The New Accounting for Collaborative Arrangements

The Financial Accounting Standards Board recently issued guidance on how to account for consideration received pursuant to a contractual arrangement known as a “collaborative arrangement.”

Until now and due to the lack of clear guidance, this was an area where entities had significant latitude to apply their own unique approaches and judgment, leading to a diverse range of accounting policies and practices.

Entities involved in collaborative arrangements could face a major impact from the new guidance — especially if their existing approaches are out of line with the accounting that will be required in the future.

What Is a Collaborative Arrangement?

A collaborative arrangement involves a joint operating activity of two or more parties that contractually agree to work together on a set of shared business activities primarily conducted pursuant to a contract, and not through a separate legal entity created for those activities.

The parties to such arrangements are active participants in the activity and are exposed to significant risk and rewards depending on the ultimate success of the endeavor. A financial investment alone from a passive investor would not qualify as a collaborative arrangement.

This type of arrangement is common in the life sciences industry, where different companies often join forces to develop and commercialize new products and services.

For example, a biotech entity focused on developing an innovative new drug or treatment might enter into a collaborative arrangement with an established pharmaceutical company that can provide expertise, experience, and resources in key areas. These range from development and regulatory approval to marketing and commercialization.

Similar arrangements can also be found in other industries, such as technology and media, where companies believe they will benefit from formal collaboration and shared activities.

Resolving Conflicts with the New Revenue Recognition Standard

FASB originally defined the term collaborative arrangement more than a decade ago as part of its Accounting Standards Codification Topic 808. However, at the time FASB did not offer specific guidance on how to recognize and measure consideration associated with such an arrangement.

Dennis Howell

On Nov. 5, 2018, FASB narrowed this gap by issuing Accounting Standards Update 2018-18, which amends the decade-old Topic 808. The update provides guidance on accounting for consideration received from a collaborative arrangement participant.

The new guidance primarily clarifies the interaction between Topic 808 and FASB’s new revenue recognition standard, Accounting Standards Codification Topic 606. In particular, it clarifies when a transaction between entities in a collaborative arrangement should be accounted for as a contract with a customer and hence within the scope of the new revenue standard.

The new guidance applies to all entities involved in collaborative arrangements and must be applied retrospectively starting with the date they first applied the new revenue recognition standard.

Three Key Focus Areas

The new guidance on collaborative arrangements addresses three key areas: revenue scoping, unit of account, and non-revenue transactions.

Revenue Scoping

Before this new guidance, the scope of the new revenue recognition standard seemed to explicitly exclude transactions from collaborative arrangements. The standard stated that a counterparty in such an arrangement should not be considered a “customer” (which implied that any consideration from that counterparty should not be accounted for as revenue under Topic 606).

However, that final codification seemed inconsistent with the basis for conclusions that led up to it, which had indicated that transactions between participants in a collaborative arrangement can fall within the scope of the new revenue standard if the counterparty met the definition of a customer for some or all parts of the arrangement.

The new guidance clarifies that collaborative arrangements may be partially within the scope of Topic 606 in a transaction between collaborative participants. That’s the case if a unit of account (i.e., a promised good or service or bundle of goods or services) that is distinct within the collaborative arrangement is with a customer.

In such a situation, all aspects of Topic 606 should be applied, including its recognition, measurement, presentation, and disclosure requirements.

Unit of Account

A key step in determining whether a particular transaction falls within the scope of Topic 606 is determining the “unit of account.”

Prior to issuance of the new guidance, Topic 808 did not provide unit-of-account guidance. However, ASU 2018-18 amends Topic 808 to provide unit-of-account guidance that is “limited to the context of assessing the scope of the revenue guidance.”

Under the new guidance, a unit of account is within the scope of ASC 606 if the collaborative participant is a customer for part or parts of the transaction and the goods or services are distinct in accordance with ASC 606.

The new guidance further states that “if a portion of a distinct bundle of goods or services is not with a customer, the unit of account is not within the scope of Topic 606.”

Non-revenue Transactions

In developing the new guidance, FASB also considered providing recognition and measurement guidance for transactions that do not qualify to be accounted for as revenue under Topic 606. These are referred to as non-revenue transactions.

FASB ultimately decided not to propose a non-revenue accounting model. However, the new guidance does amend Topic 808 to require an entity to base its accounting policy for such transactions by analogy to authoritative accounting literature. If there is no appropriate analogy, the entity may use a reasonable, rational, and consistently applied accounting policy election.

Furthermore, the new guidance prohibits an entity from presenting a transaction with a collaborative participant as revenue under Topic 606 if such transaction is not with a customer.

Connecting the Dots

FASB’s new guidance includes several examples to illustrate how it should be applied.

In one example, a biotech entity and a pharmaceutical entity agree to participate equally in R&D and commercialization activities for a drug candidate. However, the biotech entity views the pharma entity as a customer to which it is providing distinct R&D services.

In this situation, because the pharma entity is viewed as a customer, the distinct R&D services fall within the scope of Topic 606. That means consideration received for those R&D services should be presented as revenue from contracts with customers.

In a similar example, the R&D services are not within the scope of Topic 606 because a customer/vendor relationship does not exist between the collaborative arrangement participants. As such, the consideration associated with the R&D services would not be treated as revenue from contracts with customers.

Understanding the Impact

For entities that participate in collaborative arrangements, the impact of the new guidance can vary widely, largely depending on how closely their existing accounting policies align with the guidance.

While all entities will need to reassess and possibly update accounting systems and controls, entities in close alignment may not see much of an impact, while those that are significantly out of alignment may face the biggest challenges.

While all entities will need to reassess and possibly update accounting systems and controls, entities in close alignment may not see much of an impact, while those that are materially out of alignment may face the most significant challenges.

Where additional disclosures regarding Topic 606 apply, entities may encounter difficulties in capturing historical data, which may not have been previously tracked.

Dennis Howell is a senior consultation partner for audit and assurance at Deloitte & Touche LLP and deputy industry practice professional for Deloitte Life Sciences.

This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor.

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