Latest / PwC's accounting podcast / Unraveling the accounting for collaborative arrangements

Transcript

Unraveling the accounting for collaborative arrangements · PwC's accounting podcast

• 0:00
  SPEAKER_03: Thought leadership from PWC's National Office.
• 0:06
  SPEAKER_02: Welcome to PWC's Accounting Podcast.
• 0:10
  SPEAKER_02: I'm Heather Horn.
• 0:11
  SPEAKER_02: Today we wrap up the mini-series on revenue with an episode on collaborative arrangements.
• 0:16
  SPEAKER_02: You may not know there's actually special guidance applicable to these arrangements, and they're not always easy to identify.
• 0:24
  SPEAKER_02: Learn more in this episode, including how the standard interacts with the guidance on revenue from contracts with customers.
• 0:31
  SPEAKER_01: So collaborations are not anything new, but we are seeing more and more situations where multiple parties are partnering together to develop something new.
• 0:43
  SPEAKER_01: And these arrangements are often called a collaboration.
• 0:46
  SPEAKER_01: Typically, in this situation, the parties are developing and hoping to eventually commercialize some sort of intellectual property.
• 0:55
  SPEAKER_01: But it doesn't have to be IP that they're creating, it could be any kind of product, new product, or new type of offering.
• 1:01
  SPEAKER_02: That was Angela Ferguson, standard setting leader in PWC's National Office, who's joined by Christine Moore, a director in our deals practice, and previously in the National Office.
• 1:12
  SPEAKER_02: Both specialized in accounting for revenue arrangements and frequently address these matters with our clients.
• 1:18
  SPEAKER_02: Let's get started as they fill us in on the accounting.
• 1:26
  SPEAKER_02: Angela Christine, thanks so much for joining me today for, I believe, our final episode of our revenue series.
• 1:33
  SPEAKER_02: And today's episode is covering collaboration.
• 1:36
  SPEAKER_02: And it's definitely the first time we've covered this here on the podcast.
• 1:38
  SPEAKER_02: So, Angela, maybe just to kick things off with you, very curious why we picked this topic.
• 1:44
  SPEAKER_01: Sure, Heather.
• 1:45
  SPEAKER_01: First of all, thanks for having me back on the podcast.
• 1:47
  SPEAKER_01: And today I've asked Christine to join me because she has a lot of practical experience with these types of arrangements.
• 1:53
  SPEAKER_01: So collaborations are not anything new, but we are seeing more and more situations where multiple parties are partnering together to develop something new.
• 2:05
  SPEAKER_01: And these arrangements are often called a collaboration.
• 2:09
  SPEAKER_01: Typically, in this situation, the parties are developing and hoping to eventually commercialize some sort of intellectual property.
• 2:18
  SPEAKER_01: But it doesn't have to be IP that they're creating, it could be any kind of product, new product, or new type of offering.
• 2:24
  SPEAKER_01: So collaborations are very common in the pharma and biotech space, but we're seeing them more often in other industries as well.
• 2:33
  SPEAKER_01: And sometimes when two parties do a collaboration, they actually create a new legal entity.
• 2:39
  SPEAKER_01: You often hear about joint ventures, and they may do that through an actual new entity.
• 2:44
  SPEAKER_01: In that case, you're looking at the consolidations guidance or you're looking at the guidance on equity method investees to do your accounting.
• 2:52
  SPEAKER_01: But today we're not going to focus on that type of collaboration.
• 2:56
  SPEAKER_01: We're going to talk about collaborations where the parties are just entering into contractual agreements together to do their joint activity.
• 3:04
  SPEAKER_01: So the key point here, though, is that the term collaboration can really mean lots of different things.
• 3:11
  SPEAKER_01: There are several parts of the accounting guidance that you can end up in.
• 3:15
  SPEAKER_01: So you really need to understand the substance of the arrangement and not just focused on the fact that it's being called a collaboration.
• 3:24
  SPEAKER_02: Well, and I'm assuming, Angela, like many other things in accounting, we also may have contracts that are accounted for under this same model that maybe aren't called collaborations, or is that less common?
• 3:34
  SPEAKER_01: Yeah, that's possible.
• 3:35
  SPEAKER_01: But I think a lot of the times, you know, this will be called a collaboration in the contract, and people are jumping to conclusions about how it's going to be accounted for just because it's being called that for illegal purposes.
• 3:47
  SPEAKER_02: All right.
• 3:47
  SPEAKER_02: So definitely stay tuned for the rest of our conversation.
• 3:49
  SPEAKER_02: And then Angela, I'm so used to having you on to talk about revenue, but I know we're covering a few other accounting, not just 606 today.
• 3:57
  SPEAKER_02: So what are some of the other standards that we might hit on?
• 3:59
  SPEAKER_01: So there is a standard that specifically addresses collaborative arrangements, and that's ASC 808.
• 4:06
  SPEAKER_01: So we'll spend most of our time today talking about that standard.
• 4:11
  SPEAKER_01: And that standard actually can put you back into ASC 606 or revenues, which was one reason why we thought it made sense to cover this topic this month.
• 4:20
  SPEAKER_01: But the other guidance that could apply that we'll touch on today includes the funded RD guidance and guidance on the sale of future revenues.
• 4:29
  SPEAKER_01: And I do have to say that this is not completely comprehensive.
• 4:32
  SPEAKER_01: I mean, you have to look out for embedded derivatives and other things that could exist.
• 4:36
  SPEAKER_01: I have to say that for our financial instruments specialists, right?
• 4:40
  SPEAKER_01: But those are the areas that we'll focus on because they're the most common things that come up when looking at collaborations.
• 4:46
  SPEAKER_02: All right.
• 4:46
  SPEAKER_02: And nice that 808 is nice and symmetrical, just like 606.
• 4:50
  SPEAKER_02: So those standards go well together.
• 4:52
  SPEAKER_02: So with that, then all as background, uh Christine, let me bring you in.
• 4:56
  SPEAKER_02: And perhaps you can just start us off by walking through big picture the collaborative arrangements guidance.
• 5:01
  SPEAKER_02: So this ASC 808 guidance.
• 5:03
  SPEAKER_00: Yeah, sure.
• 5:04
  SPEAKER_00: And thanks, Heather, again, for having us on today.
• 5:07
  SPEAKER_00: So just a level set here, as Angela had mentioned, the legal form of a collaboration agreement is not going to necessarily drive the uh accounting and whether or not it's a collaborative arrangement.
• 5:19
  SPEAKER_00: So GAAP specifically defines a collaborative arrangement as a contractual arrangement with a joint operating activity where both parties are actively participating and both parties are exposed to the significant risks and rewards.
• 5:36
  SPEAKER_00: So, for example, when we talk about a joint operating activity, we're referring to development commercial activities for a two companies that are working together to develop a drug with the goal of potentially commercializing that drug once they get the necessary approvals.
• 5:56
  SPEAKER_00: That's just one example of what a joint operating activity would be.
• 6:00
  SPEAKER_00: But really, what we focus on are these three requirements.
• 6:04
  SPEAKER_00: So one, is there a joint operating activity in the arrangement?
• 6:07
  SPEAKER_00: Two, are both parties actively participating?
• 6:11
  SPEAKER_00: And three, are both parties exposed to the significant risks and rewards?
• 6:16
  SPEAKER_00: If all of those are yes, then the definition as a collaborative arrangement is met and the guidance in 808 would apply, which requires then, and we'll touch on it later, certain presentation and disclosure requirements for that arrangement.
• 6:32
  SPEAKER_00: And you may have to apply other gap as well, depending on the elements within the contract.
• 6:38
  SPEAKER_02: All right.
• 6:38
  SPEAKER_02: So it's helpful.
• 6:39
  SPEAKER_02: And I think it's an important note there that you have to meet all three of those.
• 6:42
  SPEAKER_02: Sometimes we talk about models where you just have to meet one, but in this case, uh you do have to meet all three.
• 6:48
  SPEAKER_02: I know we're gonna talk some more about each of these uh later, but just one clarifying point.
• 6:55
  SPEAKER_02: When we talk about joint operating activity, what exactly do we mean?
• 7:00
  SPEAKER_02: And sorry if I'm jumping too far ahead.
• 7:02
  SPEAKER_00: No, so joint operating activity is think about the underlying activities that are being performed jointly between the two parties.
• 7:10
  SPEAKER_00: So I use the example of there's a usually intellectual property is the common area where we see this, and that intellectual property is maybe developed to a certain point.
• 7:20
  SPEAKER_00: Two parties may then enter into a collaboration agreement to continue to push that development along.
• 7:27
  SPEAKER_00: So the underlying activities related to that development would be considered the joint operating activity between the two parties.
• 7:34
  SPEAKER_02: All right.
• 7:34
  SPEAKER_02: So then that leads to, I think, the the next question, which was your next criteria, which is around the uh active participants, because I think often this question of joint activity, you know, does it have to be equal?
• 7:48
  SPEAKER_02: What does it really mean to be active?
• 7:50
  SPEAKER_02: And so what are some of the things you think about or some of the pitfalls you may have there?
• 7:53
  SPEAKER_00: Yeah, so we we do see common factors that companies consider when they're evaluating do we really have active participation between the parties?
• 8:04
  SPEAKER_00: So generally, I think about this as both parties are responsible for the underlying activities of the joint arrangement.
• 8:13
  SPEAKER_00: So in practice, some examples would be both parties are participating on a joint steering committee, and that steering committee has oversight of the joint activities.
• 8:23
  SPEAKER_00: We would typically see joint decision making or unanimous consensus on key operating decisions related to that joint operating activity.
• 8:32
  SPEAKER_00: And then you may have both parties performing certain activities that underlie the joint operating activities.
• 8:39
  SPEAKER_00: So, for instance, you could have one party that's performing development activities and the other parties performing commercial activities.
• 8:46
  SPEAKER_00: And then when there is intellectual property involved, oftentimes we see that both parties have co-exclusive rights to the intellectual property.
• 8:58
  SPEAKER_00: So not one party has exclusive rights or ownership.
• 9:02
  SPEAKER_00: I'll say that's not an all-inclusive list, but some areas to consider and common factors that we do see uh across a number of collaboration agreements.
• 9:11
  SPEAKER_00: Maybe some examples that would indicate that the parties are not actively participating.
• 9:18
  SPEAKER_00: One being one party has exclusive rights to the intellectual property and sole decision making around that intellectual property that may indicate that maybe there's more of a passive relationship for one of the parties.
• 9:34
  SPEAKER_00: And then, second, if you have an arrangement where one party is fully responsible for performing the activities related to the joint operating activity, again, one party may be more passive in the relationship between the two parties.
• 9:48
  SPEAKER_00: I know I hit on it earlier, but the for active participation, the parties don't necessarily need to perform the same activities.
• 9:56
  SPEAKER_00: You could have one party doing development, one party performing commercial activities, but we would expect that both parties have involvement in the decisions around the joint operating activity.
• 10:08
  SPEAKER_02: And then when you are considering those activities, do you have to make sure they're sort of commensurate in importance?
• 10:14
  SPEAKER_02: So the example you gave, those are both important activities.
• 10:18
  SPEAKER_02: Or how do you think about that?
• 10:19
  SPEAKER_00: Yeah, that's right.
• 10:20
  SPEAKER_00: I would consider truly when you look at the key operating activities associated with the joint arrangement, you would expect that both parties have significant involvement in either the decisions or actually performing the activities.
• 10:36
  SPEAKER_02: All right.
• 10:36
  SPEAKER_02: That's helpful.
• 10:37
  SPEAKER_02: And I feel like this is the same as a lot of other gaps we see where you have to identify these activities and then you have to think about who's performing them.
• 10:44
  SPEAKER_02: So it's very similar to even the VIE model, which we just did a series on.
• 10:48
  SPEAKER_02: So that's helpful.
• 10:49
  SPEAKER_02: All right.
• 10:50
  SPEAKER_02: And then why don't we go to this requirement, the final of your three, which is that both parties need to be exposed to the significant risks and rewards.
• 10:58
  SPEAKER_02: Again, how do you think about that?
• 11:00
  SPEAKER_00: So generally, this means that the parties agree to share in the costs associated with the joint activities as well as the profits.
• 11:09
  SPEAKER_00: So common structure that we see, especially in the development of intellectual property, is the parties will agree to cost share during the development period and then a profit share during the commercial periods when customer sales are actually occurring.
• 11:24
  SPEAKER_00: For example, the parties may agree to share in the costs and profits on a 50-50 basis.
• 11:30
  SPEAKER_00: I'll say the this cost profit sharing mechanism is typically calculated in total for all of the activities that are being performed.
• 11:37
  SPEAKER_00: So that would be irrespective of which party is responsible for the activity and incurring the costs or generating the related profits.
• 11:47
  SPEAKER_00: You're really looking at the what I would call PL in totality.
• 11:51
  SPEAKER_00: And I will say that the cost profit share doesn't necessarily need to be on a 50-50 basis.
• 11:58
  SPEAKER_00: But if there is a disproportionate split between the two parties, it's really important to consider are they truly sharing in the significant risks and rewards.
• 12:09
  SPEAKER_00: So, you know, 60-40 may still get there, 70-30 as you think about significance.
• 12:15
  SPEAKER_00: But as you shift to a further disproportionate share, you you may not have truly sharing in the significant risks and rewards.
• 12:24
  SPEAKER_02: Angela, let me go back to you with a question, because you said early on that we are not talking about arrangements when there is an entity, because those would fall into other models.
• 12:33
  SPEAKER_02: But a lot of what Christine is talking about here makes it sound like even though there isn't a legal entity, you are still almost thinking about accounting as though there is a legal entity in place in terms of tracking costs and tracking the revenue and making sure I would assume that it's segregated from other activities of those two entities.
• 12:52
  SPEAKER_02: Is that fair?
• 12:53
  SPEAKER_01: Yeah, that's right.
• 12:54
  SPEAKER_01: I mean, I think typically you'd have to keep a separate PL for the activities being performed.
• 12:58
  SPEAKER_01: And then you typically see payments being made between the two partners in order to get to that cost share that uh Christine was describing.
• 13:07
  SPEAKER_02: All right, that's helpful.
• 13:08
  SPEAKER_02: And Christine, just to clarify then, when we're talking, so 50-50 is going to be less judgment because it's obviously equal.
• 13:15
  SPEAKER_02: But as you start to move further away from 50-50, it sounds like it's safe to say there is no bright line, but the further you get away, then the more questions you're going to ask in terms of is that really sharing in the significant risks and rewards.
• 13:30
  SPEAKER_00: That's right.
• 13:31
  SPEAKER_00: And that's how I would think about it.
• 13:32
  SPEAKER_00: I mean, there are common examples that we see where it's fairly clear that the parties are not sharing the significant risks and rewards.
• 13:41
  SPEAKER_00: So if you have one party's performing the activities and they're being reimbursed at market rates, that likely would be more indicative of a service relationship.
• 13:51
  SPEAKER_00: And then you're evaluating okay, is this really in potentially a transaction with a customer that would be in the scope of 606?
• 14:00
  SPEAKER_00: Uh the other common example that we see is a royalty stream with a relatively small royalty to one of the partners.
• 14:10
  SPEAKER_00: So that partner is actually then, as you think about it, capped on the reward in the commercial period and likely not truly sharing in the significant rewards associated with the joint operating activity.
• 14:24
  SPEAKER_00: So I'd say those examples also then thinking about the disproportionate, if there is a disproportionate share of the sharing of the costs or the profits would potentially indicate that you're not sharing in the significant risks and rewards.
• 14:39
  SPEAKER_02: And then what if one of the parties is the one that brings the initial IP, or is that not really fall that into this type of arrangement?
• 14:47
  SPEAKER_00: So it is very common to see what I would say one party contributing the intellectual property to the collaboration or licensing it to the collaboration.
• 14:57
  SPEAKER_00: And oftentimes there's an upfront payment associated with that.
• 15:01
  SPEAKER_00: That won't necessarily preclude concluding that the both parties are exposed to the significant risks and rewards.
• 15:08
  SPEAKER_00: However, it's really important to understand that upfront payment for the intellectual property, the basis for that payment, and whether or not it correlates to the value of the intellectual property that the one party is putting in at inception of the collaboration agreement.
• 15:26
  SPEAKER_01: And is it fair to say, Christine, I mean, typically with that IP is only allowed to be used for the joint operating activity.
• 15:34
  SPEAKER_01: So it's not like the one partner is licensing, has other rights to that IP beyond just use in the collaboration.
• 15:40
  SPEAKER_00: That's right.
• 15:41
  SPEAKER_00: Usually the scope of that license is going to be co-exclusive rights, and both parties will have those co-exclusive rights, but they can't use it outside of the collaboration.
• 15:50
  SPEAKER_02: That's very helpful.
• 15:51
  SPEAKER_02: And I would guess, but please clarify here that if one party brought the IP and then they're going to be paid back by the from the by the other party by receiving, let's say, first profits or something else, that doesn't really feel like you're really sharing risks and rewards.
• 16:06
  SPEAKER_00: That's that's right.
• 16:07
  SPEAKER_00: Yeah.
• 16:08
  SPEAKER_00: That would ultimately say that you know one party truly isn't sharing in the significant rewards associated with the the IP.
• 16:17
  SPEAKER_02: Or the risks, I guess, too.
• 16:18
  SPEAKER_02: Right.
• 16:18
  SPEAKER_02: So all right.
• 16:20
  SPEAKER_02: So that's helpful.
• 16:20
  SPEAKER_02: So now that we've gone through all of this, Angela, let me pull you in to talk about then.
• 16:25
  SPEAKER_02: Let's assume that you've crossed all these bridges and you do conclude you meet those three criteria so that you are uh in that collaborative arrangement accounting.
• 16:34
  SPEAKER_02: What is the model then?
• 16:36
  SPEAKER_01: Yeah, so the standard on collaborative arrangements, and again, that's ASC 808, it's a little unique because it doesn't have a full accounting model in the standard.
• 16:47
  SPEAKER_01: It instead it focuses more on presentation and disclosure.
• 16:51
  SPEAKER_01: But generally, for other aspects of the accounting, it has you look to really all other areas of gap to see if there's other gap that would apply.
• 17:01
  SPEAKER_01: So even if you conclude that the arrangement meets all those criteria that Christine just went through and you're in the scope of collaborative arrangements, you still might end up applying other GAAP.
• 17:11
  SPEAKER_01: And often that means you end up going back to ASC 606 for a portion of or potentially even all of the arrangement.
• 17:20
  SPEAKER_01: All right, so when would that occur?
• 17:22
  SPEAKER_01: So, first, the standard in uh or ASC 808 uh has you determine the units of account in the arrangement.
• 17:31
  SPEAKER_01: And this is very similar to determining the distinct goods or services, which we talk a lot about in ASC 606.
• 17:39
  SPEAKER_01: In fact, 808 points you back to 606 for those criteria to determine what are the units of account.
• 17:46
  SPEAKER_01: And then for each unit of account that you identify, you have to consider whether other gap applies to that particular unit of account.
• 17:55
  SPEAKER_01: So it's probably easiest for me to just walk through an example to explain how that works.
• 17:59
  SPEAKER_01: So, as we were uh discussing earlier, a common type of collaborative arrangement involves one party licensing its IP to be used in the collaboration, right?
• 18:09
  SPEAKER_01: And then some follow-on RD activities.
• 18:12
  SPEAKER_01: In that case, you would you would assess whether the license of IP and the RD activities are separate units of account.
• 18:20
  SPEAKER_01: And again, you're looking to the guidance on determining distinct goods and services to make that conclusion.
• 18:27
  SPEAKER_01: And really, that could go either way, it depends on the facts and circumstances.
• 18:31
  SPEAKER_01: Sometimes we see that they are distinct and separate units of account, and sometimes they are not.
• 18:38
  SPEAKER_01: So let's assume in this case that they are separate units of account.
• 18:42
  SPEAKER_01: The next thing you would do is look at each thing, the license of IP and the RD activities, and assess whether those are really in the scope of other standards, in this case, whether they are transactions with a customer and therefore in the scope of 606.
• 19:00
  SPEAKER_01: And some things you would think about in that assessment is are you transferring a good or service to the other party?
• 19:06
  SPEAKER_01: And for example, is licensing IP and RD activities.
• 19:11
  SPEAKER_01: Is that part of your ordinary business activities that you would typically perform for a customer?
• 19:18
  SPEAKER_01: So again, you could again meet all those criteria to be a collaborative arrangement, but then look at these individual units of account and conclude that one or more of them are in the scope of 606.
• 19:31
  SPEAKER_02: And Angela, just to clarify there in your example, so you said that the licensor is licensing its IP to the other party, but they are them working together for the development.
• 19:43
  SPEAKER_02: And even in that case, you could wind up as saying that's a licensing agreement in 606, even though they're both involved in the subsequent.
• 19:51
  SPEAKER_01: You could.
• 19:51
  SPEAKER_01: And again, it depends on like what rights are being granted under that license.
• 19:56
  SPEAKER_01: And then is granting a license to your IP something that you typically do for other customers.
• 20:02
  SPEAKER_00: Yeah, I'd even say, too, when evaluating the research and development activities, you could end up in the spot where those activities are also in the scope of 606, even though the counterparty is a collaborative partner.
• 20:16
  SPEAKER_00: It's more so looking at what is the entity's ordinary activities.
• 20:21
  SPEAKER_02: All right.
• 20:21
  SPEAKER_02: So definitely very important to understand all of the relationships here and the contractual agreements.
• 20:27
  SPEAKER_02: So then, Angela, what about if there are units of account that you've identified then that aren't in the scope of the revenue standard or I guess other gap?
• 20:37
  SPEAKER_01: Right.
• 20:37
  SPEAKER_01: I mean, if if the unit of account is not in the scope of six of six or any other gap, then you look to whether there's other gap that's appropriate to apply by analogy.
• 20:48
  SPEAKER_01: And if there's no other gap that's appropriate to apply by analogy, then the standard has you apply a reasonable, rational, and consistently applied accounting policy.
• 21:00
  SPEAKER_02: All right.
• 21:01
  SPEAKER_02: I feel like this is interesting, not something we normally come across here.
• 21:05
  SPEAKER_02: So, Christine, can you provide us with any perhaps examples or explanation of what we would consider a reasonable, rational, and I guess consistently applied, although that part hopefully is not so difficult, but the reasonable and rational accounting policy.
• 21:19
  SPEAKER_00: Yeah.
• 21:20
  SPEAKER_00: So maybe just to start here, when evaluating a reasonable and rational accounting policy, it's really important to understand the economic substance of the transactions between the collaborative partners.
• 21:34
  SPEAKER_00: And then you want to determine a policy that best reflects those transactions between the partners.
• 21:42
  SPEAKER_00: Generally, the questions arise on a reasonable and rational accounting policy when you have one party that's responsible for performing certain activities and they're getting payments from their collaborative partner.
• 21:57
  SPEAKER_00: So maybe first hitting on some again.
• 22:00
  SPEAKER_00: Examples from a presentation perspective as to what would be a reasonable and rational accounting policy.
• 22:06
  SPEAKER_00: So one example is in the scenario that a party is performing research and development activities and getting a reimbursement from their collaborative partner.
• 22:18
  SPEAKER_00: It may make sense to present those reimbursements as a reduction of RD expense if the nature of the relationship is to really share in the cost of the RD.
• 22:31
  SPEAKER_00: So think then the company should only reflect its portion of the shared RD expense, and it ultimately ends up with a net presentation on the PL.
• 22:41
  SPEAKER_00: In other situations, it may be more appropriate to reflect the payments from a collaborative partner as gross on the PL, either as revenue separate from revenue from contracts with customers, or as other income.
• 22:59
  SPEAKER_00: If the party receiving the payment from the collaborative partner is presenting those payments as revenue, it needs to be clear that that revenue is separate from revenue for transactions with customers.
• 23:14
  SPEAKER_00: So typically what we see is that companies will caption these transactions as collaboration revenue on their PL, and then in the footnotes, clearly disclose that those transactions are not in the scope of 606.
• 23:29
  SPEAKER_00: In the other scenario that a company presents the payments as other income, we would expect that that would be presented within continuing operations.
• 23:39
  SPEAKER_02: And then deciding if some a company's going down this route, what would lean towards revenue versus other income?
• 23:48
  SPEAKER_00: I would think about it as is it part of the entity's major ongoing central operations?
• 23:54
  SPEAKER_00: And if it is, then other revenue may be a more appropriate classification as opposed to if it's a one-off arrangement with a collaborative partner presenting that maybe as other income.
• 24:05
  SPEAKER_02: So I guess, Angela, going back to what you were talking about in terms of figuring out if it's in 606, the key sort of there is really that it is with a customer.
• 24:15
  SPEAKER_02: That's what would push it to 606.
• 24:17
  SPEAKER_02: If it's the same type of arrangement but not with the customer, then it could still be in revenue.
• 24:23
  SPEAKER_02: Yeah.
• 24:23
  SPEAKER_02: But so this maybe you can clarify a bit.
• 24:26
  SPEAKER_01: Well, there's some fine lines there, right?
• 24:28
  SPEAKER_01: But entering into collaborations might be part of what you do as your business.
• 24:33
  SPEAKER_01: And so it's appropriate to show this collaboration revenue that's not 606 revenue, even though it's not really a transaction with a customer.
• 24:42
  SPEAKER_01: So in that case, it's really in my mind more of like is it a one-way street where you're performing for another party and then they're paying you for it?
• 24:50
  SPEAKER_01: Or is it truly this collaborative activity and you're just receiving some payments from the other party as part of that collaboration?
• 25:00
  SPEAKER_02: All right.
• 25:00
  SPEAKER_02: Let's keep going.
• 25:01
  SPEAKER_02: I may have a few more questions.
• 25:03
  SPEAKER_02: And then how about then, Christine, going back to you?
• 25:06
  SPEAKER_02: How do you think about timing and some of the disclosures?
• 25:09
  SPEAKER_00: So usually when determining the timing of recognition for these payments from a collaborative partner, companies will often look to uh similar timing of recognition as the revenue model provides.
• 25:21
  SPEAKER_00: So recognizing the benefit in the PL as the underlying costs are being incurred on the underlying activities.
• 25:30
  SPEAKER_00: And then I would say I think in addition to presentation and timing, what's is really important is the disclosures around this and making sure that it's clear to the reader the impacts of this accounting policy as a result of the transactions between the collaborative partners.
• 25:54
  SPEAKER_02: All right.
• 25:54
  SPEAKER_02: So definitely a lot to think about there in terms of especially the presentation piece of thing and things.
• 26:01
  SPEAKER_02: And then Angela, how about anything else more broadly from a presentation disclosure?
• 26:06
  SPEAKER_01: Yeah, a couple other things to highlight.
• 26:08
  SPEAKER_01: So as we were discussing earlier, typically there are two stages, right?
• 26:12
  SPEAKER_01: There's the development stage, and then eventually the parties are hoping they're going to develop something that's successful and they're going to be able to commercialize it and enter into arrangements with third parties to sell whatever it was that they were developing, right?
• 26:28
  SPEAKER_01: So in that commercial stage, when you're in transactions with true customers, third parties, then the revenue from those third party customers is going to be recorded by the gross amount of revenue is going to be recorded by the party of the two collaboration partners, the party that's the principal to that customer.
• 26:49
  SPEAKER_01: So the key question there is which of those two parties is the principal in the transaction with the third-party customer.
• 26:57
  SPEAKER_01: And parties could agree to take on that principal role for different populations of customers.
• 27:04
  SPEAKER_01: For example, they could decide one partner is going to be the principal for transactions in the United States, and other, the other partner is going to be the principal for transactions outside of the US.
• 27:15
  SPEAKER_01: So they may split up the customer population one way or another.
• 27:20
  SPEAKER_02: Angela, before you go on there, can I ask a question?
• 27:22
  SPEAKER_02: Because if I think back to the sharing of the significant risks and rewards, then would the expectation be if I split up the population and in your example, one takes the US, one takes outside the US, then would they each be expected to keep their own profit, or would it be expected to share the significant risks and rewards that you would need to be sharing in that?
• 27:43
  SPEAKER_01: I think typically they're still tracking the PLs still to see what the profit is on those sales and potentially making profit-sharing payments to each other.
• 27:53
  SPEAKER_01: Is that right, Christine?
• 27:54
  SPEAKER_00: Yeah, usually you would see you could have the parties taking rights in specific territories to sell, but they're going to bring everything back together to calculate that shared profit and cost between the two parties.
• 28:07
  SPEAKER_00: If you did have where they had exclusive rights in one jurisdiction versus another jurisdiction, that may start to and they're not truly sharing in the profits, that may start to indicate that they're truly not sharing the significant risks and rewards.
• 28:21
  SPEAKER_02: All right, that's helpful.
• 28:22
  SPEAKER_02: And then so, Angela, back to your principal versus agent.
• 28:25
  SPEAKER_02: I'm sure you're that's where you're going.
• 28:27
  SPEAKER_02: Then in this scenario, if let's say you are selling outside the US and Christine is selling in the US, then your sales outside the US maybe would be gross, but why don't you explain how do you think about that principal versus agent when there's you're both involved and there's other parties involved as well?
• 28:46
  SPEAKER_01: Yeah, so it would the partner that's the principal for the transactions with, say, I'm the principal for transactions in the US, I'll recognize the gross revenue from those transactions.
• 28:58
  SPEAKER_01: And then any payments I have to make to Christine, I would record as likely a cost of sales, right, in my PL.
• 29:05
  SPEAKER_01: And then if I'm receiving payments from Christine, from the profit share, from her sales, again, I have to have a policy for how I'm going to recognize those payments.
• 29:15
  SPEAKER_01: It might be collaboration revenue or it might be going somewhere else in the PL, depending again on my policy.
• 29:21
  SPEAKER_02: All right.
• 29:21
  SPEAKER_02: That's very helpful.
• 29:22
  SPEAKER_02: And anything else then to consider from disclosure perspective?
• 29:27
  SPEAKER_01: Sure.
• 29:27
  SPEAKER_01: And we've said we've touched on this a couple times, and you can imagine why disclosure is so important for collaborative arrangements, is because there is this flexibility in coming up with an accounting policy in many cases.
• 29:38
  SPEAKER_01: And so it's very important that you have good disclosure about which policies are being applied.
• 29:45
  SPEAKER_01: And ASC 808 does have specific disclosure requirements that you have to provide information about each significant collaborative arrangement, what are the key terms and conditions, the rights and obligations, you have to disclose what accounting policy you're applying, and the income statement line items that are being impacted and those amounts.
• 30:05
  SPEAKER_02: All right, a lot to think about there.
• 30:07
  SPEAKER_02: And then I know there's some other models that we're going to talk about briefly, and if it is not under 808 or 606, but let me ask just a couple of follow-up questions.
• 30:17
  SPEAKER_02: And you may have said this at the beginning, I just want to clarify.
• 30:20
  SPEAKER_02: So does this accounting only apply when you're dealing with these types of IP RD, or can it apply more broadly than that?
• 30:29
  SPEAKER_02: Christine, I'll go to you.
• 30:30
  SPEAKER_00: It can apply more broadly.
• 30:31
  SPEAKER_00: We see it oftentimes in the health services space with hospitals.
• 30:36
  SPEAKER_00: You may have a collaboration between multiple hospitals that you have to evaluate.
• 30:40
  SPEAKER_00: I think it the important thing is to really focus on are there joint activities that the parties are agreeing to sh to share in responsibility for, similar to a joint venture, but there's just not not that legal structure associated with the joint venture.
• 30:57
  SPEAKER_02: Yeah, actually, that was my fault.
• 30:58
  SPEAKER_02: The question is why not set up the legal structure?
• 31:02
  SPEAKER_02: But I guess even your example with the hospitals, it's a little easier to picture.
• 31:05
  SPEAKER_02: Because when I was thinking of just two parties, someone's giving IP, now they're doing research.
• 31:10
  SPEAKER_02: It feels like, oh, a legal entity might be easier.
• 31:13
  SPEAKER_02: But I I can see from your other uh example, but are there other reasons people may not want to go down the legal entity route?
• 31:21
  SPEAKER_00: I think it maybe it's just the practicality of getting a legal entity set up between the parties while you're also trying to negotiate this arrangement.
• 31:29
  SPEAKER_00: We have seen instances where parties start down the path of going towards a joint venture and establishing that legal entity and then ultimately pull back and say, you know what, let's just focus on getting the terms and conditions outlined in a collaboration agreement.
• 31:43
  SPEAKER_01: And Heather, just to give you some idea of outside of the pharma biotech space, I mean, you might see two parties in the entertainment and media space coming together and developing some sort of IP in the entertainment space.
• 31:57
  SPEAKER_01: Or you might see two companies in the technology space coming together to work on some IP related to some tech, you know, technology product.
• 32:07
  SPEAKER_01: Especially we're seeing that now when you have all of this really exciting new technology that companies want to get ahead of.
• 32:14
  SPEAKER_01: They're partnering together, right?
• 32:16
  SPEAKER_01: How can I use you what you've done in AI, you know, and put it with what I've done and come up with a joint product?
• 32:23
  SPEAKER_02: Yes, because actually, Angela, that was my next question, was just how common this is.
• 32:27
  SPEAKER_02: But I guess what you're saying is it is something that is occurring relatively frequently that at a minimum companies should be thinking, hey, if I'm doing something with another party, should I be considering this accounting?
• 32:40
  unknown: Absolutely.
• 32:42
  SPEAKER_02: All right.
• 32:42
  SPEAKER_02: So then with all of that said, then I know in some cases you may not meet those three criteria to fall under this 808 model.
• 32:51
  SPEAKER_02: I'll use the word model, is that fair, even though I know you said it wasn't a full accounting model.
• 32:56
  SPEAKER_02: But uh, what are some of the other models that companies could be looking at then, Christine?
• 33:02
  SPEAKER_02: Yeah.
• 33:02
  SPEAKER_00: So Angela mentioned it at the beginning.
• 33:05
  SPEAKER_00: So I'll start with the RD funding guidance.
• 33:09
  SPEAKER_00: If the contract doesn't meet the requirements to be a collaborative arrangement and the arrangement is not with a customer, so not in the scope of 606, but you still have research and development, you should evaluate whether that arrangement is a research and development funding arrangement in the scope of ASC 730.
• 33:28
  SPEAKER_00: These types of arrangements will typically involve a passive investor that's going to provide funding for the development for a program that is not yet probable of commercial success.
• 33:42
  SPEAKER_00: So think there's there's still risk that the RD will ultimately be completed.
• 33:48
  SPEAKER_00: In exchange for that funding, the passive investor is typically looking for a return through royalties if and when that RD program is completed and commercialized, or may look for milestone payments during the commercial period.
• 34:05
  SPEAKER_00: But effectively, we think about them as financial investors that are looking for a return or a right to a future revenue stream.
• 34:15
  SPEAKER_00: The key aspect of this guidance involves assessing whether there's been a substantive and genuine transfer of RD risk to the financial investor or whether there's potentially repayment provisions outside of the outcome of the RD, so outside of royalties or maybe milestone payments based on sales, that the financial investor may be protected in some way from actually incurring risk on the RD project.
• 34:46
  SPEAKER_00: I'll just say we won't go get into the specific models from a 730 perspective, but the guidance here is fairly strict in that if there are any explicit repayment provisions that are not tied to the RD outcome.
• 35:00
  SPEAKER_00: So think a payment triggered upon a change in control or any implicit indicators that the financial investor may be repaid at some point, then the party receiving the funding from the financial investor has to record that funding as a liability on the balance sheet.
• 35:24
  SPEAKER_02: Then eventually it will flow to the income statement?
• 35:28
  SPEAKER_00: If ultimately the funding that was received from the financial investor isn't repaid for some reason, then you may have a benefit that hits the PL, but up until that point, the the funding's gonna sit as a liability on the balance sheet.
• 35:45
  SPEAKER_02: All right.
• 35:46
  SPEAKER_02: Well, definitely that's another interesting uh standard that we have not talked about before on the podcast.
• 35:51
  SPEAKER_02: So perhaps another follow-up uh podcast I'll have to have the two of you back on.
• 35:55
  SPEAKER_02: So then, Angela, let me go back to another model you mentioned that always catches my ear, which is sale of future revenue.
• 36:03
  SPEAKER_02: So definitely, how does that fit in here?
• 36:05
  SPEAKER_01: Right.
• 36:05
  SPEAKER_01: So Christine talked about a situation where a company is getting funding for RD activities, but we also see arrangements where a company is getting funding that's actually related to completed IP or another commercial product that's already been completed, or successful completion is probable.
• 36:28
  SPEAKER_01: So you don't have that risk that the RD might fail, right?
• 36:31
  SPEAKER_01: It's already done or it's basically almost done.
• 36:35
  SPEAKER_01: Then you might be in the guidance on sale of future revenues, and we're really taking a trip around the codification today because this guidance is an ASC470.
• 36:45
  SPEAKER_01: So in this scenario, again, it's typically a passive financial investor, so it's not an active participant.
• 36:51
  SPEAKER_01: We've failed the criteria to be an 808, right?
• 36:54
  SPEAKER_01: And they're providing funding to another party, and they're typically receiving a percentage of a future cash flow.
• 37:03
  SPEAKER_01: An example of this situation could be companies developed IP already, that's uh successful IP, and it's a new technology that it plans to the company plans to license to a customer, say auto manufacturers.
• 37:18
  SPEAKER_01: The investor uh may agree to give the company an upfront payment, and in exchange for that, receive a right to the stream of royalties from those licenses of IP to those auto manufacturers.
• 37:33
  SPEAKER_01: And oftentimes, from a cash flow perspective, that royalty stream is just gonna go directly to the investor.
• 37:39
  SPEAKER_01: Like it's not gonna flow through the company at that point.
• 37:43
  SPEAKER_01: There's often a misconception here that this is somehow a revenue transaction with the investor, but it's not.
• 37:51
  SPEAKER_01: They're not, you're not transferring a good or service to the investor, right?
• 37:55
  SPEAKER_01: The revenue transaction is still with the customers licensing the IP or the auto manufacturers, in my example, and that transaction is not impacted at all by this separate agreement with the investor.
• 38:11
  SPEAKER_01: So the funding that's received from the investor is typically accounted for as a financing, and that sort of makes sense when you think about it.
• 38:20
  SPEAKER_01: So it's going to be recorded as debt that then is repaid through that future royalty stream.
• 38:27
  SPEAKER_01: And I think people get confused here because, like I mentioned earlier, often that royalty stream just goes directly to the investor.
• 38:34
  SPEAKER_01: So they don't think about it as something they're receiving and then using to repay the debt.
• 38:39
  SPEAKER_01: It just goes directly to the investor.
• 38:42
  SPEAKER_01: And there are, I would say, some criteria to meet to conclude that the arrangement is debt.
• 38:48
  SPEAKER_01: But once you're in this type of arrangement, once you're in the scope of this guidance, in my experience, it's like 99.9% of the time it ends up being debt.
• 38:58
  SPEAKER_01: Like in fact, I haven't seen a situation where you don't end up concluding it's debt.
• 39:03
  SPEAKER_01: Um, and as a side note, this accounting can be quite complex because you're accounting for that debt, but in order to come up with what is the implied interest rate on that debt, you basically have to estimate that future royalty stream and continue to update those estimates so it can become quite complex.
• 39:22
  SPEAKER_02: Yeah, another good topic for another podcast.
• 39:25
  SPEAKER_02: So uh I feel like sale of future revenue is something that pops up here and there, and then often is not the model that's used.
• 39:32
  SPEAKER_02: It's considered and then not used, but it's still nonetheless a good topic.
• 39:37
  SPEAKER_02: So, all right, well, definitely a lot to think about.
• 39:39
  SPEAKER_02: And I know you mentioned derivatives, Angela, but I will not ask you how that what derivatives interact with this guidance uh in the interest of time.
• 39:47
  SPEAKER_02: But given all that we've covered here, and again, I said this earlier, I think for a lot of our listeners, this is something they're probably less familiar with, but and yet it sounds like it's something, a topic that companies should be familiar with because lots of different types of companies could be impacted.
• 40:04
  SPEAKER_02: So, what advice would you give or what is a key takeaway for you?
• 40:08
  SPEAKER_02: And Christine, and I'll go to you first.
• 40:10
  SPEAKER_00: I know we've said it a few times here, but I can't emphasize enough the importance of disclosures related to these types of arrangements, irrespective of whether or not it's a collaborative arrangement in 808.
• 40:24
  SPEAKER_00: Typically, these are going to be material significant contracts.
• 40:27
  SPEAKER_00: So it's really important to disclose the key terms and conditions that impact the accounting, and then ultimately how the reporting entity is accounting for the transactions between the partners.
• 40:43
  SPEAKER_00: As Angela had noted earlier, there are specific disclosure requirements in 808 that a company needs to consider.
• 40:50
  SPEAKER_00: If the contract is a collaborative arrangement with elements that are in other gaps, so think elements that are in the scope of ASC 606, it's important to remember that all of the disclosure requirements in that other gap will also apply to that element in this contract.
• 41:09
  SPEAKER_00: So the disclosures are not just dictated by 808.
• 41:12
  SPEAKER_00: You also then have to go and look at the disclosure requirements for the other gap.
• 41:16
  SPEAKER_02: All right, that is a great reminder.
• 41:17
  SPEAKER_02: Angela, how about from your perspective?
• 41:20
  SPEAKER_01: Yeah, I just say again that you don't want to jump to conclusions about the accounting just because it's being called a collaboration in the in the agreements.
• 41:30
  SPEAKER_01: You know, you really have to look at the substance of the transaction, what are the roles and responsibilities of the two parties to determine what is the appropriate accounting model.
• 41:40
  SPEAKER_01: And as we've talked about throughout this podcast, there's several parts of the codification you could be in, depending on what are really the roles of the of the two parties involved.
• 41:51
  SPEAKER_01: And again, you know, sometimes people really want to meet those criteria in 808 so they can conclude they have a collaborative arrangement, but that is in no way a free pass from considering other applicable gaps.
• 42:03
  SPEAKER_01: So you could even meet all of those criteria, but then end up concluding that a portion of the arrangement is still in the scope of the revenue standard or ASC 606.
• 42:13
  SPEAKER_01: So again, it's not necessarily a free pass once you just meet the criteria to be in the scope of ASC 808.
• 42:19
  SPEAKER_01: Definitely a very unique standard.
• 42:21
  SPEAKER_02: Yes, and definitely does not seem like it would make life easier.
• 42:24
  SPEAKER_02: So it's interesting that you're saying people are trying to get into it.
• 42:28
  SPEAKER_02: But um I guess it's it's nice to disclose you're working um in those types of arrangements.
• 42:33
  SPEAKER_02: So, but um definitely a lot to think about here.
• 42:36
  SPEAKER_02: I guess, Angela, where should people go for more information?
• 42:40
  SPEAKER_01: Yeah, for a few different places.
• 42:42
  SPEAKER_01: So we talk about collaborative arrangements and the interaction with the revenue standard in chapter two of our revenue guide.
• 42:49
  SPEAKER_01: We discuss funded RD arrangements in chapter eight of our PPE guide.
• 42:55
  SPEAKER_01: PPE and other assets, I believe.
• 42:58
  SPEAKER_02: So hence hence why that's probably in there.
• 43:01
  SPEAKER_02: Yeah.
• 43:01
  SPEAKER_02: The other assets.
• 43:02
  SPEAKER_01: And then uh, if you end up in the scope of sale of future revenues, we talk about that in chapter one of the financing guide.
• 43:10
  SPEAKER_02: All right, so again, a lot to think about here.
• 43:12
  SPEAKER_02: Really appreciate you both being on, and we have a few ideas for some follow-up podcasts.
• 43:16
  SPEAKER_02: So thanks for that too.
• 43:18
  SPEAKER_02: Thanks for having us.
• 43:19
  SPEAKER_02: That's our show for today.
• 43:21
  SPEAKER_02: Tune in next week for more fresh episodes.
• 43:24
  SPEAKER_02: So that you never miss any of our audio content.
• 43:27
  SPEAKER_02: Follow the PWC Accounting Podcast wherever you listen to your podcasts.
• 43:32
  SPEAKER_02: And to stay up to date on all our latest accounting and reporting news, sign up for our newsletter at viewpoint.pwc.com.
• 43:41
  SPEAKER_02: From Thought Leadership at PWC, I'm Heather Horn.
• 43:46
  SPEAKER_02: Thanks for tuning in.
• 43:53
  SPEAKER_03: This podcast is brought to you by PWC, all rights reserved.
• 43:57
  SPEAKER_03: PWC refers to the U.S.
• 43:58
  SPEAKER_03: member firm or one of its subsidiaries or affiliates, and they sometimes refer to the PWC network.
• 44:04
  SPEAKER_03: Each member firm is a separate legal entity.
• 44:07
  SPEAKER_03: Please see www.pwc.com slash structure for further details.
• 44:13
  SPEAKER_03: This podcast is for general information purposes only and should not be used as a substitute for consultation with professional advisors.