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The Alice in Wonderland World of Charity Valuation

   Aug 01, 2011

If I had a world of my own, everything would be nonsense. Nothing would be what it is, because everything would be what it isn't. And contrary wise, what it is, it wouldn't be. And what it wouldn't be, it would. You see?
-Alice in Wonderland, Disney movie (1951)

Unobservable inputs are inputs that reflect the reporting entity's own assumptions about the assumptions that market participants would use in pricing...
-The accounting profession's version of Alice in Wonderland, FASB Standard No. 157

Many charities systematically exaggerate the value of gifts-in-kind.In the wonderful world of charitable gifts-in-kind (GIK) where lives are saved and suffering is lessened, nonprofit executives can fully utilize their creative abilities when measuring the value of the donated goods they receive such as medicine, food, clothing, books, and other materials that flow through a charity's financial statements. Charities that place high values on GIK donations can falsely appear to be spending a higher percentage of their funds on programs than other groups that receive mostly cash contributions. Donors who rely on these charities' claimed program percentages when making giving decisions might think they are giving to highly efficient organizations when in fact most of their cash donations are being spent on overhead.

This past June CharityWatch obtained Feed the Children's fiscal 2010 audited financial statements and was surprised to see this charity admitting that $544 million in deworming pills, which accounted for 45% of its total fiscal 2009 income, would now be valued at only $21 million based on the new accounting guidance it is using. This means that in 2009 Feed the Children had valued its pills at least 24.9 times higher or 2,490% more than in 2010. AIP made multiple requests to the group for a per-pill breakout of how it valued its drugs. Feed the Children finally disclosed to us that the very same mebendazole deworming pills that it valued at $9.07 in 2009 were now being valued at $0.35 in 2010. FC said that its valuation methodology followed standard industry practice for each of these years.

Just imagine if a for-profit company or mutual fund had overvalued its income by a similarly unreasonable amount—investors would be outraged and demand a thorough investigation by regulatory authorities with a public accounting of what had occurred. Yet many American charities have been bending reality for quite some time by greatly exaggerating the value of their GIK without much notice from the public, the media or government regulators.

What makes the GIK valuation issue all the more troubling is that charities are not required by the IRS or their outside auditors to disclose what specific products they receive and distribute, or at what prices they value these items. For example, say Charity A and Charity B receive and distribute exactly the same amount and type of aid to the same geographic area in a given year. Because Charity A has inflated the value of these in-kind goods, it can report that its program spending is much higher than Charity B's, and will also appear to be larger and more efficient. This is unfair to Charity B which is being made to look comparatively less efficient simply because it is being more honest and reasonable when valuing its GIK. If charities were required to shine light on the details of their GIK, the public would be able to compare valuations and determine which ones are reasonable and which are inflated. Charities placing unreasonable values on donated medicines and other aid would readily be exposed.

A number of charities, including Feed the Children, defend the inflated values they formerly placed on medicines like deworming pills by saying that they were merely following earlier accounting guidance which allowed them to value these items based on U.S. prices. They argue that the new accounting guidance no longer allows them to use the typically higher U.S. prices, and this accounts for the drastic drop in their GIK income and expenses. AIP is not buying this argument and strongly believes that these charities should not have been using U.S. prices in the first place. Worms are not a medical problem in the U.S., and the 500 milligram mebendazole deworming pills that are used to help people in the developing world cannot even be legally sold here because they lack FDA approval. Any FDA-approved deworming pill for humans sold in the U.S. would be priced extremely high compared to the drugs that are available in the developing world. Charities that used the old accounting guidance as a free pass to value their GIK unreasonably high were not following the spirit of these rules.

Don't be confused by a charity's explanation of how it is now valuing in-kind donations. For example, Feed the Children's fiscal 2010 audit says that international GIK "are valued based upon the estimated wholesale market value of the items within the countries that represent the principal market of use." The principal market of use is not the end use market or the place where GIK is given to poor or needy people, such as Ethiopia or the Philippines. Rather, it is the market, real or hypothetical, where its value can be maximized. So even when a drug is available for purchase in a poor country at a cheap price, a charity can value it at an expensive price based on what it would be priced at in an active market or an imaginary one. This makes sense for valuing investments or for-profit business inventory but does not make sense for valuing a charity's GIK. So while the new guidance offers some improvements, it will not prevent some charities from continuing to value GIK unreasonably high.

One charity, Brother's Brother Foundation, should be commended for recognizing that it needed to lower the value it placed on its pharmaceutical donations before the new accounting rules required it to do so. In 2009 Brother's Brother Foundation set an example by using significantly lower valuations and calling for other charities to do the same. Brother's Brother Foundation's income was reduced to $266 million from the $623 million at which it would have been reported under its old valuation method, according to the charity's audit. Brother's Brother Foundation has paid a price for its honesty. Before implementing its valuation change Brother's Brother Foundation received publicity for being among the top spots on lists of America's largest charities. It has since been kicked down from 6th to 59th on the Chronicle of Philanthropy's Philanthropy 400 list primarily because it is being more honest about how it values its GIK donations.

Some charities inflate the contributions they report receiving by waving a wand and magically turning a purchase into a donation. This is how some nonprofit executives say off the record how it can be done: charities like to receive donations of certain types of products whose values are easy to inflate. When a charity is not successful in soliciting donations of such products in large volumes directly from donors or companies it will purchase them instead. The charity will then claim that what they paid for these products was simply a "handling fee" and that the products themselves were donated. Of course, these supposed "handling fees" often exceed what a person would pay on the open market to purchase the goods in question. By calling these transactions "donations" instead of purchases, this frees up the charity to wildly inflate the value of these products in its financial reporting.

Some charities have other tricks up their sleeves for using GIK to inflate their contributions. One scenario, as told off the record to CharityWatch by charity executives, is for a charity to buy very cheap and low quality medicine made in India and flow the purchase through a European company. The European seller can be referred to as an "anonymous donor" on the charity's tax form. As a condition of the sale, the charity can require that a receipt be provided that values the Indian products at expensive European prices. The difference between the European value and the purchased Indian value boosts on paper the reported value of a charity's income, thereby making it appear to be larger and more efficient than it actually is.

Real World Examples of the Alice in Wonderland World of GIK

  • In 2010 the Canadian Revenue Agency revoked the charitable registration of The Orion Foundation, a bogus AIDS charity purporting to help Africans. It bought medicine for 30 cents per unit and valued it at $11.50 per unit, making enough purchases to issue $91 million dollars in donor receipts. The auditors could not tell if the medicine was actually received, used, or distributed in Africa.

  • MAP International in 2009 reported that it was distributing donated drugs from Operation Blessing to the African nation of Ivory Coast. The GIK consisted of two shipments each of 7.5 million deworming pills worth nearly $80 million each. In other words they were claiming that a pill that can readily be bought from multiple sources for as little as 2 cents is worth $10.66. This valuation is absurd on its face because, according to WHO (World Health Organization), it would represent over 60% of total Ivory Coast government spending on health in 2009.

  • AmeriCares in its 2009 audit counts as program services expense $42 million dollars worth of GIK that it never distributed. Accounting rules allow charities to write-off expired or unusable GIK and count it as a program expense.

  • In 2008 a person who identified herself as a former employee of Feed the Children called CharityWatch's president and told him that she bought 2 cent deworming pills from a Dutch company that the charity valued at $12 per pill. Based on the volume purchased this amounted to a $300+ million "donation" of medicine to the charity. Two officials at the charity disputed this, including spokesperson Tony Sellars, who called it "a total inaccuracy and a nice story."

Charities are willing to speak in general terms about the complex valuation schemes they have utilized to value their GIK. They are rarely, however, willing to disclose the actual dollar amount they used to value specific types of donated goods that account for major portions of their income and expenses. For example, Feed the Children placed a value of $544 million on the mebendazole deworming pills it received from one unidentified source in 2009, which accounted for 50% of its total GIK. Yet FC, like most charities, does not publicly disclose in its financial reports at what price it valued each pill. Only after AIP asked them a number of times did they disclose this information. Even the highly regarded humanitarian charity World Vision would not disclose to CharityWatch the price at which it valued its deworming pills. Unless you know the exact amount being used to value a product it is impossible to determine if the valuation is reasonable. It is analogous to buying a car and having the salesman go on and on about what a great deal he has for you without telling you the actual selling price of the car. He can talk until he is blue in the face about how his price beats the competition, it's a special sale, it's marked down from the sticker price, etc… but unless you know the actual selling price you do not have a way of verifying whether or not you are really getting a fair deal.

Charities have been using pharmaceutical pricing guides that determine average wholesale prices (AWP) based on an honor system of unconfirmed reports on prevailing prices. People in the field joke that AWP really stands for "ain't what's paid." Some pharmaceutical companies have been sued for fraud for reporting AWP prices to the government to obtain inflated Medicare and Medicaid reimbursements for pharmacies and doctors. A partner at a major accounting firm told 2010 AICPA conference attendees that the drug pricing guide nicknamed the "red book," which has been frequently used by charities, valued deworming pills at $12 to $16 each even though she could go online and buy the same pills for ten cents. She said that some prices in the red book may be fine but that it is the responsibility of the charity's accountant to determine if the book's listed prices are reasonable.

Even charities following the new FAS 157 accounting guidance have wide latitude in how they choose to value GIK. FAS 157 was primarily written to provide guidance to for-profit companies on valuing investments and other business assets; it does not even mention GIK. It does not make sense for non-profits that receive donated goods for free and give them out to people who are too poor to pay for them to base GIK valuations on a framework designed for businesses to maximize the fair value of their assets.

Charities with Large Medical Gifts-in-Kind Chart

Another accountability black hole exists with respect to how charities are allowed to report their international aid distributions on their tax forms. When a charity makes a grant or distributes aid within the U.S. worth $5,000 or more it is required to disclose the name and address of the organization that received it. However, a charity distributing international aid is allowed in its public disclosures to hide the name and address of the foreign recipient and only disclose the major region of the world, for example, Africa, South America, or Europe, where it is distributed. Such aid is described by charities in only very general terms such as "medical supplies," "household & educational items," or "building materials." This lack of disclosure is very convenient for any charity that wants to wildly inflate the value of its GIK because it knows there are no public records that an independent watchdog or donor can use to determine whether its valuation of an in-kind grant is reasonable or was even received by the reported recipient. (AIP has pressed the IRS to begin requiring charities to disclose the names of their international grantees and to accurately and specifically disclose GIK.)

The Breast Cancer Charities of America states in its 2009 tax form that it made a GIK grant of over a million dollars to Water Missions International of Charleston, SC. The grant, which accounted for 92% of BCCA's total program expenses in 2009, was reported by the charity to consist of $908,400 in "medical supplies" and $100,000 in "water purification systems" in Honduras. This disclosure presented a rare opportunity for CharityWatch to attempt to verify an international GIK grant.

CharityWatch contacted Water Missions International and spoke with its VP of Finance, Cynthia Pennington, to confirm that the charity had received the in-kind goods Breast Cancer Charities of America claims to have granted for Water Missions International's programs in Honduras. Pennington had never heard of Breast Cancer Charities of America and told us that while Water Missions International does provide aid in Honduras, it does not collect or distribute any medical supplies there or anywhere else. She also said that Water Missions International does not accept donations of water purification systems from other charities because her group deals only with specific, proprietary systems designed to serve more than 25,000 people. This is interesting considering that Breast Cancer Charities of America's executive director, Erica Harvey, told AIP that Water Missions International is a charity her group regularly works with.

CharityWatch contacted Breast Cancer Charities of America to get to the bottom of this discrepancy. It turns out that Breast Cancer Charities of America had paid freight costs of about $5,000 to send a container to Honduras containing supplies owned by multiple charities. According to Water Missions International, the container included Water Missions International's shipment of its own water equipment to its international office. Breast Cancer Charities of America took credit for the value of Water Missions International's water equipment in its financial statements simply because it paid to ship it to Honduras. As for the medical supplies, these were donated to Breast Cancer Charities of America by another charity and were not delivered to Water Missions International but to an employee of WMI's international office for a non-WMI project. Therefore, Breast Cancer Charities of America should not be taking credit for donating these items to Water Missions International. It is CharityWatch's view that Breast Cancer Charities of America, which was in its first year of operation at the time the alleged grant was made, was attempting to gain credibility with donors by claiming to have a working relationship with Water Missions International.

The following year Breast Cancer Charities of America's reported GIK quadrupled to $4.3 million, according to its 2010 tax form. It no longer provided breakouts, however, of who received these medical supplies or how they were used since all the grants in 2010 were outside the U.S. and charities are exempt from publicly disclosing this information. Breast Cancer Charities of America did not respond to CharityWatch's question about who received these GIK medical supplies and how they were valued.

Charity Services International (CSI) arranges for the collection and distribution of GIK for Breast Cancer Charities of America, according to its 2009 tax form. Charity Services International's web site says that it is a small business that offers turn-key GIK services. Two of the benefits that Charity Services International lists for its charity clients are: "Receive high value donations of items whose value is booked as revenue" and "Reduce fundraising percentages by booking large gift values for a low service fee." Charity Services International is not shy about offering "high" and "large" value GIK to boost a charity's reported income and improve its fundraising ratio.

When CharityWatch questioned an IRS official about why it would require disclosure of domestic grant recipients but not foreign ones, the response was that charities were concerned that this information could lead to terrorist attacks against a charity or its grant recipients. CharityWatch appreciates that some charities operate in dangerous places such as Iraq or Somalia where it might be advisable to conceal the identity of grant recipients. But if a charity is providing aid to organizations in Japan, Haiti or other non-terrorist hotbeds, CharityWatch believes there ought to be disclosure of the recipient organization.

Fortunately, many charities have begun lowering their inflated GIK valuations, due in part to new accounting rules. (The chart above shows the change in medical GIK from fiscal '09 to '10 for six major charities.) But unfortunately, even with the new accounting guidance, we do not know whether most charities are now reasonably or consistently valuing in-kind goods because charities are not required to disclose the value of the specific goods they receive and distribute. For instance Feed the Children drastically lowered its deworming pill valuations in 2010 but is still inflating its valuations by over 17 times what the pills could readily be purchased for from multiple suppliers. Therefore, AIP strongly urges donors to follow the cash and subtract out in-kind goods when calculating efficiency ratios.

The good news is that as a user of CharityWatch's Guide, you have not been fooled by a charity's inflated GIK valuations. Among major charity evaluation agencies, only CharityWatch's rating methodology excludes GIK from its financial ratios. CharityWatch strives to give donors a clearer understanding of how a charity spends its money to help them avoid being misled by a group that pumps up its program ratio and lowers its fundraising ratio through unidentified and overvalued GIK.

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