Often two (or more) is better than one. This is true in life and in business. Companies may decide to share or pool resources, talents, intellectual property, assets, etc. to achieve a common goal. These strategic alliances can take many different forms and can raise issues across various accounting topics such as consolidation, equity method, revenue recognition, derivatives, and leases just to name a few. As they continue to increase in prevalence and complexity, particular attention should be paid to the accounting implications. Not only can there be multiple accounting considerations within these arrangements, but the overall accounting for the arrangement can vary widely from consolidation under ASC 810 to collaborative arrangements under ASC 808.
This post will focus on the accounting for collaborative arrangements under ASC 808. This stand-alone ASC topic has been around for a long time but was recently amended by ASU 2018-18. We first reported on that ASU in this blog. In this post, we’ll review scope of ASC 808, then illustrate the presentation and disclosure guidance for collaborative arrangements with an example. That example will help illustrate the changes stemming from ASU 2018-18. Notice that I said, “presentation and disclosure guidance”. That is the objective of ASC 808 and it does not provide its own recognition and measurement guidance, although it does reference other standards. The presentation and disclosure requirements cover transactions between participants in a collaborative arrangement and between participants in the arrangement and third parties.
A collaborative arrangement under the scope of ASC 808 is one that:
- Involves a joint operating activity, and
- Involves two or more parties who are:
- Active participants in the activity
- Exposed to significant risks and rewards dependent on the commercial success of the activity.
It is important to note that a collaborative arrangement is not primarily conducted through a separate legal entity. Examples of collaborative arrangements are jointly developing and commercializing intellectual property, a drug candidate, software, computer hardware, or a motion picture. One party may perform research and development and the other may market and sell. These arrangements are found in various industries with various commercial objectives. Another example might be the joint operation of a facility, such as a hospital.
Let’s take a look at the presentation requirements by considering the following example:
This example is a collaborative arrangement within the scope of ASC 808 because both parties appear to be actively involved in the commercial success and both parties are exposed to significant risks and rewards dependent on the commercial success of the activity. The activities under this arrangement are performed by the two parties and not by a separate legal entity.
ASC 808 states that revenues and costs incurred with third parties in connection with a collaborative arrangement should be presented in accordance with the principal/agent guidance in ASC 606, Revenue from Contracts with Customers, and other applicable literature. Payments to or from collaborators in the arrangement should be presented based on the nature of the arrangement, the nature of the company’s business, and whether the payments are in the scope of other literature.
In our example, when applying the principal/agent guidance in ASC 606, Nicks would likely conclude that it is the principal for the sales transactions with third parties and therefore will present 100% of the sales, cost of sales (COS), and marketing expense in its income statement on a gross basis. This would assume that they have also concluded that other authoritative literature does not apply to these payments, either directly or by analogy, which is most likely the case here. Therefore, Nicks would disaggregate the $15 million payment based on the nature of the activity with the profit-sharing portion as COS ($10M) and the R&D portion ($5M) as R&D expense.
That takes care of Nicks, but what about Petty? How should it present this arrangement in its financial statements?
Petty records $10 million as R&D expense for its R&D activities. However, regarding the income of $15 million received from Nicks, the answer is it depends. It depends on whether Nicks is a customer for a distinct good or service under ASC 606, according to the clarifying guidance in ASU 2018-18. Said another way, the ASU 2018-18 clarifications state that transactions in a collaborative arrangement should be accounted for under ASC 606 when the counterparty for a distinct good or service is considered a customer. A reference was added to ASC 808 to refer to the unit of account guidance in ASC 606 and requires that it be applied only to assess whether transactions in a collaborative arrangement are in the scope of ASC 606. For units of account that are within the scope of ASC 606, ASU 2018-18 states that all the guidance in ASC 606 applies (recognition, measurement, presentation, and disclosure). It is possible some separate units of account in a collaborative arrangement might be under ASC 606 while others will not.
Note that neither ASU 2018-18 nor ASC 808 provide guidance on how transactions that are not within the scope of ASC 606 should be accounted for. Therefore, entities will continue using the existing guidance in ASC 808 that states that those transactions be presented based on an analogy to other authoritative literature, which may include ASC 606, or, if there is no reasonable analogy, using a reasonable, rational, and consistently applied accounting policy election. However, the guidance precludes entities from presenting amounts related to transactions in a collaborative arrangement that are not with a customer as revenue from contracts with customers.
Now back to the example. We already stated that Petty must record the research and development expense of $10 million. Let us then assume Petty concludes that the research and development services provided to Nicks represent a distinct service provided to Nicks as a customer. Assume that Petty has concluded that Nicks is a customer because Nicks contracted with Petty to obtain R&D services that are an output of Petty’s ordinary activities in exchange for consideration. Assume that Petty routinely provides this type of service to others. Petty therefore applies ASC 606 to account for and present the net amount received from Nicks, including the profit-sharing payments as revenue when recognized. Petty won’t present sales, cost of sales, or marketing expenses related to the sales transactions with third parties because it is not the principal on those transactions.
Had Petty determined that ASC 606 wasn’t applicable under the guidance in ASU 2018-18, then it would likely have presented the $5 million related to the R&D services as a reduction of R&D expense and the $10 million profit share as other income.
The updated guidance on collaborative arrangements provided by ASU 2018-18, and illustrated via Petty in our example, is currently effective for public business entities. For all other entities, it is effective for fiscal years beginning after December 15, 2020. Retrospective application to the date of initial application of ASC 606 is required.
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