The biotech and pharmaceutical industries have been hotbeds for innovation development for the past few decades. Biotech and pharmaceutical firms provide travel vaccines, therapeutic products, diagnostics and other medical products and devices. Pharmaceutical business stalwarts Eli Lilly, Pfizer, Merck and Novartis originally started out only doing pharmaceutical research and pharmaceutical testing. They have since moved into the biotech industry space, doing research and sales and leading the way in biotech and pharmaceutical strategy innovation and life sciences innovation development.
Traditionally, strategy innovation and innovation development amongst startup biotech and pharmaceutical firms has been vital, considering that the FDA (U.S. Food and Drug Administration) approval process itself takes ages and that there is a great degree of competition and high costs involved in this niche area.
Nevertheless, venture capitalists and other business investors are often drawn to startup biotech and pharmaceutical firms because they involve biotech and pharmaceutical sales of products which address unmet clinical needs and also have enormous revenue potential, where successful. There are often biotech and pharmaceutical venture capital firms and companies offering services such as a biotech and pharmaceutical incubator too. Pharmaceutical and biotech business stalwarts Eli Lilly, Pfizer, Merck and Novartis lead the way in biotech stocks doing well on the stock market. Gradually, small business owners are jostling to get back into the biotech and pharmaceutical business for travel vaccines, therapeutic products, diagnostics and other medical products and devices.
Under U.S. Generally Accepted Accounting Principles GAAP recognition of revenue falls under Staff Accounting Bulletin SAB 101: New Revenue Recognition Guidelines, as well as SAB 104: Revenue Recognition. Under the guidance of SAB 104 and SAB 101 FASB revenue recognition, US GAAP recognition of revenue is linked intrinsically to the completion of the whole earnings process as well as the transfer of the risks and rewards of ownership to the end customer.
These apply for the biotech and pharmaceutical industry, comprising travel vaccines, therapeutic products, diagnostics and other medical products and devices. US GAAP recognition of revenue relates to biotech and pharmaceutical sale of products and biotech and pharmaceutical research and development collaborative arrangements.
GAAP Recognition of Revenue for Biotech and Pharmaceutical Sales of Products
Here, the full extent of the revenue for biotech and pharmaceutical sales of products is recognized when:
- delivery has occurred for the biotech and pharmaceutical sales
- there is persuasive evidence of the sale
- the fee for the biotech and pharmaceutical sale is fixed or determinable
- the accounts receivable are collectible.
GAAP Recognition of Revenue for Rendering of Biotech and Pharmaceutical Research Services
GAAP recognition of revenue under SAB 101 and SAB 104 FASB revenue recognition, is the same as done for biotech and pharmaceutical sales of products, with the exception of services related to certain medical devices or other products within the scope of SOP 97-2, Software Revenue Recognition.
- Under US GAAP recognition of revenue, upfront license fees are recognized as revenue over the estimated development period and milestone payments generally recognized as revenue upon achievement of the milestone event.
- US GAAP recognition of revenue also stipulates that pharmaceutical testing companies and other biotech and pharmaceutical firms potentially acting as agents on behalf of another entity need to assess whether biotech and pharmaceutical sales of products should be reported gross or net in the income statement.
Measurement of Biotech and Pharmaceutical Inventory
Entrepreneurs who wish to perform analysis on the biotech and pharmaceutical inventory will need to understand GAAP recognition of costs and measurement for the biotech and pharmaceutical inventory:
- Under GAAP recognition of inventory, inventory is carried at the lower of cost or fair value less costs to sell.
- FAS 144 requires an entity to evaluate biotech and pharmaceutical inventory for impairment whenever events or circumstances indicate that the asset may be impaired.
- A writedown of inventory is a new cost basis and is not reversible
- Capitalized pre-launch inventory is measured at the lower of cost or market
Cost Capitalization for Biotech and Pharmaceutical Inventory
GAAP recognition of costs provides guidance for certain costs such as biotech and pharmaceutical research. As such, in relation to biotech and pharmaceutical inventory, entrepreneurs must:
- Expense off inventory manufactured prior to completion of Phase III clinical trials as biotech and pharmaceutical research and development costs.
- Capitalize inventory manufactured after completion of Phase III clinical trials but before regulatory approval is obtained only if the likelihood of obtaining regulatory approval is high.
- Write off any capitalized costs as cost of sales to the income statement should the likelihood of obtaining regulatory approval decline. Upon regulatory approval, reversal of inventory previously written off is prohibited.
Jo Bilson - Jo Bilson is a management consultant with interests including venture capital and entrepreneurial finance.
