September 18, 2011 | Read Time: 10 minutes
This spring, the global antipoverty group Feed the Children issued an announcement of the sort any charity would dread making: Its revenue had plummeted by half in a year.
Feed the Children blamed the precipitous drop—from $1.2-billion in 2009 to $525-million in 2010—not on the bad economy but on a change in accounting rules.
The charity said a new rule from the Financial Accounting Standards Board governing how businesses, nonprofits, and other organizations value goods and products required it to count medicine and other items it distributes to poor people not at U.S. prices, as it had done before, but at the prices they would fetch in markets abroad.
Virtually all of the decline in Feed the Children’s revenue was caused by changing the value of a single medicine: deworming pills the charity distributes overseas to fight a parasite that leaves hundreds of millions of children sick, tired, and less likely to attend school.
In the past, the charity valued the medicine, called mebendazole, at $9.07 per tablet; now it said the value was just 35 cents, or 3.9 percent of the old number. The aid group also received half as many pills in 2010 as it did in 2009.
Exaggerated Revenue
But critics say much of the revenue that Feed the Children chalked up in the past to the deworming medicines never really existed at all, except on paper.
Watchdogs, nonprofit lawyers, charity officials, and other experts say that the charity’s financial statements and those of many of America’s other largest and best-known aid groups have for years been painting an inaccurate picture of how much revenue they are receiving.
Experts question if some of the groups are purposefully exaggerating their revenue to convince would-be donors that they are delivering more aid, and spending smaller percentages of their revenue on administration, than they truly are.
“They are competing for donor dollars, trying to look more efficient than each other, and misleading the public in the bargain,” said Christopher Murray, director of the University of Washington’s Institute for Health Metrics and Evaluation, a center supported by the Bill & Melinda Gates Foundation that analyzes global health spending. “If I give you a drug and you can go and buy the same drug for 10 cents, that drug is worth 10 cents. It’s not worth $1, and it’s certainly not worth $10.”
But Feed the Children and other charities like it say they are not trying to mislead. They say they have been complying with accounting rules every year and that they have relied on U.S. wholesale rates to value the drugs in the past not because those prices are so high but because they are published and easily accessible, unlike data on how much drugs actually sell for.
The practices in question are these: In cases where charities get inexpensive generic versions of medicines manufactured abroad, some groups record the value of the drugs not at the prices the foreign drug maker charges but at U.S. wholesale rates, which can be up to 800 times higher. Often the nonprofits pay drug suppliers for the pills and classify them as donations, a practice that watchdogs and lawyers say deserves scrutiny.
Different Interpretations
The new accounting rule has thrown light onto these practices and led more and more people to question whether the values many nonprofits have long placed on their drugs make sense. It’s also helped to unearth a big divide among nonprofit aid groups—and accountants—regarding what counts as a donation and what is considered a purchase.
Depending on how a charity chooses to interpret generally accepted accounting practices and the new accounting rule, the group might decide to count the same deworming pill toward its donation totals as zero, 2 cents, $1.74, or $16.25—or any number of values in between.
These debates are just the latest in a long-running battle over how nonprofit organizations record in their financial statements the medicines and other products they supply to poor people around the world.
Some charities that get these inexpensive medicines manufactured abroad say that while they are paying attention to discussions about valuation, it still makes the most sense to value the tablets at U.S. wholesale rates.
The groups, including International Relief and Development, Islamic Relief USA, and World Concern—which value the deworming pill at prices that range from $5.32 to $16.25 per tablet, say that humanitarian organizations haven’t come together to find a better solution. (International Relief and Development takes 50 percent off the U.S. rate when it gets drugs at a large volume, so it most recently valued the deworming pill at $6.61; Islamic Relief declined to say what value it places on the deworming tablets but says it uses U.S. wholesale rates).
Other groups, like Feed the Children, Food for the Hungry, and World Vision, have interpreted the new accounting rule to mean they need to significantly lower the values they place on drugs like the deworming tablet. Food for the Hungry dropped the value from $10.64 to $1.54; World Vision dropped from $10.64 to $1.74.
Those three charities say they are doing exactly what the new accounting rule tells them to do: valuing the drugs at the prices the pills sell for in the markets in which they are sold in the highest volume. In the absence of such markets, the rule says that organizations can value goods in the markets in which the products can get the highest price.
World Vision even reached out to the Financial Accounting Standards Board to help it discern if, and how, the guidelines apply to nonprofits. It is also paying a health-care company for data on how much the deworming tablet and a few other drugs sell for in markets abroad, where the pills are sold in the greatest numbers.
World Vision and other groups like it say their willingness to drastically drop the values of their medicines is yet more evidence that their intention is not to mislead.
“We bit the bullet on the decrease in our valuations knowing that would cause some people to question,” said Barry Gardner, chief financial officer at Food for the Hungry. “There was no resistance. It’s just the accounting rules changed and we changed with them.”
Still Too High?
But other nonprofit officials, as well as some accountants and other experts, say the values those groups are recording are still too high.
Food for the Hungry and World Vision both got the pills from a European drug supplier that sells the tablets to charities for 2 cents apiece.
In Feed the Children’s case, the group says it had a contract with an Indian drug maker, Micro Labs, in 2009 for $1,023,750 to manufacture, handle, and package 65 million pills but that the tablets themselves were donated. That would amount to about 1.6 cents a pill, though the charity says the contract was not based on such a calculation. The group has also acquired medicines from a European supplier in the past.
Other nonprofits like Direct Relief International and IMA World Health value the deworming tablets at a few cents if they get them as donations—or don’t count them toward their donation totals if they pay a supplier for the drugs.
Affects Public Image
The impact of the high values on how charities appear to the public has been significant.
In 2009 the mebendazole anti-worm pills alone accounted for nearly $900-million of the combined $3.17-billion revenue of five nonprofits that are among the largest in the United States: Crista Ministries (the parent group of aid charity World Concern), Feed the Children, Food for the Hungry, MAP International, and World Vision.
MAP, which got its medicines from Operation Blessing in 2009, has also dropped the values it places on medicines. World Concern says it still uses the high values but continues to assess its practices.
But if that same number of deworming pills—roughly 90 million—had been received by aid groups that take a different approach to valuing their medicines, the pills could have been recorded as roughly $2-million in revenue instead of $900-million—or wouldn’t have been considered revenue at all if the tablets had been purchased.
Lack of Disclosure
Charity watchdogs and some accountants say the high values some groups record don’t make sense, whether under old accounting rules or new. They say nonprofit aid organizations ought to take another look at how they are valuing their medicines.
Daniel Borochoff, president of the watchdog group American Institute of Philanthropy, which published a recent report on the overvaluation of medicines and other goods, questions why groups were ever using U.S. wholesale rates for medicines like the deworming drug.
Worms aren’t a medical problem in the United States, Mr. Borochoff says, so that is why the U.S. prices would be higher.
What’s more, the drug can’t even be sold legally in the United States at the dosages at which charities deliver in their programs abroad because those doses are not approved by the Food and Drug Administration.
“They are making a mockery of financial statements,” he says. “If this was happening in business, could you imagine? The stock market would take a dive if it was uncovered that groups were inflating their income by these amounts.”
Mr. Borochoff also points to how little information charities are required by law to share about their medicines and other goods.
In the absence of such requirements, some charities declined to disclose to The Chronicle how they value their drugs, including the deworming tablets. Among them: Operation Blessing International, which states on publicity materials that it delivered more than 19 million deworming pills in 2009.
Purchases vs. Donations
Perhaps the biggest point of contention among aid groups and accountants is whether nonprofits ought to be counting as donations the medicines for which they pay drug suppliers. Nonprofit officials and accountants who defend the practice say it is permitted under accounting rules.
They say the transactions with drug suppliers can be classified as donations, or partial donations, in their financial statements because the suppliers and manufacturers have “donative intent,” or a desire to make a gift.
In cases in which a company gives a discount to a charity, an organization can count as a donation the difference between what it pays and the actual price of the good. This concept is called a “bargain sale” and is recognized in accounting practice and by the Internal Revenue Service.
Charities and some accountants say that because the prices that nonprofits pay for the drugs are lower than the prices that some commercial buyers would pay, the charities can adjust the value of the pills on their books to commercial prices.
But other accountants and lawyers take a different view.
“The idea that you count a purchase as a donation because there was some sort of warm feeling by the seller in offering the goods is certainly creative,” said Marcus Owens, a Washington lawyer and former head of the Internal Revenue Service’s tax-exempt division. “I’m not sure I’d go into an IRS meeting with that as your lead argument. In fact, I wouldn’t bring it up at all.”
Brian O’Brien, who leads the audit practice at the accounting firm Schneider Downs, says that “donative intent” doesn’t seem to apply here.
“If a wholesaler’s primary business is to sell to nonprofits, that’s their business purpose,” he said. “That doesn’t justify donative intent.”
Clarity of Rule
People critical of the way some charities value their medicines say that the Financial Accounting Standards Board’s new rule, which was written primarily with businesses in mind, is a bad fit when applied to nonprofits.
Mr. Borochoff, of the American Institute of Philanthropy, says that while it makes sense for businesses to value their products based on sales prices in markets with the highest volumes or highest prices, it’s misleading for nonprofit groups to do so.
He and others say the accounting board ought to revisit its guidelines as they apply to charities. The organization says it has no plans to do so, though it regularly communicates with groups that have questions about its rules.
“On one end of the spectrum, games are clearly being played,” said Mr. Owens. “On the other end of the spectrum, the accounting profession has created a set of rules that allow extraordinary flexibility. The bright lines are not so bright.”
