Accounting for Research and Development Funding
Accountingfor Research and Development Funding
Pharmacannot record a liability for future royalties that will be payableto the PEI. This is because royalties cannot be paid to the donor ofthe research and development funding unless it is earned (FASB 7).The royalties earned will be only recognized when the expecteddevelopment of X will be successful and approved by a regulatoryagency, and if it will be commercialized. This is because thecontract for funding signed between the two companies wascircumstantial and not obligatory. In addition, there is a differenceexisting between royalties payable and royalties earned in the twocompanies. This means that the anticipation for receipt of royaltiesby PEI cannot be worth a translation for anticipated liability fromPharma.
PEIcannot record a liability from Pharma in the books of accountsbecause of the lack of anticipation from the contract. According tothe contract between the two companies, Pharma is not even obligatedto pay back the $500 million. This means that there is no obligationfor payment of royalties or any payments if Pharma does not developthe amounts. However, if there will be royalties in the future, therecording of the liability will be different I the two companies. ToPharma, the liability for the royalties to be paid to PEI will berecorded as royalties payable. On the other hand, PEI will record theearnings in terms of royalties as royalties earned.
However,there is an alternative to the treatment above. Pharma can recognizethis as a liability but not record it directly in the books ofaccount. This liability could be indicated as notes to financialstatements for users to get informed. This can be done every year thecompany reports its financial performance and financial position.Consequently, there is no amount that can be included as a liabilityto PEI. This is because the inclusion will not be backed by thecontractual instructions. The only amount that can be included asanticipated liability is the $500 million and any further additionalfigures.
Thecosts incurred in the activities of research and development of drugX should be recognized as expenses of the company, Pharma. This isbecause under the generally accepted accounting principles (GAAPS),costs incurred in the research and development activities of anyproduct are expensed by the company just like any other day to daycosts of the company ( Sticeand Stice 42).They are treated as costs of operation for the company that isresponsible for the development of the new product. After the end ofthe year, all the costs expensed under research and developmentaccount are subtracted from the bottom line which lowers the profitfor the company.
However,the company can consider an alternative way of treating research anddevelopment expenses. Instead of treating them like operatingexpenses, the company can opt to treat them as part of long terminvestment (FASB 9). This means that the company will view the R&Dexpenses like just any other asset that the company engages to investin. The company will allot these costs over a number of years andcapitalize them. Rather than treat them as immediate costs, Pharmawill treat them as part of their capital improvement which will be avaluable venture for the company (Sticeand Stice 42).Therefore, the immediate expenses for the year will be lower andprofits will remain unaffected.
FASB(Financial Accounting Standards Board). AccountingStandards Codification (ASC) Researchand Development Arrangements (Issued 10/82), Accessed from FASBAccounting Standards Codification database, April 18, 2014
Stice,Earl and Stice, James. IntermediateAccounting. Stamford, US: CengageLearning. 2013, Print