Pharma Firms Can Retain Current Revenue Practice Under Exception

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By Laura Tieger Salisbury

Pharmaceutical companies could save substantial money and worry if they license rather than sell their intellectual property, thereby avoiding the need to evaluate potential future royalty income under new revenue recognition accounting rules.

An exception under the new revenue standards, which take effect in January and rank among the biggest accounting changes in decades, can allow some life-sciences companies to license their IP. This would enable them to continue applying revenue recognition as they have in previous years.

Dennis Howell, senior partner at Deloitte & Touche LLP, suggested the licensing exception in the new standard might lead many life sciences companies to try to “license” their IP rather than outright “sell” the IP to avoid having to measure royalty consideration.

Companies who can use this licensing exception could see “huge differences in results” in their financial statements from those companies who sell their intellectual property product, Howell said.

However, confidentiality agreements prevented Howell from revealing specific companies that might take advantage of the exception or the monetary impact it could have on their financial statements.

Licensing Avoids Estimating Task

Without the limited licensing exception, companies may have difficulty estimating royalties in a sales contract based upon the customer’s ultimate sale using the IP product.

Under the outgoing revenue recognition standard, no estimation of royalties is required to be accounted for in financial statements until the royalty occurs, whether the transaction is structured as an outright sale or as a license.

Under the new ASC 606 revenue rules, if a drug company chooses to make an outright sale, it must estimate the future, uncertain income from the royalties, Howell said.

In explaining the licensing exception, Howell gave the example of a drug company with a patent on a new drug that enters into a licensing arrangement with a customer, before the drug has been approved by the federal regulatory authority.

The license agreement includes the license and royalties. Royalties extend over the life of the patent, which usually runs 10-15 years. With a new drug there won’t be a lot of market data or analogous drugs to look at to be able to make an estimation of future royalties, Howell told Bloomberg BNA May 16.

Estimation Uncertainty

Companies are also relying on guidance for applying Securities and Exchange Commission Staff Accounting Bulletin 74 to refrain for now from making precise estimates of the impact of the new revenue rules. The guidance says companies must evaluate whether the revenue rule will have a material effect on their financial statements, but also notes companies might not yet be able to discern if that effect will be material. If they can’t yet deduce materiality, they aren’t required to estimate the rules’ effect, the guidance for SAB 74 says.

An example is EIi Lilly and Company’s form 10k for the fiscal year ended Dec. 31, 2016. In estimating the effects of the upcoming revenue rules, Lilly said it didn’t expect the effect of the standard on their contract for product sales to have a “material effect” on their financial statements.

However, Eli Lilly reported that they were “not yet able to estimate the anticipated impact to our consolidated financial statements” from their arrangements for licensing or sale of intellectual property, and are still evaluating the effect of the new rule.

Sam Fazelli, a senior Bloomberg BNA Intelligence analyst who analyzes Eli Lilly, among other “life sciences companies,” told Bloomberg BNA May 17 that he believed that the large pharmaceutical companies did more product sales than licensing, which wouldn’t allow them to benefit from the exception. Biotechnological companies, he agreed with Howell, tended to license their intellectual property products, rather than sell them.

But Will Investors Notice?

But unlike Howell, Fazelli, speaking from the perspective of an analyst, suggested the standard wouldn’t have “that much” of an impact on the industry. He said that he had seen many accounting standards come and go, and that he didn’t think the revenue recognition standard would make much difference to investors or analysts in his industry.

“GAAP came, did a fantastic job in making it easier to compare companies,” Fazelli said. Everyone then translates the GAAP numbers into non-GAAP measures and analyzes the adjusted numbers to reach the critical value of earnings per share, he said.

ASC 606, Revenue From Contracts With Customers, was issued jointly by the Financial Accounting Standards Board and the International Accounting Standards Board on May 28, 2014.

Marc Siegel, FASB member, told Bloomberg BNA May 8 that this switch from a largely industry-based, rules-based standard to a principles-based standard allowing for more judgment was a “once-in-a generation change to the overall philosophy of revenue recognition.”

In a unified world, the international and U.S. boards came as close as possible to a unified solution, Siegel said at a revenue recognition conference co-hosted by Bloomberg BNA and Deloitte Touche LLP.

To contact the reporter on this story: Laura Tieger Salisbury in Washington at LSalisbury@bna.com

To contact the editor responsible for this story: S. Ali Sartipzadeh at asartipzadeh@bna.com

For More Information

Eli Lilly's form 10k is available at http://src.bna.com/o5C

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