. Businesses and organizations must use the principal market when determining the exact amount. When there is no principal market, they must use the “most advantageous” market.

Many drug companies donate pharmaceuticals to U.S. charities and specify that the drugs must be used abroad. Nonbinding guidance from the American Institute of CPAs advises that if a donor, like a pharmaceutical company, puts a restriction on a gift, that restriction doesn’t dictate the main market where the transaction occurs. Because antibiotics or insulin often cost vastly more in the U.S. than overseas, the difference between the foreign and domestic values can be staggering.

“In some cases the pharmaceutical in-kind gifts are such a significant part of an organization’s overall reported resources that it could significantly change the impact in the organization’s financial picture if they didn’t have it,” said Bennett Weiner, chief operating officer of the Better Business Bureau’s Wise Giving Alliance.

In some cases, the accounting may hide outright fraud. In January 2019, California Attorney General Xavier Becerra announced a $410,000 settlement with a group called Giving Children Hope, which Becerra said had a subsidiary buy drugs from a Dutch wholesaler inexpensively and then donate the same drugs to its main arm at an inflated U.S. price. The figures: $225,000 versus $34.9 million. The group also failed to provide documentation that the drugs were, in fact, distributed to anyone. Becerra said the group thrived through “accounting gimmicks.”

Becerra later in 2019 backed a bill in the California Legislature that would have made charities soliciting donations in the state ignore U.S. accounting rules and value pharmaceuticals based on their end market. Gov. Gavin Newsom (D) vetoed the bill in October.

Reporting the Details

Under FASB’s plan, for each category of nonfinancial asset groups received, they would have to say whether they planned to sell or use the asset. If they planned to use it, they would have to describe the program or activity for which it would be used.

In addition, they would have to describe any donor restrictions on the contributed asset as well as the valuation techniques and inputs used to come up with the fair value.

“Enhanced disclosures are an important first step,” Weiner said. “You have to have transparency in order to have understanding and perhaps reveal where there are problems.”

If FASB finalizes its proposal, regulators also could benefit from auditors putting more scrutiny on what charities report, said Fuchs, who is co-chief in the enforcement section of the New York State Attorney General’s Office.

“We need auditors to take it seriously,” said Fuchs. “If they don’t, it puts the burden on donors to read the fine print.”

The headlines around FASB’s proposal have focused on pharmaceutical valuations because a fast way to beef up a balance sheet is through expensive drug donations. But bad-actor charities can find other ways to beat the system.

After Hurricane Sandy hit New York, for example, regulators found several charities in upstate New York all the way south to Coney Island, Brooklyn, taking credit for the same truckload of donated bottled water and winter coats, Fuchs said.

Comments on FASB’s proposal are due by April 10.

To contact the reporter on this story: Nicola M. White in Washington at nwhite@bloombergtax.com

To contact the editors responsible for this story: Jeff Harrington at jharrington@bloombergtax.com; Kathy Larsen at klarsen@bloombergtax.com

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