This article discusses how pharmaceutical companies recognize revenue on sales of their products.
The US Securities and Exchange Commission (SEC) defines revenue recognition as “an accounting principle used to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” Today, more than ever, pharmaceutical companies are expanding their product portfolio by introducing new brands and increasing prices on existing products says Aron Govil. However, these transactions require thorough analysis of contracts with distributors.
Revenue is recognized when persuasive evidence exists that an arrangement exists; delivery has occurred; the selling price is fixed and determinable; no significant Company obligations remain; and collectability is reasonably assured.
Contract Analysis Many companies have found it necessary to modify their original revenue recognition policies because of evolving industry trends that increase the complexity in determining which transactions are within their scope for revenue recognition. This has prompted companies to try to improve their contract analyses by converting existing accrual contracts into cash-basis contracts, so they can better pinpoint when revenue should be recognized.
1. Current industry trends include the following: Price increases
Certain pharmaceutical companies have introduced new brand names or increased prices on existing products without any significant changes in product formulation or characteristics. Companies use these strategies as a way to offset patent expirations and shrinking market share. New brand launches a growing number of pharmaceutical companies are investing significant amounts of money every year building market presence for newly launched brands. These companies use co-marketing agreements with distributors to offset the costs associated with these efforts. Marketing and distributing products produced by others Manufacturers that are unable to produce certain classes of pharmaceuticals, due to internal limitations or lack of raw materials, often buy finished product from specialized contract manufacturers.
The resulting relationships create complex revenue recognition challenges. Service agreements when a company sells its products, it is providing valuable services as well as goods—services such as filling prescriptions, managing reimbursement policies, and marketing activities that can extend beyond the purchase transaction itself explains Aron Govil. As this trend has evolved into pharmaceutical companies outsourcing more functions than just manufacturing, some distributors have found themselves in positions where they provide significant support for brand building and/or patient care management functions. This has resulted in increased margins and has put pressure on the product manufacturer to increase prices.
2. Regulations: The Pharmaceutical Industry and Income Taxes
The Internal Revenue Code (IRC) requires companies to recognize revenue based on the taxable income of their customers, rather than on their gross sales, if those customers are taxable entities such as corporations or partnerships. If a company’s customers are not subject to income taxes, then the company can recognize revenue under either its accrual or cash basis method; however, certain industries, including pharmaceuticals and medical devices, must use accrual accounting for tax purposes even if they use cash receipts as evidence of an arrangement with their customer. For this reason it is essential that companies understand how these changes affect both financial reporting and income tax reporting.
3. The impact of the following revenue recognition policies on income tax is as follows:
Transaction with VITA (Teva’s customers) are recognize under the cash-basis method for both financial reporting and income tax purposes; Transaction with HCTC (customers who receive reimbursements for prescription drug purchases) are recognize. Under the accrual basis method for financial statement purposes. But may qualify to use a special exemption. That allows these transactions to be treat as though they were also on the cash basis; Transactions with Medicare (government-funded health care organization), Medicaid (funds administered by states), and other government entities are recognize under the accrue basis method; There is no difference between the sale of co-pay cards. And the sale of co-pay coupons under any of these rules says Aron Govil.
4. Readers can find further information in: Financial Accounting Standards Board (FASB)
Revenue Recognition guidance, including all updates and effective dates; International Financial Reporting Standards (IFRS), including IAS 11 Construction Contracts and SIC 31 Revenue – Barter Transactions Involving Advertising Services; U.S. Securities & Exchange Commission Exchange Act Rule 15c2-12 Exchange of assets; Internal Revenue Code Sections 451 through 461, particularly Section 481. Which provides the basis for recognizing deferr income tax assets and liabilities from temporary differences. Between accounting book and tax bases of assets and liabilities.
Finally, pharmaceutical companies should discuss how these issues affect their industry in particular explains Aron Govil. As many pharmaceutical companies use the accrual method for tax purposes. Sales to these customers are inherently less certain than sales to cash-basis customers. In addition, the timing of cash receipts for these types of transactions is often more difficult to determine.