By Dan Schell, Editorial Director, Life Science Leader
The report also addresses other soon-to-be-implemented changes such as:
According to authors Jeff Ellis and Dennis Howell “Our report details some of decisions finance and accounting professionals in the industry must make regarding these changes.” Examples include:
FUNDING MODELS ARE CHANGING
Innovation in the life sciences isn’t limited to the science of drug development; the business relationships and funding models are also constantly evolving. The Deloitte report provides some keen insights into the emerging accounting standards for R&D funding arrangements and leases. In particular, it notes that you should consider whether such an arrangement includes elements that should be accounted for as a derivative. (The report lists the characteristics that define a derivative instrument.) That’s something many companies may not have previously even considered. Here’s a short excerpt from that section:
If the life sciences company determines that its R&D funding arrangement meets the definition of a derivative instrument, it should assess whether the arrangement represents a contract that would meet any of the scope exceptions in ASC 815. For example, in certain transactions, the life sciences company is only required to make royalty payments to the investor if the compound is approved and net sales occur.
IPOS AND COLLABORATIVE ARRANGEMENTS
One of the new chapters in the Deloitte report is dedicated to IPOs, which have exploded in recent years in pharma and biotech. Ellis and Howell note that, “Many of the companies that pursue an IPO qualify for the ‘emerging growth company’ filing status, which provides many benefits [all of which are outlined in the report].” In these instances, a company will generally qualify as an emerging growth company if it has total annual gross revenue of less than $1.07 billion during its most recently completed fiscal year, and it has not issued more than $1 billion of nonconvertible debt over the past three years.
The new chapter also highlights accounting and disclosure issues commonly encountered by life sciences entities that complete IPOs, including the types of financial statements to include in a filing, when pro forma disclosures involving a significant transaction are required and how such disclosures should be prepared, when predecessor financial information is required after a material acquisition occurs, and common share-based compensation valuation issues.
In addition to increased pharma/biotech IPOs, there has been an increase in the number of collaborative arrangements between life sciences companies. The industry as a whole has been trying to reduce costs, and partnering with a third party is often one of the first strategies toward accomplishing that goal. But these arrangements are often complex with varying responsibilities and clearly defined guidelines that identify the risk and benefits to each partner. For example, the following are two common forms of these arrangements:
With any type of collaboration, it’s imperative you understand the implications related to the ASC 606 accounting standard, which addresses how companies recognize revenue from contracts with customers. The Deloitte report includes this helpful example of how an entity would determine whether an arrangement is a collaborative arrangement and, if so, whether it should be accounted for under ASC 606.
Biotech B and Pharma P enter into an agreement to research, develop, and commercialize drug X. Biotech B will perform the R&D, and Pharma P will commercialize the drug. Both parties agree to participate equally in all activities that result from the research, development, and commercialization. The reporting entity concludes that a collaborative arrangement exists because both parties are active participants and have agreed to share in the risks and rewards.
Despite this conclusion, however, there still could be a vendor/customer relationship as a result of some of the activities between the participants pursuant to the collaborative arrangement. If such a relationship exists, those parts of the contract that are related to the vendor/customer relationship may need to be accounted for under ASC 606.
There’s no doubt that there are significant changes taking place in our industry right now, and there are more to come. If you’re not aware or unsure of how those changes are going to affect your company — whether you work for a pharma, biotech, CRO, CDMO, or medical device company — you may want to take the time to download and review this report from Deloitte.
ACCOMMODATIONS APPLICABLE TO EMERGING GROWTH COMPANIES (EGCS)
There are many potential benefits for registrants that file an IPO as an EGC. For example, EGCs:
SOURCE: Chapter 12.1.2 of the Life Sciences Accounting and Financial Reporting Update — Including Interpretive Guidance, March 2019
JEFF ELLIS leads the Life Sciences and Health Care (LSHC) industry practice for Audit & Assurance and is the Life Sciences industry professional practice director (PPD) at Deloitte & Touche.
DENNIS HOWELL is a senior consultation partner in the Deloitte National Office Accounting Services and Reporting Group and the Deloitte Life Sciences deputy industry professional practice director.