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Small Fixes Eyed for Charity Accounting as California Backs Off

Nov. 4, 2019, 9:45 AM

U.S. accounting rulemakers dodged a bullet in October when California Gov. Gavin Newsom vetoed a bill that would have made charities ignore long-standing, national accounting rules if they solicited donations in the Golden State.

The Oct. 12 veto, however, didn’t resolve how to stop fraud when not-for-profit organizations report the value of expensive drugs and medical devices they intend to distribute overseas. Free from the pressure of state lawmakers tinkering with U.S. accounting rules, the Financial Accounting Standards Board is now poised to offer some clarity—in small doses.

FASB on Nov. 6 is expected to vote to make charities give more details in their financial statements about how they value donations of gifts in kind and potentially make them disclose the types of information they use to make those decisions.

This extra information could help give donors, watchdogs, and regulators a fuller picture of a charity’s finances without fundamentally changing accounting practice, said Lee Klumpp, national assurance partner at BDO USA LLP.

“Anything FASB can do with help with creating clarity on expectations on presentation and disclosure, I think is a good start,” Klumpp said.

Overhauling the rules businesses and organizations must follow to make fair value measurements appears to be a nonstarter. Under the failed California bill, charities would have been forced to ignore U.S. fair value accounting rules and value donated drugs and medical devices based on the price they fetch in the market where they will be distributed. For drugs headed to help contagious diseases in developing countries, the difference in price could be staggering.

FASB is not willing to alter the fair value measurement guidance because it could have far-reaching consequences. Also, the important guidelines apply not just to not-for-profit organizations, but to businesses as well, said Rick Cole, partner at BKD LLP and former FASB supervising project manager.

“The risk is, if you slightly tweak it, it’s like pulling a thread,” Cole said. “You pull too much and all of a sudden you have a hole in your sweater, and then you risk unraveling the fair value framework.”

No other states followed California’s lead in interfering with accounting.

Fighting Bad Actors

But FASB is under pressure to stop abuse of the accounting rules.

U.S. accounting rules require not-for-profit groups to record at fair value physical donations, which could run the gamut from cars to shipping containers of antibiotics. Organizations must use the “principal market” when determining the fair value amount.

This is where things get tricky. 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 does not dictate the main market where the transaction occurs.

Unscrupulous charities can take advantage of this rule to value donated drugs based on U.S. prices, which are higher than the prices the drugs fetch overseas. If the charity uses the U.S. value, the figure can make its balance sheet swell. A bigger number in its “contributions” line makes the charity look large and established—and make overhead and executive pay expenses look smaller in comparison.

The California attorney general in January and May accused two different charities of duping donors, in part through pharmaceutical valuation accounting maneuvers.

As FASB works through a solution, it will have to keep in mind the potential for abuse while also not punishing the charities that play by the rules.

“There’s a balance you want to have with the appropriate level of rules in place so you can be comfortable in doing the right thing but not add undue costs to the system,” Cole said. “And that’s a tough balance.”

Possible Fixes

Among possible improvements: FASB could require charities to break out more line items on their balance sheets that essentially separate the value of gifts in kind from its other contributions.

The board could make charities insert more information in their footnotes about the types of gifts they receive. They could also require charities to detail how they came up with the pricing for their donated gifts, like what source it used and what market it based the price on.

Charities reveal this type of information right now only on a voluntary basis, if at all, Klumpp said.

“The disclosures are all over the place,” he said. “They’ll disclose what it is as dollar amount but you don’t see any information in any great detail about like where is it going and where is it it used.”

Legitimate charities that want to be transparent to the readers of their financial statements wouldn’t contest revealing such information, he said.

“Most non-profits, if they think, ‘This helps my reader,’ I think they’ll be supportive of it,” Klumpp said.

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; Meg Shreve at mshreve@bloombergtax.com