In our continued effort to dig into the new revenue recognition standards industry by industry, today we examine what the new guidance could mean for those in the field of life sciences.
As our readers are more than likely aware, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) announced last year the newly converged standards for revenue recognition. The impact of these sweeping changes can be felt in each in every sector.
The new standard, issued under the title “Revenue from Contracts with Customers,” brings with it a variety of changes life science companies – which includes those in the fields of biotechnology, pharmaceuticals, biomedical technologies, food processing and others – need to consider.
For example, as noted in an article recently published in Life Science Leader on the new guidance impact, an understanding of the new standard and its potential impact on deal structures will be critical for firms considering a merger, acquisition or strategic partnership. Knowing when earnings are reported on the financial statement means knowing the ins and outs of the coming changes to accounting principles.
Although collaboration and out-licensing will most likely be the areas to feel the greatest impact of these changes, even basic transactions within life sciences companies – such as the sale of medical or pharmaceutical devices – may be accounted for very differently under the new standard. These new rules will be much more judgement-based than today’s U.S. GAAP. Life science companies may allocate revenue to more performance obligations, and possibly recognize revenue earlier, than under the existing guidance.
Companies in this sector frequently enter into collaborative arrangements, which more often than not don’t fit the traditional vendor-customer roles. For example, say a couple pharmaceutical firms agree to collaborate on a research and development effort. While current GAAP place such arrangements outside of revenue guidance, the principles embedded in the new guidance will require analysis to determine whether the terms of such arrangements scope in our out of the new revenue standard. This would represent a significant change for some firms in the industry.
When it comes to licensing of intellectual property (IP), there’s the potential for severe change as a result of the new guidance. Entities will need to determine if the intellectual property license is a separate, or distinct, performance obligation, a determination which must factor in promises to deliver other goods and services, often included as part of a bundle. The concept of ‘distinct,’ itself, has been the subject of much discussion as part of the new guidance. These licenses must be studied to determine if the timing of revenue recognition is over the license period or at the time the license is granted. Such analysis will depend on license details.
With a new principles-based standard, accounting for licensing revenues will require deep evaluation of contractual terms, as you can clearly note.
Many revenue streams in the life sciences contain variable elements, such as milestone payments, performance bonuses or incentives. While current GAAP typically disallows revenue recognition contingent upon a future event, the new standard requires variable consideration to be estimated as part of the transaction price so long as a revenue reversal is unlikely. Shifting from a risk and reward approach to an emphasis on change in control could mean life sciences companies may recognize certain variable revenue streams sooner than they do today.
The folks at consulting firm Moss Adams LLP took the time to break out life sciences-specific scenarios for collaboration and out-licensing arrangement and sale of medical devices as they relate to the new five step process of the new guidance.
As you can see, the impact of the new revenue recognition guidance will be felt far and wide just within the field of life sciences. Entities should be well into an assessment on how they will be affected and continue to monitor the actions of the governing boards for information and updates on the new standards.