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Pharmaceutical, biotech and medical device companies must confront a set of financial reporting challenges unique from other industries, stemming from a series of new and upcoming accounting standards.
“Accounting professionals are really faced with a number of changes that affect how accounting and financial reporting will be applied in the future,” said Jeff Ellis, a partner with Deloitte & Touche LLP’s life sciences industry audit practice based in Pittsburgh.
Changes in lease accounting, revenue recognition, even how a business is defined all take a different twist for life sciences companies because of how they operate and the type of products they manufacture.
Here’s a look at the top four accounting changes facing the industry.
A change in lease accounting will require companies to list operating lease liabilities on the balance sheet for the first time beginning next year.
Because of the new standard, medical device manufacturers might end up with more leases with hospitals and other health care facilities than they had previously, said Dennis Howell, senior consultation partner for accounting services and life sciences for Deloitte & Touche LLP based in Stamford, Conn.
These manufacturers often provide equipment that is needed to use the products that they sell to health care facilities but aren’t detailed in the contract. And they might now be defined as leases, Howell told Bloomberg Tax.
“I wouldn’t say there is a bright line,” Howell said. “It may have been an easier exercise to scope out the equipment out of the leasing standard historically than it will be under the new guidance.”
Most companies, however, still face the time-consuming task of inventorying lease contracts so those costs can be tallied and added to the balance sheet, Ellis said.
“For a multi-national company with operations in dozens if not hundreds of countries, getting your hands on every lease contract—that are often in different languages—can be a significant undertaking,” Ellis said.
A standard change that took effect in January clarifies the difference between a business that is bought or sold and the transfer of an asset or group of assets. The difference can result in big financial reporting changes because the purchase of an asset—like a pharmaceutical product—can be expensed, but a business purchase would be capitalized over time, Ellis said.
“This new standard is, I think so far, something that most life sciences companies think does greatly simply things, and has made the analysis much easier than it otherwise had been,” Ellis said.
Pfizer reported previously that under the new definition of a business that fewer transactions will be accounted for as business acquisitions, and that could possibly increase the pharmaceutical company’s research and development costs, according to its 2017 annual report.
Johnson & Johnson, however, expected the standard change to have no material impact on the company, according to its annual report.
The biggest change for life sciences is how companies recognize revenue, Ellis said.
First quarter financial reports—due out in the next few weeks—will mark the first time that public companies will rely on the same standards for recognizing revenue. Until now, the standards varied from industry to industry.
“I think there’s going to be a lot of interest in how this standard is applied and what the changes really are,” Ellis said.
The historic shift is expected to have widely different outcomes from company to company, even among the same industries.
Eli Lilly & Co. and Johnson & Johnson, for example, expect no significant changes to their financial statements stemming from the revenue recognition standard.
But Bristol-Myers Squibb Co. is expected to report a decrease in revenue of about $200 million and a drop in other income to the tune of $125 million because of shifts in future estimated royalties and license termination fees. That could result in a material change to its financial statement, according to a Morgan Stanley analysis of the company’s financial statements.
Most large pharmaceutical companies earn revenue from the sale of drugs to distributors, so they wouldn’t see much change in how they account for the revenue, Howell said.
Licensing guidance changed significantly, however, under the new revenue standard. Licenses are common in the industry and are frequently tied into joint ventures common in the industry called collaborative arrangements, he said.
The Financial Accounting Standards Board is working on guidance for how to account for revenue stemming from these collaborative arrangements, and an exposure draft is expected soon, Howell said.
Companies frequently join together to develop a drug—one may contribute resources to test and advance a drug, while the other may handle manufacturing or marketing. Because research and development is a costly and a long-term commitment, these partnerships provide more opportunities to get more drugs into the pipeline for regulatory approval, Howell said.
“How do you account for these,” he said. Most pharmaceutical companies wouldn’t consider their partner as a customer. But the arrangements can result in a profit if the drug is ever approved.
And those eventual profits can be hefty.
For example, the drug Eliquis, a prescription blood thinner, is the result of a joint venture between Bristol-Myers and Pfizer Inc.—and generated more than $2 billion for each company in 2017, according to financial statements.
Eli Lilly’s multiple drug collaborations generated $1.2 billion in 2017, the company reported in its annual financial statement.
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