Do Not Let Collaborative Arrangements Cause Financial Reporting Headaches

01 Jun Do Not Let Collaborative Arrangements Cause Financial Reporting Headaches

Businesses often enter into so-called ‘collaborative arrangements’ when they partner with another entity on a major project. Unfortunately, the current guidance for these types of arrangements under U.S. Generally Accepted Accounting Principles (GAAP) is somewhat vague.

Here are questions that may arise as participants report shared costs and revenue on their income statements, along with details about a recent proposal that would clarify how to report collaborative arrangements.

What is a collaborative arrangement?

Accounting Standards Codification (ASC) Topic 808, Collaborative Arrangements, provides guidance for income statement presentation, classification, and disclosures related to collaborative arrangements. It lists three requirements for collaborative arrangements:

  1. They must involve at least two parties (or participants).
  2. The parties involved must all be active participants in the activity.
  3. All participants must be exposed to significant risks and rewards dependent on the commercial success of the activity.

Collaborative arrangements are a particularly common type of joint venture for film production and life science companies. For example, two pharmaceutical companies might agree to share research and development expenses to produce a new drug. Then, if the drug succeeds, the companies also would share the revenue from sales of the drug.

What qualifies as revenue?

Today’s guidance on collaborative agreements has led to inconsistent accounting practices. Why? Topic 808 does not include guidance for determining what the appropriate unit of accounting is or when recognition criteria are met. Rather, it says to look to other areas of GAAP to account for a transaction. If there is no formal guidance available, businesses typically apply an accounting policy or another accounting method by analogy. As a result, companies may label items as ‘revenue’ when they belong elsewhere on the income statement.

To further complicate matters, the landmark revenue recognition standard goes into effect in 2018 for public companies and in 2019 for private ones. Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606), limits application of the revenue standard to arrangements that involve a customer as one of the parties to a contract.

In April, the Financial Accounting Standards Board (FASB) proposed an update to clarify the scope of its standards for revenue and collaborative arrangements. If finalized, the proposal will help partners in a collaborative arrangement determine when a transaction should be treated as revenue. Public comments on the proposed changes are due in June.

Got more questions?

We are well-informed of the latest developments on reporting collaborative arrangements. Contact us with questions about the interaction of the standards for collaborative arrangements and revenue recognition. We can help you concurrently implement the latest rules and reduce the risk of restatement.