Impact on the Life Sciences and Technology Industries of the New Revenue Guidance
June 30, 2014
Finally issued in May 2014 after many years in the making, the New Revenue Recognition Standard (ASU 2014-09) (Topic 606) “Revenue from Contracts with Customers” represents converged guidance by the FASB and IASB that all companies must follow in order to recognize revenue. It also eliminates industry-specific guidance in favor of basic principles common to virtually all industries.
That said, however, contracts in the life sciences and technology industries have certain characteristics such as multiple elements, long (greater than one year) contract terms, licenses of intellectual property, and milestone payments or other variable consideration, all of which have the potential to be significantly affected by the new revenue guidance. This potential may be in the form of either acceleration of revenue recognition, deferral of revenue recognition, or in some cases, no change at all as compared to current guidance.
Multiple Elements: One of the hallmarks of these industries is that very often under the umbrella of one contract are various deliverables, or, in the words of the new guidance, performance obligations. In life sciences contracts these may include, for instance, a medical device and related installation and service, or perhaps a license and related research and development services; while in technology, hardware, software, upgrades, professional services and the like would be included.
Under the new guidance, the identification of separate performance obligations is less restrictive than under current GAAP. Thus, there is more opportunity for each obligation under the contract to be accounted for independently from the others, and therefore, there is great potential for the revenue recognition to be different than current practice for any given company in these industries.
This impacts technology significantly with regard to the requirement under current guidance for VSOE, or Vendor-Specific Objective Evidence, of fair value for each separate deliverable under the contract. Under the new guidance, VSOE is no longer required; it can, however, still be used if available. The stand-alone selling price of an item may be established by various other less stringent means – i.e., a market analysis, a competitor’s price, and any other observable input. Even the cost of the item to the vendor plus an appropriate mark-up is allowed to be used. This certainly allows for the potential acceleration of revenue recognition under the new guidance.
Long Term Contracts: Another often-used type of contract in life sciences and technology is long-term contracts for various services to be performed over a period of time. For these, the big question to be asked under the new guidance, vs. the current risk and reward model, is when CONTROL of the item to the customer is being transferred, as that is when revenue may be recognized.
Licensing: Life sciences and technology contracts often also call for the licensing of intellectual property, i.e., the right to use a product. A license included in a life sciences and technology contract may or may not qualify as a separate performance obligation. Also, the question again needs to be answered as to WHEN the right is transferred. Is it at a point in time? Is it over a period of time?
Variable Consideration: Another aspect to be considered is a milestone payment or variable consideration (i.e., an amount receivable if a drug, for instance, gains FDA approval). Can the entity predict the amount of ultimate consideration with reasonable assurance? If so, and if the variable consideration is not sales or usage based, the variable consideration can be included in the transaction price upfront using one of two methods to estimate the amount -- the “probability-weighted” estimate or the “most likely” approach. This price, inclusive of the variable consideration, will then get allocated to the performance obligations and thus recognized into revenue.