Download US GAAP: Issues and Solutions for the Pharmaceuticals and Life Sciences Industries

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Externally sourced research and development
23.Third-party development of intellectual property
Background
Relevant guidance
Company A has appointed Company B, an independent third
party, to develop an existing compound owned by Company A on
its behalf. Company B will act purely as a service provider without
taking any risks during the development phase and will have
no further involvement after regulatory approval. Company A
will retain full ownership of the compound. Company B will
not participate in any marketing or production arrangements.
Company A agrees to make the following non-refundable
payments to Company B:
Research and development costs… shall be charged to expense
when incurred [ASC 730–10–25–1].
Nonrefundable advance payments for goods or services that
have the characteristics that will be used or rendered for future
research and development activities pursuant to an executory
contractual arrangement shall be deferred and capitalized
[ASC 730–20–25–13].
• $2 million on signing the agreement
• $3 million on successful completion of Phase II testing
How should Company A account for
upfront and subsequent milestone
payments in an arrangement in
which a third party develops its
intellectual property? 
Solution
The initial upfront payment represents a prepayment for future development by a third party and should be capitalized initially and
then amortized as Company B performs the research (i.e., generally straight line over the expected period of performance unless
another recognition pattern more accurately depicts performance). Company A should expense the milestone payment when it is
probable the payment will be made.
PwC
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