The issue in Trueblood Case 09-2 is how to account for the funding that Pharmagen pharmaceutical company will receive from Company XYZ for research and development into a new drug, X. They also have to account for the royalty payments that Pharmagen will owe Company XYZ in the future.
Pharmagen pharmaceutical company is working on developing a new drug, X. They have been self-funding the research and development costs. They entered into a Funding Agreement with Company XYZ, a private equity investor, who has agreed to provide Pharmagen with up to $500 million of the total cost needed to develop drug X over the estimated 3 year project time frame. Pharmagen is not obligated to successfully complete the drug and there are no performance obligations related to its development. The money received from XYZ is nonrefundable. However, the money provided by XYZ can only be used towards drug X. If Pharmagen successfully completed the drug and it is approved for ...view middle of the document...
The only other option under ASC 470-10-25-2 part D is that the income is to be listed as debt when “the investor’s rate of return is implicitly or explicitly limited by the terms of the transaction.” If Pharmagen does not complete research on drug X, which they are under no obligation to complete, then XYZ Corporation’s royalties would be limited to the one existing pharmaceutical. However, it is clearly stated in the funding agreement that the amounts given to Pharmagen by XYZ Corporation are nonrefundable, meaning that Pharmagen does not have to pay back the amount given to them. Therefore, it would be inappropriate to list the income received as debt and the best option would be to list it as deferred income. If the agreement did not state that the payments were nonrefundable, it could be appropriate to list the payments from XYZ Corporation as debt.
Pharmagen should report the royalty payments as a long-term liability. They should estimate the amount that they will owe XYZ Corporation, based on their analysis of the likelihood of completetion of drug X, and the royalties from the existing pharmaceutical drug. ASC 730-20-25-3 (Obligation to Repay the Other Parties) states that “if the entity is obligated to repay any of the funds provided by the other parties, regardless of the outcome of the research and development, the entity shall estimate and recognize that liability.”
Based on ASC 30-20-25-6, section A, it could be argued that even though the “entity has indicated an intent to repay all or a portion of the funds provided regardless of the outcome of the research and development,” royalty payments are not technically the repayment of funds provided. They are a monetary benefit to XYZ Corporation for their support in drug X. However, because the payment of royalties is probable and likely (ASC 730-20-25-5), I believe the liability should be estimated and recorded. XYZ Corporation is guaranteed a royalty from at least the existing commercialized drug sold by Pharmagen. If both royalties were dependent upon the success of drug X, then I would not agree that the payments are likely unless Pharmagen had a definitive way to prove that they would be able to complete drug X.