4 accounting considerations for life sciences companies

Ron Melling, Kristin Orrell, Matt Geerdes

When applying U.S. GAAP to customer contracts and certain financing transactions, life sciences companies should consider these four points.

Applying U.S. generally accepted accounting principles (GAAP) related to revenue recognition and debt versus equity classification can be a challenging proposition for life sciences companies. Complexities and nuances can create major financial reporting challenges if the appropriate guidance is not interpreted accurately and analysis is not performed correctly.

Following are four important accounting considerations for life sciences companies when it comes to revenue recognition and debt versus equity classification for financings.

1. Revenue recognition

Life sciences companies need to make sure they understand their customer contracts and have appropriately identified their performance obligations to correctly apply ASC 606, “Revenue From Contracts With Customers.” Particular consideration should be given to the following:

Contracts with contract research, contract development, and manufacturing organizations
Understanding how to apply the guidance on variable consideration in determining the “day one” transaction price
Whether revenue should be recognized at a point in time or over time

2. Financial instruments: Debt versus equity

Certain terms and conditions can affect balance sheet classification of financial instruments with characteristics of both debt and equity (for example, convertible shares), per ASC 480, “Distinguishing Liabilities From Equity.” Accounting teams at life sciences companies should have a detailed understanding of the type of financial instrument being issued and its key terms as they evaluate it for equity or liability classification.

3. Financial instruments: Embedded derivatives

Embedded derivatives in financing instruments issued by life sciences companies can take many different forms. Common types include conversion features, redemption features, term extension features, contingent interest features, and increasing interest provisions. Life sciences companies should be prepared to apply the guidance in ASC 815, “Derivatives and Hedging,” to these features to determine whether separate recognition and measurement is needed.

4. Third-party expertise

These areas are technical, complex, and susceptible to misinterpretation, particularly for accounting teams that don’t have much exposure to them. As life sciences companies work through these issues, they can collaborate with trusted advisers as they evaluate the accounting implications of their contracts.

Ultimately, life sciences companies need to get these issues right. Don’t hesitate to get additional resources if necessary.