ASC 606 Revenue recognition & impact on collaboration agreements
In May 2014, the Financial Accounting Standards Board (or FASB) issued ASU 2014-09, Revenue from Contracts with Customers (ASC 606), changing how biotech companies account for the revenue associated with their strategic collaboration agreements.Public companies were required to adopt the standard by January 2018 and have issued their first set of financials in the Q1 2018 10-Qs. Companies such as Blueprint Medicines, Surface Oncology, Jounce Therapeutics and Seres Therapeutics to name a few. Private companies will be required to adopt the standard by January 2019.
Under the new standard, biotech companies need to (1) determine whether counterparty is a customer, (2) identify the separate performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the separate performance obligations in the contract and (5) recognize revenue as the entity satisfies the performance obligation. Below, I discuss what this might look like for an early stage biotech company with a strategic collaboration:
Your contract counterparty is considered a customer if they are receiving IP and research services in exchange for an upfront and incremental milestone payments (i.e. consideration). Your contract counterparty is considered a partner if both parties are equally participating in the research and development of the program under the contract.
Performance obligations can be separated if (1) the customer can benefit from the service either on its own or together with other resources that are readily available and (2) the entity’s promise to transfer the service to the customer is separately identifiable from other promises in the contract. Under these criteria, judgment should be used if IP rights and JSC/JRC/JDC commitments have value apart from delivered research and development efforts typical under collaboration agreements. Otherwise, all obligations would be considered a single performance obligation. Jounce Theraputics had several performance obligations associated with their collaboration with Celgene, as disclosed in footnote 3 of their Q1 2018 10-Q, which they split into different performance obligations.
The transaction price is any upfront payments received and milestones that are achieved as development milestones are met. Development milestones could be considered in the transaction price as the probability of achievement increases, even if the milestone has not yet been contractually achieved.
If it is determined that there are multiple performance obligations under the contract, the transaction price must be allocated to the each obligation. Several methods are included in the standard. Based on the nature of biotech, using the relative stand-alone selling price method appears the most reasonable based on the likelihood that there is no established price for the service and the service has never been sold on a standalone basis.
Revenue is recognized using the input or output method. The above companies all used the input method (or cost-to-cost method, also known as percentage of completion method) to recognize revenue based on the ratio of actual costs incurred to the total estimated costs expected upon satisfying the identified performance obligation.
Significant judgement is involved in identifying and recognizing revenue under ASC 606. Early discussions with your auditor are advised to ensure that each component of your collaboration agreement is considered.
intheBlk software has several tools that can help make this process easier to execute operationally. Our long range planning tool can help companies identify the estimated costs to satisfy identified performance obligations. Our revenue recognition model can calculate the revenue recognized under the cost-to-cost method as actual costs and estimated costs change each reporting period. If you are interested in learning more about our services, please contact us with the form below.