Pharmagen Case

Trueblood case 09-2: Pharmagen

Pharmagen case describes a $500 million Research and Development (“R&D”) funding agreement between pharmaceutical company (“Pharma”) and third-party private investor (“PEI”). The issue is to decide on how to account for funding of the R&D and royalty payments, and identify authoritative literature applicable to the agreement.

Case states the following facts about agreement:

• Pharma will receive up to $500 million from PEI for R&D cost for new drug X

• A non-refundable funding to be used solely for drug X development costs

• PEI will provide incremental funding as long as Pharma is demonstrating progress, however Pharma is not obligated to successfully complete development, “best effort”arrangement

• Pharma estimated completion of project will take 3 years (from agreement date), and will cost estimated $1 billion

• Pharma retains all intellectual property rights to drug X

• PEI is entitled to receive future royalties on drug X revenues

• PEI is entitled to receive future royalties associated with an existing commercialized drug

Facts presented in the case call for Accounting Standards Codification (ASC) section 730-20 to be applicable. This accounting standard provides clarification and guidance to entities that entered into R&D arrangements, and advises on proper recognition. To define how transactions in Pharma and PEI agreement should be recorded, we should take a close look at ASC 730-20-25 -02, a recognition section that reads that “an entity shall determine the nature of the obligation it incurs when it enters into an arrangement with other parties who fund its research and development”. Based on the scenario, we need to determine if Pharma has an obligation to repay the other party (PEI) and should recognize funding and royalties as a liability on its’ books, or liability does not exist.

ASC 730-20-25-03 states “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. This requirement applies whether the entity may settle the liability by paying cash, by issuing securities, or by some other means”. Based on the agreement Pharma is to receive up to $500 millions in increments to fund its’ $1 billion drug X R&D costs. Funding provided by PEI is non-refundable, and agreement does not specifically state re-payment commitments between Pharma and PEI.

ASC section 730-20-25-04 states that “to conclude that a liability does not exist, the