California Drug Bill Could Hike Accounting Costs for Charities

When Hurricane Dorian battered the Bahamas last month, Americares Foundation dispatched teams of doctors and nurses as well as shipments of life-sustaining drugs for asthma, diabetes, and hypertension.

A large portion of such drugs Americares distributes to needy areas are donated by pharmaceutical companies, according to donation details on the Stamford-Conn.-based charity’s balance sheet.

That pivotal drug donation network, however, could become more complicated and costly for charities under recently passed legislation in California. The bill awaiting action by Gov. Gavin Newsom (D), A.B. 1181, aims to prevent groups from inflating their balance sheets by forcing them to value donated drugs and medical supplies bound for overseas distribution based on what they’d fetch in foreign markets, where medicine is much cheaper than in the U.S.

Even though the bill would only change California law, it could have ripple effects across the U.S. It applies to any organization that solicits donations in the nation’s most populous state, which means most large U.S. charities.

“It would require us and the industry to spend more resources getting product values for dozens of donations round the world which, in and of itself, is very challenging,” said Richard Trowbridge, Jr., CFO of Americares. “That’s money that could be going to programs instead of administration.”

Target: Bad Actors

A.B. 1181 requires any charity raising money in California to tally the value of the drugs they send overseas using the fair market value of where the medicine ends up versus determining value on what the drugs would cost in the U.S. The result would be much lower values assigned to the drugs because things like blister packs of antibiotics or vials of insulin cost more in the United States.

Regulators and charity watchdogs have charged for years that some charities pad their balance sheets by booking donated medicine based on its fair value in the U.S. A fat contribution line in an organization’s financials can dwarf its expenses—and justify high overhead or cushy executive pay. These favorable ratios can give donors a false sense of security that their dollars are put into action when they send a check or hit “donate” online.

In some egregious cases, the accounting masks outright fraud. States attorney general in recent years have cracked down on several sham charities engaging in complex pharmaceutical valuation accounting solely to dupe donors and enrich the charities’ leaders.

To some charity watchdogs, California’s action is overdue in revamping a problematic area of U.S. generally accepted accounting principles.

“The way the rules are set up now it’s so easy for charities to trick the readers of their statements,” said Daniel Borochoff, president and founder of CharityWatch.

A state like California—with outsized influence—changing regulations could prompt broader improvements in accounting, he said. “GAAP would switch to the better way of doing things,” Borochoff said.

The valuation of pharmaceuticals has been in the crosshairs of the IRS, the Federal Trade Commission, and all 50 state attorneys general for years at this point, said James Ulvog, a California CPA who runs the Nonprofit Update blog.

“That should make us all wonder what might be wrong in GAAP,” Ulvog said.

But in going after the bad actors, California’s bill also is expected to make financial reporting harder for all charities.

For starters, they’d have to figure out the nuts and bolts of determining the fair market value of different drugs in multiple countries, said Trowbridge of Americares.

“If you have a hepatitis C drug in Ethiopia, the same exact medicine could have a different value in Ghana or in Bangladesh,” he said. “And so you quickly can see the complication here. You’d be valuing the same medicines in three different locations at three different values.”

The Bill

Under U.S. GAAP, not-for-profit 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 fair value 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. Current accounting rules, however, do not delve into details about restrictions on geographic market and if that affects the drugs’ value.

California Attorney General Xavier Becerra earlier this year charged two U.S. charities with taking U.S. accounting rules to the extreme. In January, Becerra announced a $400,000 settlement with a group that had a subsidiary buy drugs from a Dutch wholesaler for a cheap price and then donate the same drugs to the charity’s main arm at a bloated U.S. value. The difference was staggering—$225,000 versus $34.9 million. Becerra called the maneuver “accounting gimmicks.” In May, he filed a lawsuit against a second group, charging it with a similar scheme.

Becerra backs A.B. 1181. The bill passed the Assembly and the Senate with large majorities. Newsom has until Oct. 13 to sign or veto it.

Impact Beyond California’s Border

Although the bill was born in California, if it becomes law it would affect most U.S. charities that solicit donations nationwide. That’s because if a charity gets money from donors across the U.S., chances are it has some California residents sending in checks.

Most charities that take money in California must register with the state attorney general’s office. The registration forms mirror the IRS’s 990 form, which in turn is based on U.S. GAAP, which is set by the Financial Accounting Standards Board.

If the governor signs the bill into law, charities will have to figure out how to follow it. Groups like the American Institute of CPAs and the National Association of State Boards of Accountancy worry about organizations keeping two sets of records to follow defacto California GAAP and also ignoring rules established by the FASB, the independent standard-setter for U.S. accounting.

If finalized as law, charities could have to put a note in the Form 990 or perhaps a footnote in their audited financial statement. Another option, some financial reporting experts say, is organizations could potentially issue an “except for” in their financial statements, meaning they could say their financial statements are presented in accordance with U.S. GAAP except for the fair value of donated pharmaceuticals, which follow California law. For organizations with material amounts of donated pharmaceuticals on their books, however, this could get tricky.

“At this point nobody knows how charities will be expected to comply,” said Charles Watkins, associate at Webster, Chamberlain & Bean LLP in Washington, who represents not-for-profit groups.