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US GAAP: Issues and Solutions
for the Pharmaceuticals
and Life Sciences Industries
2013 edition
Pharmaceuticals
and Life Sciences
November 2013
Foreword
As healthcare reform progresses and regulatory and public scrutiny of the
pharmaceuticals and life sciences industry intensifies, the need for accurate and
complete accounting under US Generally Accepted Accounting Principles (US GAAP)
has never been greater. Transparency in financial accounting will help the industry in its
pursuit of delivering greater value to patients and the healthcare system.
This publication highlights industry-specific accounting issues under US GAAP. It
provides opinions on accounting solutions for many of the most pertinent situations
specific to pharmaceuticals and life sciences companies. The solutions provide a
general framework for deciding on appropriate answers to accounting questions, which
individual companies can apply in specific situations that may give rise to different
questions and answers. The publication cannot address every situation that might occur
because companies’ accounting issues reflect their particular facts and circumstances,
which can differ by company. Creativity in licensing, manufacturing, and research and
development arrangements, for example, lead to variations in contracts, corporate
structures, and accounting requirements.
The contents of this publication are based on guidance effective as of September 30,
2013. Accordingly, certain solutions in the publication may be superseded as new
guidance and interpretations emerge.
We hope you find this publication useful in understanding the accounting for
common transactions you encounter in your business. By stimulating debate on these
topics through this publication, we hope we will encourage consistent practices by
pharmaceutical and life sciences companies in financial reporting under US GAAP.
This consistency will be critical to the continued usefulness and transparency of
pharmaceuticals and life sciences companies’ financial statements.
PwC Pharmaceutical and Life Sciences Practice
We recommend that you reference the website http://www.pwc.com/us/pharma as your
primary source for this publication and other thought leadership materials.
Portions of various FASB documents included in this work, copyrighted by the Financial
Accounting Foundation, 401 Merritt 7, Norwalk, CT 06856, are reproduced with permission.
Table of contents
Capitalization and impairment
1
1. Capitalization of internal development costs: timing—Scenario 1
2. Capitalization of internal development costs: timing—Scenario 2
3. Capitalization of internal development costs when regulatory
approval has been obtained in a similar market
4. Capitalization of development costs for generics
5. Development expenditure once capitalization criteria are met—Scenario 1
6. Development expenditure once capitalization criteria are met—Scenario 2
7. Development of alternative indications
8. Examples of research and development costs 9. Asset acquisition of a compound
10. Indefinite-life intangible assets
2
3
4
5
6
7
8
9
10
11
11. Indicators of impairment for intangibles
12. Indicators of impairment—Property, plant and equipment
13. Single market impairment accounting
14. Impairment testing and useful life
12
13
14
15
Externally sourced research and development
16
15. Exchange of intangible assets
16. Exchange of intangible assets with continuing involvement
17. Accounting for receipt of listed shares in exchange for a patent
18. Accounting for receipt of unlisted shares in exchange for a patent
19. In-licensing agreements 20. Non-refundable upfront payments to conduct research
21. Payments made to conduct research
22. Fixed-fee contract research arrangements
23. Third-party development of intellectual property
24. External development of intellectual property with buy-back options
17
18
19
20
21
22
23
24
25
26
Research and development related issues 28
25. Payments received to conduct development
26. Upfront payments received to conduct development: Initial recognition
27. Upfront payments received to conduct development: Interim recognition
28. Upfront payments received to conduct development: Completion
29. Donation payment for research
30. Capitalization of interest incurred on loans received to fund research and development 31. Treatment of trial batches in development
32. Accounting for funded research and development arrangements
33. Receipts for out-licensing 29
30
31
32
33
34
35
36
38
Table of contents (continued)
Manufacturing 39
34. Treatment of validation batches
35. Treatment and presentation of development supplies
36. Pre-launch inventory—Treatment of ‘in-development’ drugs
37. Recognition of raw materials as inventory 38. Indicators of impairment—Inventory
39. Patent protection costs
40
41
42
44
45
46
Sales and Marketing
47
40. Advertising and promotional expenditure—Scenario 1
41. Advertising and promotional expenditure—Scenario 2
42. Presentation of co-marketing income
43. Presentation of co-marketing expenses
44. Accounting for a sales based milestone payment
45. Accounting for the cost of free samples
48
49
50
52
54
56
Healthcare Reform
57
46. Accounting for the annual pharmaceutical manufacturers fee 47. Accounting for the Medicare coverage gap
58
59
Revenue recognition—Multiple element arrangements
60
48. Multiple element arrangements—Assessing standalone value 49. Multiple element arrangements—Determining best estimate of selling price 50. Multiple element arrangements—Substantive options 51. Accounting for a multiple element arrangement—Scenario 1
52. Accounting for a multiple element arrangement—Scenario 2 61
63
65
66
67
Revenue recognition—Milestone method
69
53. Milestone method of revenue recognition
54. Milestone method of revenue recognition—Sales based milestones
55. Recording a milestone payment due to a counterparty
70
71
72
Revenue recognition—General
73
56. Revenue recognition for a newly launched product
57. Pay-for-performance arrangements
58. Revenue recognition to customers with a history of long delays in payment
74
75
77
Business combination
78
59. Asset acquisition versus business combination
60. Accounting for acquired IPR&D
61. Unit of account—IPR&D
62. Pre-existing relationships in a business combination
63. Useful economic lives of intangibles
79
80
81
82
84
Acknowledgements85
Contacts86
Capitalization and impairment
PwC
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
1. Capitalization of internal development costs: timing—Scenario 1
Background
Relevant guidance
Company A is developing a vaccine for HIV that has successfully
completed Phases I and II of testing. The drug is now in Phase III
of testing. Management still has concerns about securing
regulatory approval and has not started manufacturing or
marketing the vaccine.
Research and development costs… shall be charged to expense
when incurred [ASC 730–10–25–1].
How should management account
for research and development costs
incurred related to this project? 
Solution
Costs to perform research and development, including internal development costs, should be expensed as incurred.
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Capitalization and impairment
2. Capitalization of internal development costs: timing—Scenario 2
Background
Relevant guidance
A pharmaceutical entity is developing a vaccine for HIV that has
successfully completed Phases I and II of testing. The drug is now
in the late stages of Phase III testing. It is structurally similar to
drugs the entity has successfully developed in the past with very
low levels of side effects, and management believes it will be
favorably treated by the regulatory authority because it meets a
currently unmet clinical need.
Research and development costs… shall be charged to expense
when incurred [ASC 730–10–25–1].
Should management start capitalizing
the development costs? 
Solution
No. Costs to perform research and development, including internal development costs, should be expensed as incurred, regardless
of past history with similar drugs or regulatory approval expectations. Research and development costs should not be capitalized.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
3. Capitalization of internal development costs when regulatory approval has
been obtained in a similar market
Background
Relevant guidance
An entity has obtained regulatory approval for a new respiratory
drug in Country A. It is now progressing through the additional
development procedures necessary to gain approval in Country B.
Research and development costs… shall be charged to expense
when incurred [ASC 730–10–25–1].
Management believes that achieving regulatory approval in this
secondary market is a formality. Mutual recognition treaties and
past experience show that Country B’s authorities rarely refuse
approval for a new drug that has been approved in Country A.
Should the development costs
associated with the additional
development procedures necessary
to gain approval in Country B
be capitalized? 
Solution
No. The development costs should be expensed as incurred, regardless of the probability of success and history.
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Capitalization and impairment
4. Capitalization of development costs for generics
Background
Relevant guidance
An entity is developing a generic version of a painkiller that has
been sold in the market by another company for many years.
The technological feasibility of the asset has already been
established because it is a generic version of a product that has
already been approved, and its chemical equivalence has been
demonstrated. The lawyers advising the entity do not anticipate
that any significant difficulties will delay the process of obtaining
commercial regulatory approval.
Research and development costs… shall be charged to expense
when incurred [ASC 730–10–25–1].
Should management capitalize the
development costs at this point? 
Solution
No. Research and development costs should be expensed as incurred.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
5. Development expenditure once capitalization criteria are met—Scenario 1
Background
Relevant guidance
Company A has obtained regulatory approval for a new
respiratory drug and is now incurring costs to educate its sales
force and perform market research.
Research and development costs… shall be charged to expense
when incurred [ASC 730–10–25–1].
Expenses are outflows or other using up of assets or incurrences
of liabilities (or a combination of both) from delivering or
producing goods, rendering services, or carrying out other
activities that constitute the entity’s ongoing major or central
operations [CON 6, par. 80].
Should Company A capitalize
these costs? 
Solution
No. Company A should expense sales and marketing expenditures such as training a sales force or performing market research as
incurred. This type of expenditure does not create, produce or prepare the asset for its intended use.
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Capitalization and impairment
6. Development expenditure once capitalization criteria are met—Scenario 2
Background
Relevant guidance
Company A has developed a vaccine delivery device and is now
continuing expenditure on the device to add new functionality.
The additional functionality will require Company A to receive
regulatory approval prior to selling the device.
Research and development costs… shall be charged to expense
when incurred [ASC 730–10–25–1].
Expenses are outflows or other using up of assets or incurrences
of liabilities (or a combination of both) from delivering or
producing goods, rendering services, or carrying out other
activities that constitute the entity’s ongoing major or central
operations [CON 6, par. 80].
Should Company A capitalize these
development costs? 
Solution
No. Company A should expense as incurred the costs of adding new functionality as these costs are research and
development expenditures.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
7. Development of alternative indications
Background
Relevant guidance
Company A markets a drug approved for use as a painkiller.
Recent information shows the drug may also be effective in the
treatment of cancer. Company A has commenced additional
development procedures necessary to gain approval for
this indication.
Research and development costs… shall be charged to expense
when incurred [ASC 730–10–25–1].
Should Company A capitalize the
development costs relating to
alternative indications? 
Solution
No. Costs to perform research and development, including internal development costs, should be expensed as incurred, regardless
of history with similar drugs or regulatory expectations.
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Capitalization and impairment
8. Examples of research and development costs
Background
Relevant guidance
Company A is developing a new compound to cure cancer.
Company A is analyzing its expenditures to determine which
expenditures represent research and development costs. These
expenditures include costs incurred to identify a new formulation
and a routine update to an existing manufacturing line that will
be used to make the clinical trial product.
Research and development costs… shall be charged to
expense when incurred [ASC 730–10–25–1]. Activities that
typically would be considered research and development
are included in ASC 730–10–55–1. Some of the examples in
ASC 730–10–55–1 include:
• Laboratory research aimed at discovery of new knowledge.
• Searching for applications of new research findings or
other knowledge.
• Conceptual formulation and design of possible product or
process alternatives.
• Testing in search for or evaluation of product or
process alternatives.
• Modification of the formulation or design of a product
or process.
• Design, construction, and operation of a pilot plant
that is not of a scale economically feasible to the entity
for commercial production.
Do the additional expenditures
incurred by Company A qualify as
research and development costs? 
• Engineering activity required to advance the design of a
product to the point that it meets specific functional and
economic requirements and is ready for manufacture.
Solution
Research and development costs could include materials, equipment or facility charges, compensation and benefits for personnel,
intangible assets purchased from others (if they do not have alternative use or have not achieved technological feasibility), the cost
of contract services performed by others and a reasonable allocation of indirect costs.
Company A determined that the cost associated with the identification of a new formulation would be expensed as research and
development costs, while the cost associated with the routine update to the manufacturing line would be expensed to cost of sales.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
9. Asset acquisition of a compound
Background
Relevant guidance
Company A acquired a compound for $5 million on January 1,
20X2. Assume there is no alternative future use and that the
acquired asset does not constitute a business. Company A expects
to receive regulatory and marketing approval on March 1, 20X3
and plans to start using the compound in its production process
on June 1, 20X3.
Intangible assets purchased from others (not in a business
combination) for use in research and development activities
follow the guidance in ASC 730, Research and Development. Assets
that have future alternative use are accounted for in accordance
with the guidance in ASC 350, Intangibles—Goodwill and Other.
The useful life of an intangible asset to an entity is the period over
which the asset is expected to contribute directly or indirectly to
the future cash flows of that entity [ASC 350–30–35–2].
The method of amortization shall reflect the pattern in which
the economic benefits of the intangible asset are consumed or
otherwise used up [ASC 350–30–35–6].
How should Company A account for
the acquisition of the asset? 
Solution
Because the compound was acquired prior to regulatory approval, the payment would be expensed as research and development
costs (since there is no alternative future use and the acquired asset does not constitute a business). If the compound had been
acquired after regulatory approval, Company A would begin amortizing the intangible asset on the date it is available for its
expected use. This would generally be the acquisition date for an approved compound.
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Capitalization and impairment
10.Indefinite-life intangible assets
Background
Relevant guidance
Management of a pharmaceutical entity has acquired an
intangible asset that it believes to have an indefinite useful life.
If no legal, regulatory, contractual, competitive, economic or
other factors limit the useful life of an intangible asset to the
reporting entity, the useful life of the asset shall be considered to
be indefinite [ASC 350–30–35–4].
If an intangible asset is determined to have an indefinite useful
life, it shall not be amortized until its useful life is determined to
be no longer indefinite [ASC 350–30–35–15].
An entity shall evaluate the remaining useful life of an intangible
asset that is not being amortized each reporting period to
determine whether events and circumstances continue to support
an indefinite useful life [ASC 350–30–35–16].
What is required to conclude
that an asset has an indefinite
useful life, and if so, how should
management account for it? 
An intangible asset that is not subject to amortization shall be
tested for impairment annually, or more frequently if events
or changes in circumstances indicate that the asset might be
impaired [ASC 350–30–35–18].
Solution
Management can regard an asset as having an indefinite life if there are no factors (as cited above) that would limit the asset’s
useful life. If an asset has an indefinite life, management is required to test it for impairment by comparing its fair value
with its carrying value both annually and more frequently if there is an indication that the intangible asset may be impaired.
Pharmaceutical intangible assets that might be regarded as having an indefinite life could include acquired brands (e.g., over
the counter products) or generic products. Technological and medical advances will reduce the number of situations where an
indefinite life would apply. As a result of limited patent lives, only in exceptional cases would prescription pharmaceutical products
have indefinite economic lives.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
11.Indicators of impairment for intangibles
Background
Relevant guidance
Company A has capitalized the cost of acquiring the license
rights to a product that has recently received regulatory
approval. Company A has plans to begin selling this product in
six months, and as such, is not amortizing the asset since it is not
available for use.
A long-lived asset (asset group) shall be tested for recoverability
whenever events or changes in circumstances indicate that its
carrying amount may not be recoverable [ASC 360–10–35–21].
An impairment loss shall be recognized only if the carrying
amount of a long-lived asset (asset group) is not recoverable
and exceeds its fair value. The carrying amount of a long-lived
asset (asset group) is not recoverable if it exceeds the sum of the
undiscounted cash flows expected to result from the use and
eventual disposition of the asset (asset group). That assessment
shall be based on the carrying amount of the asset (asset group)
at the date it is tested for recoverability… An impairment
loss shall be measured as the amount by which the carrying
amount of a long-lived asset (asset group) exceeds its fair value
[ASC 360–10–35–17].
What indicators of impairment
should management consider? 
Solution
ASC 360–10–35–21 provides several examples of events or changes in circumstances (not all-inclusive) that management
should consider when assessing whether an intangible asset should be tested for impairment. Some of the events or changes in
circumstances include: a significant decrease in the market price of the long-lived asset, a significant adverse change in the manner
in which the asset is used or a significant adverse legal event.
Management of pharmaceutical and life sciences entities should also consider other industry-specific indicators, including:
• Development of a competing drug;
• Changes in the legal framework covering patents, rights, or licenses;
• Failure of the drug’s efficacy;
• Advances in medicine and/or technology that affect the medical treatments;
• A pattern of lower than predicted sales;
• Change in the economic lives of similar assets;
• Relationship with other intangible or tangible assets; and
• Changes or anticipated changes in participation rates or reimbursement policies of insurance companies, Medicare or
the government.
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Capitalization and impairment
12.Indicators of impairment—Property, plant and equipment
Background
Relevant guidance
Company A announced a withdrawal of a marketed product due
to unfavorable post approval Phase IV study results. Company A
informed healthcare authorities that patients should no longer
be treated with that product. Company A has property, plant and
equipment that is dedicated specifically to the production of the
terminated product and has no future alternative use.
A long-lived asset (asset group) shall be tested for recoverability
whenever events or changes in circumstances indicate that its
carrying amount may not be recoverable [ASC 360–10–35–21].
What impairment indicators should
Company A consider? 
Solution
Company A should consider the general indicators given in ASC 360–10–35–21 when assessing whether there is an impairment of
property, plant and equipment. In addition, pharmaceutical and life sciences entities should consider industry-specific factors such
as the following:
• Patent expiry date;
• Failure of the machinery to meet regulatory requirements;
• Technical obsolescence of the property, plant and equipment (for example, because it cannot accommodate new
market preferences);
• Changes in medical treatments;
• Market entrance of competitive products;
• Product recall; and
• Changes or anticipated changes in third-party reimbursement policies that will impact the price received for the sale of
product manufactured by the property, plant and equipment.
As a result of withdrawing the product, Company A determined that the property, plant and equipment was fully impaired as there
were no future cash flows associated with the long-lived asset group.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
13.Single market impairment accounting
Background
Relevant guidance
Company A acquired the rights to market a topical fungicide
cream in Europe. The acquired rights apply broadly to the
entire territory and, as such, Company A determined that it
would account for the acquired right as one unit of account. For
unknown reasons, patients in Country X prove far more likely
to develop blisters from use of the cream, causing Company A
to withdraw the product from that country. As fungicide sales
in Country X were not expected to be significant, the loss of the
territory, taken in isolation, does not cause the overall value from
sales of the drug to be less than its carrying value.
A long-lived asset (asset group) shall be tested for recoverability
whenever events or changes in circumstances indicate that its
carrying amount may not be recoverable [ASC 360–10–35–21].
An impairment loss shall be recognized only if the carrying
amount of a long-lived asset (asset group) is not recoverable
and exceeds its fair value. The carrying amount of a longlived asset (asset group) is not recoverable if it exceeds the
sum of the undiscounted cash flows expected to result from
the use and eventual disposition of the asset (asset group)
[ASC 360–10–35–17].
For purposes of recognition and measurement of an impairment
loss, long-lived asset or assets shall be grouped with other assets
and liabilities at the lowest level for which identifiable cash flows
are largely independent of the cash flows of other assets and
liabilities [ASC 360–10–35–23].
How should Company A account
for the withdrawal of a drug from a
specific territory? 
Solution
Company A acquired the rights to market the fungicide cream over a broad territory and not specifically in Country X. Therefore,
the entire territory would likely represent the lowest level of identifiable cash flows for testing impairment of the marketing rights.
Because revenues from product sales in Country X were not significant, the withdrawal of the product from Country X’s market
would not be considered a triggering event that would require an impairment analysis to be performed.
However, Company A should carefully consider whether the development of blisters in patients in Country X is indicative of
potential problems in other territories. If the issue cannot be isolated, a triggering event would be considered to have occurred
and a broader impairment analysis should be performed, including the consideration of the potential for more wide-ranging
decreases in sales.
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Capitalization and impairment
14.Impairment testing and useful life
Background
Relevant guidance
Company A has a major production line that produces its
blockbuster antidepressant. The production line has no
alternative use. A competitor launches a new antidepressant
with better efficacy. Company A expects sales of its drug to
drop rapidly and significantly. Although positive margins
are forecasted to continue, Company A identifies this as an
indicator of impairment. As a result of the new competition,
Company A may exit the market for this drug earlier than
previously contemplated.
A long-lived asset (asset group) shall be tested for recoverability
whenever events or changes in circumstances indicate that its
carrying amount may not be recoverable [ASC 360–10–35–21].
An impairment loss shall be recognized only if the carrying
amount of a long-lived asset (asset group) is not recoverable
and exceeds its fair value. The carrying amount of a long-lived
asset (asset group) is not recoverable if it exceeds the sum of the
undiscounted cash flows expected to result from the use and
eventual disposition of the asset (asset group)… An impairment
loss shall be measured as the amount by which the carrying
amount of a long-lived asset (asset group) exceeds its fair value
[ASC 360–10–35–17].
When a long-lived asset (asset group) is tested for recoverability,
it also may be necessary to review depreciation estimates and
method… or the amortization period… Any revision to the
remaining useful life of a long-lived asset resulting from that
review also shall be considered in developing estimates of future
cash flows used to test the asset (asset group) for recoverability…
[ASC 360–10–35–22].
How should Company A assess the
impairment and useful lives of
long-lived assets where impairment
indicators have been identified? 
If an impairment loss is recognized, the adjusted carrying
amount of a long-lived asset shall be its new cost basis. For
a depreciable long-lived asset, the new cost basis shall be
depreciated (amortized) over the remaining useful life of that
asset. Restoration of a previously recognized impairment loss is
prohibited [ASC 360–10–35–20].
Solution
Assuming that the antidepressant asset group represents the lowest level of identifiable cash flows, Company A should evaluate
the carrying amount of the antidepressant’s asset group (including the production line) relative to its future undiscounted cash
flows. An impairment loss should be recognized if the carrying amount of the antidepressant’s asset group exceeds the future
undiscounted cash flows. The resulting impairment would be based on the difference between the carrying amount of the unit and
its fair value.
In addition, Company A should revise the estimated useful life of the affected assets remaining after the impairment analysis is
performed based on the estimated period it expects to obtain economic benefit from the assets. After recognizing the impairment
and revising the estimated useful life for the affected assets, Company A would continue to amortize the remainder of the asset over
its expected useful life.
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Externally
Research and
sourced
development
research
and development
16
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Externally sourced research and development
15.Exchange of intangible assets
Background
Relevant guidance
Company A is developing a hepatitis vaccine compound.
Company B is developing a measles vaccine compound.
Company A and Company B enter into an agreement to swap
the two products. Company A and Company B will not have any
continuing involvement in the products that they have swapped.
The fair value of Company A’s compound has been assessed as $3
million. The carrying value of Company B’s compound was zero,
as it was internally developed.
The cost of a non-monetary asset acquired in exchange for
another nonmonetary asset is the fair value of the asset
surrendered to obtain it, and a gain or loss shall be recognized on
the exchange. The fair value of the asset received shall be used to
measure the cost if it is more clearly evident than the fair value of
the asset surrendered [ASC 845–10–30–1].
A nonmonetary exchange shall be measured based on the
recorded amount… of the nonmonetary asset(s) relinquished,
and not on the fair values of the exchanged assets, and not on
the fair values of the exchanged assets, if any of the following
conditions apply:
• The fair value of neither the asset(s) received nor the asset(s)
relinquished is determinable within reasonable limits.
• The transaction is an exchange of a product or property held
for sale in the ordinary course of business for a product or
property to be sold in the same line of business to facilitate
sales to customers other than the parties to the exchange.
• The transaction lacks commercial substance
[ASC 845–10–30–3].
A non-monetary exchange has commercial substance if the
entity’s future cash flows are expected to significantly change as a
result of the exchange [ASC 845–10–30–4].
How should Company A
account for the swap of
vaccine products? 
Solution
Company A should recognize the compound received at the fair value of the compound given up, which is $3 million. Company A
should also recognize a gain on the exchange of $3 million ($3 million–zero book value for the compound Company A gave up)
because Company A has no continuing involvement or additional obligations with respect to the product given up.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
16.Exchange of intangible assets with continuing involvement
Background
Relevant guidance
Company A is developing a hepatitis vaccine compound.
Company B is developing a measles vaccine compound.
Company A and Company B enter into an agreement to swap
these two compounds. Under the terms of the agreement,
Company A will retain the marketing rights to its hepatitis vaccine
compound for all Asian countries. The fair value of Company A’s
compound has been assessed as $3 million, including $1 million
relating to the Asian marketing rights.
The cost of a non-monetary asset acquired in exchange for
another nonmonetary asset is the fair value of the asset
surrendered to obtain it, and a gain or loss shall be recognized on
the exchange. The fair value of the asset received shall be used to
measure the cost if it is more clearly evident than the fair value of
the asset surrendered [ASC 845–10–30–1].
A nonmonetary exchange shall be measured based on the
recorded amount… of the nonmonetary asset(s) relinquished,
and not on the fair values of the exchanged assets, if any of the
following conditions apply:
(a) The fair value of neither the asset(s) received nor the asset(s)
relinquished is determinable within reasonable limits.
(b) The transaction is an exchange of a product or property held
for sale in the ordinary course of business for a product or
property to be sold in the same line of business to facilitate
sales to customers other than the parties to the exchange.
(c) The transaction lacks commercial substance
[ASC 845–10–30–3].
How should Company A account
for the swap of vaccine compounds,
assuming that the transaction has
commercial substance? 
A non-monetary exchange has commercial substance if the
entity’s future cash flows are expected to significantly change as a
result of the exchange [ASC 845–10–30–4].
Solution
Company A should recognize the compound received at the fair value of the compound given up, which is $2 million
($3 million–$1 million). The fair value of $1 million relating to the marketing rights is excluded from the calculation because the
rights have not been sold.
Company A needed to assess whether it had continuing involvement related to the compound it had exchanged to determine the
appropriate accounting for the $2 million. If Company A has determined it had continuing involvement, the gain would be deferred
and recognized over the continuing involvement period. The SEC Staff has reiterated that ASC 845, Nonmonetary Transactions,
is a measurement standard and does not address the timing of revenue or gain recognition. Company A would need to assess the
“earned” and “realized” criteria of CON 5, Recognition and Measurement in Financial Statements of Business Enterprises, and the
“performance” and “delivery” criteria of SAB Topic 13.A to determine the appropriate recognition timing.
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Externally sourced research and development
17.Accounting for receipt of listed shares in exchange for a patent
Background
Relevant guidance
Company A agrees to acquire a patent from Company B in order
to develop a drug. Company A will pay for the right it acquires by
giving Company B 5% of its shares (which are listed). Company B
is in the business of licensing and selling patents in its patent
portfolio. The listed shares are considered to be equal in value to
the patent. If Company A is successful in developing a drug and
bringing it to the market, Company B will receive a 5% royalty on
all sales. Company B expects to classify the shares as available-forsale securities.
An investment in the stock of an investee… shall be measured
initially at cost [ASC 325–20–30–1].
If a security is acquired with the intent of selling it within hours
or days, the security shall be classified as trading. However, at
acquisition an entity is not precluded from classifying as trading
a security it plans to hold for a longer period. Classification
of a security as trading shall not be precluded simply
because the entity does not intend to sell it in the near term
[ASC 320–10–25–1a].
Investments in debt securities and equity securities that have
readily determinable fair values not classified as trading securities
or as held-to-maturity securities shall be classified as availablefor-sale securities [ASC 320–10–25–1b].
The cost of a non-monetary asset acquired in exchange for
another nonmonetary asset is the fair value of the asset
surrendered to obtain it, and a gain or loss shall be recognized on
the exchange. The fair value of the asset received shall be used to
measure the cost if it is more clearly evident than the fair value of
the asset surrendered [ASC 845–10–30–1].
How should Company B
account for this transaction? 
Solution
Company B should initially recognize the shares received as available-for-sale securities at their fair value. Company B should also
derecognize the patent that is transferred to Company A, and recognize any gain arising from the sale of the patent. The fair value
of the shares received represents the amount of the consideration received, which would likely be used to measure this transaction
as it is more readily determinable (market quoted value) than the value of the patent given up. As Company B is in the business of
routinely licensing and selling patents in its patent portfolio, it would be appropriate to recognize a gain on the sale of the patent as
revenue. Transaction costs, if any, would be recorded as a reduction of the gain on the sale of the patent.
Company B should not yet recognize any asset relating to the future royalty stream from the potential sales of the drug because
this stream of royalties is contingent upon the successful development of the drug. The revenue will generally be recognized on an
accrual basis in the period that the royalties are earned (e.g., when the related sales on which the royalties are determined occurs),
if Company B has an ability to reasonably estimate such royalties.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
18.Accounting for receipt of unlisted shares in exchange for a patent
Background
Relevant guidance
Company A agrees to acquire a patent from Company B in
order to develop a drug. Company A will pay for the right it
acquires by giving Company B 10% of the shares in an unlisted
subsidiary. Company B does not typically sell patents in its patent
portfolio. If Company A is successful in developing a drug and
bringing it to the market, Company B will receive a 5% royalty
on all sales. Company B expects to classify these shares as
An investment in the stock of an investee… shall be measured
initially at cost [ASC 325–20–30–1].
available-for-sale securities.
If a security is acquired with the intent of selling it within hours
or days, the security shall be classified as trading. However,
at acquisition an entity is not precluded from classifying
as trading a security it plans to hold for a longer period.
Classification of a security as trading shall not be precluded
simply because the entity does not intend to sell it in the near
term [ASC 320–10–25–1a].
Investments in debt securities and equity securities that have
readily determinable fair values not classified as trading securities
or as held-to-maturity securities shall be classified as availablefor-sale securities [ASC 320–10–25–1b].
How should Company B account
for this transaction? 
The cost of a non-monetary asset acquired in exchange for
another nonmonetary asset is the fair value of the asset
surrendered to obtain it, and a gain or loss shall be recognized on
the exchange. The fair value of the asset received shall be used to
measure the cost if it is more clearly evident than the fair value of
the asset surrendered [ASC 845–10–30–1].
Solution
Generally, the fair value of the patent given up will likely be more readily determinable than the fair value of the shares because
these shares are of an unlisted subsidiary. ASC 320 states that fair value is only deemed readily determinable if sales prices or
bid-and-asked quotations are currently available on a securities exchange registered with the Securities and Exchange Commission
or in the over-the-counter market, or similar foreign market.
Company B would generally be expected to conclude that the fair value of the shares is the same value as the patent given up. As
Company B is not in the business of licensing and selling patents in its portfolio, Company B should recognize the gain arising
from the sale of the patent (fair value less carrying value of the patent) as a gain on sale of long-lived assets (separately stated, if
material) or as other income. Transaction costs would be recorded as a reduction of the gain.
Company B should not yet recognize any asset relating to the future royalty stream from the potential sales of the drug because
this stream of royalties is contingent upon the successful development of the drug. The revenue will generally be recognized on an
accrual basis in the period that the royalties are earned (i.e., when the related sales on which the royalties are determined occurs),
if Company B has an ability to reasonably estimate such royalties.
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Externally sourced research and development
19.In-licensing agreements
Background
Relevant guidance
Company A and Company B enter into an agreement in which
Company A will license Company B’s know-how and technology
to manufacture a compound to treat HIV. It cannot use the
know-how and technology for any other project. Company A
has not yet concluded that economic benefits are likely to flow
from this compound or that relevant regulatory approval will be
achieved.
Research and development costs… shall be charged to expense
when incurred [ASC 730–10–25–1].
The costs of intangibles that are purchased from others for a
particular research and development project and that have no
alternative future uses… and therefore no separate economic
values are research and development costs at the time the costs
are incurred [ASC 730–10–25–2c].
Company A will use Company B’s technology in its facilities for a
period of three years. The agreement stipulates that Company A
will make a non-refundable payment of $3 million to Company B
for access to the technology. Company B will also receive a
20% royalty from all future sales of the compound.
How should Company A account for
the in-licensing agreement? 
Solution
Company A should expense the $3 million when incurred as research and development costs since the know-how and technology
have no alternative future uses.
The royalty payments of 20% of sales are generally presented in the income statement within cost of sales.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
20.Non-refundable upfront payments to conduct research
Background
Relevant guidance
Company A engages a contract research organization (CRO) to
perform research activities for a period of two years in order to
obtain know-how and to discover a cure for HIV. The CRO is well
known in the industry for having modern facilities and good
practitioners dedicated to investigation. The CRO receives a
non-refundable, upfront payment of $3 million in order to carry
out the research under the agreement. It will have to present a
quarterly report to Company A with the results of its research.
Company A has full rights to the research performed, including
an ability to control the research undertaken on the potential cure
for HIV. The CRO has no rights to use the results of the research
for its own purposes.
Research and development costs… shall be charged to expense
when incurred [ASC 730–10–25–1].
Non-refundable 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 executor
contractual arrangement shall be deferred and capitalized
[ASC 730–20–25–13].
How should Company A account
for the upfront payments made to
the CRO? 
Solution
Although the payment is non-refundable, Company A will receive a future benefit as the CRO performs the research services over
the two-year period. Therefore, the upfront payment should be capitalized and recognized in the income statement (as research
and development expense) using the straight-line method, unless another method is more reflective of the CRO’s effort. Company A
should continue to evaluate whether it expects the goods to be delivered or services to be rendered each reporting period to assess
recoverability of the asset.
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Externally sourced research and development
21.Payments made to conduct research
Background
Relevant guidance
Company A, a small pharmaceutical company, is engaged by
Company B, a large pharmaceutical company, to develop a
new medical treatment for migraines over a five-year period.
Company A is engaged only to provide research and development
services and will periodically have to update Company B
with the results of its work. Company B has exclusive rights
over the development results. Company B will make 20 equal
non-refundable quarterly payments of $0.25 million (totaling
$5 million), if Company A can demonstrate compliance with
the development program. Payments do not depend upon the
achievement of a particular outcome.
Research and development… shall be charged to expense when
incurred [ASC 730–10–25–1].
How should Company B recognize
the payments it makes to
Company A? 
Solution
Company B should recognize research and development expense of $0.25 million each quarter for as long as it authorizes
Company A to continue performing the research.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
22.Fixed-fee contract research arrangements
Background
Relevant guidance
Company A enters into a contract research arrangement with
Company B. Company B will perform research on a library of
molecules and will catalogue the research results in a database.
The costs of services performed by others in connection with
the research and development activities of an entity, including
research and development conducted by others [on] behalf of
the entity, shall be included in research and development costs
[ASC 730–10–25–2(d)].
Company A will pay Company B $3 million only upon completion
of the contracted work. The payment is based on delivery of the
research services. There is no success based contingency.
How should Company A
account for the contract
research arrangement? 
Solution
The costs should be expensed as Company B performs the services and recorded as research expense. Company A should accrue the
contract research costs over the expected period of the research. Company A will need some visibility into Company B’s pattern of
performance in order to properly expense the contract research costs under the arrangement. The structuring of the payments does
not alter the accounting treatment.
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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.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
24.External development of intellectual property with buy-back options
Background
Relevant guidance
Company A has out-licensed the development of an existing
compound to Company B, an independent third party. There was
no upfront consideration paid between the parties. Company A
will neither retain any involvement in the development of its
compound nor participate in the funding of the development.
However, in the case of successful completion of the development
as evidenced by regulatory approval in the key markets,
Company A has the option to buy-back the rights to its compound.
The following terms are agreed:
If the entity is obligated to repay any of the funds provided
by the other parties regardless of the outcome of the research
and development, the entity shall estimate and recognize that
liability. This requirement applies whether the entity may settle
the liability by paying cash, by issuing securities, or by some other
means [ASC 730–20–25–3].
• If the development fails, Company B bears all the costs it
incurred without any compensation.
• If the development is successful and Company A exercises
its buy-back option, Company B receives an agreed buy-back
payment (as well as future sales based milestone payments
and royalty streams).
• If the development is successful and Company A does not
exercise the option, Company B can commercialize the
compound on its own (paying milestones and royalties to
Company A under the license arrangement).
To conclude that a liability does not exist, the transfer of the
financial risk involved with research and development from the
entity to the other parties must be substantive and genuine. To
the extent that the entity is committed to repay any of the funds
provided by the other parties regardless of the outcome of the
research and development, all or part of the risk has not been
transferred [ASC 730–20–25–4].
The following are examples of conditions leading to the
presumption that an entity will repay the other parties
[ASC 730–20–25–6]:
• The entity has indicated an intent to repay all or a portion of
the funds provided regardless of the outcome of the research
and development.
• The entity would suffer a severe economic penalty if it failed
to repay any of the funds provided to it regardless of the
outcome of the research and development.
• A significant related party relationship between the entity
and the parties funding the research and development exists
at the time the entity enters into the arrangement.
• The entity has essentially completed the project before
entering into the arrangement.
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Externally sourced research and development
24. External development of intellectual property with buy-back options (continued)
Relevant guidance (continued)
If the entity’s obligation is to perform research and development
for others and the entity subsequently decides to exercise an
option to purchase the other parties’ interests in the research
and development arrangement or to obtain the exclusive rights
to the results of the research and development, the nature of
those results and their future use shall determine the accounting
for the purchase transaction or business combination… [ASC 730–20–25–9].
The costs of services performed by others in connection with
the research and development activities of an entity, including
research and development conducted by others [on] behalf of
the entity, shall be included in research and development costs
[ASC 730–10–25–2(d)].
How should Company A account
for payments in an arrangement
in which a third party develops its
intellectual property? 
Solution
Company A effectively removes its exposure to failure of the development of its compound, having transferred all development risks
to Company B. In this case, there are no indicators that would lead to a presumption that the buyback will occur and that a liability
should be recognized before any decision to reacquire the rights were to occur.
Through exercise of the buy-back option, Company A reacquires the commercialization right intangible asset. Since exercise of the
buy-back option is triggered upon regulatory approval, the buyback payment would be capitalized when contractually due and then
amortized over the useful life of the commercialization right.
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Research and development related issues
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Research and development related issues
25.Payments received to conduct development
Background
Relevant guidance
Company A, a small pharmaceutical company, contracts with
the much larger Company B to develop a new medical treatment
for migraines over a five-year period. Company A is engaged
only to provide development services and will periodically have
to update Company B with the results of its work. Company B
has exclusive rights over the development results. It will make
20 equal non-refundable quarterly payments of $0.25 million
(totaling $5 million), if Company A can demonstrate compliance
with the development program. Payments do not depend upon
the achievement of a particular outcome. Company A estimates
the total cost will be $4 million.
Service revenue should be recognized on a straight-line basis,
unless evidence suggests that the revenue is earned or obligations
are fulfilled in a different pattern, over the contractual term
of the arrangement or the expected period, during which
those specified services will be performed, whichever is longer
[SAB Topic 13A].
In the first quarter of year one, Company A incurs costs of
$0.4 million, in line with its original estimate. Company A is in
compliance with the research agreement, including the provision
of updates from the results of its work.
How should Company A
recognize the payments it
receives from Company B to
conduct development? 
Solution
If costs incurred are a reasonable representation of the services performed, Company A should recognize the revenue on
a proportional performance basis. Otherwise, Company A should recognize the revenue on a straight-line basis over the
five-year period.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
26.Upfront payments received to conduct development: Initial recognition
Background
Relevant guidance
Company A has appointed Company B to develop an existing
compound on its behalf. Company B will have no further
involvement with the compound after regulatory approval.
Company A will retain full ownership of the compound
(including intellectual property rights), even after regulatory
approval is obtained. Company A agrees to make the following
non-refundable payments to Company B:
Many arrangements require the customer to pay a certain amount
of money at the start of the contract. These upfront payments
are often characterized as non-refundable and are sometimes
earmarked for “past services,” for “access” to some intangible
right, or for some general “rights.” Unless the upfront payment
is in exchange for a product, service or right and represents
the culmination of a separate earnings process, the upfront fee
should be deferred over the longer of the contractual life of an
arrangement or the customer relationship life. The customer’s
perception of value received is paramount in this assessment
[SAB Topic 13].
• $3 million on signing of the agreement
• $1 million on commencement of Phase III clinical trials
• $2 million on securing regulatory approval
In addition, Company A will reimburse Company B for any
expenditures incurred above $3 million.
Company B expects to incur costs totaling $3 million up to the
point of securing regulatory approval. Company B cannot reliably
estimate whether the compound will obtain regulatory approval.
How should Company B recognize
the initial payment it has received
from Company A? 
Solution
Company B should record the initial payment as deferred income. This deferred income will subsequently be recognized as revenue
based on proportional performance or on a straight line basis over the expected development period if development is performed
evenly. At no point, however, should the revenue recorded exceed the amount of cash received. When the payment is initially
received, the earnings process has not been completed. The future milestone payments are not included in the determination of
revenue, as their receipt cannot be reliably estimated and no earnings process has been completed.
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Research and development related issues
27.Upfront payments received to conduct development: Interim recognition
Background
Relevant guidance
Company B is now in the process of fulfilling the contract with
Company A outlined in Scenario 26. It has incurred $2 million in
development costs from the inception of the contract on March
1, 20X4 through December 31, 20X4, as projected in the original
development plan. Company B estimates that the level of costs
incurred approximates the amount of services delivered under
the contract.
Upfront fees, even if non-refundable, are earned as the products
and/or services are delivered and/or performed over the term
of the arrangement or the expected period of performance and
generally should be deferred and recognized systematically over
the periods that the fees are earned. Service revenue should be
recognized on a straight-line basis, unless evidence suggests that
the revenue is earned or obligations are fulfilled in a different
pattern, over the contractual term of the arrangement or the
expected period during which those specified services will be
performed [SAB Topic 13].
How should Company B recognize
deferred income and costs incurred
to conduct development for
another party? 
Solution
Company B should recognize the revenue on a straight-line basis or proportionally over the contract term based on the level of
effort spent each period. Costs incurred may be an appropriate basis for measuring level of effort. Initial set-up costs for materials,
equipment or similar items should not be considered as they are generally not related to revenue generating activities. Under a
proportional performance method, since Company B has incurred $2 million in development costs to date and expects to incur
another $1 million, it should have recognized as revenue a comparable ratio of deferred income (e.g., 66.7% or $2 million
as revenue).
No consideration should be given to the future milestone payments, as their receipt cannot be reliably estimated and no earnings
process has been completed.
It is important to note that Company B has no continuing involvement after the development phase in this scenario. If there was
continuing involvement (e.g., co-marketing, manufacturing, steering committees), the terms of those deliverables would need to be
considered in determining the appropriate period to recognize the upfront payment as revenue.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
28.Upfront payments received to conduct development: Completion
Background
Relevant guidance
Regulatory approval has been received for the compound
on which Company B is working (Scenarios 26 and 27).
Company A has paid the $1 million and the $2 million milestone
payments specified in the development contract in addition
to the $3 million it paid on signing the contract. Company B
has incurred costs of $3 million to reach this point, in line with
original expectations.
Upfront fees, even if non-refundable, are earned as the products
and/or services are delivered and/or performed over the term
of the arrangement or the expected period of performance and
generally should be deferred and recognized systematically over
the periods that the fees are earned. Service revenue should be
recognized on a straight-line basis, unless evidence suggests that
the revenue is earned or obligations are fulfilled in a different
pattern, over the contractual term of the arrangement or the
expected period during which those specified services will be
performed [SAB Topic 13].
How should Company B recognize
the milestone payments? 
Solution
Company B could recognize the milestone payments received ($1 million due upon commencement of Phase III clinical trials and
$2 million for securing regulatory approval) under either the milestone method of revenue recognition, or another proportional
performance method.
To utilize the milestone method of revenue recognition, the milestones would need to be substantive and represent the achievement
of defined goals worthy of the payments. To be substantive, the consideration must (a) be commensurate with either (i) the
vendor’s performance to achieve the milestone or (ii) the enhancement of the value of the delivered item or items as a result of a
specific outcome resulting from the vendor’s performance to achieve the milestone; (b) relate solely to past performance; and (c)
be reasonable relative to all of the deliverables and payment terms (including other potential milestone consideration) within the
arrangement [ASC 605-28-25-2].
In this example, Company B has no remaining obligations to Company A when it receives the two milestone payments. As a result,
regardless of whether Company B utilizes the milestone method of revenue recognition or another proportional performance
method to recognize the amounts received, the $3 million received should be recognized since the earnings process relative to these
payments have been fully completed.
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Research and development related issues
29.Donation payment for research
Background
Relevant guidance
Company A has made a non-refundable gift of $3 million to a
university. The donation is to be used to fund research activities in
the area of infectious diseases over a two-year period. Company A
has no right to access the research findings.
Contributions made shall be recognized as expenses in the
period made and as decreases of assets or increases of liabilities
depending on the form of the benefits given… unconditional
promises to give cash are recognized as payables and contribution
expenses [ASC 720–25–25–1].
How should Company A recognize
the donation? 
Solution
Company A should expense the donation when incurred (normally when paid) or at the time an unconditional promise to give is
made, whichever is sooner, in the income statement (generally selling, general and administrative expense).
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
30.Capitalization of interest incurred on loans received to fund research
and development
Background
Relevant guidance
Company A has obtained a loan from Company B, another
pharmaceutical company, to finance the late-stage development
of a drug to treat cancer.
Interest shall be capitalized for the following types of assets
(“qualifying assets”) [ASC 835–20–15–5]:
• Assets that are constructed or otherwise produced for an
entity’s own use, including assets constructed or produced for
the entity by others for which deposits or progress payments
have been made.
• Assets intended for sale or lease that are constructed or
otherwise produced as discrete projects…
• Investments (equity, loans, and advances) accounted for
by the equity method while the investee has activities in
progress necessary to commence its planned principal
operations provided that the investee’s activities include the
use of funds to acquire qualifying assets for its operations.
The investor’s investment in the investee, not the individual
assets or projects of the investee, is the qualifying asset for
purposes of interest capitalization.
Can Company A capitalize
the interest incurred for
borrowings obtained to
finance research and
development activities? 
Solution
Borrowing costs associated with costs for research and development projects are expensed as incurred as development costs as they
do not qualify as assets.
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Research and development related issues
31.Treatment of trial batches in development
Background
Relevant guidance
Company A, a commercial laboratory, is manufacturing a stock
of 20,000 doses (trial batches) of a newly developed drug, using
various raw materials. The doses can only be used in patient trials
during Phase III clinical testing, and cannot be used for any other
purpose. The raw materials can be used in the production of other
approved drugs.
The costs of materials (whether from the entity’s normal
inventory or acquired specially for research and development
activities) and equipment or facilities, that are acquired or
constructed for research and development activities and that have
alternative future uses (in research and development projects or
otherwise) shall be capitalized as tangible assets when acquired
or constructed…
However, the cost of materials, equipment or facilities that
are acquired or constructed for a particular research and
development project and that have no alternative future uses
(in other research and development projects or otherwise)
and therefore no separate economic values are research
and development costs at the time the costs are incurred
[ASC 730–10–25–2(a)].
How should Company A account
for the raw materials and
trial batches? 
Solution
Company A should initially recognize the raw materials acquired for the production of trial batches as inventory since the raw
materials have alternative future use in the production of other approved drugs. As the trial batches do not have any alternative
future use and the technical feasibility of the drug is not proven (the drug is in Phase III), the trial batches (including the cost of raw
materials used in production) should be charged to development expense when they are produced.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
32.Accounting for funded research and development arrangements
Background
Relevant guidance
Company A partners with Investor B, an unrelated financial
investor, for the development of selected compounds that are
in Phase II development. Investor B commits a specified dollar
amount to fund the research and development of the selected
compounds. In exchange for the funding, Investor B will receive
royalties on future sales of product resulting from the compounds
being developed. Investor B will not receive any repayment if the
compounds are not successfully developed (i.e., the transfer of
financial risk for the research and development is substantive).
Investor B does not participate in any of the development or
commercialization activities.
ASC 730–20, Research and Development Arrangements, provides
guidance on accounting for research and development
arrangements through which a company can obtain the results
of the research and development funded partially or entirely
by others. This guidance requires a company to determine the
nature of the obligation it incurs when it enters into a research
and development funding arrangement to ascertain whether the
obligation is (i) a liability to repay the funding party or (ii) to
perform contractual services.
ASC 470–10–25, Debt, provides guidance on the accounting
for cash received from an investor when a company agrees to
pay the investor, for a defined period, a specified percentage or
amount of revenue of a particular product line, business segment,
trademark, patent, or contractual right. This guidance discusses
whether cash proceeds received from a sale of future revenues
should be classified as debt or deferred income.
What factors should Company A
consider to determine the
most appropriate accounting
model for the research and
development funding? 
Solution
While ASC 730–20 only relates to research and development funding, ASC 470–10–25 does not specifically exclude research and
development funding arrangements from its scope. If the research and development risk is substantive, such that it’s not probable
the development will be successful, the guidance in ASC 730–20 could be followed. However, if the successful completion of the
research and development is probable at the time the funding is received, the guidance in ASC 470–10–25 is most applicable.
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32. Accounting for funded research and development arrangements (continued)
Solution (continued)
To conclude that a liability does not exist, the transfer of financial risk involved with the research and development from
Company A to Investor B must be substantive and genuine. When assessing the substance of the transfer of financial risk,
Company A should consider any explicit or implicit obligations to repay any or all of the funding. If surrounding conditions suggest
that it is probable that Company A will repay any of the funds regardless of the outcome of the research and development, the
funding should be recorded as a liability. Assessing the probability of repayment requires significant judgment and will be based on
the facts and circumstances of the transaction.
Examples of conditions leading to a presumption that repayment is probable include the following:
• Company A has indicated an intent to repay all or a portion of the funds regardless of the outcome of the research
and development;
• Company A would suffer a severe economic penalty if it failed to repay any of the funds provided to it regardless of the
outcome of the research and development; and
• A significant related party relationship exists between the parties (in this scenario Company A and Investor B are unrelated).
Given the nature of the development and regulatory process, Company A determines that there is significant risk associated with
the research and development and that successful development is not probable. Accordingly, Company A will apply the guidance in
ASC 730–20 to evaluate the accounting for the research and development funding (i.e., whether it is a liability to repay the funding
party or an obligation to perform contractual services).
In this example, Company A has no explicit or implicit obligation to repay any of the funds and therefore determines that the
arrangement is an obligation to perform contractual services.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
33.Receipts for out-licensing
Background
Relevant guidance
Company A and Company B enter into an agreement in which
Company A will license Company B’s know-how and technology
to manufacture a compound for HIV. Company A will use
Company B’s technology for a period of three years. Company B
will have to keep the technology updated and in accordance
with Company A’s requirements during this three-year period.
Company B obtains a non-refundable upfront payment of
$3 million for access to the technology. Company B will also
receive a royalty of 20% from sales of the HIV compound if
Company A successfully develops a marketable drug.
When the elements of an out-licensing arrangement represent
a single unit of accounting, the upfront fee should be deferred
over the contractual life of the arrangement unless the upfront
payment is in exchange for products delivered or services
performed that represent the culmination of a separate earnings
process [SAB Topic 13].
Revenue should be recognized on a straight-line basis, unless
evidence suggests that the revenue is earned or obligations are
fulfilled in a different pattern, in which case that pattern should
be followed [SAB Topic 13].
How should Company B account
for a non-refundable upfront fee
received for licensing out its
know-how and technology to a
third party? 
Solution
Company B should recognize the non-refundable upfront fee received on a straight-line basis over the three-year term of the
license. The $3 million upfront fee is a service fee for granting a third party access to its technology and to keep it updated in
accordance with its requirements for a period of three years. This is the case even if the technology maintenance requirements are
not expected to be significant.
Company B should recognize the royalty receipts as revenue when earned. If material, the royalty should be presented as a separate
class of revenue in Company B’s income statement.
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PwC
Manufacturing
Research and development
PwC
39
US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
34.Treatment of validation batches
Background
Relevant guidance
A laboratory has just completed the development of a new
machine to mix components at a specified temperature to create
a new formulation of aspirin. The laboratory produces several
batches of the aspirin, using the new machinery to obtain
validation (an approval for the use of the machine) from the
relevant regulatory authorities. The validation of the machinery
is a separate process from the regulatory approval of the new
formulation of aspirin.
Property, plant, and equipment and most inventories are
reported at their historical cost which is the amount of cash, or
its equivalent, paid to acquire an asset, commonly adjusted after
acquisition for amortization or other allocations [CON 5, par. 67].
This includes directly attributable expenditures incurred in
acquiring the equipment and preparing it for use.
The historical cost of acquiring an asset includes the costs
necessarily incurred to bring it to the condition and location
necessary for its intended use. If an asset requires a period of
time in which to carry out the activities necessary to bring it to
that condition and location, the interest cost incurred during that
period as a result of expenditures for the asset is a part of the
historical cost of acquiring the asset [ASC 835–20–05–1].
Should expenditures to validate
machinery be capitalized? 
Solution
The laboratory should capitalize the costs incurred (including materials, labor, applicable overhead) to obtain the necessary
validation for the use of the machinery, together with the cost of the machinery. Validation is required to bring the machinery to its
working condition. However, management should exclude abnormal validation costs caused by errors or miscalculations during the
validation process (such as wasted material, labor or other resources). If the machinery requires revalidation, the costs related to
this would be expensed as incurred as the asset had already been prepared for its original intended use.
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Manufacturing
35.Treatment and presentation of development supplies
Background
Relevant guidance
A laboratory has purchased 10,000 batches of saline solution.
These batches are used in trials on patients during various
Phase III clinical tests. They can also be used as supplies for
other testing purposes, but have no other uses. Management is
considering whether the batches should be recorded as an asset.
The cost of such materials consumed in research and
development activities and the depreciation of such equipment
of facilities used in those activities are research and development
costs. However, the costs of materials, equipment, or facilities
that are acquired or constructed for a particular research and
development project and that have no alternative future uses
(in other research and development projects or otherwise)
and therefore no separate economic values are research
and development costs at the time the costs are incurred.
[ASC 730–10–25–2].
Should costs associated
with supplies used in clinical
testing be accounted for
as inventory? 
An asset has three essential characteristics: (a) it embodies a
probable future benefit that involves a capacity, singly or in
combination with other assets, to contribute directly or indirectly
to future net cash inflows, (b) a particular entity can obtain the
benefit and control others’ access to it, and (c) the transaction
or other event giving rise to the entity’s right to or control of the
benefit has already occurred [CON 6, par. 26].
Solution
The batches do not meet the definition of inventory because they can only be used for development. However, the batches do
meet the definition of an asset (other current asset or prepaid asset) since they have alternative future uses in other development
projects. They should therefore be recorded at cost and accounted for as supplies used in the development process. When supplies
are used, the associated cost forms part of research and development expense.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
36.Pre-launch inventory—Treatment of ‘in-development’ drugs
Background
Relevant guidance
Company A developed a new drug and needs to have sufficient
quantities of inventory on-hand in anticipation of commercial
launch once regulatory approval to market the product has been
obtained. Company A has filed for regulatory approval and is
currently awaiting a decision. Company A believes that final
regulatory approval is probable.
Assets are probable future economic benefits obtained or
controlled by a particular entity as a result of past transactions or
events [CON 6, par. 25].
Company A produced 15,000 doses following submission of
the filing for regulatory approval. If regulatory approval is not
obtained, the inventory has no alternative use.
Inventory is defined as the aggregate of those items of tangible
personal property that have any of the following characteristics:
(a) held for sale in the ordinary course of business, (b) in process
of production for such sale, or (c) to be currently consumed
in the production of goods or services to be available for sale
[ASC 330–10–20].
The primary basis of accounting for inventories is cost, which has
been defined generally as the price paid or consideration given to
acquire an asset. As applied to inventories, cost means in principle
the sum of the applicable expenditures and charges directly or
indirectly incurred in bringing an article to its existing condition
and location. It is understood to mean acquisition and production
cost, and its determination involves many considerations
[ASC 330–10–30–1].
A departure from the cost basis of pricing the inventory is
required when the utility of the goods is no longer as great as
their cost. Where there is evidence that the utility of goods, in
their disposal in the ordinary course of business, will be less
than cost, whether due to physical deterioration, obsolescence,
changes in price levels, or other causes, the difference shall
be recognized as a loss of the current period. This is generally
accomplished by stating such goods at a lower level commonly
designated as market [ASC 330–10–35–1].
A write-down of inventory to the lower of cost or market at the
close of a fiscal period creates a new cost basis that subsequently
cannot be marked up based on changes in underlying
circumstances [ASC 330–10–S99–2].
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Manufacturing
36. Pre-launch inventory—Treatment of ‘in-development’ drugs (continued)
How should the costs
associated with the production
of pre-launch inventory for
‘in-development’ drugs be
accounted for? 
Solution
Pre-launch inventory can be capitalized if it has probable future economic benefit. The assessment of whether pre-launch inventory
has probable future economic benefits depends on individual facts and circumstances. Factors to consider include whether key
safety, efficacy and feasibility issues have been resolved, status of any advisory committee reviews, and understanding of any
potential hurdles to regulatory approval or product reimbursement.
Company A believes that the filing for regulatory approval indicates that future economic benefit is probable. Accordingly, the
pre-launch inventory can be capitalized at the lower of cost or market. Periodic reassessments should be made to determine
whether the inventory continues to have a probable future economic benefit (e.g., whether regulatory approval is still probable and
whether product will be sold prior to expiration of its useful life). If the value of inventory is written down based on this
reassessment, the reduced amount is the new cost basis (i.e., if regulatory approval is ultimately obtained, the inventory is not
written back up). If at any time regulatory approval is deemed to not be probable, the inventory should be written down to its net
realizable value, which is presumably zero assuming that the product cannot be sold.
Companies should consider whether additional financial statement disclosures are necessary related to the capitalization of
pre-launch inventory, including the accounting policy and total amount capitalized. Further, if inventory that had previously been
written down is ultimately sold, companies should consider disclosing the impact on margins.
PwC
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
37.Recognition of raw materials as inventory
Background
Relevant guidance
Company A buys bulk materials used for manufacturing a variety
of drugs. The materials are used for marketed drugs, samples
and drugs in development. The materials are warehoused in a
common facility and released to production based upon orders
from the manufacturing and development departments.
Inventory is defined as the aggregate of those items of tangible
personal property that have any of the following characteristics:
• Held for sale in the ordinary course of business
• In process of production for such sale
• To be currently consumed in the production of goods or
services to be available for sale [ASC 330–10–20].
How should purchased
materials be accounted for
when their ultimate use is
not known? 
The costs of materials (whether from the entity’s normal
inventory or acquired specially for research and development
activities) and equipment or facilities that are acquired or
constructed for research and development activities and that
have alternative future uses (in research and development
projects or otherwise) shall be capitalized as tangible assets when
acquired or constructed. The cost of such materials consumed
in research and development activities and the depreciation
of such equipment of facilities used in those activities are
research and development costs. However, the costs of materials,
equipment, or facilities that are acquired or constructed for
a particular research and development project and that have
no alternative future uses (in other research and development
projects or otherwise) and therefore no separate economic values
are research and development costs at the time the costs are
incurred [ASC 730–10–25–2].
Solution
Company A should account for raw materials that can be used in the production of marketed drugs as inventory. When the material
is consumed in the production of sample products, Company A should account for the sample product to be given away as an
expense in accordance with its policy, which would generally be either when the product is packaged as sample product or the
sample is distributed. When the materials are released to production for use in the manufacturing of drugs in development, the cost
of the materials should be accounted for as research and development expense.
Alternatively, if the bulk materials were only able to be used for a particular research and development project, and did not have
alternative future uses, the costs would be recognized as research and development expense when incurred.
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Manufacturing
38.Indicators of impairment—Inventory
Background
Relevant guidance
Company A has decided to temporarily suspend all operations
at a certain production site due to identified quality issues.
Company A initiated a recall of products manufactured at that
certain site. Additionally, Company A carries a significant amount
of raw material inventory used in the manufacture of the product.
Where there is evidence that the utility of goods, in their disposal
in the ordinary course of business, will be less than cost, whether
due to physical deterioration, obsolescence, changes in price
levels, or other causes, the difference should be recognized as a
loss of the current period [ASC 330–10–35–1].
Is the inventory used
to manufacture the
product impaired? 
Solution
Company A would need to consider all available evidence to determine if there is an impairment. Suspending production and
recalling the product are indicators that the carrying value of raw material inventory used to manufacture the drug may not be
recoverable. Other factors that Company A may consider include: the reason for the recall, its history with past recalls, if the quality
issue could be fixed, and if the raw materials could be used for other products.
PwC
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
39.Patent protection costs
Background
Relevant guidance
“Assets are probable future economic benefits obtained or
Research and development
Company A has a registered patent on a currently marketed drug.
Company B copies the drug’s active ingredient and sells the drug
during the patent protection period. Company A goes to trial and
is likely to win the case, but has to pay costs for its attorneys and
other legal charges.
controlled by a particular entity as a result of past transactions or
events [CON 6, par. 25].”
…the legal and other costs of successfully defending a patent
from infringement are “deferred legal costs” only in the sense
that they are part of the cost of retaining and obtaining the future
economic benefit of the patent [CON 6, par. 247].”
If defense of the patent lawsuit is successful, costs may be
capitalized to the extent of an evident increase in the value of
the patent. Legal costs which relate to an unsuccessful outcome
should be expensed [AICPA TPA Sec 2260].
Should legal costs relating to the
defense of pharmaceutical patents
be capitalized? 
Solution
Capitalizing or expensing patent defense costs has evolved into an accounting policy decision. Generally in the pharmaceuticals
and life sciences industries, patent defense costs are not viewed as enhancing the value of a patent. In cases where it is believed that
the defense of the patent merely maintains rather than increases the expected future economic benefits from the patent, the costs
would generally be expensed as incurred.
Companies could capitalize external legal costs incurred in the defense of its patents when it is believed that a successful defense is
probable and that the value of the patent will be increased by virtue of a successful outcome; in that case, costs may be capitalized
to the extent of the increase. Capitalized patent defense costs are amortized over the remaining life of the related patent.
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Sales and Marketing
PwC
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
40.Advertising and promotional expenditure—Scenario 1
Background
Relevant guidance
A pharmaceutical company has developed a new drug that
simplifies the long-term treatment of kidney disease. The
company’s commercial department has incurred significant costs
with a promotional campaign, including television commercials
and presentations in conferences and seminars for doctors.
The costs of advertising… shall be expensed either as incurred or
the first time the advertising takes place. The accounting policy
selected from these two alternatives shall be applied consistently
to similar kinds of advertising activities. Deferring the costs of
advertising until the advertising takes place assumes that the
costs have been incurred for advertising that will occur. Such
costs shall be expensed immediately if such advertising is not
expected to occur [ASC 720–35–25–1].
How should these costs be
accounted for and presented in the
income statement? 
Solution
The company should not recognize its advertising and promotional costs as an intangible asset, even though the expenditure
incurred may provide future economic benefits. Depending on the policy it selected, the company should charge all promotional
costs to the income statement as incurred or the first time the advertising takes place. Promotional costs should be included within
sales and marketing expenses.
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Sales and Marketing
41.Advertising and promotional expenditure—Scenario 2
Background
Relevant guidance
Company A recently completed a major study comparing its
Alzheimer drug to competing drugs. The results of the study were
highly favorable and Company A has invested in a significant
new marketing campaign. The campaign will be launched at the
January 20X4 International Alzheimer Conference. Company A
has also paid for direct-to-consumer television advertising,
which will appear in February 20X4. Related direct-to-consumer
internet advertising will also begin in February 20X4, and will be
paid based on when viewers “click-through” to its Alzheimer site.
The costs of advertising should be expensed either as incurred
or the first time the advertising takes place [ASC 340–20–25–3]
except for:
• Direct-response advertising whose primary purpose is to elicit
sales to customers who could be shown to have responded
specifically to the advertising and that results in probable
future benefits [ASC 340–20–25–4].
How should expenditure on
advertising and promotional
campaigns be treated in the 20X3
financial statements (i.e., before the
campaign is launched)? 
Solution
Advertising and promotional expenditure (i.e., all costs to develop and produce the marketing campaign and related materials,
including the television and internet advertisements) should be treated as an expense when incurred or the first time the
advertisement takes place, whichever is the Company’s consistently applied policy. Amounts paid to television broadcast providers
should be accounted for as a prepayment and expensed when the advertisement airs in 20X4. Costs for hits to Company A’s internet
site should be expensed based upon the click-through rate in 20X4.
Please note that the above solution assumes the advertising and promotional activities would be deemed to be “Other than Direct
Response Advertising” under ASC 340–20.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
42.Presentation of co-marketing income
Background
Relevant guidance
Company A and Company B have entered into a co-marketing
agreement for Compound Y. Compound Y was developed solely
by Company B and recently received approval from the regulatory
authorities to be sold. Under the terms of the agreement,
Company A has made an upfront payment to Company B to obtain
an exclusive marketing right for Compound Y in Japan.
A collaborative arrangement is a contractual arrangement
that involves a joint operating activity. These arrangements
involve two (or more) parties who are both active participants
in the activity and exposed to significant risks and rewards
dependent on the commercial success of the activity
[FASB Codification Glossary].
Company B will manufacture the product and sell it to
Company A. Company A will also pay Company B 20% of its net
sales of Compound Y. The promotion and commercialization of
drugs are Company A’s main activities, although in this case they
are performed jointly with a third party.
Participants in a collaborative arrangement shall report
costs incurred and revenue generated from transactions
with third parties (that is, parties that do not participate
in the arrangement) in each entity’s respective income
statement pursuant to the guidance in [ASC] 605–45…
[ASC 808–10–45–1].
The primary purpose for Company B entering into the
co-marketing arrangement with Company A was to allow
Company B to utilize Company A’s experienced sales force with
extensive knowledge of the Japanese market. Company B does
not have a presence in Japan.
For costs incurred and revenue generated from third parties,
the participant in a collaborative arrangement that is deemed
to be the principal participant for a given transaction under
[ASC] 605–45 shall record that transaction on a gross basis in its
financial statements [ASC 808–10–45–2].
Payments between participants pursuant to a collaborative
arrangement that are within the scope of other authoritative
accounting literature on income statement classification shall
be accounted for using the relevant provisions of that literature.
If the payments are not within the scope of other authoritative
accounting literature, the income statement classification for
the payments shall be based on an analogy to authoritative
accounting literature or if there is no appropriate analogy, a
reasonable, rational, and consistently applied accounting policy
election [ASC 808–10–45–3].
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Sales and Marketing
42. Presentation of co-marketing income (continued)
How should Company B present
the co-marketing income it
receives from Company A in its
financial statements? 
Solution
Company B first needs to evaluate whether the co-marketing agreement represents a collaborative arrangement between two
parties who are both active participants in the activity and exposed to significant risks and rewards dependent on the commercial
success of the activity.
In this case, Company B concluded that the co-marketing agreement is not a collaborative arrangement since Company A is not an
active participant in the arrangement. In particular, Company A was not involved in the research and development of Compound Y;
it did not participate on a steering committee or other oversight or governance mechanism, nor does it have a legal right to the
underlying intellectual property.
Since the co-marketing agreement is not a collaborative arrangement, the agreement represents an arrangement between
third parties and Company B’s accounting for its co-marketing income will depend on whether it is the principal or agent in the
arrangement based on the factors in ASC 605–45–45–2. In this case, Company B determines that Company A is the principal for
sales in the Japanese market. Therefore, Company B should recognize 100% of the sales of Compound Y to Company A as sales
revenue and the corresponding costs of production as cost of sales. The co-marketing income, at 20% of Company A’s sales, would
typically be presented as royalty income and disclosed separately as a component of revenue, if material.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
43.Presentation of co-marketing expenses
Background
Relevant guidance
Company A and Company B have entered into a co-marketing
agreement for Compound Y. Compound Y was developed solely
by Company B and recently received approval from the regulatory
authorities to be sold. Under the terms of the agreement,
Company A has made an upfront payment to Company B to obtain
an exclusive marketing right for Compound Y in Japan.
A collaborative arrangement is a contractual arrangement
that involves a joint operating activity. These arrangements
involve two (or more) parties who are both active participants
in the activity and exposed to significant risks and rewards
dependent on the commercial success of the activity
[FASB Codification Glossary].
Company B will manufacture the product and sell it to
Company A. Company A will also pay Company B 20% of its
net sales of Compound Y. The promotion and commercialization
of drugs are Company A’s main activities, although in this case
they are performed jointly with a third party.
Participants in a collaborative arrangement shall report
costs incurred and revenue generated from transactions
with third parties (that is, parties that do not participate
in the arrangement) in each entity’s respective income
statement pursuant to the guidance in [ASC] 605–45…
[ASC 808–10–45–1].
The primary purpose for Company B entering into the
co-marketing arrangement with Company A was to allow
Company B to utilize Company A’s experienced sales force with
extensive knowledge of the Japanese market. Company B does
not have a presence in Japan.
For costs incurred and revenue generated from third parties,
the participant in a collaborative arrangement that is deemed
to be the principal participant for a given transaction under
[ASC] 605–45 shall record that transaction on a gross basis in its
financial statements [ASC 808–10–45–2].
Payments between participants pursuant to a collaborative
arrangement that are within the scope of other authoritative
accounting literature on income statement classification shall
be accounted for using the relevant provisions of that literature.
If the payments are not within the scope of other authoritative
accounting literature, the income statement classification for
the payments shall be based on an analogy to authoritative
accounting literature or if there is no appropriate analogy,
a reasonable, rational, and consistently applied accounting
policy election [ASC 808–10–45–3].
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Sales and Marketing
43. Presentation of co-marketing expenses (continued)
How should Company A present its
co-marketing inflows and outflows
in its income statement? 
Solution
Company A first needs to evaluate whether the co-marketing agreement represents a collaborative arrangement between two
parties who are both active participants in the activity and exposed to significant risks and rewards dependent on the commercial
success of the activity.
In this case, Company A concluded that the co-marketing agreement was not a collaborative arrangement since it was not an
active participant in the arrangement. Company A was not involved in the research and development of Compound Y, there is
no participation by Company A on a steering committee or other oversight or governance mechanism, and it has no legal right
to the underlying intellectual property. In addition, Company A was not exposed to significant risks and rewards as part of this
arrangement since Compound Y was approved for sale by the regulatory authorities prior to the execution of the co-marketing
agreement and the rewards that Company A can obtain are limited to the Japanese market.
Since the co-marketing agreement is not a collaborative arrangement, the agreement represents an arrangement between third
parties and Company A’s accounting for its co-marketing expenditures will depend on whether it is the principal or agent in the
arrangement based on the factors in ASC 605–45–45–2. If Company A determines it is the principal for sales in the Japanese
market, Company A should present the payments received from customers as sales revenue, and the cost of purchasing Compound Y
from Company B as inventory and then cost of goods sold. The co-marketing amounts paid to Company B, 20% of net sales of
Compound Y, represent a royalty in return for the product rights in that territory and should be presented as cost of goods sold.
If Company A determined it was the agent in the Japanese market, it would recognize revenue calculated as payments due from
customers less payments owed to Company B.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
44.Accounting for a sales based milestone payment
Background
Relevant guidance
Company A acquires the intellectual property rights to one of
Company B’s completed compounds for an upfront cash payment
of $15 million and agrees to make an additional one time sales
based milestone payment of $10 million if and when sales for
the related product in any one year reach a specified sales target
level. In this case, Company A has determined that the transaction
does not constitute a business and, therefore, will account for
it as an asset acquisition. The sales based milestone payment,
if made, does not entitle Company A to additional intellectual
property rights beyond those already obtained in the initial asset
acquisition. Rather, the payment is in effect a one-time royalty
since it is due to Company B for the achievement of a specified
sales level.
An estimated loss from a contingency shall be accrued by a charge
to income if both of the following conditions are met:
Company A capitalizes the $15 million payment made to acquire
the IP rights since the rights relate to a completed compound and
the cost is considered recoverable based on expected future cash
flows. The useful life of the intellectual property rights is 15 years
and Company A begins amortizing $1 million per year. At the
end of the third year, following a significant uptick in sales of the
product, it becomes probable that the specified sales level will be
met the following year.
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• Information available before the financial statements are
issued or are available to be issued . . . indicates that it is
probable that an asset had been impaired or a liability had
been incurred at the date of the financial statements. . . .
• The amount of loss can be reasonably estimated
[ASC 450–20–25–2].
A lessee shall recognize contingent rental expense . . . before the
achievement of the specified target that triggers the contingent
rental expense, provided that achievement of that target is
considered probable [ASC 840-10-25].
Sales and Marketing
44. Accounting for a sales based milestone payment (continued)
How should Company A account
for the $10 million sales based
milestone payment? 
Solution
Company A follows a practice of accruing the sales based milestone payment when it becomes probable that it will be paid. The
obligation to make the milestone payment, while contingent on the company reaching a specified sales level, is considered to be
established on the date the agreement to make the payment is entered into. Accordingly, at that date Company A concludes that it
has a contractual contingent obligation, based on having received the intellectual property license rights, and accrues the additional
amount when payment is no longer contingent. In this case, that occurred when it became probable that the payment will be made.
After concluding that the sales based milestone should be accrued, Company A would then consider the economics of the
arrangement to determine the expense recognition pattern. Because $25 million is the total consideration paid for the intellectual
property rights, it would be appropriate to adjust the carrying value of the intellectual property rights on a cumulative catch-up
basis as if the additional amount that is no longer contingent had been accrued from the outset of the arrangement when the
obligation for that amount was established. Accordingly, Company A would immediately expense 20% (3 out of 15 years) of the
$10 million sales based milestone and capitalize the remainder of the payment. At the end of the third year, Company A would have
expensed an aggregate of $5 million, and $20 million remains capitalized on the balance sheet. Alternatively, if the economics of
the arrangement were such that the payment appeared to be the equivalent of an additional royalty to be paid annually, it would be
appropriate to expense the $10 million payment over the relevant annual period. This might be the case, for example, if there were
similar sales based milestone targets in each year of the arrangement.
As a general rule, a view to amortize the $10 million payment prospectively over the remaining term (twelve years in this
example) would only potentially be supportable if the payment was in exchange for additional intellectual property rights under
the arrangement.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
45.Accounting for the cost of free samples
Background
Relevant guidance
Company A is eager to increase knowledge of its new generic pain
medication within hospitals. Accordingly, Company A’s sales force
distributes free samples of the pain medication during sales calls
and at certain hospital conventions.
If the consideration consists of a free product or service… or
anything other than cash… or equity instruments…, the cost
of the consideration should be characterized as an expense
(as opposed to a reduction of revenue) when recognized in
the vendor’s income statement. That is, the free item is a
deliverable in the exchange transaction and not a refund or
rebate of a portion of the amount charged to the customer
[ASC 605–50–45–3].
How should Company A classify
and account for the costs of free
product distributed in order to
promote sales? 
Solution
The cost of product distributed for free and not associated with any specific sale transaction should be classified as an expense
according to the Company’s policy, which would generally be either marketing expense or cost of sales. Company A should account
for the sample product to be given away at conventions and during sales calls as an expense in accordance with its policy, which
would generally be either when the product is packaged as sample product or upon distribution of the sample.
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Healthcare Reform
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
46.Accounting for the annual pharmaceutical manufacturers fee
Background
Relevant guidance
The Patient Protection and Affordable Care Act, which was
signed into law in the US in 2010, imposes an annual fee on
pharmaceutical companies that manufacture or import branded
prescription drugs for each calendar year beginning on or after
January 1, 2011. The determination of an entity’s relative portion
of the fee is based on the entity’s branded prescription drug
sales for the preceding year as a percentage of the industry’s
branded prescription drug sales for the same year. Company A,
a pharmaceutical manufacturer that sells branded prescription
drugs to the US government, calculates its annual fee for the year
ending December 31, 20X3 to be $4 million.
This Subtopic provides guidance on the annual fee paid by
pharmaceutical manufacturers to the U.S. Treasury in accordance
with the Patient Protection and Affordable Care Act…
[ASC 720-50-05-1].
How should Company A
record the $4 million in its
financial statements? 
Solution
Company A would record a $4 million liability, and a corresponding deferred cost, once it sells a branded prescription drug to the
US government in 20X3, which thereby obligates it to pay the annual fee. The deferred cost would typically be amortized to the
income statement as an operating expense over the calendar year that it is payable (e.g., over the course of 20X3 for the 20X3 fee)
using a straight-line method.
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Healthcare Reform
47.Accounting for the Medicare coverage gap
Background
Relevant guidance
The Patient Protection and Affordable Care Act, which was
signed into law in the US in 2010, requires pharmaceutical
manufacturers to fund 50% of the Medicare coverage gap,
starting on January 1, 2011. Pharmaceutical manufacturers are
required to provide discounted products to applicable Medicare
beneficiaries receiving covered Part D drugs while in the
Medicare coverage gap.
The existing guidance on contingent sales incentives in
ASC 605–50, Customer Payments and Incentives, is the most
analogous guidance with respect to the Medicare coverage gap.
What accounting models can
Company A, a pharmaceutical
manufacturer, utilize to account for
sales made that are affected by the
Medicare coverage gap? 
Solution
There are two models that Company A can utilize to account for the Medicare coverage gap: (i) the spreading model or (ii) the
point of sale model. The model chosen by Company A represents an accounting policy election that should be consistently applied.
Spreading Model
Under the spreading model, the estimated impact of the coverage gap rebate expected to be incurred for the annual period is
recognized ratably using an effective rebate percentage for all sales to Medicare patients throughout the year. If Company A elects
to use the spreading model, appropriate estimates of both the impact of the Medicare coverage gap rebate and its total expected
applicable sales will need to be made as both amounts are needed to compute the effective rebate percentage.
Point of Sale Model
Under the point of sale model, the revenue reduction is recognized at the time the specific sales of drugs into the channel occur that
are expected to ultimately be resold to Medicare patients who are in the coverage gap. If Company A elects to use the point of sale
model, it will need to estimate when the specific sales to Medicare patients who are in the coverage gap will occur, and consider
both its pharmaceutical products, as well as other pharmaceutical products that its typical end consumer may be acquiring to
determine the specific timing of when the end consumer is likely to enter into the coverage gap.
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Revenue recognition—
Multiple element arrangements
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Revenue recognition—Multiple element arrangements
48.Multiple element arrangements—Assessing standalone value
Background
Relevant guidance
Company A, a biotechnology company, enters into an
arrangement with Company B, a pharmaceutical company.
Company A provides Company B with a license to its intellectual
property. Company B agrees to perform research services and
will participate on a joint steering committee. Company B
pays Company A an upfront payment at the inception of the
arrangement when the license is delivered to Company B.
Company A delivered the license to Company B in the
first quarter.
In an arrangement with multiple deliverables, the delivered item
or items shall be considered a separate unit of accounting if both
of the following criteria are met:
• The delivered item or items have value to the customer
on a standalone basis. The item or items have value on a
standalone basis if they are sold separately by any vendor
or the customer could resell the delivered item(s) on a
standalone basis. In the context of a customer’s ability to
resell the delivered item(s), this criterion does not require
the existence of an observable market for the deliverable(s)…
• If the arrangement includes a general right of return
relative to the delivered item, delivery or performance of
the undelivered item or items is considered probable and
substantially in the control of the vendor
[ASC 605–25–25–5].
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
48. Multiple element arrangements—Assessing standalone value (continued)
What factors should Company A
consider when assessing
whether a delivered item has
standalone value? 
Solution
Company A should assess the following in determining whether a delivered item has standalone value:
• Whether similar deliverables are sold separately by any vendor
• Whether a customer could resell the deliverables (e.g., considering legal restrictions that preclude resale)
• Whether a hypothetical customer would use the deliverable for its intended or another productive purpose (a deliverable that
could only be sold for scrap value would not be considered to have standalone value).
When a customer can resell a deliverable or sublicense its rights to the deliverable for a reasonable amount of consideration,
the assessment that the delivered item has standalone value is driven by the fact that the customer or a third party could derive
economic benefit from the delivered item. When there is not a secondary market, companies will have to use judgment to determine
whether it could resell the delivered item for reasonable consideration on a standalone basis. The assessment should consider
whether the company could recover a significant portion of its original purchase price in a hypothetical sale (rather than only
for salvage or scrap value). If it could resell or sublicense the deliverable for reasonable consideration, it would be appropriate to
conclude that there is standalone value for the delivered item.
Another factor that impacts if a delivered item has standalone value is whether the research services are required to be performed
by the vendor or if they could be performed by a third party. If the vendor must perform the research services because it has
proprietary know-how or specialized expertise that another vendor is not able to provide, the delivered item might not have
standalone value. If the research services do not require any specialized expertise, and could be performed by a third party, this
might indicate that the delivered item has standalone value separate from the research services.
Whether a delivered item has standalone value could also be impacted by contractual rights that prohibit a company from
transferring the delivered item. Such legal restrictions are common in the pharmaceutical and life sciences industries. Companies
need to consider all relevant facts and circumstances when there is a legal restriction before concluding whether a delivered item
has standalone value. If a customer could exploit the delivered item through its own use or development, it may be appropriate to
conclude the item has standalone value, regardless of whether a transfer restriction exists. In instances where additional services
can only be obtained from the vendor in order for the customer to exploit the delivered item, this is an indicator that standalone
value may not exist.
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Revenue recognition—Multiple element arrangements
49.Multiple element arrangements—Determining best estimate of selling price
Background
Relevant guidance
Company A enters into an arrangement that includes a license,
research services, and a participatory joint steering committee.
Each of these deliverables is a separate unit of account. Vendorspecific objective evidence or third-party evidence of the
standalone selling prices of these items does not exist.
Arrangement consideration shall be allocated at the inception of
the arrangement to all deliverables on the basis of their relative
selling price (the relative selling price method)… When applying
the relative selling price method, the selling price for each
deliverable shall be determined using vendor-specific objective
evidence of selling price, if it exists; otherwise, third-party
evidence of selling price… If neither vendor-specific objective
evidence nor third-party evidence of selling price exists for a
deliverable, the vendor shall use its best estimate of the selling
price for that deliverable… when applying the relative selling
price method [ASC 605-25-30-2].
How would Company A determine
its best estimate of selling
price for the license, research
services, and a participatory joint
steering committee? 
Solution
License
The appropriate model for estimating the selling price will depend on the nature of and specific rights associated with the license.
Historically, models have been used with respect to valuation for tax or business combination purposes that might be useful in
making this estimate. For example:
Income approach
Examples of the income approach include the discounted cash flow method and the transfer pricing or profit split method. Key
areas of judgment in this approach may include: cash flow projections, risk adjustment for stage of development, discount rate
selection, and level of expected returns.
Cost approach
In applying a cost approach, companies should consider costs incurred to date in developing the intellectual property and an
amount that constitutes a reasonable profit margin or return on investment. Key areas of judgment in this approach may include
identifying relevant direct or indirect costs and determining the appropriate return rate.
Because the income approach relies heavily on cash flow projections, it may be more relevant in instances where a license is already
in use or is expected to be exploited within a relatively short timeframe. Alternatively, the cost approach may be more relevant to
licenses in the early stage of their life cycle, where reliable forecasts of revenue or cash flows may not exist.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
49. Multiple element arrangements—Determining best estimate of selling price (continued)
Solution (continued)
Research services
Many companies may consider the amount of effort necessary to perform research services as the most appropriate unit of
measurement. This might include cost rates for full time equivalent (FTE) employees and the expected amount of resources to
be committed. Key areas of judgment regarding pricing may include: selection of FTE rates for different levels of commitment or
experience, inclusion of appropriate levels of profit margin, and comparisons to similar services offered in the marketplace. Key
areas of judgment regarding quantity may include: estimated total number of FTE hours, potential contractual requirements and
the estimated period over which the development process will occur.
Joint steering committee
Steering committees, as well as certain upgrade rights, were not historically valued by many companies due to the fair value
requirement of the prior accounting guidance, thus, the inclusion of these deliverables in an arrangement often resulted in either
full deferral or ratable revenue recognition. Companies may find valuing these items particularly challenging as it may be difficult
to determine the expected level of hours to be incurred and rates to be used. Depending on the nature of the services, some
companies may determine that steering committee efforts include time related to meeting preparation, attending the steering
committee meetings, and working on any follow-up matters that result from the meetings. In addition, examples (not all inclusive)
of information that might be considered when establishing rates may include an evaluation of compensation paid to individuals of
similar experience or fees paid to consultants on an advisory board. These assessments will need to consider the specific facts and
circumstances in each arrangement.
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Revenue recognition—Multiple element arrangements
50.Multiple element arrangements—Substantive options
Background
Relevant guidance
Company A enters into an arrangement to provide Company B
with a license to use its intellectual property for a single
indication. Company A also provides Company B with an option
during the term of the arrangement to purchase additional
indications if the intellectual property is effective for any other
indications. The option has not been offered at a significant
incremental discount.
A vendor shall evaluate all deliverables in an arrangement
to determine whether they are separate units of accounting.
That evaluation shall be performed at the inception of the
arrangement and as each item in the arrangement is delivered
[ASC 605-25-25-4].
How should Company A evaluate the
option it provided to Company B? 
Solution
Notional options for a customer to purchase additional products or services at agreed-upon prices in the future should be treated
as deliverables if the option is not substantive and the customer is essentially obligated to purchase the optional items. When
determining whether an option is substantive, a company should evaluate if the exercise of that option represents a separate
buying decision.
Even when an option is substantive, a company needs to evaluate whether that option has been offered at a significant incremental
discount. When it is, the “in-the-money option” would be considered a separate deliverable requiring a portion of the arrangement
consideration to be deferred at inception. For example, an option to buy unrelated additional products or services at a price equal
to fair value may be a separate buying decision and, if so, would not be a deliverable in the original arrangement. However, if the
additional products or services are essential to the functionality of another deliverable in the arrangement, and no other vendor
could provide the necessary products or services, the customer would effectively be required to exercise the option and, therefore,
it would not be considered a substantive option. In such a case, the products or services to be delivered upon the exercise of that
option would be accounted for as a deliverable in the original arrangement.
Customer B appears to have sole discretion when, or if, to exercise the option. In addition, the option is not being offered at a
“significant incremental discount,” nor is the option essential to the functionality of the current deliverable. The decision to exercise
the option is therefore a separate economic purchasing decision by Company B and the option would not be a deliverable in the
original arrangement.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
51.Accounting for a multiple element arrangement—Scenario 1
Background
Relevant guidance
Company A, a biotechnology company, enters into a license
arrangement with Company B, a pharmaceutical company,
to jointly develop a potential drug that is currently in Phase II
clinical trials. As part of the arrangement, Company A agrees
to provide Company B a perpetual license to Company A’s
proprietary intellectual property. Company A also agrees to
provide research and development services to Company B to
develop the potential drug. The research and development
services provided by Company A could be provided by another
company. As a result, there are two deliverables in this
arrangement: a license and research and development services.
Arrangement consideration shall be allocated at the inception of
the arrangement to all deliverables on the basis of their relative
selling price (the relative selling price method)…
[ASC 605-25-25-4].
Company A receives an upfront payment of $20 million at the
inception of the arrangement and is eligible to receive milestone
payments of $10 million at the commencement of the Phase III
clinical trial and $25 million upon regulatory approval.
What consideration should be included in
the initial relative selling price allocation? 
Solution
In making this assessment, Company A needs to consider which payments are fixed or determinable at the inception of the
arrangement. It is common for arrangements in the pharmaceutical and life sciences industries to include contingent consideration
such as milestone payments. These and other similar types of additional arrangement consideration need to be carefully assessed
before being included in the arrangement consideration at the inception of an arrangement.
In this case, Company A concludes that there are two deliverables in the arrangement: a license and research and development
services. Further, Company A views all consideration aside from the upfront payment to be contingent at the inception of the
arrangement, such that only the upfront fee is fixed or determinable at the inception of the arrangement. Based on the estimated
selling price for the two deliverables, the following represents the initial relative selling price allocation (in millions):
Estimated Selling Price
Relative Selling Price Allocation
License
$30
$20 x 75% ($30/$40) =
$15
Research and
development services
$10
$20 x 25% ($10/$40) =
$5
$40
$20
Company A determined that the license has stand alone value because the research services could be completed by other vendors.
As the license has standalone value, Company A recognizes $15 million upon delivery of the license and will recognize revenue for
the research and development services as the services are performed. As Company A achieves the subsequent milestones, it would
allocate them to both the delivered and nondelivered items within the arrangement given the Company has not made the election
to apply the milestone method of revenue recognition.
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Revenue recognition—Multiple element arrangements
52.Accounting for a multiple element arrangement—Scenario 2
Background
Relevant guidance
Company A, a biotechnology company, enters into a license
arrangement with Company B, a pharmaceutical company, to
develop the technology for a possible drug indication for a term of
15 years. In exchange for an upfront, non-refundable payment of
$50 million from Company B and future royalty payments if and
when the drug is sold, Company A agrees to:
Where there are multiple elements within an arrangement, a
determination of the units of accounting needs to be made in
accordance with ASC 605–25, Revenue Recognition—Multiple
Element Arrangements.
• Grant a license to Company A’s proprietary intellectual
property to Company B, which gives Company B the right
to develop the drug indication, manufacture the drug, and
market and distribute the drug. The intellectual property
cannot be sublicensed by Company B.
• Perform research and development services for Company B.
• Manufacture the active pharmaceutical ingredient of the
drug during the clinical trials for Company B during the term
of the arrangement. (Company B is capable of manufacturing
the active pharmaceutical ingredient itself.)
How should Company A separate
the various deliverables into
multiple units of account? 
In an arrangement with multiple deliverables, the delivered item
or items shall be considered a separate unit of accounting if both
of the following criteria are met:
• The delivered item or items have value to the customer
on a standalone basis. The item or items have value on a
standalone basis if they are sold separately by any vendor
or the customer could resell the delivered item(s) on a
standalone basis. In the context of a customer’s ability to
resell the delivered item(s), this criterion does not require the
existence of an observable market for the deliverable(s)…
• If the arrangement includes a general right of return
relative to the delivered item, delivery or performance of
the undelivered item or items is considered probable and
substantially in the control of the vendor [ASC 605-25-25-5].
A vendor shall evaluate all deliverables in an arrangement to
determine whether they represent separate units of accounting.
This evaluation shall be performed at the inception of the
arrangement and as each item in the arrangement is delivered
[ASC 605-25-25-4].
Solution
The license to Company A’s intellectual property would be the first delivered element. Company A will evaluate whether the license
to the intellectual property has standalone value. Typically a license is not sold separately (i.e., without any other elements). Some
arrangements allow the customer to sublicense, or resell the rights, which is an indicator that the license has standalone value.
However, a careful read of the contract is necessary to determine whether the right to sublicense is substantive and not a limited
right. If the customer is prohibited from reselling or sublicensing its right to the license, or if the right to sublicense is limited, it may
indicate that the license does not have standalone value.
This arrangement also includes ongoing research and development activities. When the customer is contractually required to use
the seller for ongoing research and development or other services, a license will have standalone value only if the customer would
(hypothetically) be able to reap the benefits from the license without further involvement from the seller. If only the seller has the
requisite technical capabilities to perform the services, that would suggest the license does not have standalone value.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
52. Accounting for a multiple element arrangement—Scenario 2 (continued)
Solution (continued)
In assessing whether the customer could develop the technology without the seller’s involvement, the experience and capabilities of
the customer and the stage of development of the technology should be considered. A license to technology can mean many things,
and understanding the rights associated with the license is key to the analysis. Is the customer purchasing all rights associated with
the technology, including rights to develop, manufacture, and commercialize the license? Or is the customer obtaining only limited
rights? Do these rights revert to the vendor under any circumstances? It is important to have an accurate understanding of these
factors in order to properly evaluate if the license has standalone value.
In this fact pattern, Company A concludes the license to the intellectual property does not have standalone value apart from
the research and development services because of its unique know-how with respect to the services and the inability of the
counterparty to sublicense the intellectual property. However, the combined license to the intellectual property and research
and development services collectively has standalone value from the manufacturing services because Company B has the right to
manufacture the drug or outsource it to another manufacturer. The arrangement would be treated as having two separate units
of accounting, one being the combined license to the intellectual property and research and development services, and the other
being the manufacturing services. The total arrangement consideration would be allocated to each separate unit of accounting
using the relative selling price method. The revenue recognition pattern for each unit of accounting would need to reflect the
earnings process of all the deliverables in each unit of accounting.
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Revenue recognition—Milestone method
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
53.Milestone method of revenue recognition
Background
Relevant guidance
Company A has entered into an arrangement with Company B
whereby Company A has agreed to provide to Company B a
license to its intellectual property and perform future research
and development. In return, Company B has paid Company A
an upfront payment of $10 million and may pay Company A
additional amounts in the aggregate of up to $100 million,
dependent upon the successful achievement of specified
milestones, as follows:
The guidance in this Subtopic shall be met in order for a
vendor to recognize… consideration that is contingent upon
the achievement of a substantive milestone in its entirety [as
revenue] in the period in which the milestone is achieved
[ASC 605–28–25–1].
• $25 million upon commencement of Phase II clinical trials
If the consideration from an individual milestone is not
considered to relate solely to past performance, the vendor is not
precluded from using the milestone method for other milestones
in the arrangement [ASC 605–28–25–3].
• $25 million upon first patient enrollment in Phase III
clinical trials
• $50 million upon regulatory approval
Company A has concluded that the license is not separable
from the research and development activities. Company A
has made the policy election to apply the milestone method
of revenue recognition.
How should Company A
account for the contingent
milestone consideration
under the arrangement? 
Solution
The proper timing of revenue recognition depends on whether the milestones in the arrangement are substantive. This
determination should be made at the inception of the arrangement. To be substantive, the consideration must (a) be commensurate
with either (i) the vendor’s performance to achieve the milestone or (ii) the enhancement of the value of the delivered item or
items as a result of a specific outcome resulting from the vendor’s performance to achieve the milestone; (b) relate solely to past
performance; and (c) be reasonable relative to all of the deliverables and payment terms (including other potential milestone
consideration) within the arrangement [ASC 605-28-25-2].
Each milestone must be analyzed separately to determine whether it meets the criteria to be considered substantive. If Company A
decides the milestones are substantive, such milestones would be recognized as revenue in full in the period in which the
milestones were achieved.
If a milestone payment is not substantive, that milestone payment may be treated as additional arrangement consideration. If the
multiple element arrangement is treated as a single unit of accounting, the non-substantive milestone will be allocated to the single
unit of accounting. If, however, the multiple element arrangement meets the criteria for separating deliverables and deliverables
are accounted for as separate units of accounting, the non-substantive milestone will be allocated to all deliverables using the
relative selling price method.
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Revenue recognition—Milestone method
54.Milestone method of revenue recognition—Sales based milestones
Background
Relevant guidance
Company A has made the accounting policy election to apply
the milestone method of revenue recognition to any substantive
milestones that are achieved. In the current year, Company A
entered into an arrangement with Company B whereby
Company A has agreed to provide to Company B a license to
use its intellectual property. In return, Company B has paid
Company A an upfront fee of $10 million and will pay Company A
an additional $20 million if Company B’s annual sales exceed
$250 million.
The guidance in this Subtopic shall be met in order for vendor
to recognize… consideration that is contingent upon the
achievement of a substantive milestone in its entirety [as
revenue] in the period in which the milestone is achieved
[ASC 605–28–25–1].
If the consideration from an individual milestone is not
considered to relate solely to past performance, a vendor is not
precluded from using the milestone method for other milestones
in the arrangement [ASC 605–28–25–3].
How should Company A account
for the contingent milestone
consideration of $20 million? 
Solution
The $20 million milestone represents a sales based milestone that is similar to a royalty. Sales based milestones generally do not fall
within the scope of ASC 605–28 since the achievement of the targeted sales levels is not based in whole or in part on the vendor’s
performance and is not a research or development deliverable.
In most situations, all contingencies associated with sales based milestones have been resolved upon receipt of the sales based
milestone and no remaining performance obligations exist relating to the payment. As a result, sales based milestones could
be recognized in revenue when earned. However, if the vendor has remaining obligations to the customer at the time the sales
based milestone is achieved, the consideration received from the sales based milestone may need to be combined with any other
arrangement consideration and allocated to the deliverables in the arrangement.
In this example, Company A has no remaining obligations after the initial license is provided to Company B. As a result, when the
sales based milestone is achieved, Company A would recognize the full amount of the sales based milestone in revenue.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
55.Recording a milestone payment due to a counterparty
Background
Relevant guidance
Company A entered into an arrangement with Company B.
Company A paid Company B an upfront fee upon signing the
arrangement and will pay Company B a milestone payment of
$2 million upon Food and Drug Administration (“FDA”) approval.
An estimated loss from a loss contingency shall be accrued by a
charge to income if both of the following conditions are met:
Company A follows a practice of accruing contingent
payments when they become probable of being paid. Their
accounting is supported by the loss contingency guidance and is
also consistent with the guidance on contingent rentals.
• Information available before the financial statements are
issued or are available to be issued… indicates that it is
probable that an asset had been impaired or a liability had
been incurred at the date of the financial statements.
• The amount of the loss can be reasonably estimated
[ASC 450-20-25].
A lessee shall recognize contingent rental expense… before the
achievement of the specified target that triggers the contingent
rental expense, provided that achievement of that target is
considered probable [ASC 840-10-25].
When should Company A record
the milestone payment due to
Company B? 
Solution
The milestone payment is due under the contractual terms of the agreement based upon the resolution of a contingency. Under
Company A’s practice, it accrues the milestone payment when the achievement of the milestone is probable. Once Company A
concludes that the milestone payment due to Company B is probable of occurring, the amount of the payment ($2 million) would
be recorded in the financial statements.
Due to the uncertainties associated with the FDA approval process, it may be difficult for Company A to conclude that achievement
of this particular milestone is probable prior to the occurrence of the event that triggers the milestone (e.g., FDA approval). All
facts and circumstances regarding the nature of the milestone should be considered when evaluating when the achievement of a
milestone is probable.
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Revenue recognition—General
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
56.Revenue recognition for a newly launched product
Background
Relevant guidance
Company A, a calendar year-end company, received approval
from the Food and Drug Administration (“FDA”) for Product X,
a treatment for hepatitis C, on October 15, 20X2. Commercial
launch of the product occurred on December 1, 20X2. Company A
distributes Product X through a wholesale distribution model
to pharmacies, healthcare providers, and government agencies,
among others. Company A has implemented a general return
policy that allows customers to return product purchased directly
from Company A during a period of six months prior to and up to
12 months after the product expiration date.
If an entity sells its product but gives the buyer the right to
return the product, revenue from the sales transaction shall be
recognized at time of sale only if all of the following conditions
are met:
Company A maintains contractual agreements with all customers.
The contractual terms of the agreements state that ownership
transfers at the point of shipment and that Company A has no
future performance obligations following shipment. Company A
has analyzed the credit worthiness of its customers and concluded
that there are no factors that give rise to uncertainty regarding
collection of amounts due. Product X is the first product to be
commercialized by Company A and, therefore, Company A has no
actual returns history and no historical experience in estimating
future returns.
• The buyer’s obligation to the seller would not be changed
in the event of theft or physical destruction or damage of
the product.
• The seller’s price to the buyer is substantially fixed or
determinable at the date of sale.
• The buyer has paid the seller, or the buyer is obligated to pay
the seller and the obligation is not contingent on resale of
the product…
• The buyer acquiring the product for resale has economic
substance apart from that provided by the seller…
• The seller does not have significant obligations for future
performance to directly bring about resale of the product by
the buyer.
• The amount of future returns can be reasonably estimated…
[ASC 605–15–25–1].
Should Company A recognize
revenue at the time of shipment? 
Solution
The ability to recognize revenue in this case depends on Company A’s ability to estimate future returns. The lack of historical
experience is a key data point in the determination, but it is not the only data point to be considered and therefore does not
automatically preclude revenue recognition at the time of sale. Instead, Company A must evaluate all sources of available
information, including internal data (e.g., product return policy, product shelf life, and estimates of inventory sold into the
distribution channel) as well as external data (e.g., estimated wholesaler inventory levels, estimated market demand, history of
returns of comparable products, etc.) to determine whether adequate information exists to develop a reasonable estimate of future
returns. If Company A is unable to make a reasonable estimate of returns, it would be precluded from recognizing revenue until (i)
the product is sold through to the end customer, (ii) the returns window lapses or (iii) adequate information becomes available.
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Revenue recognition—General
57.Pay-for-performance arrangements
Background
Relevant guidance
Company A manufactures, markets, and sells Drug B to a
hospital. The hospital administers Drug B to its patients. When
Drug B is shipped to the hospital, the hospital is obligated to pay
Company A under normal 30-day payment terms. However, if
after a defined treatment period of three months, patients’ test
results do not meet pre-determined objective criteria, the hospital
is eligible for a full refund for the administered product from
Company A. The hospital has two months after the treatment
period to process the request for refund (i.e., a total of five
months after the initial treatment).
Company A would look to guidance on estimating returns in
ASC 605–15–25, Sales of Product when Right of Return Exists,
when concluding whether future refunds can be reasonable
estimated. This evaluation would include whether there is
a sufficient company specific historical basis upon which to
estimate the refunds and whether the company believes that
such historical experience is indicative of future results.
Company A obtained Food and Drug Administration (“FDA”)
approval for Drug B two years ago, and began selling Drug B
immediately to the hospital. Over the past two years, Company A
and the hospital have been tracking the number of patients whose
post-treatment test results did not meet the pre-determined
criteria, and it has consistently ranged from 6–7% on a monthly
and annual basis. Based on the nature of this drug as well
as the relatively consistent patient results over the past two
years, Company A expects future refunds to be consistent with
historical results.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
57. Pay-for-performance arrangements (continued)
Can Company A record revenue
at the time of the initial sale,
with a reserve for the portion
of sales that it expects will not
meet the pre-determined criteria,
or should it defer all revenue
until the end of the refund period
(i.e., until five months after the
initial treatment)? 
Solution
If Company A can demonstrate it has sufficient historical evidence to support its estimates, it may elect to record revenue at the time
of sale along with a reserve for the portion of sales that will be refunded because they are not expected to meet the pre-determined
criteria, assuming all other revenue recognition criteria are met. Notwithstanding the above, Company A could continue to defer
recognition of the revenue until the contingency has lapsed. This is an accounting policy decision that should be consistently
applied and disclosed.
It should be noted that slight variations from the facts presented above may cause the model to change and preclude revenue
recognition before resolution of the performance contingency.
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Revenue recognition—General
58.Revenue recognition to customers with a history of long delays in payment
Background
Relevant guidance
Company A, a pharmaceutical company, sells to a governmental
entity in a country in Europe. Company A has historically
experienced long delays in payment for sales to this entity due
to slow economic growth and high debt levels in the country.
Company A currently has outstanding receivables from sales to
this entity over the last three years and continues to sell product
at its normal market price. The receivables are non-interest
bearing.
In order to be able to recognize revenue, a company must
conclude that it meets the four revenue recognition criteria in
ASC 605, Revenue Recognition:
• Persuasive evidence or an arrangement exists
• Delivery has occurred or services have been rendered
• The seller’s price to the buyer is fixed or determinable
• Collectibility is reasonable assured
The SEC’s Division of Corporation Finance guidance,
issued in January 2012, regarding European sovereign
debt holding disclosures.
How should Company A
account for the outstanding
receivables and future sales to
the governmental entity in this
country in Europe? 
CF Disclosure Guidance Topic No. 4 provides the Division of
Corporation Finance’s views regarding disclosure relating to
registrant’s exposures to European countries. It was determined
that SEC registrants’ disclosures have been inconsistent, and
that investors would benefit from additional disclosure of total
exposures to European countries.
Solution
It may be difficult in the current environment for Company A to determine whether its price to the governmental entity is fixed or
determinable or if collectibility is reasonably assured. This is particularly the case when customers have stopped paying for sales
on a timely basis or have demanded significant reductions in selling price as a condition to settle past invoices. Slow payment may
not necessarily preclude revenue recognition; however, it may impact the amount of revenue that can be recognized because the
receivable may need to be discounted at initial recognition. Revenue should not be recognized if collectibility is not reasonably
assured, or the amount of discounts and allowances (either due to potential price adjustments or to discounting for the time value
of money) cannot be reasonably estimated.
If Company A determines that it meets the four revenue recognition criteria, it will then need to evaluate whether it can record
revenue for the entire amount of the sale or for a discounted amount. If Company A did not expect to receive payment for a period
greater than one year, it would need to discount current sales transactions (i.e., sales are recorded net of the discount) for this
specific customer that has an established pattern of not paying amounts owed on a timely basis. The amount of the discount
applied, which relates to the time value of money, is based on the estimated collection date and the customer’s borrowing rate.
Company A should determine if additional financial statement disclosure is necessary surrounding concentration or risk. This may
include: (i) volume of business transacted in a particular market or geographic area; (ii) impact on liquidity; and (iii) discussion of
counterparty default risk. Company A should also consider qualitative factors in deciding whether its exposure to Europe sovereign
government is material.
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Business combination
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Business combination
59.Asset Acquisition versus Business Combination
Background
Relevant guidance
Company A owns the right to several drug compound candidates
that are currently in Phase I. Company A’s activities consist
of research and development that is being performed on the
early stage drug compound candidates. Company A employs
management and administrative personnel as well as scientists
who are vital to performing the research and development.
Company B acquires the rights to the drug compound candidates
along with the scientists formerly employed by Company A who
are developing the acquired Phase I drug compound candidates.
ASC 805–10–20 indicates that a business is an integrated set
of activities and assets that is capable of being conducted and
managed for the purpose of providing a return…. This definition
of a business can result in a broad range of transactions qualifying
as business acquisitions.
Should Company B account
for the transaction as a
business combination or
an asset acquisition? 
Businesses consist of assets/resources, and systems, standards, or
protocols applied to those assets/resources, that have the ability
to create economic benefits.
Additionally, as noted in ASC 805–10–55–5, to be considered a
business, not all of the inputs and associated processes used by
the seller need to be transferred, as long as a market participant
is capable of continuing to manage the acquired group to provide
a return (e.g., the buyer would be able to integrate the acquired
group with its own inputs and processes) or readily obtain those
inputs and processes.
Solution
Company B should consider the stage of development of the drug compound candidates in determining whether a business has
been acquired. In most cases, there are likely to be more processes associated with later stage drug compounds than those in earlier
stages. However, a transaction involving the acquisition of drug compound candidates in early stage development can still be a
business combination.
Company B acquired the Phase I drug compounds, along with the scientists who are vital to performing the research and
development. The scientists have the necessary skills and experience, and provide the necessary processes (through their skills and
experience) that are capable of being applied to inputs to create outputs.
While Company B did not acquire a manufacturing facility, testing and development equipment, or a sales force, it determined
that the likely market participants are other large pharmaceutical companies that already have these items or could easily
replicate them.
These factors would likely lead Company B to account for this acquisition as a business combination.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
60.Accounting for acquired IPR&D
Background
Relevant guidance
Company A is in the pharmaceutical industry and owns the rights
to several product (drug compound) candidates. Its only activities
consist of research and development performed on the product
candidates. Company B, also in the pharmaceutical industry,
acquires Company A, including the rights to all of Company A’s
product candidates, testing and development equipment, and
hires all of the scientists formerly employed by Company A, who
are integral to developing the acquired product candidates.
Company A also had a product candidate that received Food and
Drug Administration (“FDA”) approval, but for which it had not
yet started production at the time of acquisition by Company B.
Company B accounts for this transaction as an acquisition
of a business.
Under ASC 805, acquired IPR&D continues to be measured at
its acquisition date fair value but is accounted for initially as an
indefinite-lived intangible asset (i.e., not subject to amortization).
Post-acquisition, acquired IPR&D is subject to impairment testing
until the completion or abandonment of the associated research
and development efforts. If abandoned, the carrying value of
the IPR&D asset is written off. Once the associated research
and development efforts are completed, the carrying value of
the acquired IPR&D is reclassified as a finite-lived asset and is
amortized over its useful life.
The requirement to recognize acquired IPR&D in an acquisition as
an indefinite-lived intangible asset does not apply to incremental
costs incurred on the IPR&D project after the acquisition date.
These incremental costs continue to be expensed as incurred
under ASC 730–10–25.
How should Company B account
for the acquired IPR&D? 
Solution
Company B will measure the acquired IPR&D at its acquisition date fair value and record it as an indefinite-lived IPR&D intangible
asset. Subsequent to the acquisition, the acquired IPR&D would be tested for impairment annually or more frequently if events
or changes in circumstances indicate that the asset might be impaired. This impairment test would compare the fair value of the
IPR&D asset to its carrying value. Incremental research and development costs subsequent to the acquisition would be expensed.
With regard to Company A’s product candidate that received FDA approval, any such completed product development (i.e., no
longer “in-process”) would be recognized as a finite-lived intangible asset at the date of acquisition, separate from the acquired
IPR&D. The testing and developing equipment would be separately recognized as tangible assets, measured at fair value, and
depreciated over their estimated useful lives.
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Business combination
61.Unit of account—IPR&D
Background
Relevant guidance
Company A acquired Company B, which is accounted for as an
acquisition of a business under ASC 805. At the acquisition date,
Company B was pursuing completion of an IPR&D project that,
if successful, would result in a drug for which Company A would
seek regulatory approval in the US and Japan. This research and
development project is in the latter stages of development but is
not yet complete. The nature of the activities and costs necessary
to successfully develop the drug and obtain regulatory approval
for it in the two jurisdictions are not substantially the same. If
approved, the respective patent lives are expected to be different
as well. In addition, Company A intends to manage advertising
and selling costs separately in both countries.
Under ASC 805, because of the requirement to capitalize and
test the acquired IPR&D asset for impairment, it is important
to determine the appropriate unit of account. Determining the
appropriate unit of accounting for valuing and recognizing
acquired IPR&D can be complex when an approved drug may
ultimately benefit various jurisdictions. One common approach
is to record separate jurisdictional assets for a research and
development activity that will benefit various jurisdictions, while
another approach is to record a single global asset. When making
the unit of account determination, companies may consider,
among other things, the following factors:
• Phase of development of the related IPR&D project(s)
• Nature of the activities and costs necessary to further develop
the related IPR&D project(s)
• Risks associated with the further development of the related
IPR&D project(s)
• Amount and timing of benefits expected to be derived from
the developed asset(s)
• Expected economic life of the developed asset(s)
• Whether there is an intent to manage advertising and
selling costs for the developed asset(s) separately or on a
combined basis
What is the unit of account for the
acquired IPR&D asset? 
• Once completed, whether the product would be transferred as
a single asset or multiple assets
Solution
The acquired IPR&D project would likely be recorded as two separate “jurisdictional” IPR&D assets. While there may be other
factors to consider, Company A’s assessment may lead it to believe that the development risks, the nature of the remaining activity
and costs, the risk of not obtaining regulatory approval, and, as noted above, expected patent lives for the acquired IPR&D are not
substantially the same in both countries. Finally, Company A intends to manage the drug separately, including separate advertising
and selling costs in each country.
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
62.Pre-existing relationships in a business combination
Background
Relevant guidance
Company A in-licenses a Phase I compound from Company B in
20X5. With the in-license agreement, Company A acquires the
global exclusive rights to develop and commercialize the asset,
including rights to manufacture, market, and sell any successful
product. The rights granted are for 25 years, the full protected
life of the intellectual property. Company B retains the ownership
(legal title) of the initial intellectual property.
The acquirer and acquiree may have a relationship that existed
before they contemplated the business combination, referred
to here as a preexisting relationship. A preexisting relationship
between the acquirer and acquiree may be contractual or
non-contractual… [ASC 805-10-55-20].
The terms of the in-licensing agreement are that Company A
pays $300 million upfront and, if commercialized, a 5% royalty
on all sales. Company A is responsible for all development of the
product and any incremental intellectual property completed by
Company A is owned by Company A.
The product has successfully moved to pre-Food and Drug
Administration (“FDA”) approval (i.e., Phase III). Company A
acquires Company B for $2 billion in 20X3, and the acquisition
is accounted for as a business combination. There was no stated
settlement provision provided for by the in-license agreement.
Assume that the market rate to in-license the intellectual property
is the same as above: $300 million of payments plus a 5% royalty.
However, the market rate to in-license both initial intellectual
property and the incremental intellectual property would be a
20% royalty (which is equivalent to the $2 billion in fair value of
the company). The higher cost reflects the fact that a Phase III
asset is more likely to generate positive cash flows compared to a
Phase I asset.
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If the business combination in effect settles a pre-existing
relationship, the acquirer recognizes a gain or loss, measured
as follows:
• For a pre-existing non-contractual relationship, such as a
lawsuit, fair value
• For a pre-existing contractual relationship, the lessor of
the following:
– T he amount by which the contract is favorable or
unfavorable from the perspective of the acquirer when
compared with pricing for current market transactions for
the same or similar items…
– T he amount of any stated settlement provision in
the contract available to the counterparty to whom
the contract is unfavorable… [ASC 805–10–55–21].
Business combination
62. Pre-existing relationships in a business combination (continued)
How should the settlement of
the in-licensing arrangement be
accounted for by Company A upon
acquisition of Company B? 
Solution
As the terms at the date of acquisition are assumed to be the same as in the original agreement ($300 million of payments plus a
5% royalty) if Company A were to license the IP retained by Company B, there is no settlement gain or loss to be recognized as a
result of the acquisition.
This view is consistent with the market value of “the same or similar items” being the market value of the intellectual property
retained by Company B. The value of the intellectual property in total has increased due to the successful development efforts
and clinical trials conducted by Company A in moving the compound from Phase I to Phase III. These incremental developments,
including the efforts expended and funded to move from Phase I and enter into Phase III are already owned by Company A. As such,
the gain or loss from settlement of the pre-existing licensing relationship should be based solely on the value of the same or similar
intellectual property asset that was originally licensed to Company A by Company B. Determination of the gain or loss should not
include the value developed between the date Company A in-licensed the compound and the date Company A acquired Company B
because this value is already owned by Company A. In this fact pattern, the 15% increase in royalty rate (20% for the Phase III
asset compared to 5% for the Phase I asset) relates to the value attributable to the research and development and regulatory
developments undertaken, owned and funded by Company A, and would not be included in the measurement of the settlement
gain or loss.
If the fair market terms of an in-license for the intellectual property owned by Company B, exclusive of the value of the asset owned
by Company A, had changed such that the terms of the original in-license arrangement were favorable or unfavorable at the time of
the business combination, the favorable or unfavorable value would be recorded by Company A as a settlement of the pre-existing
relationship (gain or loss).
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US GAAP—Issues and Solutions for the Pharmaceuticals and Life Sciences Industries
63.Useful economic lives of intangibles
Background
Relevant guidance
As part of a business combination, Company A has acquired a
license to manufacture and sell a newly approved pharmaceutical
drug. As part of the acquisition, Company A will record an
intangible asset for the acquired license.
The useful life of an intangible asset to an entity is the period over
which the asset is expected to contribute directly or indirectly to
the future cash flows of that entity [ASC 350–30–35–2].
What factors should
Company A consider in its
assessment of the useful life
of the intangible asset? 
An entity shall evaluate the remaining useful life of an intangible
asset that is being amortized each reporting period to determine
whether events and circumstances warrant a revision to the
remaining period of amortization. If the estimate of an intangible
asset’s remaining useful life is changed, the remaining carrying
amount of the intangible asset shall be amortized prospectively
over that revised remaining useful life [ASC 350–30–35–9].
Solution
When determining the useful life of an intangible asset, Company A should consider the factors included in ASC 350–30–35–3.
Some of these factors include: the expected use of the asset, historical experience with similar arrangements, and the expected
future cash from the asset.
In addition to these factors, pharmaceutical and life sciences companies should consider industry-specific factors, such as
the following:
• Duration of the patent right or license of the product;
• Redundancy of a similar medication/device due to changes in market preferences;
• Unfavorable court decisions on claims related to product liability or patent ownership;
• Regulatory decisions over patent rights or licenses;
• Development of new drugs treating the same disease;
• Changes in the environment that make the product ineffective (e.g., a mutation in the virus that is causing a disease, which
renders it stronger);
• Changes or anticipated changes in participation rates or reimbursement policies of insurance companies; and
• Changes in government reimbursement or policies (e.g., Medicare, Medicaid) for drugs and other medical products.
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Acknowledgements
This publication would not be possible without
the contribution of the partners and staff
of PwC’s Pharmaceutical and Life Sciences
industry team, including:
• Kevin Burney Partner Boston
• Brett Cohen Partner Florham Park
• James Connolly Partner Boston
• Gerry Flynn Partner Florham Park
• John Hayes Partner Florham Park
• Jeffrey Hemman Partner Boston
• Denis Naughter Partner Florham Park
• Mark Barsanti Senior Manager Boston
• John Charters Senior Manager Boston
• Christopher Kean Senior Manager London
• Sonia Luaces Senior Manager Florham Park
• Chris Mutter Senior Manager Florham Park
• Kristine Pappa Senior Manager Amsterdam
• Lindsey Piziali Senior Manager San Jose
• Frank Raciti Senior Manager Philadelphia
• Lambert Shiu Senior Manager San Jose
• Dusty Stallings Partner Florham Park
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Contacts
To have a deeper conversation about
how this subject may affect your business,
please contact:
Karen C. Young
Partner, US Pharmaceutical and Life Sciences
Assurance Leader Florham Park, NJ
973 236 5648
karen.c.young@us.pwc.com
Adrian Beamish
Partner, Pharmaceutical and Life Sciences
Assurance San Jose, CA
408 817 5085
adrian.beamish@us.pwc.com
Jim Connolly
Partner, Pharmaceutical and Life Sciences
Assurance Boston, MA
617 530 6213
james.m.connolly@us.pwc.com
John Hayes
Partner, Pharmaceutical and Life Sciences
Assurance Florham Park, NJ
973 236 4452
john.c.hayes@us.pwc.com
Denis Naughter
Partner, Pharmaceutical and Life Sciences
Assurance Florham Park, NJ
973 236 5030
denis.naughter@us.pwc.com
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PwC
About
PricewaterhouseCoopers
PricewaterhouseCoopers’ Pharmaceutical and Life Sciences
Industry Group (http://www.pwc.com/us/pharma) is
dedicated to delivering effective solutions to complex strategic,
operational and financial challenges facing pharmaceutical
and life sciences companies. We provide industry-focused
assurance, tax, and advisory services to build public trust and
enhance value for our clients and their stakeholders. More than
180,000 people in 158 countries across our network of firms
share their thinking, experience, and solutions to develop fresh
perspectives and practical advice.
http://www.pwc.com/us/pharma
© 2013 PwC. All rights reserved. “PwC” and “PwC US” refers to PricewaterhouseCoopers LLP, a Delaware limited liability partnership, which is a member firm
of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity. This document is for general information purposes only,
and should not be used as a substitute for consultation with professional advisors. NY-14-0286