Life sciences companies adjust to new accounting rules

By Michael Cohn for AccountingToday.com

Biotech, pharmaceutical, medical device and related businesses are dealing with recent accounting standards, plus a new tax law, amid a changing landscape for their industry.

A recent Deloitte report provided an update for the life sciences sector on accounting and financial reporting issues, including recent Financial Accounting Standards Board standards on revenue recognition, leases and the definition of a business, along with existing guidance related to R&D costs, M&A transactions, contingencies, financial instruments, financial disclosure and more. Deloitte released the annual report late last month in conjunction with the CBI Accounting & Reporting Congress in Philadelphia.

“The revenue recognition standard required a lot of interpretation as to how it should be applied in the context of this industry,” said Dennis Howell, senior consultation partner in accounting services and life sciences deputy industry professional practice director at Deloitte & Touche LLP. “A lot of time was spent by companies trying to evaluate specifically the individual provisions of that standard and how it may or may not apply, whether it was with respect to, for example, collaborative arrangements, which are quite common in this industry, or licensing transactions that are also quite common. There was a lot of interpretive work done to determine whether or not there would be a change in practice for these companies.”

The Securities and Exchange Commission is keeping a close watch on how companies are implementing the rev rec standard.

“The main thing for most life sciences companies, particularly in the public space, will be monitoring how the SEC reacts to the implementation of the new revenue standard,” said Jeff Ellis, a partner and life sciences industry professional practice director at Deloitte & Touche LLP. “To this point, companies have been undertaking primarily an internal effort to determine what the impacts actually are, and now for the first time they will be reporting those impacts externally, so investors, analysts and regulators are all going to be evaluating the implementation and what that looks like, how those disclosures change. I think most in the community are very interested to understand what those external perspectives might be.”

Unlike the revenue recognition standard, the lease accounting standard that takes effect at the end of the year for public companies may not apply to as many companies in the life sciences space, but it could be complicated for the ones that have to deal with it.

“Leasing in contrast is one where I would say most companies probably are concluding that there aren’t a whole lot of industry-specific interpretations,” said Howell. “But the effort to actually implement it is going to be much more extensive in some ways, simply by virtue of the fact that they need to accumulate all of the contracts that meet the definition of a lease and then record on the balance sheet the values of those contracts. It’s a significant implementation exercise for a lot of companies.”

The lease accounting standard could be an area of interest for medical device makers in particular. “The med device companies generally have had to consider from the lessor perspective, but sometimes they may have equipment that they place at a customer’s location to sell a product that will work with that equipment,” said Howell. “Historically there’s been a consideration around when you’re accounting for those transactions as to whether some piece of that is in the lease literature, specifically the equipment. There’s more guidance now in the new leases standard around situations where you have placed equipment at a customer’s location. I think that could lead a company to potentially having perhaps more leased elements because of placed equipment than they had in the past.”

Another FASB standard that takes effect this year pertains to the definition of a business, and it too has implications for life sciences companies. “That standard is important because there are significantly different accounting consequences, depending upon whether a transaction meets that new definition of a business or it doesn’t,” said Howell. “The new standard requires companies to go through a different type of analysis than they’ve undertaken in the past to arrive at conclusions as to whether something that’s been acquired or disposed of meets that accounting definition of a business. We’ve got a whole host of interpretations in the publication around that judgment: what is a business and what is not?”

The new hedge accounting standard is also attractive for some companies that are considering adopting it early before it becomes a requirement. “There’s a new hedge accounting standard that will simplify the application of hedge accounting that a lot of companies are thinking of early adopting,” said Ellis. “It’s not effective yet, but a lot of companies are thinking about early adopting. I think we’ll see in Q1 disclosures for the first time of the extent to which it has been early adopted. Many of the other financial instruments standards are probably on a longer-term horizon.”

FASB board member Marsha Hunt discussed another FASB standard relating to collaboration arrangements at the CBI conference. “The reason why that project came about with the FASB is there were questions as to whether some of those arrangements should be within the scope of the new revenue literature,” said Howell. “These arrangements are fairly common with biotech companies as well as large pharmas. The project is not final yet. There will be an exposure draft that will be coming out shortly, but this is certainly an area of interest for companies. We’re just monitoring the status of the project. Hopefully there will be some FASB standard setting sometime during 2018.”

Also at the CBI conference, a representative from the SEC’s Division of Corporation Finance spoke about another area of concern. “One of the themes that they see in their group, and I think it’s an area that has been the subject of comment letters, relates to multiple-element litigation arrangements,” said Howell. “Anytime you have a settlement where you have a legal contingency, there may be other elements to the arrangement you need to consider.”

The new tax law is also provoking discussion in the life sciences field, as in other industries.

“Within the tax legislation, there’s this provision referring to intangible assets, known as the GILTI [Global Intangible Low-Taxed Income] provision,” said Howell. “It really affects a lot of companies like pharmaceutical companies that have intangible assets in foreign jurisdictions, and it’s going to require a different way of calculating the taxes that are ultimately due, based on those tax structures. Similarly with respect to tax reform, there are changes to individual deductions that are very common in the life sciences space, whether it’s the manufacturing deductions, the orphan drug tax credits, R&D expenses. There are changes in the deductibility of those costs that are pretty unique to this industry.”