Once the performance obligations in a biotech collaboration agreement have been identified and revenue has been allocated to each performance obligation, an entity needs to determine whether revenue is recognized at a point in time or over a period of time. There are three criteria to determine if revenue is recognized over a period of time. For biotech companies, the most relevant criteria is whether the company's performance creates or enhances an asset (for example, in process research) that the customer controls as the asset is created or enhanced (criteria 2).
Two common biotech examples of a performance obligation where the revenue is recognized at a point in time are a stand-alone license and clinical drug supply. Below is an example stand-alone license disclosure:
If the license to the Company’s intellectual property is determined to be distinct from the other performance obligations identified in the arrangement, the Company recognizes revenue from non-refundable, up-front fees allocated to the license when the license is transferred to the customer and the customer is able to use and benefit from the license. (Source: Agenus Q2 2018 10-Q)
Below is an example clinical drug supply disclosure:
We will recognize the amount attributed to the AKCEA-APO(a)-LRx API (active pharmaceutical ingredient) supply when we deliver API to Novartis; (Source: Akcea Therapeutics Q2 2018 10Q)
The accounting treatment in both scenarios is simple - once the customer controls the asset (license is transferred or clinical supply is delivered), all the revenue associated with the performance obligation should be recognized.
An example of a performance obligation where revenue is recognized over a period of time is research and development services. Below is an example of a disclosure of research and development services:
We will satisfy the development services performance obligation for AKCEA-APO(a)-LRx as the research and development services are performed. We determined that the period of performance of the research and development services was two years, or through December 2018. We recognize revenue related to research and development services performed using an input method by calculating costs incurred at each period end relative to total costs expected to be incurred; (Source: Akcea Therapeutics Q2 2018 10Q)
Our research suggests that almost all biotech companies that recognize revenue over time use an input method, also known as a cost-to-cost method, to recognize revenue.
Here is an example disclosure discussing the rationale for the selecting the input method:
Under ASC 606, the Company recognized revenue using the cost-to-cost method, which it believes best depicts the transfer of control to the customer. Under the cost-to-cost method, the extent of progress towards completion is measured based on the ratio of actual costs incurred to the total estimated costs expected upon satisfying the identified performance obligation. Under this method, revenue will be recorded as a percentage of the estimated transaction price based on the extent of progress towards completion. (Source: Surface Oncology Q2 2018 10-Q)
Given that almost all biotech companies use the input method for recognizing revenue, we will dive into input models in a future blog post. In the meantime, if your company is struggling with building and maintaining an input model for recognizing revenue, check out intheBlk's ASC 606 revenue recognition tool and reach out to see how our software solution can help.