Transaction Accounting - cbinet.com2).pdf · Transaction Accounting ... Genentech Chiron DuPont...

Copyright © 2015 Deloitte Development LLC. All rights reserved.

Bob Owens

Vice President, Assistant Controller

Bristol-Myers Squibb

Jeff Ellis

Audit Partner

Deloitte & Touche LLP

Daphne Quimi

Vice President and Controller

Amicus Therapeutics

Todd Pierro

M&A Partner

Deloitte & Touche LLP

March 17, 2015

Transaction AccountingCommon Arrangements & Implications

1

Agenda

1. Overview of Transaction Environment

2. Business vs. Asset

3. Applying the VIE Model

4. Collaboration Accounting, Accounting for

Licensing Arrangements, JV Accounting,

R&D Funding Arrangements

Overview of Transaction Environment

Key issues &

challenges

• Change in healthcare environment

• Increase focus on cost effectiveness for prescription drugs

• Recent focus on “complicated” disease conditions with unknown disease pathways and drug targets

• Survival rates for both small molecules and biologics have been decreasing

• Lengthy and costly clinical trials to demonstrate efficacy, safety ,and appropriate outcome measures

Observed themesIn search of more blockbuster drugs Fill the R&D pipeline gap Improve investment decision-

making process

Unstated primary

objectives

Maximize expected value, multiple shots on

goal

Sustain short-term revenue,

increase number of programs in

R&D

Minimize total R&D costs

Risk attitude/

preference

Risk seeking Increase in risk seeking behavior Risk aversion

Steps taken to achieve

objectives

Prioritize diseases with high prevalence rate Increase in Colloboration between

companies

Seek partners to share

development costs and

advance R&D

R&D budget

Recent trends for pharmaceutical companies

2005 2006 2007 2008 2009 2010 2011 2013 2014

4

Changing Environment - Industry Consolidation

J&J

Novo Nordisk

Eli LillyBMS

Takeda

AstraZeneca

Sanofi

AbbVie

RochePfizer

Amgen

Teva

GSK

Celgene

Merck

ALZA

Biogen Biovail

Amgen

Celgene

Astra

Bayer AG

Centocor

Genentech

Chiron

DuPont

Gilead

Cephalon

Eli Lilly

J&J

IDEC

Immunex

KOS Pharma

Hexal

IVAX

Nycomed Onyx

Pfizer

Medicis

Pharmacia

MedImmune

Pharmasset Pharmion

Novo Nordisk

Sanofi

Takeda

Warner-

Lambert

Solvay Stiefel Labs Synthelabo

Past (1999) Present (2014)

Drug development’s unique risk profile has driven the consolidation of research-based pharmaceutical and biotechnology firms through a series of large-scale M&A transactions to form large scale R&D engines

Source: Datamonitor “Big Pharma Mega-Mergers 1995–2014” report; Factset Mergers; Deloitte Consulting LLP Analysis

Note: Illustrates historical M&A deals above $2.5 billion for the 20 largest biopharmaceutical firms by market capitalization (Nov-2013); Acquisitions of several generic

firms excluded

Small Molecule focus Large Molecule focusSmall and Large Molecule

Valeant

BMS

Genzyme

Ciba Geigy

Imclone

Organon

Biosciences

Millenium

Teva

Zeneca

Gilead

Bayer AG

Valeant

Novartis

Alcon

Amylin

Glaxo

Wellcome

Merck

Schering AGSchering

Plough

Wyeth

Aventis

Knoll

Roche

SmithKline

Beecham

Abbott Abgenix Abraxis

Biogen Idec

58 pharmaceutical and biotechnology firms… ... now comprise 20 companies

5Source: Thomson Reuters

M&A Trends – Value and Volume (Excluding License Arrangements)

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2009 2010 2011 2012 2013 2014

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Global Life Sciences M&A - Annual

Strategic Value PEI Value Strategic Volume PEI Volume

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Global Life Sciences M&A - Monthly


6

M&A Activity At-A-Glance (Excluding Licensing Arrangements)

Top 10 Global Transactions – 2014

Acquiror / Target Target Sub-Sector Value (US$B)

Actavis PLC / Allergan Inc. Pharmaceuticals 66.4

Medtronic, Inc. / Covidien PLC Healthcare Equipment & Supplies 47.9

Actavis PLC / Forest Laboratories, Inc. Pharmaceuticals 23.6

Novartis AG / GlaxoSmithKline PLC-Oncology business Pharmaceuticals 16.0

Bayer AG / Merck & Co.- consumer care business Pharmaceuticals 14.2

Zimmer Holdings, Inc. / Biomet, Inc. Healthcare Equipment & Supplies 13.4

Becton Dickinson & Co. / CareFusion Corp. Healthcare Equipment & Supplies 12.0

Merck & Co Inc. / Cubist Pharmaceuticals Inc. Pharmaceuticals 8.5

Roche Holding AG / InterMune, Inc. Biotechnology 8.0

GlaxoSmithKline PLC / Novartis AG-vaccines business (excluding flu) Biotechnology 7.1

7

• Life science M&A activity expected to maintain momentum into 2015

– With over $240 billion in deals completed globally, 2014 was an active year for Life

Sciences M&A. This trend is expected to continue, leading to another strong year in

2015.

• Blockbuster patent expirations, declining R&D productivity, and pricing

pressure from payers worldwide will continue to drive M&A deals

– Macroeconomic uncertainties could limit overall M&A activity in the near-term. Strategic

deals by life sciences companies are estimated to exceed investments by private equity

(PE), as PE firms seek to avoid R&D risks

– Drug Manufacturers: Large drug makers will likely acquire to boost pipelines, diversify

product portfolios, and expand into new geographies according to analysts

– Device Manufacturers: Industry experts project device makers will acquire smaller

companies to gain new technologies, expand market share and emerging markets

presence, and counter health reforms margin challenges

Trends in Life Sciences M&A

Source: Deloitte Thought Leadership, Eminence reports and White papers, Kennedy Healthcare

Consulting Marketplace 2010-2013

8

• With life science companies continuing to accumulate large amounts of

cash, the industry appears poised to experience additional M&A activity

but short-term catalysts remain obscured

– Life science stocks have performed well in recent quarters along with the broader market

• Rising Demand in Emerging Markets, But Challenges Prevail.

– Increasing affluence, a rise in chronic illnesses, and growing government health care

spending in emerging markets will increase demand.

– However, government price controls, weak patent enforcement, low disposable incomes,

and limited health care access can challenge sales.

Trends in Life Sciences M&A

Source: Deloitte Thought Leadership, Eminence reports and White papers, Kennedy Healthcare

Consulting Marketplace 2010-2013

9Source: Thomson Reuters

M&A Trends – Continued in 2015

*YTD comparison of the same period across prior years

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2010 2011 2012 2013 2014 2015

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Global Life Sciences M&A - YTD February*


Top 5 Global Transactions – YTD February

Date

AnnouncedAcquiror

Acquiror

NationTarget

Target

NationTarget Sub-Sector

Value

(US$B)

02/05/15 Pfizer Inc. US Hospira Inc. US Pharmaceuticals 16.8

02/22/15Valeant Pharmaceuticals

International Inc.US Salix Pharmaceuticals Ltd. US Pharmaceuticals 12.8

01/11/15 Shire PLC Ireland NPS Pharmaceuticals Inc. US Biotechnology 5.1

01/16/15 Investor Group1 China Hubei Biocause Pharmaceutical Co. Ltd. China Pharmaceuticals 1.6

02/26/15 Cyberonics Inc. US Sorin SpA ItalyHealthcare Equipment &

Supplies1.5

1010

Common Types of Transactions

• Traditional acquisitions (business and asset)

• Obtaining control through VIEs

– VIEs representing a business vs. VIEs representing an asset

• “Collaborations” through existing entities or joint ventures, including in-licensing / out-licensing activities

– Co-development

– Co-marketing

– Co-promotion

• R&D funding arrangements

1111

Key Questions for Common Types of Transactions

• Has control been obtained through the acquisition of a business or asset?

– Why it matters: differences in accounting, diversity in practice, SEC focus

– Determining whether the acquired set is a business or an asset

– FASB standard setting project

• If the transaction does not involve the acquisition of a business/asset, has control been obtained through other means?

– Applying the business scope exception

– Identifying variable interests

– Determining whether the entity is a VIE

– Identifying the primary beneficiary

• If control has not been obtained, what accounting applies?– Collaboration accounting

– Accounting for licensing arrangements

– Joint venture accounting

– R&D funding arrangements

Business vs. Asset

Has control been obtained through the acquisition of a business or asset?

1313

Why does it matter? – Differences in accounting

Area Business Combination / Divestment

Asset Acquisition / Divestment

Measurement of assets and liabilities

Fair value (some exceptions) Allocate purchase consideration based on relative fair values

Transaction costs Expense as incurred Record as a component of the consideration transferred

Contingent Consideration Generally record at fair value; mark to market through P&L post-close if a liability

Policy election for contingent receivable

Recognize when resolved and the consideration is paid or becomes payable

IPR&D Capitalize as an indefinite lived asset until project completed or abandoned

Expense assuming no alternative future use

Goodwill Recognize as standalone asset Cannot be recognized. The excess fair value of the consideration is allocated on relative fair value basis

Leases classification Reassessment of lease classification is not required, unless significantly modified

Reassess lease classification

Adjusted Earnings (some companies)

Amortization of intangibles / Fair Value adjmts. to contingent consideration are adjusted out of earnings

No adjustments

Divestment Accounting –Derecognition of Goodwill

Derecognize goodwill No derecognition of goodwill

Divestment Accounting – New Revenue Standard

Policy election for contingent consideration receivable

Estimate and recognize contingent consideration subject to constraint

14

Why It Matters: Diversity in Practice

…A panelist from the session on current accounting practice issues discussed the difference between the definition of an asset and the definition of a business…The panelist noted that in practice, registrants may have difficulty determining whether certain transactions constitute an asset acquisition or a business combination.

Citing an example seen in the real estate industry, another panelist noted that a registrant’s acquisition of a residential apartment building with rental lease agreements in place (i.e., a process capable of generating an output) would be indicative of a business combination. The panelist also noted that a single asset acquisition (e.g., ship, airplane, or power plant) combined with customer contracts at the time of acquisition may qualify as a business combination and that it may therefore be difficult to determine whether arrangements are part of an acquisition or separate from the acquisition…

Deloitte Heads-Up: Highlights of the 2014 AICPA Conference on Current SEC and PCAOB Developments

15

Why It Matters: PCAOB Focus

…Reiterating its statement from last year that the PCAOB primarily takes a risk-based approach in selecting engagements for inspection, the staff indicated that the Board will continue to focus on the areas it believes represent the greatest risk. The staff noted that the findings in this inspection season were frequently related to revenue recognition, inventory, goodwill and intangible assets, and business combinations…

…The PCAOB staff noted that some newer areas of PCAOB focus will include…M&A activity (including cash flow projections used to support valuations and controls related to business combinations)...

Deloitte Heads-Up: Highlights of the 2014 AICPA Conference on Current SEC and PCAOB Developments

16

Why It Matters: SEC Focus

• The SEC may request supporting information regarding an entity’s determination under ASC 805…

We note that you accounted for the acquisition of assets of [Entity A] as the acquisition of a business under the guidance of FASB ASC 805. Please provide us with your analysis of why you believe that the acquisition was one of a business rather than of assets.

Please explain to us in necessary detail why you believe this transaction constitutes the acquisition of assets, rather than of a business…. be as detailed as necessary in your supplemental response, citing applicable literature you relied upon, so that we may understand your conclusions.

Example SEC Comment Letters

17

Please refer to your response to comment one. As [intellectual property] was an approved product when you licensed it, please provide us with an analysis supporting your conclusion that the license of [intellectual property] was an asset acquisition and not a business combination. Please refer to ASC 805-10-55-4 to 9.

Please provide us an analysis of how you concluded that the commercialization agreement with [seller] and the license agreement with [licensor] qualified as business combinations under ASC 805. Please include the inputs and processes acquired that you identified in your analysis. Provide us reference to the authoritative literature on which you relied.


Example SEC Comment Letters (cont’d)

18


Please provide us your analysis supporting your conclusion that the acquisition of XYZ is not a business to be accounted for under the acquisition method of accounting. Reference for us the authoritative literature you rely upon to support your anticipated accounting…

…Please confirm that you will acquire the entire legal entity, XYZ, in this transaction.

…Please elaborate on your claim that XYZ does not have any processes. In your response tell us how XYZ has managed the development of [PROGRAM] and/or any other product candidates without strategic management, operational and/or resource management processes that at a minimum include the:

• Design and implementation of a development plan for the candidate(s);

• Execution of the development plan(s) including, but not limited to, product formulation, performing pre-clinical toxicology studies, filing an IND with the FDA, performing clinical trials and having a pre-NDA meeting with the FDA;

Example SEC Comment Letters (cont’d)

1919

So…What is a business?

• A business is an integrated set of assets and activities capable of being managed to provide a return to its owners.

• Businesses consist of (1) inputs (e.g., assets, resources), (2) processes (e.g., systems, standards, or protocols) applied to those inputs, that are capable ofcreating (3) outputs (e.g., economic benefits, such as revenues or lower costs). [ASC 805-10-55-4]

• A business need not include all of the inputs or processes that the seller used in operating that business if market participants are capable of acquiring the business and continuing to produce outputs, for example, by integrating the business with their own inputs and processes. [ASC 805-10-55-5]

– Generally the acquired set of activities and assets must have at least some inputs and processes in order to be considered a business

– Missing inputs or processes can be readily acquired without significant delay or effort by a market participant

• Does not need to be a legal entity

• Outputs do not need to be present at the acquisition date (e.g., development stage entities can be businesses)

2020

Applying the Definition: Views of Members of PhRMA

• Members of PhRMA drafted and shared with the FASB Staff a

white paper that:

– Highlights the challenges encountered when interpreting the current

authoritative literature regarding the definition of a business.

– Provides interpretations the group believes are applicable in the life sciences

industry as well as the application of these interpretations in practice via

examples.

– Suggests modifications to the current authoritative literature regarding the

definition of a business

• Members of PhRMA view the following considerations as

particularly important:

– Phase of development and the meaning of “capable of” from a market

participant’s viewpoint

– “Know-how” – whether an input or a process

– Contemporaneous arrangements – whether considered part of acquired set of

assets

– Employees – whether an acquired process

– Continuing revenue stream – whether a business

2121

Phase of Development & Meaning of “Capable of”

• Consider whether a market participant would be capable of using the acquired set to generate outputs

– Market participant – strategic buyer, financial buyer, or both?

• Product candidates that are closer to regulatory approval may be more likely a business

– The earlier the stage of development, the lower the likelihood there may be inputs or functioning processes

– The later the stage of development, the higher the probability of generating some kind of return on investment (e.g., ability to sublicense could allow a company to generate economic benefits even without FDA approval)

– Be careful in considering Phase 3 a “bright line”• Prior to Phase 3, the likelihood of technical success (i.e., FDA approval) is ≤ 10-30%

• Product candidates in Phase 3 trials often have success rates > 50%

Market ParticipantStrategic Financial

Preclinical through Phase 2 Not likely capable of generating a return

Possibly capable of generating a return

Phase 3 More likely capable of generating a return

More likely capable of generating a return

2222

Know-How: Input or Process?

• Know-how represents the protocols, formulas, data and results of testing (the “playbook”)

• Determining whether know-how represents an input or a process may be important as processes are necessary in order to meet the definition of a business

– Does it matter when the product candidate is acquired (during a phase or at the end of a phase)?

PhRMA Illustration #1 – Input or Process Acquired?

Big Pharma in-licenses a product candidate upon completion of Phase 2 and is entitled to all of the know-how associated with the product candidate. Big Pharma does not acquire any other activities (e.g., no CRO or CMO) or assets. The know-how provides the protocols, formulas, data and results of testing relating to Phases 1 and 2. A market participant will need to develop the procedures and protocols to conduct R&D activities in Phase 3.

Analysis Because the product candidate was acquired at the end of Phase 2, and a market participant would need to develop the procedures and protocols to conduct R&D activities in Phase 3, the know-how would be considered an input. As a result, because the acquired set consists only of inputs (the product candidate and associated know-how), the acquired set would not be considered the acquisition of a business.

2323

Know-How: Input or Process?

PhRMA Illustration #2 – Input or Process Acquired?

Big Pharma in-licenses a product candidate whose Phase 3 trial is underway (in-house or through the use of a CRO) and is entitled to all of the know-how associated with the product candidate. Big Pharma does not acquire any other activities (e.g., no CMO) or assets. The know-how provides the protocols, formulas, data and results of testing for the work performed to date and includes procedures and protocols to perform the R&D activities in Phases 3. Big Pharma determines that any market participant would use the acquired protocols to conduct Phase 3 testing.

Analysis Because the product candidate was acquired while Phase 3 is underway and includes procedures and protocols to conduct the R&D activities in Phase 3, the know-how would be considered a process. As a result, because the acquired set consists of inputs (the product candidate) and processes (the know-how) and the acquired set likely is capable of generating a return (due to the later stage of development), the acquired set likely would be considered the acquisition of a business.

2424

Contemporaneous Arrangements: Part of an Acquired Set?

• Common processes acquired include clinical manufacturing organization (CMO) or other supply agreements and/or clinical contract organization (CRO) or other R&D service agreements

• CRO and CMO arrangements often result in the provision of services that advance the technology and, therefore, are considered processes (although some question whether such arrangements represent “the ability to obtain access to necessary materials or rights,” i.e., inputs).

• Assuming the CRO/CMO arrangement is considered a process, consider whether the arrangement will transfer (i.e., be assumed by the buyer).

• What if the buyer enters into the same or a similar arrangement contemporaneously with (1) a new CRO/CMO, (2) the same CRO/CMO, or (3) the seller?

Relevant considerations may include:

– Are the terms of the new arrangement at market or at terms similar to the seller’s previous arrangement?

– Is the arrangement only for a transitional period (e.g., TSA)?

2525

Employees: Acquired Process?

• ASC 805-10-55-4b states that “an organized workforce having necessary skills and experience following rules and conventions may provide the necessary processes that are capable of being applied to inputs to create outputs.”

• Consider which employees will transfer

– Do transferred employees have sufficient knowledge of one or more of the substantive processes needed to generate outputs (e.g., lead scientists who perform R&D activities) or do transferred employees perform administrative functions (e.g., accounting and payroll)?

• Consider TSA arrangements

– What is the purpose and design of the arrangement, the nature of services being provided by the seller (i.e., whether a substantive process is transferred through the terms of the arrangement), and the duration of the arrangement?

– Upon expiration of the TSA, will the buyer need to enter into a new agreement or hire new employees to perform the same functions?

2626

Continuing Revenue Stream: Indicative of a Business?

• Does the acquisition of inputs and outputs but no observable processes constitute a business?

PhRMA Example

Pharma acquires a license to exclusively commercialize an approved product in a particular jurisdiction. No manufacturing activities were transferred, but the acquired set includes enough inventory for sale until a market participant is capable of manufacturing the product.

Analysis The main revenue producing activities associated with the acquired set remain substantially the same before and after the acquisition, and accordingly, the acquired set would constitute a business.

2727

Applying the Definition: Deloitte observations

Potential Indicators of Business Combination Potential Indicators of Asset Acquisition

Key business processes acquired(e.g., Has begun planned principal activities)

No processes acquired or only administrative processes acquired

Entity could manage the assets to provide a return to its owners (e.g., Is pursuing a plan to produce outputs)

Entity could not manage the assets to provide a return to its owners without combining them with other assets

Key elements are missing but can be easily replicated or obtained

Key elements are missing and cannot be easily replicated or obtained

Able to produce "Day 1" outputs Not able to create economic benefits

Presence of liabilities and/or goodwill No goodwill present

• In making the determination of whether a set of activities represents a business or an asset, it is important to:

1. Identify the elements in the acquired group (i.e., the assets purchased and processes transferred);

2. Assess the capability of those elements to generate economic benefits; and 3. Assess the impact of any missing elements on a market participant's ability to generate

economic benefits

Development-stage entities might not yet have outputs, but if a set has begun operations, has inputs and processes, and is following a plan to produce outputs, it may qualify as a business.

28

Example 1

Facts

• Pharma Co (P) enters into a worldwide license, manufacturing and distribution agreement with L for a compound in clinical development.

• P receives the right to manufacture, market and distribute the compound in perpetuity if and when regulatory approval is obtained.

• P does not acquire any tangible manufacturing assets, employees, or contract manufacturing or research arrangements.

29

Example 1

Outcome

• P identifies numerous missing elements for producing outputs…

– Inputs (e.g., regulatory approved compound, equipment and facilities, personnel)

– Processes (e.g., contract or other manufacturing)

• The missing inputs/processes to develop and produce the compound cannot be acquired without significant delay or effort by a market participant.

• P concludes the group of assets is not a business.

Remember to consider the nature and extent of missing inputs/processes.

30

Example 2

Facts

• Biotech Co. (B) enters into a worldwide license, manufacturing and distribution agreement with L for an approved drug.

• B receives the right to manufacture, market and distribute the newly developed drug in perpetuity and obtains manufacturing know-how and documentation from L.

• B does not acquire any tangible manufacturing assets, employees, or contract manufacturing arrangements, and expects delays in having regulatory-approved manufacturing facilities.

31

Example 2

Outcome

• B identifies numerous missing elements for producing outputs…

– Inputs (e.g., regulatory approved equipment and facilities, personnel)

– Processes (e.g., standard operating procedures, contract manufacturing)

• The missing inputs/processes to produce the developed drug cannot be acquired without significant delay or effort by a market participant.

• B concludes the group of assets is not a business.

Remember to consider the nature and extent of missing inputs/processes.

32

Example 3

Facts

• Pharma Co (P) acquires a manufacturing plant (the “facility”) in AnyCountry.

• Acquisition of the facility includes the plant’s tangible assets, employees, and business licenses/registrations.

• P intends to immediately modify the facility to produce active pharmaceutical ingredients (e.g., raw materials) instead of finished dosage forms (e.g., finished goods).

• Because of the planned modifications, P does not acquire the facility’s existing customer contracts and will not continue to sell any of the products previously manufactured in the facility.

33

Example 3

Outcome

• The facility contains the elements necessary for producing outputs…

– Inputs (i.e., tangible assets, intangible assets, employees)

– Processes (i.e., the production of finished dosage forms)

• P’s intended use for the facility is not a factor – the assessment is from the perspective of a market participant.

• Because the plant was operating and producing outputs upon acquisition, a market participant could have acquired the plant and continued to operate it in that manner.

• P concludes the facility is a business.

Remember to consider the market participant perspective.

34

Example 4

Facts

• Big Pharma buys all of the outstanding shares of Target Biotech

• Target Biotech’s operations include R&D activities on several preclinical compounds that it is researching. Target Biotech has employees that are performing the R&D activities who have previously demonstrated the ability to generate additional preclinical compounds through their research.

• In addition, Target Biotech has an arrangement with a CRO to complete certain research and development activities and an arrangement with a CMO to supply clinical trial materials. These arrangements are assumed by Big Pharma in connection with the acquisition.

• Target Biotech does not have a marketable product and has generated only losses since inception.

35

Example 4

Outcome

• CMO/CRO arrangements (processes) are assumed by Big Pharma.

• R&D employees that will transfer to Big Pharma are performing activities to generate additional preclinical compounds through their research, which, in the aggregate, increases the likelihood that the acquired set is capable of generating a return.

• The production of additional compounds outweighs the fact that the R&D efforts to commercialize the acquired compounds may not be successful (the acquired compounds are not “capable of” generating a return on their own due to the low probability of technical success for such early stage of the compounds). As such, due to the inputs and processes obtained, the acquired set of assets and activities would likely have the ability to generate a return.

• Big Pharma concludes acquired set is a business.

36

Example 5

Facts

• Big Pharma buys all of the outstanding shares of Target Biotech

• Target Pharma is a development stage entity that is researching one compound for a single treatment indication that has completed Phase 1 clinical trials. Big Pharma acquires only the intellectual property and know-how for protocols, formulas, data and results of testing relating to Phase 1 activities and a manufacturing agreement for clinical supply production levels only of the active pharmaceutical ingredient (API).

• Big Pharma does not acquire any employees or other assets as part of the purchase agreement. At the time of acquisition, Big Pharma determined that Phase 2 clinical trials will need to be designed and conducted by Big Pharma.

37

Example 5

Outcome

• Big Pharma, like other market participants, would need to develop procedures and protocols to conduct Phase 2 R&D activities using the acquired intellectual property.

• Because Big Pharma did not acquire any employees or contract with any of the former lead scientists that have knowledge of the product candidate, or acquire any other assets other than the intellectual property and an early stage API manufacturing agreement, Big Pharma did not assume any significant processes that would be considered sufficient to carry on the business in a manner that could be “capable of” generating a return.

• Big Pharma concludes acquired set is not a business.

38

BMS Critical Accounting Policies (2014 Form 10-K)

Accounting for transactions as business combinations and divestitures is significantly different than asset acquisitions and divestitures. For example, acquired IPRD is capitalized for business combinations and expensed for asset acquisitions and the fair value of contingent consideration and goodwill are only recognized in business combination transactions. Similarly, when a portion of a reporting unit that constitutes a business is to be disposed of, goodwill associated with that business is included in the carrying value of the business in determining the gain or loss on disposal. Derecognition of goodwill does not occur in asset dispositions. As a result, it is important to determine whether a business or an asset or group of assets is acquired or divested. A business is defined in ASC 805 –Business Combinations as an integrated set of inputs and processes that are capable of generating outputs that have the ability to provide a return to its investors or owners. Typical inputs include long-lived assets (including intangible assets or rights to use long-lived assets), intellectual property, and ability to obtain access to required resources. Typical processes include strategic management, operational and resource management processes that are typically documented or evident through an organized workforce…

Business Combinations and Divestitures

39

BMS Critical Accounting Policy (2014 Form 10-K)

…We consider all of the above factors in determining whether a business was acquired (or divested) as well as the stage of development if no commercial products are involved. For example, in evaluating our acquisition of iPierian, we concluded that no significant processes were transferred to us, thus the transaction was accounted for as an asset acquisition. As a result, $148 million allocated to the lead investigational compound was expensed and not capitalized. In addition, contingent consideration from potential regulatory and approval milestones of $550 million and sales-based royalties were not included in the purchase price. Similarly, in evaluating our divestiture of our diabetes business to AstraZeneca, we concluded that all necessary inputs and processes were transferred, and consequently the transaction was accounted for as the sale of a business, which resulted in the allocation of $600 million to the carrying value of the business in determining the gain on sale…

Business Combinations and Divestitures (cont'd)

40

BMS Example #1: iPierian Acquisition

In April 2014, BMS acquired all of the outstanding shares of iPierian, Inc. (iPierian), a biotechnology company focused on new treatments for tauopathies, a class of neurodegenerative diseases. The acquisition provides BMS with full rights to IPN007, a preclinical monoclonal antibody to treat progressive supranuclear palsy and other tauopathies. The consideration includes an upfront payment of $175 million, contingent development and regulatory milestone payments up to $550 million and future royalties on net sales if any of the acquired preclinical assets are approved and commercialized. No significant iPierian processes were acquired, therefore the transaction was accounted for as an asset acquisition because iPierian was determined not to be a "business" as that term is defined in ASC 805 - Business Combinations. The upfront payment allocated to IPN007 was $148 million and included in research and development expenses. The remaining $27 million was allocated to deferred tax assets for net operating losses and tax credit carryforwards.

41

BMS Example #2: Diabetes Divestment

…Gain contingencies (including contingent proceeds related to the divestitures) are not recognized until realized…

…The gain on sale of the diabetes business was $247 million. The gain was based on the difference between the consideration allocated to the sale of the business (net of transaction fees) and the carrying value of the diabetes business net assets (including a $600 million allocation of goodwill and the reversal of $821 million of net deferred tax liabilities attributed to Amylin)…

42

BMS Example #3: Divestment of Other Brands

…In February 2013, BMS and The Medicines Company entered into a two-year alliance for Recothrom…BMS also granted The Medicines Company an option to acquire the patents, trademarks, inventory and certain other assets exclusively related to Recothrom at a price determined based on a multiple of sales (plus the cost of any remaining inventory held by BMS at that time). In February 2015, The Medicines Company exercised the option and acquired the trademarks, intellectual property and inventory…

…In October 2012, BMS and…Valeant…entered into an alliance for certain mature brand products in Europe…BMS also granted Valeant an option to acquire the trademarks and intellectual property exclusively related to the products at a price determined based on a multiple of sales. In January 2015, Valeant exercised the option and acquired the trademarks and intellectual property…

…[Assets held-for-sale at 12/31/14 includes goodwill allocated to the Recothrom and mature brands businesses]. The allocation of goodwill was based on the relative fair value of the businesses being divested to the Company’s reporting unit…

43

Amicus Example: Callidus Biopharma Acquisition

In November 2013, the Company acquired Callidus, through the merger of the Company's subsidiary, CB Acquisition Corp. with and into Callidus. Callidus was a privately-held biologics company focused on developing best-in-class ERTs for LSDs and its lead ERT is ATB200 for Pompe disease in late preclinical development. The acquisition of the Callidus assets and technology compliments Amicus' CHART™ platform for the development of next generation ERTs.

In consideration for the merger, the Company agreed to issue an aggregate of 7.2 million shares of its common stock, par value $0.01 per share, to the former stockholders of Callidus. As of December 31, 2014, approximately 25 thousand shares remain issuable to former Callidus stockholders. In addition, the Company will be obligated to make additional payments to the former stockholders of Callidus upon the achievement by Callidus of certain clinical milestones of up to $35 million and regulatory approval milestones of up to $105 million as set forth in the Merger Agreement, provided that the aggregate consideration shall not exceed $130 million.

44

Standard Setting on the Horizon?

Project Objective

This project is intended to address “whether transactions involving in-substance nonfinancial assets (held directly or in a subsidiary) should be accounted for as acquisitions (or disposals) of nonfinancial assets or as acquisitions (or disposals) of businesses.” The project also aims to clarify the guidance for partial sales of nonfinancial assets.

December 17 FASB Action AlertThe Board discussed ways to resolve practice issues associated with applying the definition of a business.

FASB Project: Clarifying the Definition of a Business

45


• The Phrase “Capable of”: The Board decided to retain the concept of capable of in the definition of a business.

• Processes: The Board decided to clarify that to be a business the set of activities and assets must include inputs and one or more substantive processes that together contribute to the ability to create outputs. The Board instructed the staff to develop factors that indicate when a process is substantive.

• De Minimis or Other Similar Threshold: The Board decided that the staff should explore a threshold to be used in the definition of a business similar to the de minimis threshold in EITF Issue No. 98-3, Determining Whether a Nonmonetary Transaction Involves Receipt of Productive Assets or of a Business. Issue 98-3 said that if all but a de minimis amount of the fair value of the transferred set of activities and assets was represented by a single tangible or identifiable, intangible asset, that was an indicator that the transferred set was an asset rather than a business.

FASB December 17 Action Alert

46


• Outputs: The Board decided to revise the definition of outputs to focus on goods and services to customers.

• Market Participant: The Board decided not to explore changes to the concept of a market participant in the definition of a business but asked the staff to provide clarifying guidance on how to analyze an acquisition from a market-participant perspective.

• Examples: The Board may explore adding examples to help in the interpretation of what is a business.

FASB December 17 Action Alert (cont’d)

Applying the VIE Model

If the transaction does not involve the acquisition of a business/asset, has control been obtained through other means?

48

No

No

Yes

No

Overview of VIE Model

Voting Interest Entity (VoE).Apply other guidance.[e.g. ARB 51, SFAS 94,

APB 18]

Consolidate the VIE

No

Yes

Yes

Yes

Do not consolidate the VIE. Apply other guidance.[e.g. APB 18, FAS 115,

FAS 133, FAS 13]

Step 3: Is the entity a variable interest entity (“VIE”)?

Step 1: Is the entity or reporting entity scoped out of the Interpretation?

Step 2: Does the reporting entity hold a variable interest (“VI”) in the entity?

Step 4: Is the reporting entity the primary beneficiary (“PB”) of the VIE?

49

– Typically the most judgmental exception to apply

– A “business”, as defined in ASC 805, need not be evaluated under a variable interest entity consolidation model unless any of the following apply:

‒ The reporting entity and/or its related parties participated in the design or redesign of the entity (however, if the entity is a joint venture, as defined in the accounting literature, participation in design or redesign is not problematic).

‒ Substantially all of its activities either involve or are conducted on behalf of the reporting entity and its related parties.

‒ The reporting entity and its related parties provide more than half of the entity’s subordinated financial support.

‒ The activities of the entity are primarily related to securitizations or other forms of asset-backed financings or single-lessee leasing arrangements.

Business Scope Exception

50

• A variable interest is any interest that exposes a reporting entity to variability in the fair value of the net assets of a VIE exclusive of variable interests

• Assets, operations and purchase agreements typically create variability; liabilities, equity and off-take arrangements typically absorb variability

Identification of Variable Interests

Examples of Variable Interests

Trade A/P Guarantees of an entity

License, royalties, and other similar arrangements linked where the reporting entity earns income from based on the entity’s performance (e.g., sales)

Fees paid to a decision maker

Operating leases (in which the entity is the lessor) with an embedded residual value guarantee, a non-fair-value-based purchase option, or both

Long-term liabilitiesof an entity

Put options held by an entity

Total return swaps on specified assets owned by an entity

Fees paid to a service provider

Operating leases (in which the entity is lessee)

Equity of an entity Stand-alone call options written by an entity on specified assets owned by that entity

Fixed price forward contracts to sell specified assets owned by an entity

Stand-alone residual value guarantees on an entity’s leased assets, written call options covering such leased assets, or both

Supply agreements with variable cost component (when the entity is the supplier/seller)

51

Identification of Variable Interests

Examples of Nonvariable Interests

Assets of an entity License, royalties, and other similar arrangements linked where the entity earns income from based on the reporting entity’s performance (e.g., sales)

Fixed price forward contracts to purchase assets not owned by an entity, fixed-price contracts to sell assets not owned by an entity

Options, guarantees, and similar financial instruments or contracts written by an entity

Other derivatives Operating leases in which the entity is the lessor, in the absence of a residual value guarantee, a non-fair-value-based purchase option, or other similar provisions

52

Determining whether an Entity is a VIE

• An entity is a VIE if any one of the following 3 conditions are met:

– Total equity investment at-risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support

– Holders of equity investment at-risk lack

‒ Power to direct the activities of the entity that significantly impact economic performance; or

‒ The obligation to absorb losses or right to receive residual returns of the entity

– Voting rights of some investors are disproportionate to their obligation to absorb losses/receive returns and substantially all of the activities are on behalf of the investor with disproportionate voting rights

Equity investors do not have sufficient skin in the game so why should we respect voting interest model??

Equity investors do not have attributes we would expect equity holders to have, so why should we respect voting interest model??

Anti-abuse provision designed to prevent structuring opportunities to circumvent consolidation under voting interest model

53

Determining whether an Entity is a VIE: Equity at Risk

• Example: Development-stage Entity

– Assumptions:

‒ Entity D is a development-stage entity

‒ Investor A and B each contributed $1M of equity financing to D

‒ Entity D’s current activities consist of Phase II drug development. Upon successful completion of Phase II, D plans to commence Phase III development. Upon regulatory approval, D plans to engagement in commercialization activities. Entity D’s bylaws allow A and B to fund additional equity upon completion of Phase II and III.

‒ Is equity at risk sufficient?

– Analysis: When assessing the sufficiency of equity at risk, D need only consider the current “phase” of development. Thus, if at inception, the $2M of equity capital is deemed sufficient to finance Phase II, D would be considered to have sufficient equity at risk. This determination should be reassessed at the commencement of phase III and commercialization activities, upon the funding of additional equity financing, or upon the occurrence of any of the events in ASC 810-10-35-4.

54

Determining whether an Entity is a VIE: Considering Equity Holders

In October 2014, BMS entered into an agreement with F-Star Alpha Ltd (F-

Star). The agreement provides BMS with an exclusive option to purchase F-

Star Alpha and its Phase 1 read lead asset FS102, a targeted therapy in

development for the treatment of breast and gastric cancer…During the

option period, BMS will be responsible for conducting and funding the

development of FS102…F-Star was determined to be a variable interest

entity because its equity holders lack the characteristics of a controlling

financial interest…

BMS Example: F-Star

55

Determining whether an Entity is a VIE: Disproportional Voting Rights

• Example: Joint venture

– Assumptions:

‒ Entity A and B contribute $1 million each for 50% interest in JV to manufacture drug compound X to sell to a wide distribution network of customers

‒ Entity A and B each get 50% of the vote in the JV

‒ Entity A also provides JV with subordinated debt

‒ Entity A and B are not related parties

50% 50%

Subordinated Debt

A B

JV

– Analysis: Entity A has disproportionately few voting rights as they have a 50% vote in the joint venture, but absorb a greater percentage of expected losses through their combined subordinated debt and equity interest; BUT

Substantially all of the activities (selling drug compound X) do not appear to be on behalf of an investor, Entity A, with disproportionately few voting rights

– Conclusion: Joint venture is not a VIE

56

Determining the Primary Beneficiary

Controlling financial interest

NoDoes the reporting entity have the

power to direct the activities of the VIE

that most significantly

impact the VIE’s economic

performance?

Does the reporting entity have the

obligation to absorb losses or the right

to receive benefits, both of which

could potentially be significant to the

VIE?

The VIE is not

consolidated by the

reporting entity.

Yes

Yes

No

The reporting entity has a

controlling financial interest

The VIE must be consolidated by

the reporting entity

Note – This chart

excludes related party

considerations for ease

of display. Related

parties should be

considered in each step.

57


For VIEs, we may be required to consolidate an entity if the contractual

terms of the arrangement essentially provide us with control over the entity,

even if we do not have a majority voting interest. We assess whether we are

the primary beneficiary of a VIE based on our power to direct the activities of

the VIE that most significantly impact the VIE's economic performance and

our obligation to absorb losses or the right to receive benefits from the VIE

that could potentially be significant to the VIE. As such, we have

consolidated those entities in our consolidated financial statements. As of

December 31, 2014, the only material VIE was our joint venture with BMS…

…The daily operations of the joint venture are governed by four primary joint

committees formed by both BMS and Gilead. We are responsible for

accounting, financial reporting, tax reporting, manufacturing and product

distribution for the joint venture. Both parties provide their respective bulk

active pharmaceutical ingredients to the joint venture at their approximate

market values…

Gilead (BMS) Example: Joint Venture

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• Sequential Power: Determining the primary beneficiary through the life of the entity

‒ Primary beneficiary determination is evaluated continuously.

‒ Result: Since the primary beneficiary determination is based on power to direct significant activities, the primary beneficiary determination can change as activities that are significant to the entity’s economic performance change.

‒ Consider whether changes in circumstances represent a change in power over the most significant activities or the initiation of the most significant activities of the entity.


Requires significant judgment and

consideration of features like puts /

calls, etc.

59

• Example

– Entity C is formed by two investors to develop and manufacture a new drug. Assume that C is a VIE and that each investor holds a variable interest in C.

– Investor A has power over the R&D activities to develop and obtain FDA approval for the drug (stage 1), and those activities most significantly affect C’s economic performance during that stage.

– Investor B has the power over the manufacturing process, distribution, and marketing of the drug if and when FDA approval is obtained (stage 2), and those activities would most significantly affect C’s economic performance during that stage.

Which party is the primary beneficiary?


60

– Analysis: Entity C was designed such that there are two distinct stages during the life of C, and the variable interest holders expect that the second stage will only begin upon FDA approval. Also, the activities and decisions before and after FDA approval are significant to the economic performance of C (in this example, they are different activities directed by different parties). In addition, the variable interest holders conclude that there is substantial uncertainty about whether FDA approval will be obtained and that the approval is outside their control.

– For these reasons, in the absence of evidence to the contrary, FDA approval would be considered a contingent event that results in a change in power from Investor A to Investor B, and that contingent event is substantive. Therefore, the primary-beneficiary determination should focus on stage 1 activities until the contingent event occurs and the investor that has power over the R&D activities would initially have the power to direct the most significant activities of C. If FDA approval is obtained, the primary-beneficiary determination would focus on stage 2 activities and the variable interest holder that has the power over the manufacturing process, distribution, and marketing of the drug would have the power to direct the most significant activities of C.


Collaboration Accounting

Licensing Arrangements

JV Accounting

R&D Funding Arrangements

If control has not been obtained, what accounting applies?

62

Collaborations, Licensing, JV and R&D Funding

• Often, arrangements do not involve the outright acquisition of a business/asset or obtaining control of an entity. Examples include:

– Collaborations

– Licensing Agreements

– Joint Ventures

– R&D Funding Arrangements

• Drivers of entering into such agreements

– Transfer or share risk of R&D

– Transfer or share manufacturing, sales and marketing efforts once products are approved

– Ability to develop more compounds when resources are limited

– Transform low priority assets into viable and potentially successful assets by partnering

– De-prioritize indications and/or assets

– Accelerate development of certain assets

– Balance financial reporting and liquidity consideration

• In these types of arrangements, upfront and ongoing consideration is often exchanged. Accounting for these types of transactions requires an evaluation of the rights and obligations of each of the parties.

63

Accounting for Collaborations

• ASC 808 defines collaborative arrangements as a contractual arrangement that involves a joint operating activity. These arrangements involve two (or more) parties that meet both of the following requirements:

– They are active participants in the activity

– They are exposed to significant risks and rewards dependent on the commercial success of the activity

• Participants should evaluate whether an arrangement is a collaborative arrangement at its inception and reevaluate through life of endeavor.

• The following are indicators that can be used to identify a collaboration agreement:

– Participants are “active” contributors to the arrangement (actively participate) and are not solely financial investors

– Participants are exposed to significant risks and rewards dependent on the commercial success of the endeavor

– There is a steering committee or other mechanism to provide participating rights to the participants

– The participants conduct their joint activities primarily outside of a legal entity

Guidance and Overview

64


• What it does – ASC 808 provides guidance on the income

statement presentation and disclosures related to collaborative

arrangements.

• What it does not do – ASC 808 does not address recognition or

measurement matters, for example, determining the appropriate

units of accounting, the appropriate recognition requirements for a

given unit of accounting, or when the recognition criteria are met.

Thus, even when a collaboration is within the scope of ASC 808,

companies must look to other GAAP (possibly by analogy) to

determine the appropriate recognition and measurement for the

activities subject to the arrangement.

• Looking forward – Collaborative arrangements are specifically

scoped out of the new issued revenue recognition guidance.

ASC 808

65


• Transactions with third parties (parties that do not participate in the

arrangement) should be reflected in each entity's respective

income statement pursuant to the guidance in ASC 605-45

• The principal for a given activity will report revenues and expenses

on a gross basis.

• Payment between participants are to be classified based upon:

– Nature of the arrangement and business operations

– Contractual terms

– Other income statement classification authoritative accounting literature (apply

relevant provisions)

– Analogy to authoritative accounting literature (example – if an arrangement

includes reimbursement for R&D costs by entity A to entity B, that portion of the

net payment may be classified in entity A’s income statement as R&D expense)

– If no appropriate analogy, use of a reasonable, rational and consistent policy

application is allowed

ASC 808 – What it Does – Income Statement Presentation

66


• In order to apply the proper accounting treatment to a collaboration

agreement, it is important that companies make the appropriate

determination of whether the company is acting as the principal or

the agent

• Appropriate review of the details of the contract are essential to this

process

• ASC 605-45 provides guidance that a company should consider the

following factors when determining gross vs. net presentation:

– If it acts as the principal in the transactions;

– takes title to the product;

– has risks and rewards of ownership, such as the risk of loss for collection,

delivery, or returns; and

– acts as an agent or broker (including performing services, in substance, as an

agent or broker) with compensation on a commission or fee basis.

Determination of Principal vs. Agent

67


• Pharma and Biotech agree to equally participate in R&D and commercialization activities for a drug candidate

• Joint development and marketing agreement (a 50 percent, 50 percent arrangement) is established.

• Biotech is responsible for R&D and Pharma is responsible for the commercialization activities.

• One participant is required to make a payment to the other participant for the proportionate share of the excess of the entities’ combined operating results.

• In the first period, Biotech incurred R&D expenses of $10 million and Pharma had sales of $50 million and manufacturing expenses of $20 million and marketing expenses of $10 million. Pharma owes Biotech $15 million, such that each participant realizes a $5 million net profit from the arrangement (total sales of $50 million, less total expenses (including research and development) of $40 million, divided by 2).

Example #1 – Participants perform different activities

68


Pharma Accounting

Outcome #1 – Participants perform different activities

Biotech Accounting

Sales to third parties 50,000$

Cost of goods sold (including

$10,000 payable to Biotech for

profit sharing) 30,000

SG&A 10,000

R&D (including $5,000 payable

as a reimbursement of

Biotech's expenses incurred) 5,000

Net profit 5,000

Revenues from

collaborative arrangement 15,000$

Cost of goods sold -

SG&A -

R&D 10,000

Net profit 5,000

69


• Pharma and Biotech agree to equally participate in R&D and commercialization activities for a drug candidate

• Joint development and marketing agreement (a 50 percent, 50 percent arrangement) is established.

• Pharma and Biotech both agree to provide resources during the R&D, and Pharma is responsible for the commercialization activities.

• As both participants are performing R&D activities, there may be periods in which Biotech must make a payment to Pharma for its proportionate share of the R&D activities and periods in which Pharma must make payments to Biotech.

• One participant is required to make a payment to the other participant for the proportionate share of the excess of the entities’ combined operating results.

• In the first period, Biotech and Pharma incurred R&D expenses of $10 million and $15 million, respectively. Pharma had sales of $75 million, related manufacturing expenses of $22.5 million, and marketing expenses of $20 million. As a result, Pharma owes Biotech $13.75 million, such that each participant realizes $3.75 million net profit from the arrangement (total sales of $75 million, less total expenses of $67.5 million, divided by 2).

Example #2 - Participants perform some of the same activities

70

Sales to third parties 75,000$

Cost of goods sold (including

$16,250 payable to Biotech for

profit sharing) 38,750

SG&A 20,000

R&D (including $2,500 payable

as a reimbursement of

Biotech's expenses incurred) 12,500

Net profit 3,750

Revenues from

collaborative arrangement 13,750$

Cost of goods sold -

SG&A -

R&D 10,000

Net profit 3,750


Pharma Accounting Biotech Accounting

Outcome #2 - Participants perform some of the same activities

71

Collaboration Disclosure Example

BMS enters into collaboration arrangements with third parties for the development and

commercialization of certain products. Although each of these arrangements is unique

in nature, both parties are active participants in the operating activities of the

collaboration and exposed to significant risks and rewards depending on the

commercial success of the activities. BMS may either in-license intellectual property

owned by the other party or out-license its intellectual property to the other party.

These arrangements also typically include research, development, manufacturing,

and/or commercial activities and can cover a single investigational compound or

commercial product or multiple compounds and/or products in various life cycle

stages.

Payments between alliance partners are accounted for and presented in the results of

operations after considering the specific nature of the payment and the underlying

activities to which the payments relate. Multiple alliance activities, including the

transfer of rights, are only separated into individual units of accounting if they have

standalone value from other activities that occur over the life of the arrangements. In

these situations, the arrangement consideration is allocated to the activities or rights

on a relative selling price basis. If multiple alliance activities or rights do not have

standalone value, they are combined into a single unit of accounting.

BMS Example:

72

Collaboration Disclosure Example

Amicus Example:

In November 2013, Amicus entered into the Revised Agreement with GSK, pursuant

to which Amicus has obtained global rights to develop and commercialize migalastat

as a monotherapy and in combination with ERT for Fabry disease…

…Under the terms of the Revised Agreement, GSK will no longer jointly fund

development costs for all formulations of migalastat. In evaluating the impact of both

the Expanded Collaboration Agreement and the Revised Agreement, the Company

applied the accounting guidance regarding the impact of potential future payments it

may make in its role as a vendor (i.e., Amicus) to its customer (i.e., GSK) and

evaluated if these potential future payments could be a reduction of revenue from

GSK. If the potential future payments to GSK are as follows:

– a payment for an identifiable benefit, and

– the identifiable benefit is separable from the existing relationship between the

Company and GSK, and

– the identifiable benefit can be obtained from a party other than GSK, and

– the Company can reasonably estimate the fair value of the identifiable benefit,

then the potential future payments would be treated separately from the collaboration

and research revenue. However, if all these criteria are not

satisfied, then the potential future payments are treated as a reduction of revenue.

73

Accounting for Licensing Arrangements

• Out-licensing arrangements

–Allows a company to license or sell assets to another company which

funds the development

–Licensor receives financial payments, may also receive rights to

access program after development

• In-licensing arrangements

–Allows a company to in-license R&D compounds to quickly expand

its portfolio without the risks and costs involved with substantial R&D,

may complement developed in-house compounds

–Additional payments may be made to the licensor when certain

milestones are met

Overview

74


Structure: Straightforward transaction in which licensee receives all

rights and licensor receives financial payments in the form of upfronts,

milestones and royalties

Rationale: Preferred structure for large biopharma entities, affords

licensee immediate and potential future value with no further resource

commitment

Frequency: Commonly used structure

Licensee Licensor

Upfront, milestones, royalties

Exclusive rights, control

Overview

75


• Licensing arrangements often involve up-front and ongoing payments. Accounting for these payments involves different considerations for the payer and recipient:

– For the payer, payments are often evaluated under SFAS 2 (e.g., access to a technology that has no alternative future use and expensed when incurred).

• Consider also whether any portion of payments represents non-refundable advanced payment for future R&D activities to be performed (requiring capitalization and amortization as R&D is performed under EITF 07-3).

– For the recipient, consideration of revenue recognition literature is often relevant (either directly or by analogy). For example, understanding rights and obligations includes evaluating:

• Are there multiple deliverables (e.g., R&D licensing rights, options to IP, distribution rights, etc.) in the arrangement? If so, do they represent separate units of accounting?

• Does the payment represent consideration for the culmination of a separate earnings process?

• Should the milestone method (ASC 605) be applied? Consideration can be recognized entirely in the period the milestone is achieved if the milestone meets all criteria to be considered “substantive” (guidance, however, does not preclude other recognition methods as long as that method does not recognize revenue in its entirety in the period the milestone is achieved, hence the milestone method).

Consideration Exchanged

76

Example #1 – Recipient (BMS)

• BMS (“the Company”) entered into an alliance with AstraZeneca where co-exclusive

license rights were granted to AstraZeneca in exchange for an upfront payment and

potential milestone payments.

• Both parties actively participated in a joint executive committee and other operating

committees and had joint responsibilities for the R&D, distribution, sales and

marketing activities.

• BMS manufactured the products in all three alliances and was the principal in the

end-customer product sales in substantially all countries.

• For each alliance agreement, the rights transferred to AstraZeneca did not have

standalone value as such rights were not sold separately by BMS or any other party,

nor could AstraZeneca have received any benefit for the delivered rights without the

fulfillment of other ongoing obligations by BMS under the alliance agreements.

• As such, each global alliance was treated as a single unit of accounting. As a result,

upfront proceeds and any subsequent contingent milestone proceed were amortized

over the life of the related products.

77

Example #2 – Recipient (Amicus)

• Amicus (“the Company”) entered into a license and collaboration agreement with

Biogen to develop small molecules for the treatment of Parkinson's disease.

• Biogen was responsible for funding all discovery, development, and

commercialization activities and the Company was also eligible to receive

development and regulatory milestones, as well as modest royalties in global net

sales.

• As the Company has not commenced its planned principal operations (i.e. selling

commercial products) the Company is only performing development of its

compounds, and therefore, development activities are part of the Company's

ongoing central operations.

• The Company evaluated the contingent milestones and determined that the

contingent milestones are “substantive” and would be recognized as revenue in the

period that the milestone was achieved.

• The Company determined that the research based milestones are commensurate

with the enhanced value of each delivered item. The research based milestones

would relate to past performances when achieved and are reasonable relative to the

other payment terms within the Biogen Agreement, including the cost sharing

arrangement.

78

Accounting for Joint Ventures

• ASC 323 defines a corporate joint venture as a corporation owned and operated by a small group of entities (the joint venturers) as a separate and specific business or project for the mutual benefit of the members of the group.

• The purpose of a joint venture frequently is to:

– share risks and rewards in developing a new market, product or technology

– combine complementary technological knowledge

– pool resources in developing production or other facilities

• To meet the definition of a joint venture, an arrangement must typically have all of the following characteristics:

– The arrangement must be organized within a separate legal entity

– The entity must be under the joint control of the venturers

– The venturers must be able to exercise joint control of the entity through their equity interests

• Joint control is a joint venture’s most distinguishing feature

– Venturers need not have equal ownership interests to have joint control

– Joint control can be shared among more than two venturers

– Joint control can exist if one of the venturers has significant participating rights, provided that decisions related to the joint venture require the unanimous approval of the venturers.

– If the venturers intend to make joint control temporary (such as when a joint venture expects to conduct an initial public offering in the near future and subsequently eliminate joint control), joint venture accounting should not be applied

Guidance and Overview

79


• US GAAP does not specifically address the accounting by a joint

venture (JV) for noncash assets contributed at formation. In light of

this, joint venturers have generally looked to the views of the SEC

staff for guidance.

• If assets contributed at formation meet the definition of a

“business”, there are two approaches a joint venturer might

consider:

Fair value approach – May be appropriate for recognizing assets that meet the

definition of a business when all of the following conditions are met:

The new entity meets the definition of a joint venture in ASC 323

The venturers are not related parties

Fair value is reasonably determinable

Carryover basis approach (less common) – Does this approach result in

decision-useful information for the users of the financial statements?

Accounting at formation

80


• The appropriate accounting depends on the nature of any assets contributed

– If assets are contributed that meet the definition of a business or non-profit activity, the deconsolidation and derecognition guidance in ASC 810 requires the venturers to recognize the equity they receive at fair value, generally resulting in a gain or loss

– If assets are contributed that do not meet the definition of a business, the venturersneed to consider whether:

– the substance of the transaction is addressed by other guidance (apply other GAAP)

– the contribution is an interest in a subsidiary (i.e. a legal entity) that holds the assets (apply ASC 810), otherwise apply ASC 845

– The provisions of the VIE model must also be considered

• Investments in JV’s are generally accounted for under the equity method, unless the fair value option is elected in accordance with ASC 825)

– Under the equity method the venturer would perform a purchase price allocation pursuant to ASC 823 upon initially recognizing the equity interest

Accounting by the venturers

81


• Disclosures by the JV

A JV should disclose the policies it elects with respect to the

accounting for assets contributed at formation, in addition to all

other disclosures required by US GAAP

• Disclosures by the venturers (guidance to consider)

ASC 323-10-50 – Equity method investments (includes

disclosures related to the election of the FV option and any

impairment charges recorded on the investment)

ASC 810-10-50 – Deconsolidation (disclosures related to any

gain or loss recognized) and VIE’s (certain disclosures required

if determined to be a VIE)

ASC 280-10-50 – Segment reporting (if the JV qualifies as a

separate operating segment)

Disclosure requirements

82

Example #1 - Joint Ventures

• Assume Companies Pharma A and Pharma B, which are not related parties, each contribute businesses into a newly formed corporation. Pharma A and B each have a 50% equity interest and appoint four members to a eight-member board of directors. Unanimous consent of the board members is required for all significant decisions. Control is based on the rights granted through the equity interests.

• Based on the facts provided, the new entity is a joint venture. The activities

are conducted in a separate legal entity, all significant decisions require the

unanimous consent of the venturers and the venturers exercise joint

control through their equity investments.

83

Example #2 - Joint Ventures

• Pharma and Biotech enter into a joint marketing arrangement that both

refer to as a “joint venture.” Biotech agrees to perform R&D activities and

Pharm performs sales and marketing activities. Each company

contractually agrees to share a specified percentage of the revenues

received from the sale of products made under the joint marketing

arrangement. However, there was no separate entity established to

conduct the joint sales and marketing activities and each company retains

its own assets and conducts its activities separately from the other. The

companies are not related parties.

• Based on the facts provided, the arrangement is not a joint venture. While

the companies have contractually agreed to share control over the

arrangement, no separate entity has been established to house the related

assets and conduct the joint marketing activities. Therefore, the activities

would not be capable of being jointly controlled by the venturers through

their equity investments.

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Accounting for R&D Funding Arrangements

• For many years companies have sought arrangements with non-pharma and entities not considered to be collaborators, primarily as a source of risk reduction and funding.

• Various degrees of activism by investors (passive to integrated)

• There has been considerable debate and no clear bright lines as to whether these arrangements are financings subject to EITF 88-18 (ASC 470-10-25) or R&D funding subject to FAS 68 (ASC 730-20).

• Typical fact pattern:

Unrelated financial investor “partners” with pharma to further develop selected compounds

Usually no legal entity is created

Investor commits a specified or up to a specified amount

The investor will receive royalties on future sales of products, if any, resulting from the compound(s) being developed

Investor receives no payment or repayment if compound(s) are not successfully developed and commercialized

Investor does not participate in development or commercialization activities

Overview

85

Accounting for R&D Funding Arrangements

• Two potential accounting models which have elicited considerable debate in the industry

– EITF 88-18 (ASC 470-10, Sales of Future Revenues)

– FAS 68 (ASC 730-20, Research and Development Arrangements)

• ASC 470-10 results in treating the funding as an obligation to repay (i.e. liability)

• Under ASC 730-20, an entity must evaluate a funding arrangement to determine if the arrangement results in an obligation to repay the counter-party or an obligation to perform contractual services

• Although there are no bright lines, generally an entity would follow ASC 470-10 guidance if the R&D risk transferred to the counter-party is not substantive

• Generally an entity would follow ASC 730-20 if the R&D risk transferred to the counter-party is substantive and genuine and the R&D project is subject to normal risk of development and commercialization

Guidance and Accounting Considerations

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