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8.3 Joint venture vs collaborative arrangements
Publication date: 30 Nov 2021
us Consolidation guide 8.3
When an investor is evaluating whether it has entered into a joint venture arrangement, the investor should consider whether the arrangement is instead a collaborative arrangement. A collaboration arrangement is a series of contracts that cause entities to share economic risks and rewards, as defined in ASC 808.
Definition from ASC 808-10-20
Collaborative arrangement: A contractual arrangement that involves a joint operating activity. These arrangements involve two (or more) parties that meet both of the following requirements: (a) they are active participants in the activity and (b) they are exposed to significant risks and rewards dependent on the commercial success of the activity.
Entities may enter into arrangements to participate in a joint operating activity to develop and commercialize intellectual property (i.e., the development and commercialization of a new drug, software, computer hardware, or a motion picture). Collaborative arrangements in the scope of ASC 808 are usually executed through contracts, and are typically not conducted through a separate legal entity created by the sponsors specifically to perform the joint operating activity.
When a collaborative arrangement is conducted through a separate legal entity, the sponsors should evaluate whether joint venture accounting applies, as discussed in EM 6. If the arrangement does not meet the criteria to apply joint venture accounting, the sponsors would likely apply the equity method, as discussed in EM 1 to EM 4.
Sponsors are specifically prohibited from applying the equity method of accounting to collaborative arrangements in which a separate legal entity does not exist as per ASC 808-10-15-4. For arrangements where a separate legal entity does not exist, costs incurred and revenue generated from transactions with third parties should be reported by the participant in the collaborative arrangement.
In November 2018, the FASB issued ASU 2018-18, Clarifying the Interaction between Topic 808 and Topic 606, which clarifies when transactions between parties to collaborative arrangements are in the scope of the ASC 606. The ASU clarifies that a collaborative arrangement could be partially in the scope of other guidance, including ASC 606. The amendments also specify that companies should apply the “distinct” guidance in ASC 606 for the purpose of determining whether ASC 606 is applicable to part of an arrangement. If a transaction is outside the scope of ASC 606, the related amounts cannot be presented together with revenue in the scope of ASC 606.
To determine whether a portion of a collaborative arrangement is in the scope of ASC 606, the guidance in ASC 606 on identifying “distinct” goods and services should be applied to identify each unit of account within the arrangement. That guidance requires first assessing whether a good or service is capable of being distinct, based on whether the counterparty can benefit from the good or service either on its own or with resources that are readily available. Second, the guidance requires companies to assess whether a good or service is separately identifiable from other promises in the contract. In other words, companies must assess whether the nature of the promise, within the context of the collaborative arrangement, is to transfer each of the goods or services individually or, instead, to transfer a combined item to which the promised goods or services are inputs.
Collaborative arrangements often include a license to intellectual property in addition to various activities, such as research and development, manufacturing, and other commercialization activities. Assessing whether these activities are distinct could require significant judgment, particularly when all of the activities within the collaborative arrangement have some level of interdependence. Goods or services that are not distinct are combined with other goods or services in the contract until a bundle of goods or services that is distinct is identified.
Once the units of account within a collaborative arrangement are determined, an entity should assess if all or part of each unit of account is a transaction with a customer. A customer is a party that has contracted to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration. If an entire unit of account is a transaction with a customer, ASC 606 should be applied to that unit of account, including all recognition, measurement, presentation, and disclosure requirements.
If the entire unit of account is not a transaction with a customer, that unit of account is not in the scope of ASC 606. This would be the case, for example, if some aspect of the single unit of account is determined to be with a collaborative partner not in the capacity of a customer. In these circumstances, the reporting entity can apply (1) elements of the accounting under ASC 606, (2) other relevant guidance by analogy, or (3) a reasonable accounting policy if there is no appropriate analogy. Companies should consider the nature of the arrangement and its business operations to determine the appropriate accounting for portions of a collaborative arrangement outside the scope of ASC 606.
Transactions with collaborative partners in the scope of ASC 606 are subject to all of the presentation and disclosure guidance in that standard. The amendment precludes entities from including transactions outside the scope of ASC 606 with revenue subject to ASC 606; however, the guidance does not prescribe any specific presentation for these transactions.
ASC 808 permits entities to present transactions based on an analogy to other authoritative guidance, or a reasonable, rational and consistently applied policy election, if there is no appropriate analogy. Judgment should be applied in determining how to account for transactions within a collaborative arrangement that are not in the scope of ASC 606. Given that the amendments do not provide specific guidance for these transactions, limited changes from current accounting policies in this area are expected. As a result, it is likely that diversity in how entities account for these transactions will continue. There may be instances when it will be acceptable to present transactions in the scope of ASC 808 as “revenue;” however, these amounts cannot be included with revenue in the scope of ASC 606.
ASU 2018-18 is effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The guidance is effective for nonpublic business entities for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021. Companies can early adopt the new guidance, but no earlier than their adoption of ASC 606.
An entity should apply the amendments in ASU 2018-18 retrospectively, with the cumulative effect of initially applying the guidance recognized as a cumulative adjustment to retained earnings (modified retrospective) at the later of (1) the earliest annual period presented or (2) the date of initial application of ASC 606. For example, a calendar year-end public company that will adopt the ASU on January 1, 2019, and adopted ASC 606 on January 1, 2018, would record the cumulative effect of adopting this amendment as of January 1, 2018. Financial information in periods subsequent to January 1, 2018 would be recast in the period of adoption (e.g., first quarter 2018 would be recast when shown as prior period information with first quarter 2019).
Practical expedients similar to the modified retrospective transition method for ASC 606 are available. Under the expedients, an entity may elect to apply the amendments retrospectively either to all collaborative arrangements or only to uncompleted collaborative arrangements at the date of initial application of ASC 606. Also, entities may elect the practical expedient for contract modifications permitted under ASC 606, which allows an entity to aggregate the effects of all contract modifications that occur before the adoption date. Entities should disclose their use of these elections.
Example CG 8-4, which is based on Example 4 in ASC 808-10-55, illustrates the accounting considerations for a collaborative arrangement when a separate legal entity does not exist.
EXAMPLE CG 8-4
Determining the relevant accounting model to apply to a collaborative arrangement
Company A and Company B agree to jointly participate in the production and distribution of a major motion picture. Company A will manage the day-to-day production activities and will be responsible for distribution in the United States. Company B will be responsible for the distribution in Europe and Asia.
The terms of the arrangement state that both companies will share equally in all production costs incurred. Further, Company A will pay 50% of the net profits (that is, revenues less distribution costs) from the United States distribution to Company B, and Company B will pay 50% of the net profits from European and Asian distribution to Company A. The companies are responsible for initially funding all distribution costs in their respective locations. For purposes of this example, no license to intellectual property has been conveyed to Company B.
How should Company A account for the costs incurred and revenue generated from the transactions?
Analysis
As Company A has entered into a collaborative arrangement with Company B without the formation of a separate legal entity, Company A would be prohibited from applying the equity method of accounting to the arrangement. During production, Company A would look to the guidance in ASC 605-45 (ASC 606 after the adoption of ASU 2018-18), and if Company A determined that it was the principal for the revenue generated from third parties in the United States, Company A would record the gross revenue from the United States distribution as revenue in its income statement, and likewise record all of the associated distribution costs for distribution in the United States.
Company A would record a receivable from Company B for half of the production costs, with a corresponding reduction of its capitalized film costs. Regarding the income statement classification of net participation costs owed to or from Company B, prior to the adoption of ASU 2018-18, Company A would look to its own accounting policy assuming no other accounting literature applies either directly or by analogy. For example, Company A’s accounting policy may be that it records net participation costs due from production partners as additional revenue and net amounts due to production partners as a cost of sales. After the adoption of ASU 2018-18, Company A should consider whether net participation remittances from Company B are within the scope of ASC 606 and, if so, account for these receipts as revenue.
8.3.1 Research and development arrangements
Companies may enter into unique arrangements, such as R&D focused partnerships, strategic alliances, and collaborations to fund research and development activities. When those arrangements do not involve a separate legal entity, but are structured through contractual arrangements whereby the entities actively participate in the research and development of a product, the arrangement may qualify for accounting as a collaborative arrangement in accordance with ASC 808. The demand for new sources of capital has led many companies to explore innovative R&D funding arrangements. Oftentimes various partners or investors, who may be financial/passive investors, assist in development funding and share the financial risks and rewards of the R&D efforts. If these investors are not actively participating in the R&D efforts, the investment would not be in scope of ASC 808 and the investors should assess whether the arrangement is within the scope of ASC 730-20, Research and Development Arrangements, or ASC 470-10-25, Sales of Future Revenues.
Arrangements between pharmaceutical companies (“Pharma”) and financial investors have become more prevalent in recent years. These arrangements tend to utilize one of the following strategies:
• Direct R&D Funding: This strategy is predicated on a financial investor providing direct funding to Pharma for specified R&D projects in return for future payments (e.g., milestone payments, royalties on sales) contingent upon successful completion of the R&D.
• Newco R&D Funding: This strategy involves a third party investor establishing a new entity to perform the R&D, which may be outsourced back to Pharma or to an unaffiliated contract research organization, often with a predetermined exit (e.g., providing Pharma a call option or contingent forward purchase) only upon successful completion of the R&D.
A company that actively participates in a direct R&D funding arrangement should look to ASC 808 to determine whether it has entered into a collaboration arrangement. The company may then need to consider accounting guidance per ASC 606, Revenue from Contracts with Customers, ASC 730, Research and Development, or ASC 470, Debt.
A company with an interest in a new entity that was created to facilitate an R&D funding arrangement should evaluate whether it is required to consolidate the entity under the guidance in ASC 810.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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