Will a proposed FASB standard open the flood gates for life sciences R&D funding arrangements?

By Jeff Ellis, Audit & Assurance Partner and US & Global Life Sciences Audit & Assurance Leader, Deloitte & Touche LLP, and Dennis Howell, Audit & Assurance Partner and Senior Consultation Partner, Deloitte & Touche LLP

Talking points

• FASB has proposed a new accounting standard that could change the way life sciences companies account for R&D funding arrangements.
• If finalized, it would simplify accounting for many life sciences R&D funding arrangements by excluding them from the derivative accounting model.
• These changes could lead to an uptick in the number of life sciences R&D funding arrangements.

Success in the life sciences industry often comes down to one thing: research and development (R&D) funding. One reason is the often jaw-dropping cost of R&D. Moving an asset, say, a new drug, from discovery to launch costs US$2.284 billion on average.¹ These steep pharma R&D costs help explain why large pharmaceutical companies spent a record US$161 billion on R&D in 2023—an increase of almost 50% since 2018.²

Accounting and reporting for costly R&D programs in pharma and other life sciences segments can be complex, but a proposed Financial Accounting Standards Board (FASB) standard, if finalized, would create new exceptions that would potentially simplify the way companies account for R&D funding arrangements. Before diving into the details of the proposed standard, let’s take a closer look at the mechanics of R&D funding arrangements.

R&D funding arrangements 101

To offset the cost of R&D programs, many companies look for capital through R&D funding arrangements. In these arrangements, passive third-party investors often provide funding in exchange for milestone payments or other forms of compensation (typically sales-based royalties) that are contingent on the successful completion of the R&D programs and the related approval of the compound(s) being developed.

Typically, life sciences companies retain all intellectual property rights to any compounds resulting from the R&D efforts, and the investor does not receive repayment or any other compensation if a compound subject to the R&D arrangement is not successfully developed or commercialized.

How derivatives complicate R&D funding arrangements

Accounting for these arrangements can be challenging, particularly because of the broad and evolving definition of “derivative” and the complexity of applying scope exceptions to contracts that meet this definition. The typical cost and complexity of applying the derivative guidance, together with its possible unintended accounting consequences, have led some companies historically to structure R&D funding arrangements in a way that does not require accounting for them as derivatives or, alternatively, to avoid these transactions altogether.

Proposed FASB standard would exclude R&D funding arrangements from the derivative model

Proposed Accounting Standards Update—Derivatives and Hedging (Topic 815) and Revenue From Contracts With Customers (Topic 606): Derivative Scope Refinements and Scope Clarification For a Share-Based Payment From a Customer in a Revenue Contract, an accounting standard proposed by FASB, could change this situation. Among other things, it would specifically exclude certain contracts from the derivative accounting model. Under the proposed standard, a new scope exception would apply to contracts with “underlyings” based on the operations or activities specific to one of the parties to the contract.

Underlyings represent the occurrence (or nonoccurrence) of a specified event, such as obtaining regulatory approval for an R&D project or achieving a product development milestone. The proposed standard would exclude many R&D funding arrangements from the derivative model because the life sciences company performing the R&D project is one of the parties to the contract. Bottom line: Life sciences companies would no longer need to account for many R&D funding arrangements as derivatives under this proposal.

Expected outcomes

If the proposed standard is finalized, we expect many life sciences companies and investors to actively consider entering into new R&D funding arrangements. Accounting for R&D funding arrangements will often remain complex because of the need to consider, among other factors, the risks associated with the R&D program being funded as well as the deliverables—such as license rights to intellectual property (IP) subject to the R&D program—to be provided to the funding party. Even so, a derivative scope exception would remove a significant impediment in many instances to executing these transactions.

Could the proposed standard, if finalized, cause R&D funding floodgates to open? That remains to be seen. But with the often high cost of drug development, many life sciences companies will look for new ways to offset their costs while investors look for new opportunities to maximize returns.

What role can Deloitte play?

Deloitte can advise on how to decipher the proposed FASB accounting standard. Don’t hesitate to reach out to us or others in our Life Sciences Accounting & Assurance practice with any questions or to understand the proposal’s potential impact to your company. For more information on accounting for R&D funding arrangements, see chapter 3.2.1 of Deloitte’s 2024 Life Sciences Industry Accounting Guide.

Endnotes

¹ IQVIA, Global trends in R&D 2024, February 2024.

2 Deloitte, Unleash AI’s potential: Measuring the return from pharmaceutical innovation – 14th edition, Deloitte, April 2024.

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